Terms Every Beginner Real Estate Investor Should Know Part 4

Real Estate Contract Terms

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Congrats! You made it to the final part of my four-part series covering Real Estate Terms and Acronyms.

Hang in there! We are on the home stretch of this very long article.

If you haven’t read Parts one, two, and three yet, please be sure to read them. You don’t want to skip the first three parts as this final section builds on the real estate terms covered in the first three parts. To summarize, I decided to publish a list of real estate terms and metrics explaining how to calculate them. However, the list turned out to be too long to cover in a single article, so I decided to split it in to four shorter, easier to read parts.

In this section, we culminate everything that we have learned in the first three sections with an overview of the important real estate contract terms. Before you sign on the line, you should have a thorough understanding of these terms so that you can negotiate the purchase contract that best suits you. After all, this is the final and probably the most important step in any investment property acquisition process. What do you say, let’s get through this section already…

• PSA: This refers to the Purchase and Sale Agreement also known the Contract or Purchase Agreement. This a legal document that anyone interested in purchasing a property will sign and send to the seller when making an offer to purchase a property. To protect your interests, make sure that you have an experience real estate attorney draw up your contracts. I am not an attorney and do not offer any legal advice.
• Ernest Money Deposit (EMD): This refers to the amount of money that the buyer is willing to put in to escrow to convince the seller to take the property off the market with the expectation that the buyer is serious. The EMD is usually refundable if the buyer decides not to go through with the purchase and notifies the seller before the due diligence (see DD below) periods ends, according to the terms of the contract. If the buyer changes his mind after the due diligence has expired, this money is usually retained by the seller as liquidated damages for the time the property was off the market. The PSA controls the EMD. Many people include creative language in the PSA regarding the EMD.  I am not an attorney and do not offer any legal advice. Please consult with an experience real estate attorney to protect your interests.
• Due Diligence Period (DD): This term refers to a period of days during which the buyer is allowed to confirm the financial details as well check the physical condition of the property. It is recommended to have at least a property inspection done by a licensed inspector. Additional recommended due diligence items are survey, wood destroying organism inspection, and appraisal. Some investors go beyond these basics and have the roof, electrical, plumbing, and major appliances inspected by specialists. It is up to you and your comfort level to decide how much due diligence you want to do. The more you can check the less you will be surprised with unexpected issues after closing. If at any time during due diligence period, buyer decides not to go through with the purchase and notifies the seller according to the terms of the contract, the buyer can walk away from the deal without any further legal obligations. I am not an attorney and do not offer any legal advice. Please consult with an experience real estate attorney to protect your interests.
• Physical Inspection: This term usually means that the buyer will retain the services of a licensed property inspector to conduct a physical inspection of the property during the due diligence period. The inspector will check all aspects of the property according to the agreement that you sign with him and provide a report detailing his findings. I recommend that you always have a physical inspection done on any property you are purchasing.
• Appraisal: This is conducted by a licensed appraiser who is usually retained by the lender to ascertain the current market value of the property. While you are paying for the appraisal, the appraiser works for the lender. The lender will send you the appraisal report. If the property value is less than the purchase price, the lender may ask you to make a higher down payment or they will refuse to finance the purchase. You may attempt to re-negotiate a lower purchase price with the seller. If you are purchasing a property in cash, you may choose to have an appraisal done to make sure that you are not over-paying for the property.
• Survey: It is always a good idea to have survey done by a licensed land surveyor. This will tell you if the property is built within the boundaries of the land with appropriate setbacks according to county rules. This will help you identify any issues during the due diligence period. You will be confident that you are getting the correct property that you have agreed to purchase. Often the lender as well as the title insurance company will require a survey.
• Title Insurance: This term refers to a form of insurance that protects the buyer against financial loss from defects in the title to the property. Title insurance will defend the owner against a lawsuit attacking the title or reimburse the owner for the actual monetary loss incurred up to the dollar amount of insurance provided by the policy. It is always in the buyer’s best interest to obtain a clear title to the property at closing. There are two types of policies – owner and lender. The lender will require title insurance to protect their interest in the property. Usually the seller will pay for the owner’s policy and the buyer will pay for the lender’s policy. Pay special attention to the exceptions on the owner’s policy. These will usually be listed on “Schedule B, Section II” of the title commitment document. It will be in your best interest to have as many of these exceptions as possible removed.

Every investment, including real estate, contains some form of risk. My hope is that you will use you knowledge of the terms listed in this four-part series to help you make better decisions and mitigate some of the risks.  While this is a fairly comprehensive list, this series covers the most commonly encountered terms needed to get started in real estate investing. There are many more terms and acronyms that you will come across as you advance in your journey. Wikipedia has a much longer and detailed index of real estate related terms.

I wish you good luck in your journey towards passive income!