Real Estate Novation

Real Estate Novation Image

Let’s discuss real estate novation. Like many things within the world of real estate, novation can be complex to understand. Not only can it become difficult to understand, it’s also very important to grasp for your real estate career. Luckily in this article we put together everything you need to know about real estate novation. Today, we’ll break down novation, when it and how it occurs, and of course what you need to know for your real estate exam.

What is Real Estate Novation?

Novation is the procedure in which an original contract is terminated and replaced with a new one. The legal process of novation makes it possible to transfer all contract benefits and liabilities from previous parties to a set of new ones. In plain terms, it’s a simple way to replace an old contract with a new one while maintaining most or all of its original properties.

Fun fact, like many real estate terms, the term novation is derived from Latin. In Latin, the word novus means “new.” In real estate, novation is commonly utilized to transfer complex property leases and other comparable situations. Novation is frequently employed in one of two situations. It can be used to replace one party in a contract or agreement with another, or it can be used to replace previous terms or contracts with new ones. This is done with the cooperation and consent of all affected parties in either circumstance.

What is the Process of Real Estate Novation?

Novation can occur in both commercial and residential transactions, and actually occurs more often than you may think. For novation to be considered valid, four conditions must be met:

  • A pre-existing, valid contractual obligation must exist
  • Agreement from all parties involved to the new contract must occur
  • Nullification of the original contract must occur
  • New contract validity must exist

Things that may be changed in novation include; the rent or price of a property, the terms of a lease, the effective date, the closing costs, and of course, the name of those affected. Within these changes, it’s worth noting the initial contract is nullified by novation. Any past contracts are effectively null and void, and the new agreement is the only one that matters going forward (or until another novation occurs).

Real Estate Novation Examples

Real estate novation occurs in many different situations. As we discussed earlier, novation occurs in commercial and residential transactions. Real estate novation commonly occurs in leasehold agreements, primarily when a lease needs to be transferred from one party to another. 

Here’s a perfect example. Imagine you sign a one-year rental agreement with a landlord for an apartment but want to leave the lease six months in. If all parties agree, you can transfer the lease to a new tenant (or lessee).

What is the Difference Between Subletting, Assignments, and Novation in Real Estate?

For tenants and landlords looking to re-adjust their leases they typically have three options: subletting, assignments, or novation.

What is Subletting?

Subletting sometimes called a sublease, is a contract under which a tenant rents out their apartment or portion of their apartment to another individual while their name is still on the lease. The original tenant is referred to as the sublessor, and the new tenant is referred to as a sublessee.

Subletting can last a full term or have different term dates; either way, the new lease is held under the provisions of the original lease. The critical thing to remember is the original tenant is liable to the landlord and can be sued for any unpaid rent or breach of the lease by the new tenant. In most cases, the original tenant also has the right to prosecute the new tenant for any money owed to them or the landlord.

What are Assignments?

A contract assignment occurs when a party assigns its contractual rights to a third party. Assignments make it possible to transfer all contract benefits from previous parties to a set of new ones. Unlike novation (that occurs to replace an old contract with a new one), assignments transfer the rights from the original party to a new one. There is no new contract; it’s the same one but with different parties.

Novation vs Assignment

With novation, all parties must consent. If you are novating your rights, you need the consent of the other party to the contract and the third party who will be obtaining your rights. With an assignment, only some parties must consent. And that makes sense, right? One is establishing a new contract (novation), while the other is just transferring the rights of an existing contract to another party(assignment).

Another significant difference between novation and assignment is the liability. With novation, both benefits and liabilities are transferred to a new party. With an assignment, it’s just the benefits. 

It’s worth noting even though it is not required by law, some landlords may request cash in exchange for novation, establishing a sublease, and issuing an assignment. The fee could vary widely depending on the parties and type of transaction.

How Often Does Real Estate Novation Occur?

Let’s apply all this information to a real-life example. As previously said, novation in real estate is most common when a leased property is transferred from one party to another. Therefore, a college apartment building is a perfect example.

Students transfer all the time or unexpectedly have to leave. These decisions are typically made after resigning a lease, which they feel pressured to do earlier with the offer of a lowered rent rate. After deciding to leave, they face still being contracted to an apartment building they will not be residing in.

Looking across craigslist or any university app, you will see posts upon posts of students trying to be relieved from their leases and turning them over to another student interested in living at their spot. In these situations, novation can be applied.

After finding an agreeing party, the landlord, previous leasing party, and new hopeful leasing party must all negotiate and agree on changes to the existing contract. Or, through novation, they rewrite the contracts and agreements so that all parties are satisfied.

What to Know for the Real Estate Exam

Understanding how real estate novation is applied in different situations is essential for exam day. Remember, novation occurs when an original contract is terminated and replaced with a new one. A third party assumes rights and obligations that are identical to those of one of the original contract’s parties, or until a new contract is written and agreed upon. 

Author:
Zackary Smigel is a real estate professional with a love for teaching, based out of Pittsburgh, PA. He's had the opportunity to work with some of the brightest minds in real estate and has spent years learning how to become a successful agent.

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