This article distinguishes the purchase agreement used for acquiring income property from purchase agreements used for other purposes and reviews its use as a checklist for due diligence investigations.
Investigating a property’s worth
At an investment property marketing session, an agent looking for properties to acquire on behalf of his client picks up a mini- package on a property listed for sale by another agent. The package contains an Annual Property Operating Data (APOD) sheet. On review of the APOD, the property appears to match the income property requirements of his client.
The client is contacted. Both the agent and the client drive by the property. The building’s exterior appearance is acceptable. The area surrounding the property looks stable. The property seems properly located for a project of its size and type. It is agreed the agent will gather more information on the property.
The agent obtains a profile on the property from a title company. The title is consistent with information received from the listing agent regarding trust deeds and vesting.
To begin an analysis of the property, the agent contacts the listing agent for more fundamentals on the property, asking him to produce:
· a rent roll spread sheet covering each unit (type, size, tenant, commencement of occupancy, expiration of lease, rent amount and any discount/free rent, payment history, furnishings, etc.);
· a two-year occupancy history on each unit;
· information regarding security arrangements and criminal activity on or around the property during the past year;
· a property manager or resident manager who is available for an interview;
· information regarding maintenance procedures and the repair services used;
· a copy of schedule “B” (CC&R exclusions) to the owner’s policy of title insurance;
· the lender’s name and the balance, payments, interest rates and due date on each existing loan; and
· any available information relating to the integrity of the property’s condition and the nature of the property’s location which might adversely affect the property’s value.
The prospective buyer’s agent asks for all this information knowing the seller and the listing agent owe a duty to all prospective buyers and their agents to inform them of all facts about the property that are known or readily available to them which might have an adverse impact on its market value. Hopefully, the listing agent has already gathered all the fundamental property information and has it ready in a complete listing or marketing package.
If the listing agent has not yet gathered the facts which are available to him, he will likely insist the information is not necessary for a prospective buyer to submit an offer. However, price negotiations should not commence until disclosures of all readily available property data and information have been handed over by the seller or his listing agent since the confirmation of the veracity of these disclosures is what due diligence investigations prior to closing are all about.
The prospective buyer is advised the seller or the seller’s agent may insist he enter into a confidentiality agreement before some of the information requested of the seller’s agent will be released. Thus, the buyer may need to identify himself to the seller before the seller will release information on the tenants, their leases and property operations, which the buyer needs to determine the property’s worth and set the price and terms, before making an offer.
When the information is received and reviewed, if it warrants a further investigation into the suitability of the property for acquisition, the buyer’s agent and prospective buyer will then personally inspect the premises and any vacant units, and thoroughly discuss operations with those who manage the property.
After receiving these initial disclosures and conducting a minimal investigation, the buyer’s agent will prepare a purchase agreement if the property still appears to be suitable to the prospective buyer. By submission of the purchase agreement offer, they will commence negotiations on the price to be paid and the conditions which must be met so the prospective buyer can complete a due diligence investigation to confirm his initial expectations about the property. Any counteroffer by the seller will sort out the seller’s willingness to permit the prospective buyer to corroborate the property’s worth.
Analyzing the income property purchase agreement
The income property purchase agreement, first tuesday Form 159, is used to prepare and submit the buyer’s written offer to purchase income property, excluding one-to-four unit residential property. Terms for payment of the price are limited to conventional financing, an assumption of existing loans and a carryback note. Form 159 is also properly used by sellers in a counteroffer situation to submit their fresh offer to sell the real estate. [See Form 159 accompanying this chapter]
The purchase agreement offer, if accepted, becomes the binding written contract between the buyer and seller. Its terms must be complete and clear to prevent misunderstandings so the agreement can be judicially enforced. Thus, Form 159 is a comprehensive “boilerplate” purchase agreement which serves as a checklist, presenting the various conventional financing arrangements and conditions a prudent buyer would consider when making an offer to purchase.
Each section in Form 159 has a separate purpose and need for enforcement. The sections include:
1. Identification: The date of preparation for referencing the agreement, the name of the buyer, the amount of the good-faith deposit, the description of the real estate, an inventory of any personal property included in the transfer and the number of pages contained in the agreement and its addenda are set forth in sections 1 and 2 to establish the facts on which the agreement is negotiated.
2. Price and terms: All the typical variations for payment of the price by conventional purchase-assist financing or an assumption of existing financing are set forth in sections 3 through 9 as a checklist of provisions. On making an offer (or counteroffer), the terms for payment and financing of the price are selected by checking boxes and filling blanks in the desired provisions.
3. Acceptance and performance: Aspects of the formation of a contract, excuses for nonperformance and termination of the agreement are provided for in section 10, such as the time period for acceptance of the offer, the broker’s authorization to extend performance deadlines, the financing of the price as a closing contingency, procedures for cancellation of the agreement, a sale of other property as a closing contingency, cooperation to effect a §1031 transaction and limitations on monetary liability for breach of contract.
4. Due diligence contingencies: Contingencies for the buyer’s due diligence investigations into income and expense records, rental income statements, hazard disclosures, property condition disclosures, and other relevant information to be delivered by the seller are set forth in section 11.
5. Property Conditions: The buyer’s confirmation of the physical condition of the property as disclosed prior to acceptance is confirmed as set forth in section 12 by the seller’s delivery of reports, warranty policies and certifications not handed to the buyer prior to entry into the purchase agreement.
6. Closing conditions: The escrow holder, escrow instruction arrangements and the date of closing are established in section 13, as are title conditions, title insurance, hazard insurance, prorates and loan adjustments.
7. Brokerage and agency: The release of sales data on the transaction to trade associations is authorized, the brokerage fee is set and the delivery of the agency law disclosure to both buyer and seller is provided for as set forth in section 14, as well as the confirmation of the agency undertaken by the brokers and their agents on behalf of one or both parties to the agreement.
8. Signatures: The seller and buyer bind each other to perform as agreed in the purchase agreement by signing and dating their signatures to establish the date of offer and acceptance.
Preparing the income property purchase agreement
The following instructions are for the preparation and use of the Income Property Purchase Agreement, first tuesday Form 159. Form 159 is designed as a checklist of practical provisions so a broker or his agent can prepare an offer for a prospective buyer who seeks to purchase conventionally financed, other than one-to- four unit, income property located in California.
Each instruction corresponds to the provision in the form bearing the same number.
Editor’s note — Check and enter items throughout the agreement in each provision with boxes and blanks, unless the provision is not intended to be included as part of the final agreement, in which case it is left unchecked or blank.
Document identification:
Enter the date and name of the city where the offer is prepared. This date is used when referring to this purchase agreement.
Facts:
1. Buyer, deposit and property: Enter the name of each buyer who will sign the offer.
Enter the dollar amount of any good-faith, earnest money deposit. Check the appropriate box to indicate the form of the good-faith deposit. Enter the name of the payee (escrow, title company or broker).
Enter the name of the city and county in which the property is located.
Enter the legal description or common address of the property, or the assessor’s parcel number (APN).
Enter the description of any personal property included, or enter words of reference, such as “see attached inventory,” and attach an itemized list of the inventory. The seller’s trade fixtures to be purchased by the buyer must be listed as inventory if they are to be acquired by the buyer. [See first tuesday Form 250]
2. Entire agreement: Enter the number of pages comprising all of the addenda, disclosures, etc., which are attached to the purchase agreement.
Terms for payment of the purchase price:
3. Cash down payment: Enter the dollar amount of the buyer’s cash down payment toward the purchase price.
3.1 Additional down payment: Enter the description of any other consideration to be paid as part of the price, such as trust deed notes, personal property or real estate equities (an exchange). Enter the dollar amount of its value.
4. First trust deed note: Check the appropriate box to indicate whether the transfer of title is to be “subject- to” an existing loan or by an “assumption” of the loan if the buyer is to take over an existing first trust deed loan. Enter the lender’s name. Enter the remaining balance, the monthly principal and interest (PI) payment and the interest rate on the loan. Check the box to indicate whether the interest is adjustable (ARM), and if so, enter the index name. Enter any monthly impound payment made in addition to the PI payment. Enter any due date or other terms unique to the loan.
4.1 Loan balance adjustments: Check the appropriate box to indicate the financial adjustment desired for loan balance differences at the close of escrow.
4.2 Impound balances: Check the appropriate box to indicate whether the impound account transferred to the buyer will be with or without a charge to the buyer.
5. Second trust deed note: Check the appropriate box to indicate whether the transfer of title is to be “subject- to” an existing loan or by an “assumption” of the loan if the buyer is to take over an existing second trust deed loan. Enter the lender’s name. Enter the remaining balance, the monthly PI payment and the interest rate on the loan. Check the box to indicate whether the interest is adjustable (ARM), and if so, enter the index name. Enter the due date for payment of a final/balloon payment.
6. New trust deed loan: Check the appropriate box to indicate whether any new financing will be a first or second trust deed loan. Enter the amount of the loan, the monthly PI payment, the term of the loan and the rate of interest. Check the box to indicate whether the interest will be adjustable (ARM), and if so, enter the index name. Enter any limitations on loan points.
6.1 Buyer’s loan qualification: Check the box to indicate the seller is authorized to cancel the agreement if the buyer is to obtain a new loan and fails to deliver documentation from a lender indicating he has been qualified for a loan. Enter the number of days the buyer has after acceptance to deliver written confirmation of his qualification for the loan.
7. Bond or assessment assumed: Enter the amount of the principal balance remaining unpaid on bonds and special assessment liens (such as Mello-Roos or 1915 improvement bonds) which will remain unpaid and become the responsibility of the buyer on closing.
Editor’s note — Improvement bonds are obligations of the seller which may be assumed by the buyer in lieu of their payoff by the seller. If assumed, the bonded indebtedness becomes part of the consideration paid for the property. Some purchase agreements erroneously place these bonds under “property tax” as though they were ad valorem taxes, and then fail to prorate and charge the unpaid amount to the seller.
8. Seller carryback note: Enter the amount of the carryback note to be executed by the buyer as partial payment of the price. Enter the amount of the note’s monthly PI payment, the interest rate and the due date for the final/balloon payment.
8.1 Special carryback provisions: Check the appropriate box to indicate any special provisions to be included in the carryback note or trust deed. Enter the name of any other special provision to be included in the carryback note or trust deed, such as impounds, discount options, extension provisions, guarantee arrangements or right of first refusal on the sale or hypothecation of the note.
8.2 Carryback disclosure: Fill out and attach a Seller Carryback Disclosure Statement as an addendum. [See first tuesday Form 300]
Editor’s note — Further approval of the disclosure statement in escrow creates by statute a buyer’s contingency allowing for cancellation until time of closing on any purchase of one-to-four unit residential property.
8.3 Notice of Delinquency: Requires the buyer to execute a Request for Notice of Delinquency and pay the costs of recording and serving it on senior lenders since they will have priority on title to the trust deed securing the carryback note.
8.4 Buyer creditworthiness: Requires the buyer to provide the seller with a completed credit application.
8.5 Approval of creditworthiness: Enter the number of days within which the seller may cancel the transaction for reasonable disapproval of the buyer’s credit application and report.
8.6 Subordination: Provides for the seller to terminate this transaction if the parameters agreed to for financing by an assumption or origination of a trust deed loan with priority on title to the carryback note are exceeded.
8.7 Personal property as security: Requires the buyer on the transfer of any personal property in this transaction to execute a security agreement and UCC-1 financing statement to provide additional security for any carryback note.
9. Purchase price: Enter the total amount of the purchase price as the sum of lines 3, 3.1, 4, 5, 6, 7 and 8.
10. Acceptance and performance periods:
10.1 Delivery of acceptance: Check the appropriate box to indicate the time period for acceptance of the offer. If applicable, enter the number of days in which the seller may accept this offer and form a binding contract.
Editor’s note — Acceptance occurs on the return delivery to the person making the offer (or counteroffer) or to his broker of a copy of the unaltered purchase agreement offer containing the signed acceptance.
10.2 Extension of performance dates: Authorizes the brokers to extend the performance dates up to one month to meet the objectives of the agreement — time being of a reasonable duration and not the essence of this agreement as a matter of policy. This extension authority does not extend to the acceptance period.
10.3 Loan contingency: Authorizes the buyer to cancel the transaction at the time scheduled for closing if the financing for payment of the price is not obtainable or assumable.
10.4 Sale of other property: If the closing of this transaction is to be contingent on the buyer’s receipt of net proceeds from a sale of other property, enter the address of the property to be sold by the buyer.
10.5 Cancellation procedures: Provides the method of cancellation required to terminate the agreement when the right to cancel is triggered by other provisions in the agreement, such as contingency or performance provisions.
10.6 Exchange cooperation: Requires the parties to cooperate in an IRS §1031 transaction on further written notice by either party. Provides for the parties to assign their interests in this agreement.
10.7 Liability limitations Provides for a dollar limit on the buyer’s liability for the buyer’s breach of the agreement. Check the first box and enter the maximum dollar amount of money losses the seller may recover from the buyer or check the second box to indicate the buyer’s monetary liability is limited to the good-faith deposit tendered with the offer to buy.
Editor’s note — Liability limitation provisions avoid the misleading and unenforceable forfeiture called for under liquidated damage clauses included in most purchase agreement forms provided by other publishers of forms.
11. Due Diligence Contingencies:
Approval period: Enter the number of days the buyer has to approve or disapprove and cancel this agreement after the buyer’s receipt of each item listed below. This section calls for the buyer to complete a due diligence investigation to confirm the representations of the seller and the seller’s broker and the pre-contract expectations of the buyer about the property. If the buyer is unable to confirm his expectations, he may waive the requirements or cancel the transaction.
11.1 Operating records: Requires the seller to make income and expense records and supporting documents available to the buyer for inspection as soon as possible after acceptance of the offer.
11.2 Rents and deposits: Requires the seller to prepare a detailed rent roll profile on each occupancy and deliver it to the buyer as soon as possible after acceptance.
11.3 Natural Hazard Disclosure (NHD) Statement: Requires the seller to prepare and deliver to the buyer a NHD Statement disclosing the seller’s knowledge of the hazards listed on the form.
11.4 Condition of property: Requires the seller to prepare and deliver a statement disclosing the physical condition of the property as known to the seller.
11.5 Inventory: Requires the seller to prepare and deliver an itemized list of all personal property being transferred to the buyer on closing.
11.6 Valuation inspection: Enter the number of days after acceptance in which the buyer is to investigate the market value of the property to confirm its value justifies the price the buyer has agreed to pay.
11.7 Title report: Requires the seller to deliver a preliminary title report to the buyer for review to confirm the condition of title allows the buyer to use the property as he intended.
11.8 Tenant Estoppel Certificate: Requires the seller to produce Tenant Estoppel Certificates prior to seven days before the date scheduled for closing to confirm the tenants’ acquiescence to the terms stated in the certificate.
11.9 Tenant security: Requires the seller to prepare and deliver a statement disclosing criminal activity affecting individuals on the property and any crime prevention undertaken or which should be undertaken.
12. Property Conditions:
12.1 Seller to furnish: Check the appropriate box(es) within the following subsections to indicate the items the seller is to furnish prior to closing.
a. Pest control: Check the box to indicate the seller is to furnish a structural pest control report and clearance.
b. Home inspection report: Check the box to indicate the seller is to employ a home inspection company and furnish the buyer with the company’s home inspection report.
c. Home warranty: Check the box to indicate the seller is to furnish an insurance policy for home repairs. Enter the name of the insurer and the type of coverage, such as for the air conditioning unit, etc.
d. Local ordinance compliance: Check the box to indicate the seller is to furnish a certificate of occupancy or other clearance required by local ordinance.
e. Other terms: Check the box and enter any other report, certification or clearance the seller is to furnish.
f. Other terms: Check the box and enter any other report, certification or clearance the seller is to furnish.
12.2 Safety compliance: Requires smoke detectors and water heater bracing to exist or be installed by the seller.
12.3 Property maintenance: Requires the seller to maintain the present condition of the property until the close of escrow.
12.4 Fixtures and fittings: Confirms this agreement includes real estate fixtures and fittings as part of the property purchased.
Editor’s note — Trade fixtures are personal property to be listed as items on an attached inventory at section 1.
12.5 Leasing and lease modifications: Requires the seller to obtain the buyer’s consent (which will not be unreasonably withheld) to any new tenancies or modifications of existing tenancies entered into during the escrow period.
13. Closing conditions:
13.1 Escrow closing agent: Enter the name of the escrow company handling the closing.
a. Escrow instructions: Check the box to indicate the purchase agreement is to also serve as the mutual instructions to escrow from the parties. The escrow company will typically prepare supplemental instructions they will need to handle and close the transaction. [See first tuesday Form 401]
b. Escrow instructions: Check the box to indicate escrow instructions have been prepared and are attached to this purchase agreement. Attach the prepared escrow instructions to the purchase agreement and obtain the signatures of the parties. [See first tuesday Form 401]
13.2 Closing date: Check the appropriate box to indicate the method to be used to set the date on which escrow is scheduled to close. Following the checked box, enter the specific date for closing or the number of days anticipated as necessary for the parties to perform and close escrow. Also, prior to seven days before closing, the parties are to deliver all documents needed by third parties to perform their services by the date scheduled for closing.
a. Escrow charges: Requires each party to pay their customary escrow closing charges, amounts any competent escrow officer can provide on inquiry.
13.3 Title insurance: Provides for the title to be vested in the name of the buyer or their assignee. Enter the name of the title insurance company which is to provide a preliminary title report in anticipation of issuing title insurance. Check the appropriate box to indicate the type of title insurance policy to be issued.
a. Policy endorsements: Enter any endorsements to be issued with the policy.
b. Payment of premium: Check the appropriate box to indicate whether the buyer or seller is to pay the title insurance premium.
13.4 Fire insurance: Requires the buyer to provide a new policy of hazard insurance.
13.5 Prorates and adjustments: Authorizes prorations and adjustments on the close of escrow for taxes, insurance premiums, rents, interest, loan balances, service contracts and other property operating expenses, prepaid or accrued.
13.6 Personal property: Requires the seller to execute a bill of sale for any personal property being transferred in this transaction at section 1.
a. Personal property report: Check the box to indicate escrow is to order a UCC-3 from the Secretary of State on any personal property located on the real estate which is to be transferred by bill of sale to the buyer.
13.7 Assignment of leases: Requires the seller to assign all leases and rental agreements to the buyer on closing. [See first tuesday Form 595]
a. Ownership notice: Requires the seller to notify each tenant of the change of ownership. [See first tuesday Form 554]
13.8 Tenant security deposits: Requires the seller to credit or pay the buyer on the close of escrow for security deposits held by the seller under the existing occupancies. Requires the seller to notify each tenant of the transfer of the security deposit. [See first tuesday Form 586]
Editor’s note — Proper notice to the tenant regarding the security deposit transfer to the buyer eliminates all future liability the seller may have had due to the seller’s original receipt of the deposits.
13.9 Rent due and unpaid at closing: Treats delinquent unpaid rent as paid for purposes of prorations. The buyer is credited for his share of paid and unpaid rents for the month of the closing. On any later recovery by the buyer of delinquent prorated rent, the buyer is to forward the entire amount received to the seller.
13.10 Service contracts: Enter the name of the providers of services under contracts the buyer is to assume.
a. Prorations: Authorizes the proration of amounts prepaid or unpaid on the service contracts.
13.11 Buyer’s possession: Requires the seller to deliver possession of the property to the buyer on the close of escrow.
13.12 Property destruction: Provides for the seller to bear the risk of loss for any casualty losses suffered by the property prior to the close of escrow. Thus, the buyer may terminate the agreement if the seller is unable to provide a marketable title or should the property improvements suffer major damage.
14. Brokerage fee:
14.1 Fee amount: Enter the total amount of the fee due all brokers to be paid by the seller. The amount may be stated as a fixed dollar amount or a percentage of the price.
Editor’s note — The defaulting party pays all brokerage fees and the brokerage fee can only be altered or cancelled by mutual instructions from the buyer and seller.
14.2 Fee sharing: Enter the percentage share of the fee each broker is to receive.
Editor’s note — The percentage share may be set based on an oral agreement between the brokers, by acceptance of the listing broker’s MLS offer to a selling office to share a fee, or unilaterally by an agent when preparing the buyer’s offer.
14.3 Agency law disclosures: Attach a copy of the Agency Law Disclosure addendum for all parties to sign. The disclosure is mandated to be acknowledged by the buyer with the offer and acknowledged by the seller on acceptance as a prerequisite to the brokers enforcing collection of the fee when the property involved contains one-to-four residential units. [See first tuesday Form 305]
14.4 Disclosure of sales data: Authorizes the brokers to report the transaction to trade associations or listing services.
15. Other terms: Enter any special provision to be included in the purchase agreement.
Agency confirmation:
Buyer’s broker identification: Enter the name of the buyer’s broker. Obtain the signature of the buyer’s broker or the selling agent acting on behalf of the buyer’s broker. Check the appropriate box to indicate the agency which was created by the broker’s (and his agents’) conduct with the parties.
Seller’s broker identification: Enter the name of the seller’s broker. Obtain the signature of the seller’s broker or the listing agent acting on behalf of the seller’s broker. Check the appropriate box to indicate the agency which was created by the broker’s (and his agents’) conduct with the parties.
Signatures:
Buyer’s signature: Enter the date the buyer signs the purchase agreement and each buyer’s name. Obtain each buyer’s signature on the purchase agreement and on each attachment which requires his signature. Enter the buyer’s address, telephone and fax numbers, and email address.
Seller’s signature: Enter the date the seller signs the purchase agreement and each seller’s name. Obtain each seller’s signature on the purchase agreement and on each attachment which requires his signature. Enter the seller’s address, telephone and fax numbers, and email address.
Rejection of offer:
Should the offer contained in the purchase agreement be rejected instead of accepted, and the rejection will not result in a counteroffer, enter the date of the rejection and the names of the party rejecting the offer. Obtain the signatures of the party rejecting the offer.
Observations
As a policy of the publisher, this purchase agreement does not contain clauses which tend to increase the risk of litigation or are generally felt to work against the best interests of the buyer, seller and broker. Excluded provisions include:
· an attorney fee provision, which tends to promote litigation and inhibit contracting;
· an arbitration clause, which, if included and initialed, absolutely waives the buyer’s and seller’s right to a fair and correct decision by trial and appeal; and
· a time-essence clause, since future performance (closing) dates are, at best, estimates by the broker and his agents of the time needed to close and are too often improperly used by sellers in rising markets to cancel the transaction before the buyer or broker can reasonably comply with the terms of the purchase agreement.
