Types of Contracts in Real Estate Transactions

Instructor: Shawn Grimsley

Shawn has a masters of public administration, JD, and a BA in political science.

Contracts are ever-present in real estate transactions. In this lesson, you'll learn about several different types of contracts used in real estate, including what they are used for and how they work.

Contracts - Overview of Essential Elements

Randy is a real estate agent, and he deals with different types of contracts on nearly a daily basis--either because he's a party to a contract or one of his clients is. As any real estate agent will tell you, a contract is simply a legally enforceable agreement between two or more people. Well, maybe it's not that simple.

In order to be enforceable, five requirements must be met:

  1. Offer
  2. Acceptance
  3. Consideration
  4. Capacity
  5. Legality of purpose

Let's look at a typical real estate example to clarify the elements. Sally, Randy's client, is selling her home. She receives an offer from Barry to buy it. Barry has offered to purchase the house, meeting the first element.

The offer is a bit below Sally's listing price, but she can live with it. Sally decides to accept the offer. We now have an offer and acceptance, but we don't yet have an enforceable contract.

We need consideration, which is just a fancy word for the value each party receives in exchange for making the contract. Sally is getting a promise from Barry that he'll pay the purchase price, and Barry is getting a promise from Sally that she'll deed the property over upon payment. These mutual promises are sufficient consideration to make the contract enforceable.

Both Sally and Barry have the legal capacity to contract. While minors usually don't have this capacity, Sally and Barry are adults. Moreover, neither is suffering from a mental disease or defect inhibiting their ability to enter into a contract.

Finally, the contract serves a legal purpose. The purchase of real estate is perfectly legal. Consequently, the agreement between Sally and Barry meets this element as well.

Unilateral, Bilateral & Multilateral Contracts

A contract can be unilateral, bilateral or multilateral. A unilateral contract exists when one person makes a promise or undertakes to perform without another party doing the same. For example, let's say that Oliver has a house he wants to sell, but he doesn't want to use just one real estate agent. Instead, he utilizes an open listing. Under an open listing, Oliver will pay a commission to the first agent that presents a buyer with an acceptable offer to purchase that closes successfully. Oliver has made the promise to pay a commission, but there is no reciprocal promise from any agent. Instead, a binding contract occurs when an agent presents Oliver the requisite buyer.

A bilateral contract is actually a bit easier to understand. It involves two parties who exchange promises to perform. Sally and Barry's purchase agreement is a perfect example of a bilateral contract. Barry has promised to pay Sally the purchase price in exchange for Sally's promise to deed Barry the house upon payment.

As you might suspect, a multilateral contract is simply a contract where three or more parties swap promises of performance. For example, let's say Randy is a buyer's agent for two real estate investors who want to partner up and buy an apartment building from the current owner. In this case, we have two buyers and one seller, making three parties to the contract.

Non-Executory & Executory Contracts

Contracts can be non-executory or executory. An executory contract is just a contract where at least one party still has to perform. For example, Sally and Barry's purchase agreement is an executory contract until the sale closes and Barry gets his deed and Sally gets her purchase price. Once both Sally and Barry have performed at closing, the contract is non-executory, or fully performed.

Option Contracts

An option contract is a special type of contract that pops up in real estate transactions frequently. In a nutshell, an option contract gives someone the right to buy something at a certain price by a certain date if the person wants to do so.

Let's say Danny's a real estate developer who wants to buy a piece of real estate, but he's a bit short on cash. He enters into an option contract with the owner where Danny pays the owner some money for the right to buy the property within 90 days for the price noted in the option contract. Danny doesn't have to exercise the right to purchase.

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