Summary: Contingencies are an important part of the buying process for rental properties. Many new investors don’t understand that putting in an offer doesn’t commit you to buying that property as long as you have contract contingencies for rental properties in place. In this article, we cover the common contingencies and the conditions that have to be met in order to be able to back out of a deal.
If you’re going to be successful as an investor, you’re going to need to understand contingencies.
In this article, I’m assuming you are relatively new to real estate investing. I’m also assuming that you haven’t put in an offer on an investment property before.
Bottom line:
- When you put in an offer on a property, you submit your offer on a contract called a purchase and sale agreement.
- Along with your offer, you’ll typically write a check for a refundable earnest money deposit. The title/escrow company oftentimes holds this earnest money.
- Your offer will often also include contract contingencies for rental properties. These contingencies allow you to get out of a deal without losing your earnest money. In other words, if you meet the requirements of the contingency, you can get your earnest money back.
- There are several different contingencies you can use. Rental property investors should understand these basic contingencies that they are including in their offers.
Before we dive into contingencies, let’s do a brief primer on the buying process for rental properties.
Buying Rental Properties
You’ve identified a great rental property. You call your agent and tell her that you want to put in an offer.
If you’ve worked with your agent before, they usually understand the next few steps.
If you haven’t, the next step is to agree on a few key items like purchase price, how much earnest money, who is going to buy the property, and what type of financing you are going to use. They might even ask you, “What contingencies do you want to include?”
You might not know the answer but that’s why you’re here! To learn about contract contingencies for rental properties!
Let’s assume you get past the contingency step and you answer your agent’s questions. The next step is for your agent to complete a purchase and sale agreement. She’ll send you a copy to review and sign and send the other to the listing agent.
Let’s assume that the seller has accepted your offer. Once this happens, you’ll deliver an earnest money check to the appropriate recipient, oftentimes a title/escrow company.
Next is the due diligence phase. This is when you inspect the property, review the leases, review the neighborhood, etc.
If the property, leases or neighborhood aren’t what you thought they would be, you can use one of your contingencies to get out of the deal. This simply entails having your agent notify the listing agent in writing that you are going to walk away from the deal using one of the contingencies you have in place.
There are a whole bunch of different contingencies. There is some variation in terms of what they’re called or what’s most commonly used.
Therefore, I think it’s probably useful to cover the two most common ones and then later, I’ll cover the rest.
Inspection Contingency
The first one is the inspection contingency. This is the one that allows you to get out of the deal if your inspection uncovers something that does not meet your expectations. In some states, the language is so broad that it allows you to get out of a deal if it doesn’t meet your “subjective satisfaction.” This could mean something as little as the paint color on the wall or the smell of a particular room.
It’s important to note that during this time, you’re going to pay for inspections. This is not free. You have to pay for an inspector to come out and spend part of his/her day to inspect your property. So if you trigger this contingency and you walk away from a deal, then you don’t get this money back.
Once you’ve completed your inspections, there is typically a deadline called an inspection response date. This is the date by which you need to respond to the seller what you want to do next. You usually have the option to 1) walk away 2) counter or 3) ask for additional time.
If you counter, this is your chance! Ask the seller for what you need to make the deal work for you.
Financing Contingency
Let’s assume the seller accepts and the contract moves forward. At this point, you and the seller have to get past the second common contingency, the financing contingency. The mortgage contingency is another name for this.
The financing contingency oftentimes includes an appraisal contingency, which we’ll cover in the next section. This contingency is triggered when you are unable to obtain financing for the deal despite your “good faith efforts.” The good faith effort part is the key. The seller might even have the right to request proof that you put in a good faith effort.
Assuming you put in a good faith effort and you couldn’t get a loan, the financing contingency would be triggered and you would be able to get out of the deal and get your earnest money back.
Note that similar to the inspections you paid for, you aren’t going to get back any costs you might have paid to the lender when applying for the loan.
Other Contingencies
Now let’s talk about some of the other contingencies you might run into. There is variation on their names, depending on your market.
Appraisal contingency: The appraisal contingency is closely tied to the financing contingency. Sometimes it’s part of the financing contingency. This contingency triggers when the property doesn’t appraise for the price that you’ve agreed upon with the seller. When this happens, this gives you yet another opportunity to walk away from the deal and you still can get your earnest money deposit back.
Title contingency: This contingency covers you if there’s an issue with the seller’s title. This is also commonly referred to as a “defect on title.” This means that someone has a claim on title, either in the form of a lien or the ownership of the property is in question. This contingency allows you to walk if you see a problem with the title.
Home sale contingency: This contingency makes your purchase contingent on the sale of another property. You can use this when you need the proceeds of the sale to pay for your purchase. This protects you as the buyer but in a seller’s market, this type of contingency will make your offer a lot less attractive to the seller. What contract contingencies for rental properties do you use when you put in an offer? Please share your experiences with contingencies in our public Facebook groups, including our Physicians and Professionals groups.
If you’d like to know more about rental properties, check out our article on How to Challenge Property Taxes on Rental Properties!
