Module 1: Introduction to Real Estate Transactions

Owning a home has an almost mythical quality as part of the “American dream.” The process of negotiating, agreeing and executing the transfer of real estate, though, can be long, complex and fraught with risk for both sides. This program will take you through the process of real estate transactions, from the contract negotiation through the closing. We will focus on the practical aspects of each step along the way.

The Roles of Broker and Attorneys

Brokers

The first stage, of course, is for the buyer and seller to reach an agreement on price and related terms. Real estate sales are often facilitated by real estate brokers, who market houses and show them to buyers in exchange for a fee that is usually a percentage of the sale price, usually about 5 or 6% of the sale price. The broker must be licensed by the state (in some states, attorneys are automatically eligible to broker real estate) and gaining and maintaining that status requires certain training and continuing education elements. The term real estate “agent” is either used interchangeably with “broker” or may refer to somebody working under a broker. Either way, a licensed broker must be ultimately responsible for the transaction.

While it is possible for a single broker or agent to facilitate a sale, the trending practice is for the buyer and the seller to each be represented by a broker. The seller’s broker consults on staging the home and advertises its availability. The buyer’s broker brings in the buyer, shows the home to the buyer and presents offers on the buyer’s behalf.

The National Association of Realtors maintains the Multiple Listing Service, which facilitates cooperation between brokers and agents. It also lobbies for the interests of “realtors” (the term given to members of the Association) and maintains codes of ethics. In exchange, realtors pay annual or monthly fees to the Association and its local chapters.

Membership in National Association of Realtors and the Multiple Listing Service is not required for real estate agents and brokers, but non-MLS members may not be entitled to share commissions with MLS-member brokers and non-MLS members don’t have access to the same level of information as do MLS members. As a practical matter, most people who are serious about working as a broker or agent will have to join the MLS.

Note that brokers and agents are not strictly necessary for real estate transactions. Homeowners can sell their houses “by owner” and save the commission. When homeowners do engage Realtors, they do so to maximize exposure and to reach buyers represented by MLS members.

Listing Agreements

    Brokers typically list homes after they have been engaged with a listing agreement (a written listing agreement is required by the National Association of Realtors and many states). Listing agreements give the broker the authority to list and market the property and give the broker a commission when the property is sold. To protect the broker from buyers and sellers trying to circumvent the commission by conducting the transaction outside of the broker’s auspices, most listing agreements give the broker exclusive marketing rights. This exclusivity can be in the form of:

1.     An “exclusive right to sell.” This arrangement states that if the property is sold in the time frame covered by the contract (often 6 months or a year), the broker is entitled to the commission, regardless of who brought in the buyer.

2.     An “exclusive agency.” This arrangement awards the commission only if a broker or agent was involved in the transaction. If the buyer finds the seller directly (or vice versa), the broker is not entitled to a commission.

Attorneys

          In many parts of the country, it is common for residential real estate deals to be completed without assistance of attorneys. The parties represent themselves or are represented by their agents and only consult attorneys if problems arise. In other parts of the country, it is standard for each side of a house sale to be represented by counsel. Neither approach is “right” or “wrong,” as attorneys may provide security and expertise, but at the cost of attorneys’ fees. When attorneys are involved in real estate transactions, they typically enter the picture only when the buyer and seller have reached an agreement on basic terms.

Real Estate Transfer Agreements

Letters of Intent, Offer Sheets and Binders

Should a buyer and seller want to enter a deal, but are not yet ready to execute a contract, they can formalize the potential offer’s terms by using an offer sheet or “letter of intent.”  This outlines the proposed transaction, so the parties can negotiate before committing to a contract. It resembles a contract, but the letter is more concise and often uses bullet points and tables instead of lengthy and formal language.  It demonstrates a buyer’s interest in the property or clarifies the terms at issue in ongoing negotiations.[1]  A letter of intent can also be helpful to a buyer who wants to secure lender financing.[2] A signed offer sheet is sometimes colloquially referred to by real estate agents as a “binder,” which is ironic, considering that it doesn’t bind anyone. Nobody is bound to go through with the transaction until the contract is signed.

If the buyer and seller are both ready to enter the next phase, they will draft a real estate purchase agreement. While usually written in legalese prose and formal language with heavy boilerplate, contracts can be binding even if written informally, as long as the intent to form a contract is there.[3] This is demonstrated by the famous Lucy v. Zehmer case, in which a contract was written and signed on the back of a restaurant receipt.

The Real Estate Contract

The real estate contract formalizes the purchase agreement and binds the parties. It must identify the parties and describe the agreement’s purpose.  It must accurately describe the property and provide the payment terms, including amount, timing and method of payment.

If the parties choose to impose any conditions on the sale, such as the successful completion of a building inspection or removal of holdover tenants, the agreement should identify which party is responsible for fulfilling each condition and clearly describe how, when, and under what terms they’ll satisfy the conditions.[4] Finally, all parties must sign and date the agreement and, in many states, it must also be notarized.  

Real estate transactions take time and natural disasters can damage the property between contract and closing, which is when the transfer occurs.

If there is no risk of loss provision in the agreement, the risk of damage falls on the buyer under the doctrine of “equitable conversion” since, once the contract is signed, the buyer is the “equitable” owner.[5] To prevent confusion or an unfair result, the contract should include a risk of loss provision to explicitly address who bears the risk of loss. Whoever bears the risk of loss should maintain insurance to cover such loss.   

Personal Property

A house purchase may include the appliances, equipment and other personal property in it.  In these cases, the contract should specify what personal property is included with the sale. The seller may execute a bill of sale in addition to the deed to specify the personal property being sold, especially where the sale includes personal property not affixed to the house.

Condition of Property

Depending on state law, sales of houses may contain implied warranties that the major systems like plumbing, heating, and electrical are in properly working order at the time of closing. [6] To counteract the implied warranty, many real estate contracts contain “as is” clauses, which disclaim any warranties associated with the condition of the property. The purchaser is typically afforded the opportunity to bring in an engineer or inspector to inspect the property and subsequently accepts the property regardless of its condition. If the home inspector finds problems with the house, the seller may want to renegotiate or ask that the buyer remedy the conditions. Some states require that the seller complete disclosure forms before the signing of the contract, which disclose problems that the seller has knowledge of.

If property has warrantied improvements on it, such as a 10-year warrantied roof that was installed three years ago, the seller should include an assignment of warranties document in the transaction. Similarly, the property has a tenant renting any portion of the land, the tenant’s lease must be assigned from the seller to the buyer. A purchaser receiving an assignment of lease typically requires that a seller indemnify the new owner against any adverse claims that arise against the new owner resulting from defaults on the lease that occurred prior to the new owner taking possession.

Breach of Contract

A contract binds the buyer and seller to move forward with the transaction on the stated terms at the closing.  After executing the agreement, neither the buyer nor the seller can back out without breaching the agreement. [7] Still, a breach doesn’t always give the other party the right to terminate the agreement. Most contracts allow notice and waiting periods and provide opportunities for remedy and continue performance.[8]  Parties must pay special attention to the requirements for termination upon breach before terminating the deal.

Different remedies are available depending on who breaches. If a seller breaches, a court can grant specific performance and force the seller to complete the sale. This remedy is available because it is assumed that each parcel of land is unique and monetary damages will not truly give the buyer the benefit of his bargain. If specific performance isn’t possible, the buyer can seek money damages. The seller may be liable for the return of the buyer’s earnest money deposit plus interest and expenses for title examination, land survey preparation, and attorney’s fees.

If the buyer breaches a purchase agreement and refuses to complete a sale, a seller can seek monetary damages. A court won’t provide specific performance to force the buyer to buy the home because monetary damages are adequate to compensate the non-breaching seller.

To avoid the hassle and uncertainty of calculating actual damages for a buyer’s breach, a real estate contract may include a liquidated damages clause, which is a pre-negotiated sum that one party to an agreement will owe in the event of a breach.  This allows predictability and can act as a type of insurance against the cost of a breach. Though they’re commonly included, a court will disregard it if the financial penalties it assesses are exorbitant.[9] In most cases, the liquidated damages clause is the amount of the earnest money deposit, which is paid to an escrow agent at the time the contract is executed. If the buyer breaches the contract, the escrow agent pays the money to the seller, who keeps it as damages for the breach 

Short Sales

No one wants their homes to decline in value. However, millions of Americans faced this unfortunate reality during and after the 2007-2009 economic recession, where real estate values declined in most of the country.  Many people found themselves in the unfortunate position of having taken out a mortgage to purchase a home when prices were high, but a few years later, the property wasn’t worth what it was mortgaged for. By 2010, nearly one-quarter of U.S. homes were worth less than their mortgage loans.[10]  In colloquial terms, this is called being “underwater” and it makes it difficult to sell the property and it increases the risk of buyer default.

If the property owner stops paying a mortgage, rather than going through the expense and hassle of foreclosing on a house that is worth less than the bank’s mortgage interest, a bank may allow the property to be sold for the market price, even if it’s less than what is due on the mortgage. This is known as a “short sale.”

Short sale contracts will include an addendum executed between the buyer, the seller, and the seller's mortgage lender addressing how the mortgage on the property will be discharged.  In the case of a non-recourse loan, the bank can only collect the proceeds of the sale, and the owner is not liable for the difference between the short sale price and the amount owed. Many states require all mortgages to be non-recourse loans. In states that allow recourse loans, if the loan is a recourse loan, the owner is liable for the difference between the amount owed on the mortgage and the short sale price. [11]   

Mortgage lenders that face a high likelihood of property foreclosure are drawn to short sales. A short sale avoids the costs and hassles associated with foreclosure, and it gives the parties an opportunity to find a buyer who is willing to pay more than what the property would fetch at a foreclosure auction. However, because it involves a sale where the purchase price is not sufficient to pay off the mortgage holder, a short sale can only be accomplished if the mortgage lender has agreed to release the mortgage for less than what is owed. In these cases, the lender issues a “short sale letter” approving the sale and creating a framework for the discharge of the mortgage. The mortgagor and mortgagee must sign the short sale letter and they can include any number of terms regarding payment and other conditions the lender requires to discharge the loan. Most lenders retain the authority to review and approve a real estate sale, and a short sale letter will include deadlines for closing a sale.[12]  

The Closing

A real estate transaction ends with a process called “closing,” which is when both parties must fulfill all terms and conditions of the exchange. The closing ends the transaction and contract terms are no longer applicable after the closing unless the contract states that such term will survive closing.

Real estate closings can be done in person by the buyer or seller or through an escrow or power of attorney agent.[13]

Closing documents may include affidavits of title, settlement statements, deeds, bills of sale, notes, security instruments and assignments of warranties or leases on the property.  An attorney, paralegal or title closer will build a file with all documentation pertaining to a real estate transaction, and at closing, all documents must be assembled and executed.

Closing documents vary based upon the nature of the real estate transaction. For example, closings where the buyer is using a purchase money mortgage to buy the house are more complex and require many more signatures. Title insurance companies also may require more formalities. At a minimum, the seller must provide the type of deed called for by the contract and must provide “marketable title” to the buyer.

All parties who are due payments are typically paid at closing. Of course, this includes the purchase money, but also includes the broker’s fee, satisfaction of the mortgage loans on the property that the seller still owns, attorney’s fees, title insurance premiums, etc.

In the remainder of this course, we’ll look in more detail at aspects of real estate transactions, including financing, title examinations and insurance, deeds and factors relevant to concurrent interest holders.