Contracts are the cornerstone of every real estate transaction, whether commercial or residential. Real estate professionals and real estate exam takers need to be familiar with the various aspects of real estate contracts. Inside this article, we’ll cover contract validity, contract clauses, the different types of real estate contracts, and more.
Are Real Estate Contracts on the Real Estate Exam?
Regardless of what state you are taking your real estate exam in, there will be real estate contract-related questions on the exam. It’s a fact; real estate contracts will show up. It’s hard to give you an exact number since every state varies. However, on average, our data suggest that anywhere between 10-30% of questions on the real estate exam will feature real estate contract-related topics.
No matter how you look at it. It’s best to be as prepared as possible, especially since every right question is as equally as important as the next on the real estate exam.
Do Real Estate Agents use Real Estate Contracts?
Yes. Real estate agents use contracts frequently. Agents use them in sales contracts, leases, and many different real estate-related situations. Typically, agents do not draft real estate contracts. Instead, real estate firms will often use standardized form contracts that allow agents to fill in the blanks with the specifics of the sale.
While real estate agents do not write the contracts they still need to be able to explain contracts to their clients. The worst thing an agent can do is come off as uneducated or underprepared, especially to a client.
Contract Validity
A real estate contract can be valid, void, or voidable. It’s imperative to understand the difference. When it comes to contract validity, you have to be familiar with each term and need to understand what elements create each instance.
What Makes a Contract Valid in Real Estate?
To make a real estate transaction valid in real estate all parties must sign a legally binding contract, and something of value must be exchanged. There are four main elements of a valid real estate contract:
- The party must be the legal age of 18 or older and deemed legally competent.
- The contract must be legal or hold a legal purpose.
- A clear and specific consideration must be included in the agreement.
- The contract must hold mutual consent or be agreed upon by both parties.
What are Void Contracts?
A void contract is one that lacks all or one of the elements that make a contract valid. The contract is invalid at the time of its establishment and is not legally enforceable. Void contracts are not contracts because they lack an essential element of a contract and are thus unenforceable.
A void contract, in most situations, is void because it lacks one or more fundamental elements that would make it valid. Because it isn’t a legally binding agreement, neither party has to do anything to end it. When a contract directly violates contract law, it loses its enforceability. Neither side has the right to sue for failure to fulfill.
Here are some characteristics that may cause a contract to be void:
- The contract isn’t legally binding.
- The contract does not bind the parties in any legitimate way.
- The contract is unable to establish legal rights attached to affected parties.
- The contents within the contract are against the law.
- The contract does not include any form of compensation in any way.
What Are Voidable Contracts?
A voidable contract is a legal agreement between two parties that may be unenforceable for any number of reasons. Voidable contracts have the necessary elements to be enforceable, so they appear to be valid, but can be rejected by one party if the contract is discovered to have any number of defects.
Most real estate sales contracts include contingency clauses, making them voidable.
Here are some characteristics that may cause a contract to be voidable:
- One or both parties change their mind about the agreement.
- One party was duped, pressured, or misled into signing the contract and uses their right to challenge its legality.
- One or both parties decide to rescind the consent.
- The contract was established under duress, fraud, deception, or coercion making it voidable.
What is the Difference Between Void and Voidable?
Void contracts are not contracts because they lack an essential element of a contract and are thus unenforceable. Voidable contracts have the necessary elements to be enforceable, so they appear to be valid, but can be rejected by one party if the contract is discovered to have any number of defects.
Bilateral Contracts vs Unilateral Contracts
Contracts can be divided in numerous ways. One way is by the number of parties involved in a transaction. When referring to parties involved, there are two types of contracts: unilateral and bilateral. The difference between the two is in the number of parties involved. In a unilateral contract, only one party makes a promise, while in a bilateral contract two parties make promises.
What is a Bilateral Contract?
A bilateral contract is an agreement between two or more parties. Most business and personal contracts fall into this category.
Bilateral contracts are very common. You’ve probably taken part in one within the last week. Every time you buy groceries, go to the doctors, or even subscribe to Netflix, you are taking part in a bilateral contract. Most real estate contracts are bilateral.
What is a Unilateral Contract?
A unilateral contract is a contract in which only one party makes a promise to perform an action.
An insurance contract or a reward contract are both examples of unilateral contracts.
Implied Contracts and Implied-in-Fact vs Implied-in-Law Contracts
An implied contract is a legally enforceable obligation that arises from one or more parties due to the parties actions, conduct, or circumstances. It has the same legal effect as an express contract, a contract between two or more parties that is willingly entered into and agreed upon verbally or in writing. An implied contract is presumed to exist but does not require written or verbal confirmation.
Implied contracts are legally binding and enforceable in the same way that express contracts are. Enforcing these types of contracts might be problematic because the contract’s particular terms are not defined. States utilize the statutes of fraud to regulate when contracts must be written, but ultimately these laws differ from state to state. In many jurisdictions, certain agreements such as property sales contracts require an enforceable written contract and thus cannot be implied.
Implied-in-Fact
An implied-in-fact contract is created when two parties act as if they have reached an agreement. So, it’s a type of implied contract made through nonverbal behavior rather than exact words.
Implied-in-fact contracts have the same properties as express contracts. There is an offer from one party that the other party accepts, consideration exists, and both parties desire to enter into a contract. The provisions of an implied-in-fact agreement are inferred from the conduct of the parties rather than being stated explicitly or in writing.
In most cases, an implied contract has the same legal force as a written contract. However, proving the existence and conditions of an implied contract may be more challenging in the event of a disagreement. In some jurisdictions, real estate contracts may not be formed on an implied-in-fact basis, necessitating a written agreement.
Implied-in-Law
Implied-in-law contracts, sometimes known as quasi-contracts, are the final option for judges faced with a scenario in which one party is using the other. This approach is used by courts to reward someone for services rendered, not because one party offered and even if neither party meant to enter into a contract, but because the person who got the products or services would be unfairly enriched if they were not compensated.
In plain terms, an implied-in-law contract is a legally enforceable agreement that neither party intended to make. Courts accept an implied-in-law contract in cases where one party would otherwise be unfairly enriched at the expense of another party, even though the parties involved did not intend to make it.
What are Option Contracts?
A real estate option contract is an arrangement, where the seller gives the buyer the option to purchase property at a given price for a set period. This one-of-a-kind contract is solely between one seller and one buyer.
The option itself usually comes with a specific purchase price and is valid for a set time, usually 30 to 90 days. It’s worth noting, with an option contract, the buyer is not required to purchase the property, while the seller is required to sell to the buyer within the contract’s terms.
Real estate option contracts have four components:
- The contract must be in writing.
- The contract must specify the location, such as the lot and block, subdivision, city, and state.
- The agreed-upon time frame of the contract must grant the buyer’s right to purchase.
- The buyer and the seller must agree upon the purchase price.
What are Listing Agreements?
A listing agreement is a real estate contract in which a property owner contracts with a real estate agent to find a buyer for the owner’s property. The owner executes the listing agreement to give a real estate broker the authority to act as the owner’s agent in the sale of the owner’s property, for which the owner agrees to pay a commission.
A listing agreement is a personal service contract. That means that should the seller die, or either party becomes incapacitated, or the property is physically destroyed in an accident, the listing agreement is terminated.
Types of Listing Agreements
What is an Open Listing?
An open listing is a listing when any agent or broker can participate in the listing and is entitled to a commission if he or she produces the sale.
Open listings are truly open. Sellers might consider an open listing if there are a lot of buyers in the marketplace. Some sellers believe they can advertise a home adequately and reach buyers themselves, so they don’t see a reason to hire an agent directly.
What is an Exclusive Right to Sell Listing?
An exclusive right to sell listing is when one broker is appointed as the sole agent of the seller and has exclusive authorization to represent the property. The broker receives a commission no matter who sells the property while the listing agreement is in effect.
What is an Exclusive Agency Listing?
An exclusive agency listing is where the seller employs one broker to act as the exclusive agent of the property owner, The broker receives a commission only if he or she is the absolute cause of the sale. The seller retains the right to sell the property independently without obligation.
The big difference – in the last two, is with the exclusive-agency listing, if the owner sells the property themselves the real estate agent gets no commission. Obviously, the party would have to have proof that the real estate agent was the reason the buyer is there to buy the house or vice versa. This is the main reason exclusive-agency listings are not that common.
It is important to note with exclusive listings; If two exclusive listings are signed the seller could be liable for two commissions. This is usually stated on the real estate contract. In a standard listing, there should only be one commission. The seller hires a broker to find a buyer. Plain and simple. The brokers will then share that commission with the real estate agent who facilitated the transaction on their behalf.
What is Listing with an Option?
Listing with an option is a type of listing for a real estate agent or broker to purchase the particular property. Believe it or not, It is legal for a real estate agent or broker to buy listed property. However, it needs to be specified in the listing agreement.
Most states require licensees to disclose that they have a license before an offer is made on any property that they are interested in purchasing. Many states require this disclosure to be in writing, and they may also require the disclosure of the broker’s profit in the transaction.
What is a Net Listing?
A net listing is when a real estate agent agrees to sell an owner’s property for a set minimum price. Anything over the minimum price belongs to the agent as commission. On the contract, there is no set commission, and this makes net listings controversial.
In fact, in some states net listings are illegal in order to protect the consumer or in other states, the agent must disclose his or her exact commission in the listing price.
What are Purchase Agreements?
The single most important real estate contract is the agreement of sale. Depending on where you live, it is referred to as a real estate purchase agreement, agreement of sale, offer to purchase, earnest money agreement, or deposit receipt. Though they all sound different, they are very much all the same.
The purchase agreement is a contract that legally binds two or more parties together to specific obligations that create a legally binding contract between the buyer and the seller. So in plain terms, a Purchase Agreement is the document buyers and sellers sign with all the terms and conditions of their transaction on it.
The form itself is usually predrafted or preprinted. Forms vary from state to state. Usually, the only thing the agent and clients will do is fill in the blanks. Agents should never draft a purchase agreement themselves, as they are not lawyers, and if there is anything wrong with the wording of the contract, an agent can be held responsible in a court of law.
Some non-residential sales or notable transactions may require a non-preprinted form; if this is the case, it’s in all parties’ best interests to have an attorney or specialist draft the document.
What are Contract Clauses?
A clause identifies a particular section of a real estate contract. There are many types of clauses in real estate, and you are likely to see many of them on your real estate exam and during your real estate career.
Clauses are sections in purchase agreements, deeds, mortgages, and more. It doesn’t matter which state you live in or where you live, if you are dealing with a real estate contract – odds are it has clauses inside it. Clauses are designed to highlight a specific action, topic, or insurance within a contract so typically they are super important.
What is the Habendum Clause?
The habendum clause is the statement in a real estate contract that describes the rights and interests being given. It almost always begins with the words “to have and to hold.”
Put simply the habendum clause tells the buyer, or leasee, EXACTLY what they are getting.
Fun fact: Many states, such as Pennsylvania, require specific contracts to have a habendum clause for the contract to be officially recorded and legally recognized.
What is the Alienation Clause?
The alienation clause is a provision in a mortgage or deed of trust signed with the lender that states that the borrower must pay the mortgage in full before the borrower can transfer the property.
This just means the clause prevents new buyers taking over an existing or the previous mortgage.
What is the Defeasance Clause?
The defeasance clause is a required contract provision that ensures that the title for the property is transferred to the buyer, once the mortgage is fully paid off.
Basically it’s the clause that specifies that the lender must surrender all rights to the property once the mortgage is paid. Now it’s worth noting this provision only exists in certain states. For more on that read here.
What is the Acceleration Clause?
The acceleration clause is a real estate contract provision that requires a borrower to repay all of an outstanding loan if upon a breach of the contract.
This basically means that if a borrower breaks any terms of their mortgage, the lender can demand an “accelerated” payment.
What is the Prepayment Penalty Clause?
A prepayment penalty clause states that a lender can penalize a borrower if the borrower pays off the mortgage much sooner than usual.
This just means as it sounds. If someone payoffs their mortgage too soon they can be slapped with a fee.
What is the Subordination Clause?
The subordination clause is a clause in a real estate contract which establishes order of priorities of financial claims (liens).
This clause, seen commonly in refinancing, just establishes who gets paid first in case of a foreclosure.
What is the Release Clause?
A release clause is a contract provision (typically in a blanket mortgage) that allows for the freeing of all or part of a property from a claim through a proportional or full amount of the mortgage being paid off.
All this does is allow investors to pay off a specific portion of their blanket mortgage vs in one lump sum.
Contact Clauses Takeaways
It’s pretty obvious most of these clauses are some form of insurance for the banks or lenders. For example, the alienation clause, the acceleration clause, and the prepayment penalty clause all protect the lenders in some way or another, usually by asking for some form of payment.
Of course, it’s worth mentioning these clauses are not the ONLY clauses in real estate contracts but the main ones you’ll see on the real estate exam and in your real estate career.
Some non-residential sales or notable transactions may require a non-preprinted form; if this is the case, it’s in all parties’ best interests to have an attorney or specialist draft the document.
What is an Executed Contract?
When contracting parties have signed a contract and both parties have done all they promised to do, it is called an executed contract or executed agreement.
It’s worth noting, most real estate transactions require execution. A sales contract, for example, is executed when the seller has transferred title to the buyer and the buyer has paid the seller. Execution must occur to finalize the agreement; without execution, a transaction is incomplete and therefore doesn’t exist.
What is an Execution Date?
The execution date or date executed is the day the contract is signed. The effective date is the day the contract goes into effect. Both dates can both be found in a contract. In many instances, the execution and effective dates are the same; however, that is not the case in some circumstances.
What is an Executory Contract?
An executory contract is a contract in which the terms are set but will be fully completed later. Examples are real estate deeds, development contracts, car leases, rental leases, and other executory contracts. Both parties involved in an executory contract have responsibilities to fulfill until the contract is fully executed. An executory contract must be written and signed by all parties involved in the transaction.
Now it’s Your Turn, Master Real Estate Contracts Now!
Now that we’ve covered pretty much everything you need to know about real estate contracts you may be thinking what’s next? Well, luckily for you, you are already in the right place! We offer fully comprehensive real estate practice exams filled with real estate contract problems. Test your knowledge, and if for some reason you are still struggling, look into our real estate exam prep course, which comes with videos covering every aspect of the real estate exam (including real estate contracts).
Thanks for reading, until next time!
