© 2010 Rockwell Publishing Lesson 7: Types of Real Estate Contracts Principles of California Real Estate

© 2010 Rockwell Publishing The six types of contracts real estate agents commonly encounter are: listing agreements buyer representation agreements purchase agreements land contracts option agreements leases Types of Real Estate Contracts

© 2010 Rockwell Publishing Listing Agreement Listing agreement: Written contract between owner and broker hired to handle sale. Sets forth parties’ rights and responsibilities. Parties are seller and broker (not salesperson). Listing agreement doesn’t give broker authority to accept offers or transfer title to seller’s property.

© 2010 Rockwell Publishing Earning a Commission In listing agreement, seller agrees to compensate broker for services, usually by commission (also called brokerage fee). Commission amount usually percentage of property’s sale price.

© 2010 Rockwell Publishing Earning a Commission Broker’s only recourse against non-paying seller is lawsuit. Broker is legally entitled to collect commission only if: parties had written agreement (listing agreement), broker was licensed at time she performed services for seller, and broker met listing agreement terms. Three requirements

© 2010 Rockwell Publishing Earning a Commission Terms will be met for most agreements if ready, willing, and able buyer for property is found during listing period. Ready, willing, and able buyer: Any party offering to buy property at price and on terms that were stated in listing agreement. Ready, willing, able buyer

© 2010 Rockwell Publishing What if offer meets all of seller’s terms, but seller doesn’t accept it? Seller is still liable for broker’s commission. Broker is generally entitled to commission if buyer makes offer on terms stated in listing agreement (or on any other terms seller chooses to accept). Earning a Commission Ready, willing, able buyer

© 2010 Rockwell Publishing Able: Capacity to contract and financial resources necessary to complete purchase. Earning a Commission Ready, willing, able buyer

© 2010 Rockwell Publishing Ready, Willing, Able Buyer General rule: Once ready, willing, and able buyer found, broker has earned commission, even if sale never closes. Seller must pay commission even if: seller changes mind, decides not to sell seller doesn’t have good title seller can’t deliver possession to buyer buyer and seller agree to end transaction Sale fails to close

© 2010 Rockwell Publishing Summary Earning a Commission Listing agreement Commission Ready, willing, and able buyer

© 2010 Rockwell Publishing Types of Listing Agreements Payment of broker’s commission also affected by type of listing agreement used: open listing exclusive agency listing exclusive right to sell listing

© 2010 Rockwell Publishing Types of Listing Agreements Open listing: Listing given to as many brokers as owner chooses (also called non-exclusive listing). Broker earns commission only if procuring cause: primarily responsible for bringing about sale. Disputes may arise between brokers over who was procuring cause. Open listing

© 2010 Rockwell Publishing Broker working on open listing may lose commission if another broker finds acceptable buyer first. If seller finds buyer on her own, no commission owed to any broker. Open listings used only if seller insists. (Multiple listing services generally won’t accept open listings.) Types of Listing Agreements Open listing

© 2010 Rockwell Publishing Broker working on open listing should keep list of prospects (as evidence of being procuring cause if one of those persons ends up buying the property). Types of Listing Agreements Open listing

© 2010 Rockwell Publishing Types of Listing Agreements Exclusive agency listing Exclusive agency listing: Seller signs listing agreement with only one broker. If seller finds buyer, no commission owed to broker. If broker (or anyone other than seller) finds buyer, broker is entitled to commission.

© 2010 Rockwell Publishing Types of Listing Agreements Exclusive right to sell listing Exclusive right to sell listing: Seller lists property with only one broker, who is entitled to commission if property sells during listing period, no matter who finds buyer. Even if seller finds buyer without any help, listing broker still gets commission. Brokers prefer this listing option.

© 2010 Rockwell Publishing Open vs. Exclusive Listings Due diligence Unilateral contract: Seller pays commission if broker finds buyer, but broker doesn’t promise to search for buyer (open listing). Bilateral contract: In exchange for seller’s promise to pay commission, broker promises due diligence and good faith effort to sell property (exclusive listings).

© 2010 Rockwell Publishing Summary Types of Listing Agreements Open listing Exclusive agency listing Exclusive right to sell listing

© 2010 Rockwell Publishing Elements of a Listing Agreement Basic elements of listing agreements: signatures property description terms of sale broker’s authority commission provisions safety clause termination date

© 2010 Rockwell Publishing Elements of a Listing Agreement Signatures Under statute of frauds, listing agreement must be in writing and signed by seller. It’s best to have all property owners sign, but only need one owner’s signature. Broker’s signature not necessary; she can accept by providing services.

© 2010 Rockwell Publishing Elements of a Listing Agreement Property description A complete legal description is advisable, but any description that identifies the property with certainty is adequate.

© 2010 Rockwell Publishing Elements of a Listing Agreement Terms of sale Agreement should specify sale terms, including price of property and other basic elements, such as any items excluded from the sale. If seller won’t sell even though offer meets terms of sale described in listing agreement, broker can claim commission.

© 2010 Rockwell Publishing A listing agreement usually authorizes broker to accept good faith deposits from buyers. Broker is acting for seller (not buyer) when accepting deposit. So if broker mishandles funds, seller suffers the loss. Elements of a Listing Agreement Broker’s authority

© 2010 Rockwell Publishing Elements of a Listing Agreement Commission provisions Listing agreement forms usually have space to write in broker’s commission rate/amount. Actual amount can’t be pre-printed because commissions must be negotiable between seller and broker. Pre-printed rate = Violation of antitrust laws

© 2010 Rockwell Publishing Net listing: Agreement that specifies net amount seller will accept from sale. Any proceeds over that amount—no matter how much—will be payment to broker. Legal in CA, as long as broker discloses her commission amount before seller commits to transaction. Elements of a Listing Agreement Commission provisions

© 2010 Rockwell Publishing Commission Provisions Payment Payment usually made by check, but seller may give broker promissory note, assign existing note, or assign other funds from buyer to seller. Broker can’t charge seller for expenses unless seller specifically agrees in listing agreement.

© 2010 Rockwell Publishing Commission Provisions Safety clause: Provides that broker is entitled to commission if seller sells property during set period after listing expires (6 months, for example). Included in most exclusive agreements. Also called protection clause or protection period clause. Safety clause

© 2010 Rockwell Publishing Safety clause helps prevent seller from avoiding paying commission by waiting until after listing expires to accept buyer’s offer. Some safety clauses require broker to give seller list of prospective buyers that agent worked with during listing period. Commission Provisions Safety clause

© 2010 Rockwell Publishing Elements of a Listing Agreement Termination date: Date when broker’s authority to act on seller’s behalf ends. In California, broker must include termination date in every exclusive listing. Termination date not required for open listings. No minimum or maximum requirement for listing period (up to parties to negotiate). Termination date

© 2010 Rockwell Publishing Summary Elements of a Listing Agreement Signatures Property description Broker’s authority Commission provisions Safety clause Termination date

© 2010 Rockwell Publishing Buyer Representation Agreements Buyer representation agreement: Written agreement in which buyer hires broker to help her find and purchase property. Can be exclusive or nonexclusive. If exclusive, broker usually entitled to compensation if buyer purchases property during agreement period.

© 2010 Rockwell Publishing Buyer Representation Agreements Broker duties: Duties listed in contract may include: locating properties preparing offers and presenting them negotiating with sellers helping buyer get financing providing other guidance

© 2010 Rockwell Publishing Buyer Representation Agreements Ways buyer’s broker can be compensated: commission split (with listing broker, if purchased home listed with MLS) buyer-paid fees hourly rate percentage fee (% of purchase price) flat fee (lump sum for term of agreement)

© 2010 Rockwell Publishing Purchase Agreements Purchase agreement: Written agreement between buyer and seller that describes all terms of sale. (Sometimes called deposit receipt.)

© 2010 Rockwell Publishing Purchase Agreements Seller accepts buyer’s offer by signing purchase agreement. Agent gives each party copy and binding contract has been formed. Forming the contract

© 2010 Rockwell Publishing Purchase Agreements Statute of frauds requires purchase agreements to be in writing and signed by all parties. Many transactions involve more than one buyer and more than one seller. Real estate agent is responsible for getting all necessary signatures. Parties and signatures

© 2010 Rockwell Publishing Parties and Signatures Purchase agreements for community property must be signed by both husband and wife. If married person buys property as separate property, spouse’s signature would not be necessary. Community property

© 2010 Rockwell Publishing Purchase Agreements Terms of sale Purchase agreement should state basic financial terms: price downpayment amount method of payment

© 2010 Rockwell Publishing Purchase Agreements Contingencies Purchase agreements often include one or more contingency clauses: provisions making sale dependent on fulfillment of specified conditions. If conditions are not met, agreement will terminate without liability.

© 2010 Rockwell Publishing Most residential purchase agreements contain financing contingency making agreement contingent on buyer’s ability to obtain financing. Other common contingences: satisfactory inspection sale of buyer’s home Purchase Agreements Contingencies

© 2010 Rockwell Publishing Purchase Agreements Contingencies Time limit should be placed on conditions, and language should make clear what must be done to remove contingency. If agent believes contingency may affect closing date or date of possession, she must disclose this to both parties, or risk disciplinary action.

© 2010 Rockwell Publishing Purchase Agreements Possession If possession will be transferred before or after closing, parties should execute an interim occupancy agreement. Once purchase agreement is signed, buyer has equitable title, though can’t take possession until possession date.

© 2010 Rockwell Publishing Purchase Agreements Risk of loss Uniform Vendor and Purchaser Risk Act: Law deciding who suffers loss when property under contract is damaged or destroyed. Seller bears risk of loss until property transferred to buyer. Risk of loss is buyer’s once property transferred. Parties can choose to allocate loss differently with risk clause in contract.

© 2010 Rockwell Publishing Purchase Agreements Time is of the essence Time is of the essence clause: Makes performance of terms on specified dates essential element in contract. Clause is found in most agreements. Failure to perform by agreed date is material breach of agreement.

© 2010 Rockwell Publishing Purchase Agreements Good faith deposit Purchase agreement should state under what circumstances good faith deposit will be refunded to buyer or forfeited to seller. Broker should disclose form of the deposit to seller before seller accepts offer.

© 2010 Rockwell Publishing Good Faith Deposit Liquidated damages Buyer and seller may agree that if buyer defaults, seller can keep good faith deposit, instead of suing buyer. In CA residential transactions, liquidated damages are generally capped at 3% of purchase price.

© 2010 Rockwell Publishing Liquidated damages provision must be: in boldface type separately initialed by both parties. If buyer defaults, listing broker usually receives half of seller’s liquidated damages, but amount can’t be more than he would have received if deal closed. Good Faith Deposit Liquidated damages

© 2010 Rockwell Publishing Purchase Agreements Broker’s compensation Many purchase agreements also have language about broker compensation. If no separate written listing agreement exists, this provision in purchase agreement meets statute of frauds requirement for written listing agreement.

© 2010 Rockwell Publishing Purchase Agreements Licensee identification Real estate agents involved in transaction must make sure that their license numbers are disclosed in the purchase agreement.

© 2010 Rockwell Publishing Purchase Agreements Amendments Once both parties have signed purchase agreement, contract can be modified only by written amendment. Amendment must be signed by all parties who signed original agreement.

© 2010 Rockwell Publishing Summary Buyer Representation/Purchase Agreements Buyer representation Purchase agreements Contingency clauses Interim occupancy Time is of the essence Liquidated damages

© 2010 Rockwell Publishing Types of Real Estate Contracts Land contract Land contract: Agreement in which buyer agrees to pay seller purchase price in installments, rather than paying full price all at once. Also called called installment sales contract, or contract for deed. Not commonly used anymore in CA.

© 2010 Rockwell Publishing Seller = Vendor Buyer = Vendee Vendee agrees to make regular payments of principal and interest to vendor over set period. Vendee takes immediate possession. Types of Real Estate Contracts Land contract

© 2010 Rockwell Publishing Land Contracts Equitable title v. legal title Vendee gets immediate possession but only has equitable title during contract term. Vendor keeps legal title until contract price fully paid. When fully paid, vendor delivers deed (legal title) to vendee.

© 2010 Rockwell Publishing Land Contracts Recording Vendee should record land contract. Document needs acknowledgment to be recorded (notarized signature). Document should contain purchase price and both parties’ signatures.

© 2010 Rockwell Publishing Land Contracts Vendee’s rights Vendee’s rights under land contract: Encumbrances: Vendee may encumber property (but few lenders consider land contract adequate security). Sale of property: Vendee may also sell interest, by assigning right to receive deed when contract price paid off.

© 2010 Rockwell Publishing Land Contracts Vendor’s responsibilities under land contract: Liens: If vendor creates liens against property, must apply vendee’s payments to balance due on liens. Prepayment: Vendor can only prohibit prepayment by vendee within first 12 months following sale. Vendor’s responsibilities

© 2010 Rockwell Publishing Land Contracts Default If vendee defaults, vendor can terminate land contract by giving notice of termination. If vendee fails to cure, vendor may retake possession. After default, land contract remains cloud on title; vendor may need to obtain quitclaim deed from vendee or file quiet title action.

© 2010 Rockwell Publishing Option Agreements Option agreement: Contract in which property owner (optionor) gives another party (optionee) opportunity to buy or lease property for fixed price within set period of time. Optionor agrees not to sell or lease property to anyone else during option period. Option expires automatically at end of option period.

© 2010 Rockwell Publishing Option Agreements Consideration given to make an option agreement binding can be nominal, but something must actually be given (not just discussed). Option agreement for real property must be in writing and state contract terms. Oral option agreements unenforceable.

© 2010 Rockwell Publishing Optionee not required to exercise option; he can walk away from transaction, with loss of consideration as only consequence. Unilateral contract, binding optionor only. If optionee decides to exercise option he must give written notice to optionor, and optionor legally bound to comply. Exercise of option forms bilateral contract. Option Agreements

© 2010 Rockwell Publishing Assignment of option is permitted unless specifically prohibited in agreement. Example: lease with option to purchase. Option Agreements Assignment

© 2010 Rockwell Publishing Sometimes real estate licensee who is listing property may also obtain an option. Before exercising option, licensee must disclose anticipated profit and get seller’s written consent. Option Agreements Licensees

© 2010 Rockwell Publishing An option may be recorded, but it is only a contract right, not property interest. If option is recorded and later exercised, optionee’s interest will relate back to recording date. If option not exercised, it will remain on record as cloud on optionor’s title (until cloud lifted). Option Agreements Recording

© 2010 Rockwell Publishing Important not to confuse right of first refusal with option. Right of first refusal: Gives someone first opportunity to purchase or lease property, if and when it becomes available. Option Agreements Right of first refusal

© 2010 Rockwell Publishing Summary Land Contracts and Option Agreements Land contract Legal title v. equitable title Default Option agreements

© 2010 Rockwell Publishing Types of Real Estate Contracts Leases Lease: Contract in which one party (tenant or lessee) pays rent to property owner (landlord or lessor) in exchange for possession of real estate. Also called rental agreement. Relationship between landlord and tenant governed by lease terms and state/local landlord/tenant laws.

© 2010 Rockwell Publishing Leases Basic requirements Lease is both method of conveyance and contract: not valid without all essential contract elements. If lease is for more than one year it must be in writing and signed by landlord. Tenant’s payment of rent considered acceptance: signature not required.

© 2010 Rockwell Publishing A written lease should state parties’ names and include adequate property description. If lease agreement should be in writing, but isn’t, a periodic tenancy is created (such as month-to-month lease). Leases Basic requirements

© 2010 Rockwell Publishing Landlord/Tenant Issues Payment of rent Rent usually paid at beginning of rental period, but if lease doesn’t specify, rent is not due until end of rental period.

© 2010 Rockwell Publishing Landlord/Tenant Issues Security deposit Security deposit: All fees or deposits made by tenant to secure lease are considered security deposits by state law. At end of lease, funds can be used for necessary cleaning and repairs, with tenant entitled to any funds remaining. Tenant cannot be charged for “reasonable wear and tear” (damage from normal use).

© 2010 Rockwell Publishing If unfurnished unit: security deposit can’t exceed 2x monthly rental payment. If furnished unit: deposit can’t exceed 3x monthly rental payment. If lease term six months or longer, landlord may require security deposit equal to six months’ rent or more, if designated as advance rent payment. Landlord/Tenant Issues Security deposit

© 2010 Rockwell Publishing Landlord must return deposit to tenant within 21 days after tenant vacates, or send written explanation why all or part is being retained. Law applies even if deposit is called “nonrefundable.” Penalty for noncompliance: actual damages plus amount up to 2x deposit. Landlord/Tenant Issues Return of security deposit

© 2010 Rockwell Publishing Landlord may enter premises in emergencies, and to make repairs or to show the property. (Generally, must give tenant 24 hours’ notice.) Tenant must return premises to landlord in same condition as at start of tenancy, less reasonable wear and tear. Landlord/Tenant Issues Inspection and repairs

© 2010 Rockwell Publishing Lease may be renewed through renewal agreement or by implication—landlord simply accepts rental payment from tenant after original lease expires. If lease renewed by implication, renewal term is same as original term, but can’t exceed one year (non-written agreement). Landlord/Tenant Issues Renewal

© 2010 Rockwell Publishing Summary Landlord/Tenant Issues Lease requirements Payment of rent Security deposits Entry by landlord Renewal

© 2010 Rockwell Publishing Leases Transferring leased property Landlord can generally sell property during tenant’s lease term, but new buyer takes title subject to lease (must honor its terms). Tenants can also transfer lease interests through: assignment sublease novation

© 2010 Rockwell Publishing Transferring Leased Property Assignment Assignment: Tenant transfers possession to another party (assignee) for all of remaining lease term. Assignee has primary liability for rent; original tenant is secondarily liable if assignee fails to pay.

© 2010 Rockwell Publishing Sublease: Original tenant transfers partial lease interest to subtenant (part of time or part of property). Sometimes referred to as “sandwich lease” because tenant is between landlord and subtenant. Transferring Leased Property Sublease

© 2010 Rockwell Publishing Subtenant is liable to tenant for rent, but tenant keeps primary liability to landlord. Subtenant pays tenant, then tenant pays landlord. Tenant must pay landlord even if subtenant has not paid as agreed. Transferring Leased Property Sublease

© 2010 Rockwell Publishing Novation: New contract created and old contract extinguished. Assignment and subleasing generally allowed without landlord’s consent, unless prohibited by lease. Novation always requires landlord’s consent. Transferring Leased Property Novation

© 2010 Rockwell Publishing Termination of a Lease Leases usually terminate because of term expiration or notice to terminate, but they may also terminate because of: surrender breach of covenant of quiet enjoyment eviction breach of implied warranty of habitability failure to pay rent condemnation

© 2010 Rockwell Publishing Termination of a Lease Notice of termination Either party may end periodic tenancy by giving notice. With month-to-month tenancy, 30 days’ notice is required. However, residential landlords must give 60 days’ notice to tenants who have lived on property for year or more.

© 2010 Rockwell Publishing Termination of a Lease Surrender Surrender: Landlord and tenant mutually agree to terminate lease; can occur at any time.

© 2010 Rockwell Publishing Termination of a Lease Breach of covenant of quiet enjoyment Landlord has duty not to disturb tenant’s possession of premises. If not expressly stated in lease, duty is implied by law. Landlord promises that he (and third parties) will not interfere with tenant’s quiet enjoyment of property.

© 2010 Rockwell Publishing Termination of a Lease Breach of covenant of quiet enjoyment Covenant is breached if tenant wrongfully evicted; can be actual or constructive. Actual eviction: Landlord orders tenant to leave property, or expels her from property. Constructive eviction: Landlord causes or permits substantial interference with tenant’s possession of property (no heat in winter, etc.).

© 2010 Rockwell Publishing Termination of a Lease Breach of warranty of habitability Implied promise that residential property is habitable—that it meets building and housing codes affecting health and safety. Included in all residential leases. Not included in commercial and industrial leases.

© 2010 Rockwell Publishing If property doesn’t meet codes and tenant notifies landlord, problem must be corrected within legal timeframe or implied warranty of habitability is breached. If warranty breached, tenant can terminate lease on grounds of construction eviction. Termination of a Lease Breach of warranty of habitability

© 2010 Rockwell Publishing Termination of a Lease Failure to pay rent Even if tenant doesn’t pay rent, lease isn’t automatically terminated. Landlord must first give tenant notice of nonpayment. If tenant doesn’t pay rent after notice, landlord can file unlawful detainer action against tenant.

© 2010 Rockwell Publishing If court decides tenant should be evicted, it issues writ of possession (court order requiring tenant to move out). If tenant doesn’t leave, sheriff will forcibly remove tenant and belongings. Termination of a Lease Failure to pay rent

© 2010 Rockwell Publishing Termination of a Lease Condemnation A lease can also be terminated when government takes private property to put it to public use. Example: Knocking down building to build park.

© 2010 Rockwell Publishing Leases Types of leases There are five major types of leases: fixed graduated percentage net ground

© 2010 Rockwell Publishing Types of Leases Fixed lease Fixed lease: Requires tenant to pay fixed rent amount throughout lease. Also called flat lease, straight lease, or gross lease. Common with apartment rentals.

© 2010 Rockwell Publishing Landlord pays operating expenses: utilities maintenance costs taxes insurance Types of Leases Fixed lease

© 2010 Rockwell Publishing Types of Leases Net lease Net lease: Tenant required to pay fixed rent, plus some or all of property’s operating expenses.

© 2010 Rockwell Publishing Types of Leases Graduated lease Graduated lease: Similar to fixed lease, but provides for periodic rent increases, usually set at specific dates and often based on cost- of-living index. Increases are spelled out in escalation clause. Also called “step-up” lease.

© 2010 Rockwell Publishing Types of Leases Percentage lease Percentage lease: Rent amount based on percentage of gross or net income from tenant’s business. Lease typically provides for minimum rent amount, plus percentage of tenant’s business income above stated minimum.

© 2010 Rockwell Publishing Types of Leases Ground lease Ground lease: Tenant leases vacant land and constructs building on property. Usually long-term lease, to protect tenant’s financial investment in the building. Common in areas where land is scarce.

© 2010 Rockwell Publishing Summary Leases: Transfer, Termination, Types Assignment Sublease Novation Surrender Actual eviction Constructive eviction Unlawful detainer Types of leases