First let us define what a contingency is. According to Investopedia:
A Contingency Clause defines a condition or action that must be met for a real estate contract to become binding.
In other words, it’s a term that must be met before contract can proceed, if it isn’t met then the contract becomes void.
I look at contingencies as my friend when buying property and an annoyance when selling.
Why are Real Estate Contingencies Our Friend When Buying a Property?
Because contingencies give us a get out of jail free card on a real estate contract. If, for the reasons defined in the contingency, we don’t go ahead with the deal, our deposit is safeguarded. This allows us to tie up the property without risk.
Why Are Real Estate Contingencies an Annoyance When Selling a Property?
For the exact same reason. With a contingency in place, a buyer can back out of the deal based on the terms of the contingency and your deal doesn’t close. However, once contingencies have been removed and the deposit has gone hard, it will then cost the buyer their earnest money deposit if they don’t complete the contract.
As investors we have a few standard contingencies that we utilize regularly. There are many more available, but they are dependent on the transaction.
Types of Real Estate Contract Contingencies
Inspection Contingency: The buyer has a right to have the property inspected within a defined period of time – typically 5-7 days. The buyer typically has a professional home inspector examine the property. For a standard 3/2, 1500 SqFt property it takes about 4 hours for the inspection to be completed, after which a report will be generated and provided to the buyer. The buyer can then use that report to cancel the contract, request that all or some of the items be fixed or a credit given to assist with the repairs.
Financing Contingency: This gives the buyer the opportunity to obtain financing for the property. Most sellers will request proof of funds and a pre-qualification letter with an offer, however, that doesn’t eliminate the need to have a financing contingency. A typical loan, even if the buyer is prequalified, will require an appraisal and possibly an inspection of the property before official loan approval will be provided.
Appraisal Contingency: This is used to ensure the property is valued at what the buyer has offered. Lenders want assurance that the property is worth what they are loaning on it. An appraisal contingency could include a term that allows the buyer to still proceed if the appraisal comes in below the specified amount, often this is an opportunity for the buyer to renegotiate the price. This contingency, as with the others, has a time frame associated with it.
Verification of Income and Expenses Contingency: This is used in a commercial or rental contract. The buyer requests a reasonable amount of time to verify the official books on the property.
Other commercial contingencies include things like a legal survey, zoning and permits, as well as environmental cleanup liens.
Contingencies are an important part of any Real Estate contract. I hope this has provided you with a little insight into the types of and uses for contingencies used by real estate investors.