Before real estate can change hands, many details must come together so both buyers and sellers feel they are engaging in a fair exchange. Before buyers agree to hand over their hard-earned money or sellers give up their property, they want assurances that everything will be fair and square. One way to provide assurances is to have a contract that includes contingencies and contingency release clauses (also known as kick-out clauses).
Even when two parties have the best of intentions, things can go wrong. Sometimes buyers must sell their current home before they can afford to buy a new one and to their great disappointment, their house doesn’t sell quickly. Sometimes sellers are surprised by the results of various inspections, not realizing the sewer lateral needed $10,000 worth of repairs and that termites had been busy under the house.
Contingency clauses allow buyers to cancel a real estate transaction without repercussions, and kick-out clauses allow sellers to do the same. Contingencies are typically resolved through actions such as inspections, appraisals, and loan approvals—and corresponding responses to those actions. Those responses often come with price tags. Well-written purchase agreements make it clear who pays for what if the transaction falls apart (yet another reason to work with a Realtor).
Buyers almost always have a loan contingency; that is, they agree to purchase the property if their home loan is approved. If their loan is not approved, they can cancel the transaction. They often have additional contingencies, including one on the sale of their existing property and others related to any problems that might come to light after inspections and appraisals.
Because buyers want their original offer to be accepted, they often include contingencies (which benefit them) and contingency release clauses (which benefit sellers), acknowledging the cost to the seller of taking their property off the market during the escrow period. This is called an opportunity cost—the value of what someone gives up by making a specific choice. Sellers sometimes request contingencies, too. For example, especially with commercial real estate, the seller may want an accountant to review the tax ramifications of the sale, or the seller may need to find a suitable property for an exchange to avoid capital gains tax.
More commonly, however, it is the kick-out clause that protects sellers, especially if time is of the essence. The clause states that if the seller finds another buyer with better terms (faster sale, higher price, no contingencies), the seller can terminate the agreement with the current buyer and sell to the new buyer. This clause almost always includes a specific time frame, so buyers who are investing time and money with inspections and appraisals are protected for a specific period, after which, the sellers can move on.
Kick-outs do not have to end the whole transaction. They can simply require buyers to end certain contingencies. For example, the seller can execute a kick-out clause on the loan contingency which would require the buyer to commit to purchasing the house whether or not their loan is approved. It’s a risk, but it gives the seller assurances that the buyer is committed to the sale. If the buyer is confident, removing this contingency might seem reasonable. However, if the loan is not approved and the buyers want to back out of the agreement, they will likely have to forfeit their deposit. This gets into something called liquidated damages, another interesting real estate topic. I’ll talk more about this another time.
If you have questions about property management or real estate, please contact me at firstname.lastname@example.org or call (707) 462-4000. If you have an idea for a future column, share it with me and if I use it, I’ll send you a $25 gift certificate to Schat’s Bakery. Dick Selzer is a real estate broker who has been in the business for more than 45 years.