A party’s right to assign the purchase contract to a third party may be a significant issue to a seller. Sellers generally agree to execute a purchase contract with a specific purchaser only after they are convinced of the purchaser’s ability to complete the transaction. By providing the purchaser with a right to assign the contract, the seller is agreeing to substitute an unknown for the party it knows well. This may be particularly problematic in cases where the seller has agreed to provide the purchaser with take-back financing. Therefore, some sellers will not agree to an assignment of the contract or may demand the right to prohibit the assignment, with or without cause.
A “general provisions” or “miscellaneous” clause is quite common in real estate contracts. This clause allows the parties to address issues such as:
1. In the event that mortgages are used rather than deeds of trust, the word “mortgage” shall be substituted automatically.
2. If this contract provides for the assumption of existing trust(s) or for purchase subject to existing trust(s), it is understood that the balance of such trust(s) and the cash down payment are approximate amounts.
3. Trustees in all deeds of trust are to be named by the parties secured thereby.
4. The property is to be conveyed in the name(s) to be designated in writing by the purchaser prior to settlement.
5. The seller shall furnish any pertinent information required by the purchaser or his or her financing agency in reference to obtaining a loan commitment and in general shall reasonably cooperate (at the purchaser’s sole expense and obligation) with the purchaser’s acquisition of the property.
6. The words “seller,” “purchaser,” and all pronouns and any variations thereof shall be deemed to refer to the masculine, feminine, neuter, singular, or plural, as the identity of the person or entity and the context may require.
Real Estate Notices
The purchase contract should require that all notices to be provided under the terms of the contract be in writing and be mailed by certified or registered mail to the addresses stated in the contract. Written notice of address changes must be sent to all parties.
Real Estate Acknowledgment
The purchase contract must be signed by both parties in order to be enforceable and binding. The final clause of most real estate contracts is an acknowledgment clause whereby both parties acknowledge that they agree to all the contract’s terms.
Real Estate Options
You may consider using an option to gain site control over a specific site. For a fee, the potential purchaser may be able to purchase an option that would provide the purchaser or “optionee” with a defined period of time (“option period”), usually from 30 to 90 days, to evaluate the site, for example, to complete feasibility and environmental studies and to decide whether it wants to purchase the property. If the optionee decides to purchase the property, it “exercises” the option and settles on the property within the time period set out in the option agreement. Longer-term (multiyear) option contracts are more common in the development of raw land, where a developer seeks site control over a large tract of land but can afford to purchase and develop only one portion at a time. The long-term option contract might allow the developer to purchase one portion, develop and sell it, and then use the sales proceeds to exercise the option on the next portion of land, and so on.
Purchase and Option Agreements
There are not many differences between a purchase and an option contract. In fact, an option agreement must contain many if not all of the provisions included in a purchase contract because the option essentially converts into a purchase contract if the optionee exercises its option to purchase the property. Therefore, option contracts often include many of the provisions in the context of what the parties must do or provide if the option is exercised. The purchase and the option contracts do differ in the following ways:
• Unlike the purchaser of a purchase contract, who is legally committed to purchasing the property by the settlement date, the purchaser of an option is committed only to deciding whether it wants to exercise its option to purchase the property within the option period.
• Purchase contracts require a significant earnest money deposit, ranging from 5 percent to 25 percent, to “guarantee” the purchaser’s performance. Option contracts, on the other hand, generally require the purchaser to pay only a relatively small amount of money—1 percent to 5 percent of the purchase price—for the right to defer its decision on the purchase. This option fee may or may not be applied to the purchase price. The option contract should state how the option fee is to be treated.
• An option is often viewed as a purchaser’s, not a seller’s tool, because it allows the purchaser to risk very little and requires the seller to provide the purchaser with an exclusive right to purchase the property during the option period. A seller is not likely to enter into an option contract if there is significant demand for the property in the marketplace. Sellers obviously prefer to execute a purchase contract, which carries the expectation of settlement, instead of an option contract, which carries limited expectations that the property will be transferred.
• Optionees generally are required to act within the option period or lose their option on the property; purchasers in a purchase contract are often provided, for good cause, a reasonable period of time to complete the transaction even after the settlement date has expired
You may want to secure the right to extend the option period one or more times. If so, it should negotiate terms that fix:
1. The number of times that the option period can be extended.
2. The number of days or months added in each extension of the option period.
3. The additional amount of consideration that must be paid by the optionee for each extension.
4. Whether these additional fees later will be applied toward the purchase price, if settlement goes further.
5. Whether the purchase price of the property will be increased because the optionee is postponing settlement on the purchase by extending the option period.
Exercise The Option
An option agreement must include a statement of what the optionee must do to exercise the option if it wants to purchase the property, the manner by which the seller must be notified of the optionee’s exercise of the option, and any other action that the optionee must take to exercise the option, including the payment of additional funds.
At the time it exercises the option, the optionee must provide the escrow agent with an additional deposit, in order to secure the right to purchase the property. These issues can be addressed together in one paragraph.
The purchase price provision in an option agreement may be considerably more complicated than a similar provision in a purchase contract and may be utilized to address the following issues:
1. The purchase price of the property.
2. Whether the initial consideration paid by the optionee for the option will be applied, in whole or in part, toward the purchase price.
3. Whether the optionee will have to pay additional funds, at the time when it exercises the option, to create an “earnest money deposit” similar to the deposit required under traditional purchase contracts.
4. Whether the purchase price will increase, and the extent of this increase if the settlement date is postponed due to additional extensions of the option period by the optionee.
Failure to Exercise the Option
The option agreement must explicitly state the rights of the parties, should the optionee fail to exercise the option. Commonly, the option agreement will provide that:
1. The seller is to retain all consideration paid by the optionee for the option and any extensions.
2. Neither party retains any claims against the other after the expiration of the option period.
In fact, the seller may seek to include, in this provision or elsewhere in the option agreement, a statement that prohibits the optionee from recording the option in the land records of the jurisdiction where the property is situated. The statement will limit any perceived restrictions on the transferability of the property or continuing claims by the optionee upon expiration of the option.
Every loan that is obtained by a sponsor, whether from private or public lenders, will carry some variation of interest rates, maturity and amortization, financing fees and other lender charges, and prepayment provisions.
When a lender agrees to lend money, it not only wants the money or principal paid back according to a payment schedule but it also wants the borrower to pay interest on the amount of the original loan that has not yet been repaid. A lender usually determines how much interest it will charge a borrower by considering:
1. Interest costs, if any, incurred by the lender to borrow the money that it is lending the borrower.
2. The amount of interest that the lender could earn if it invested its money elsewhere, given similar risks.
3. The amount of interest being earned from investments that the lender will have to liquidate in order to make the loan.
4. The amount of money that the lender will spend over the loan term to service the loan or track the loan and the loan payments.
5. The amount of money (“profit”) that the lender wants to make over and above the direct costs incurred to borrow the money and service the loan.
6. The riskiness of the loan, as perceived by the lender.
All loans carry interest rates regardless of the profit motive of the lender. Interest rates can be “fixed” or constant throughout the loan term, or they can “adjust” or change periodically over the life of the loan. With a fixed interest rate loan, the interest rate on the loan never varies. The borrower pays, during the entire loan term, whatever interest rate it agreed to pay when it secured the loan. Interest rates on adjustable rate loans, often referred to as adjustable rate mortgages (ARMs), can change frequently over the loan term. Every adjustable rate loan should clearly state when the loan adjusts; how the new, adjusted interest rate will be established; and any limitation on the amount of increase in the interest rate that can be imposed on the borrower on a date of adjustment. ARMs with interest rates that are adjusted once a year, once every three years, or once every five years are common in the industry. However, some ARMs are adjusted every month or even more frequently. Where an interest rate is adjusted every three years, the borrower actually has secured a hybrid fixed and adjustable rate loan. The loan remains at a fixed rate of interest for three years, is adjusted, and then stays “fixed” at the adjusted rate for three more years, continuing in this manner until the end of the loan term.
When you are purchasing real estate for development, an experienced Magna Utah real estate lawyer can be of immense help. The lawyer can guide you through the purchase process and draft the required documents to complete the transaction.
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