Lesson 6

Writing the Offer  

General

      In all respects, the property checks out  as being one that you want to own - what next?  Well, you need to write a purchase contract.  This documents is also sometimes called a purchase agreement or contract to purchase, but what is in it is a lot more important than its name.
      There are a number of elements to a legal contract to purchase real estate.  Basically, they are:

Legal purpose Offer Acceptance Written (Statute of Frauds) Consideration Parties must have capacity

      Although you will not usually sit around a conference table negotiating various terms and conditions of your purchase contract, you should be aware of negotiation principles when you write your offer.  You will almost certainly negotiate after you have made your offer.  Unless your purchase offer is ridiculously out of line with value or other issue to the degree that it makes the seller mad, you should expect a counter offer from the seller.  It is likely that you will get a counter offer even if you offered full price because some of the contingencies or other issues  that you included will probably be objectionable to the seller or his agent.  Many of the same principles apply whether you are sitting across the table from the seller or instead are writing your original offer or writing a counter offer to his counter offer.

Contract Forms

     Most real estate agents who are representing a buyer will utilize a purchase contract that is (1) their firm's custom form, if a large company or a franchise such as REMAX or Century 21, or (2) their state's Association of Realtors form.  If you are working without an agent, you have the choice of obtaining a  form of the seller's agent if there is one (and there usually is), whichever type that is, or obtaining an Association of Realtors form yourself.  One of the potential problems with using the custom form of a large company is that it may contain a whole lot of references to the company name.  Accordingly, of the two choices, you usually be better off using the state Association of Realtors' form.
      An alternative is a form of a reputable independent publisher such as California's first tuesday.  Unless you are capable of judging the adequacy of the independent publisher form, assuming there is a good one available for your state, it is usually safest to use the Association of Realtors' form because state associations tend to employ competent attorneys for drafting forms and they are usually kept up to date regarding the latest statutes and Court decisions.
      One potential problem in getting a form from the seller's agent is that the agent will likely want you to let him help you fill out the form.  Remember that the seller's agent wants badly to make the deal because he will make a lot of money no matter what price the property sells for and whether it's a good deal for either the buyer or the seller.  Accordingly, if you're not sure that you can hold your own against the agent and won't let him influence your offer (probably almost impossible), don't let him work with you on the contract.  For the same reason, you need to hold your own in filling out the form along with your own agent when you have one. 
      The form, from whatever source, will have various and sundry boiler plate clauses regarding financing and other conditions and contingencies.  There is nothing wrong with using these clauses where they meet your own requirements.  However, do not be intimidated into using a clause that does not say exactly what you want.  Do not hesitate to add an addendum that contains the exact customized clauses that you need.  Be sure to line out the boiler plate clauses and refer to the addendum for each of the clauses that you wish to replace or modify.  Due to limited space on the form and for clarity it is usually best to write a new clause on the addendum rather than mark up an existing clause except for very minute changes (e.g., changing the number of days from 7 to 10).   Be sure that both parties initial every single markup on the contract.  Example of an addendum.

Price

When writing the offer, you need to decide what you are willing to pay for it.  As previously stated in Lesson 5, a good understanding of valuation is required before applying the information of this course and the subject is covered in detail by our Valuing Income Property e-course.

Deposit

      Cash deposits are customary, but smart buyers don't have to operate according to custom.  The seller wants the buyer to put up a cash deposit to keep him from backing out of the deal, because when a contract for purchase has been negotiated and signed, the seller is actually granting the buyer an exclusive option to purchase the property, subject to the terms and conditions contained in the agreement.  So, the buyer is getting a lien on the property subject to those conditions.  The seller needs something in return, right?  Sure, but why should it have to be cash?  How about a promissory note with zero interest for earnest money. Or you might execute a second mortgage or trust deed on another property as deposit money.  Use your imagination and keep your money working for you where it is.  There is other important reason to avoid cash deposits, if possible.  In the event of a deal that falls apart with accusations of fault against each party, it is harder for the seller to collect from you, and less likely that he will try, compared to your money being in escrow.  Keep in mind, though, that a legitimate escrow company will not usually release money to the seller (or the buyer) if there is a disagreement regarding it's release that is not resolved to the satisfaction of their attorney by reading the contract.

Personal Property

      If there is any personal property included in the sale or that you want included in the sale, be sure that the contract includes it.  It is sometimes best to have a separate agreement in every offer that covers any and all personal property, but make it an intrinsic part of the real estate transaction, in order to prevent a lender from subtracting the value from their loan commitment.  There are several advantages to a buyer. For example:

1. Personal property has a much faster deprecation schedule for tax purposes. If you have a seller-financed agreement, allocate a large part of the purchase to personal property and amenities.
2. The personal property must be inventoried and listed, thereby guaranteeing that you actually get what you have agreed to pay for.
3. Have a right to inspect all of the property just prior to closing. Even minor damage to incidentals can be deducted from the seller's proceeds.

      Instruct the closing agent that you want a bill of sale for all the personal property listed in inventory.  It will be very helpful in the event of an IRS audit and will also assist you in making a case for a lower property assessment with the local tax assessor or property tax appeal board.

Contingencies

General
      Contingencies are very important and it is important that they be properly written.  Be sure that your purchase contract makes contingencies out of all inspections and allows adequate time to get the results of the inspections, taking into account inspector scheduling, holidays, weekends, weather; time to analyze the reports; and time to exercise a contingency if necessary.  There are a number of general principles that you should follow when writing contingencies into your offer.

• Write all contingencies to require written approval of buyer (as opposed to automatically approved if not disapproved in writing) in order to eliminate possible loss of contingencies due to oversight or running out of time.  You can then ask for a contract amendment to allow for a little more time.
• For those contingencies that have a cost (e.g., physical inspections and Phase One Report) it is usually in the buyer's best interest to bear the cost and reduce the offered price accordingly.  The reason for this is two-fold.  First, it is usually better that the vendors to be hired are the agents of the buyer rather than of the seller for several reasons.  Second, after the offer has been accepted, you may, for one reason or another, decide that there is no need to pay for a certain inspection or may be able to get it done for much lower cost than expected.  If the seller is to pay for the inspections, he will have to keep his price high enough to cover the costs and will likely use worst case high amounts for all of the items.
• Make all time periods for contingencies requiring information from the seller start with receipt of that information rather than from date of the contract acceptance.  That way your time is not shortened due to his delay.
• Base the time period for each contingency on the total of time required to schedule a vendor, time for the vendor to provide his report, time to analysis report, and time to get a discrepancy report to the seller or into escrow - then add 20 to 30 percent.
• To the degree possible, schedule period limits of inspections in order of importance relative to decision making.
• State all time limits as number of calendar days rather than business days in order to avoid any confusion over what is or is not a business day.  Specific dates may be used for items that do not require action by the seller, but should not be used if related to a relatively short time period because any delay in execution of the contract itself can severely reduce the period remaining.

      A typical list of contingencies might be as follows:

      Note that contingencies requiring action first by the seller have periods starting from receipt of the items from the seller, whereas, other items that are completely up to the buyer have periods starting from date of acceptance.  Note also that calendar days are specifically defined rather than business days to avoid any confusion about weekends or holidays, but you must take into account the actual business days when vendors will actually be working when setting the limits.  For example, you will need a lot more calendar days for contingency periods that include the Christmas/New Years holidays or the Thanksgiving holiday than for periods that contain no holidays.  The number of days that should apply to each of your contingencies depends upon the type and complexity of the property.  If you are buying single-family home or a duplex and the only physical inspection will be performed by a property inspection service that you have already determined can provide the written report within 5 days of notice, you may consider 10 days an adequate period for physical inspections.  However, if you are buying an older shopping center and will require separate inspections of the roof, heating/cooling, plumbing, and electrical systems as well as a check for asbestos, you may want to have at least 30 days for physical inspections.  The best procedure in setting the periods is to contact a couple of vendors (or the one that you usually use) for each inspection item prior to writing the offer and ask what kind of turn-around you can expect at this time considering their work load, the weather, and any other factors that might apply to that inspection item.

Financing
      Unless you're paying cash and the money is in your bank account, a financing contingency is very important. Be specific regarding the maximum acceptable interest rate, discount points, and other costs as well as the minimum number of years of the loan that you are willing to accept.  Also, specify that it will be a loan from a legitimate lender (no loan sharks) and specify a fixed interest rate if you are unwilling to take a variable rate loan.  Finally, be sure it is clear that your inability to obtain financing meeting your criteria is a complete failure of the contingency.

Legal Issues
      For reasons discussed in the previous lesson, the contingency should state that all units are legal, both as to zoning and to building codes.

Licenses & Permits
      Require that all required licenses and permits are currently in place and there are no violations pending. If an inspection will be required in order to obtain missing license or permit, the contingency should require that it be completed immediately and that correction of any deficiencies uncovered by the inspection shall be at the expense of the seller.

Title Report & Title Insurance
      Require delivery of a preliminary title report or chain of title report as soon as possible.  You as buyer usually have the right to choose the title company or attorney and should do so.  You can ask ahead of time what the maximum period will be required for provision of the report.  State that legible copies of all documents referred to in the report are to be provided and that contingency period starts only when all documents have been provided.  It is not unusual that preliminary title reports have errors, so require that the contingency be extended by any delay resulting from errors or omissions in the report including the need for additional document copies.
      If in a jurisdiction where title insurance is available, require that extended coverage be provided, rather than the basic, even if you must pay for the coverage yourself.  Basic coverage only protects against things that are a matter of public record and fraud and does not protect against encroachments or certain other matters.  The extra cost is relatively low.  See our Title Insurance page for additional discussion about title insurance.

Financial Records
      The value of the property and the amount that you should be willing to pay for it are entirely dependent upon the income and expenses.
      Require the Seller to provide financial records that show income and expenses for at least the past 12 months.  These records to be detailed enough so that you can determine expenses in the various categories.  While income statements should be fairly well verified by the leases, verification of expenses can be more difficult.  The best verification is from the check register along with cancelled checks for the property.  The seller may be unwilling to provide these, particularly if the same account is used for more than one property.  Even if available, you may not be willing to put the time into analyzing them anyway for smaller properties.  Many buyers instead require copies of the associated parts of federal income tax returns for the past one or two years.  However, with wide availability of computer software that can provide, within minutes, any version of a tax return desired, you have no way to be sure that returns provided to you are the same as filed with the IRS.
      The best approach is to get as much financial data and as many records, including statements of service providers as possible from the seller and obtain bids from your own vendors for certain services, then check the numbers yourself.
      The expenses that are most important to verify are probably utilities.  Ask for copies of 12 months of bills for each separate utility (e.g., electric, water/sewer, rubbish).  For most other expenses you can relatively easily obtain outside verification and for some expenses the cost of what you want done is more important than what the seller had done.  The current property tax can be obtained from the County.  Insurance quotes for the coverage you want from a couple of agents is worth a lot more than what the seller paid for unknown and perhaps inadequate coverage.  You can easily obtain quotes for trash pickup, lawn service, parking lot sweeping, and most other services.  If the seller paid his teenage son to mow the lawns, this is not an indication of what it will cost you if you hire a profession maintenance company or if you push the mower yourself.
      There are two main values of seller-provided expenses even though amounts may be questionable.  One is to make sure that you know all categories of expenses involved so that you don't neglect one when getting your own quotes.  However, use your own knowledge to confirm that there are not missing categories.  The other is to perhaps indicate some problem, for example, a lot of roof repairs, plumbing repairs, etc. may indicate fundamental problems with those components.

Lease Documentation
      Leases and related documents are exceedingly important for two reasons.  First, they verify the income information that is being provided in the financial records.  Second, they disclose (1) how long tenants have been there (indicating the stability of their business), (2) the expiration date of tenancy and possible extension options (indicating when you can raise rents), (3) the future rent increases already built in (indicating future automatic income increases and therefore value increase), and (4) all sorts of other important information that has an impact on the current and future value of the property.
      The contingency should state that the seller is to provide good readable copies of all leases and other documents, including amendments, checklists, and house rules.  Be sure to require that the originals of all documents signed by tenants will be turned over at close of escrow, since if you get into any future legal hassles, copies may not be adequate.

Lead-based Paint Disclosures For Tenants
      For a residential property built before 1978, require the seller to provide copies of executed lead-based paint disclosure forms for all tenants.  Without these, you, as the new owner could become legally liable due to violations of the law by the previous owner.  The seller should be required to obtain them immediately if he doesn't already have them and to provide them to you soon after acceptance of the contract.  Property owners who fail to comply with EPA regulations face penalties of up to $10,000 for each violation and treble damages if a tenant is injured by the owner's willful non-compliance.  In addition to the federal regulations, some states (e.g., Massachusetts and Maryland) have imposed additional and more onerous regulations and penalties, so investors in pre-1978 residential income property should be sure to understand the lead paint laws of the state in which they invest..  The required federal pamphlets and forms are available on the members-only Forms Web.
      The following properties are not covered by federal law:

• Housing certified as lead-free by an accredited lead inspector
• Lofts, efficiencies and studio apartments
• Short-term vacation rentals
• A single room rented in a residential dwelling
• Retirement communities (housing designed for seniors, where one or more tenants is at least 62 years old), unless children are regularly present.

      The RHOL web site has considerable information regarding lead paint issues.

Insurance Policy
      While you will not be depending upon the cost of the sellers insurance when doing your analyses, you still want to obtain a copy of his policy or at least of the sheet showing coverage.  This information will be of value to any insurance agent that you ask for a quote because it will provide him information regarding property type and rating.  You will still want to be sure that the quote is based on adequate coverage based on your own knowledge and agent recommendation.

Physical Inspections
      While one should be concerned about physical inspections when purchasing a personal residence, it is usually of greater importance when purchasing income property.  There are several reasons why this is so.
      First, rentals are often mistreated by tenants.  Second, many landlords do minimal maintenance, often for only things that break, and do little or no preventive maintenance.  Third, some income properties, particularly commercial properties and the larger residential complexes, often have types of equipment and potential problems not found in a single-family home.
      Be sure that your purchase contract makes contingencies out of all inspections and allows adequate time to get the results of the inspections taking into account inspector scheduling, holidays, weekends, weather, time to analyze the reports, and time to utilize a contingency if necessary.
      You should specifically list those items that are part of the contingency - for example, electrical, heating/cooling, plumbing, gas, roof, appliances, and mechanical systems.

Survey
      A boundary survey is not often needed, but it is worth including as a contingency in case some reason to have one comes to light during the contingency period or if the lender requires one.

Environmental
      This is another subject that is seldom of much concern for a personal residence except for lead and, occasionally, radon issues.  The subject can be much more important for income properties, particularly commercial properties.

Super Fund Sites
      If you have not previously determined for certain that the property you're trying to buy is not in a super-fund site, you should make this issue a contingency. 

Soil & Groundwater Contamination
      For commercial properties in particular, you need to be concerned about possible soil and/or groundwater contamination and this issue should be a contingency.  This is important because every owner in the chain of ownership can be held liable if contamination is found at a later date.
      The risk of contamination depends upon (1) current tenant practices on the property, (2) previous tenant practices on the property, and (3) the history of the site prior to construction of the current improvements.

Lead Paint
      For pre-1978 residential properties, you, as buyer, should be provided with the legally required lead paint pamphlet and disclosure form.  This is in addition to receiving copies of the tenant-signed forms mentioned in the Documentation section above.  Remediation of significant lead paint can be quite expensive.  Your purchase contract should require that this be provided to you immediately after contract acceptance rather than wait to the latest date allowed by law so that you have time to deal with any questions.  You should require that you be provided copies of the reports for any testing previously done.  In any case you should include a contingency of approval of any previous or new report and require that any required remediation be at the expense of the seller.

Asbestos
      For pre-1981 construction, you may need to be concerned about asbestos, depending upon type of construction.  Regulations issued by the Occupational Safety and Health Administration (OSHA) set strict standards for the testing, maintenance and disclosure of asbestos in buildings constructed before 1981.  Asbestos is actually of more concern when trying to remove it than if it is left alone.  For information, visit the OSHA asbestos web site.  If inspection or remediation has been performed in the past, require copies of those records.  In any case you should include a contingency of approval of any previous or new report and require that any required remediation be at the expense of the seller.

Radon
      Radon is not currently a major concern of buyers in most of the country.  As might be expected, considering the nature of radon, it is not usually a concern regarding commercial properties even in an area where of concern for residential properties.  Because of the nature of the problem, radon is more of a problem for homes having basements than for those without.  It is also of more concern for newer more air-tight construction than for older leaky properties.  For a detailed discussion about radon, visit our Radon page.  If radon is a concern due to the location or type of property, include a contingency for testing.

Estoppel Certificates
      Although often not utilized unless required by the lender, as they usually are for larger properties, Estoppel Certificates should be used for every purchase of a tenant occupied property.  An Estoppel Certificate is a document signed by a tenant that, among other things (1) affirms the lease documents (attached to Certificate) and the deposit/rent amounts; (2) confirms that there are no agreements outside of the attached documents; and (3) confirms the amount of security deposit, the current rent, and  the date to which rent has been paid.   The document is sometimes called a Certificate of No Defense.  A sample basic Certificate is available in our members-only Forms Web.
      Without an Estoppel Certificate, the buyer may discover after closing that (1) a tenant had a first right of refusal or option to purchase that he'd not been given opportunity to exercise, said right being given by a separate document and not referenced in the lease, (2) there is a lease amendment that the seller had neglected to provide that extends the lease for 3 years of the unit that you, the buyer, planned to move into after close of escrow or (3) a variety of other possible problems.  Although you would have legal recourse against the seller if you had not been provided material information, doing anything about it might take years.  Doing anything about it might be impossible, for example if the seller moved to Switzerland immediately after closing escrow.  Avoid potential problems by utilizing estoppel certificates.
      Be sure that the contract provides for preparation of estoppel certificates by the buyer and/or his lender and requires that the seller assist the buyer in obtaining execution by the tenants of any certificates, whether provided by buyer and/or required by lender.  If you know that the lender will be utilizing estoppel certificates, you will probably not need to do your own separate ones.  However, you should obtain a copy of the form to be used by the lender as soon as possible to ensure that it also satisfies your needs.  In general, the lender's format will be better than anything that you could invent.
      If closing is delayed, it might be necessary to get updated amendments to the certificates to cover rents collected since the previous versions were executed or certain other special changes in circumstances, including amended or new leases.

The Tenants
      Existing tenants in investment property can be either assets or liabilities. Whenever you buy the tenants with the real estate, protect yourself.  Always require that the seller state in the purchase agreement that there are no lawsuits, regulatory agency actions, or other claims pending against the property.  Require a warrant that the seller has complied with federal and state lead laws, as well as all applicable landlord-tenant law.  A purchaser also needs to know:

• Are the tenants staying
• Status of all leases and agreements
• Security Deposit information
• Each tenant's rent payment history
• Any and all complaints by other tenants, neighbors and government about any tenant.

Escrow Period

      You, as buyer, will usually want a long escrow because you want to minimize the pressure to get everything done.  The seller will usually want a short escrow because the longer the escrow the more chance that it never closes and he doesn't get his money until closing.  However, this can be controlled by the need to close before the end of the current year or after the beginning of the next year for income tax reasons.  If the tax year is not an issue, pick a realistic closing date based upon the time required to complete all contingencies including financing.  You can even draw up a timeline chart to be sure that everything makes sense and is practical.  A typical timeline chart might look like this.

     You should include in the contract that there can be no new leases, amendments to existing leases, or waiver of terms of leases that impact the property beyond the close of escrow date without buyer approval.

Possession Before or After Closing

      If the seller will retain possession of the property or any part thereof after the close of escrow or if the buyer will get possession of the property or any part thereof before the close of escrow, the parties should execute a formal lease agreement covering the subject period of time.  The lease agreement should be detailed and provide for most, if not all, issues that would apply to a third-party tenant, including maintenance and insurance issues as well as penalties for breach of the lease.
      If free rent is involved for pre-close possession by the buyer, the seller might want to provide for market rent beginning with the close of escrow date in the event that escrow does not close on schedule, with the penalty rent paid in escrow.  As the buyer, you will want to avoid such a rent penalty if possible. If free rent is involved for post-close possession by the seller, you as buyer should provide for market rent taking affect at the end of the expiration of the seller's possession, as that will increase the probability of the seller leaving as scheduled or compensate you in the event that he doesn't. 

Final Check

      Before you sign the contract, read it carefully and then read it again.  A signed real estate contract is a legally binding agreement.  The BIG print giveth, and the small print taketh away.  Most people, including brokers and attorneys do not read every word in a contract because they assume the language is "standard."   Handwritten or typed-in additions to any contract take priority when conflicts exist in meaning.  Ambiguities are held against the party that prepared the documents.  Cross out and initial any item that you wish to change.  For major changes use an addendum.  When in doubt, don't sign - reconsider or renegotiate.

Pre-Course Quiz

Introduction
Lesson 1
Lesson 2
Lesson 3
Lesson 4
Lesson 5
Lesson 6
Lesson 7
Lesson 8
Lesson 9
Lesson 10
Lesson 11
Lesson 12
Lease Option

Summary

Final Exam