Page 1 - Contracts Study Guide for the Real Estate License Exam

General Information

Contracts can come in all shapes and sizes. They can be both written and verbal. Contracts can be an agreement to do something or to not do something. Some contracts are legally binding on both parties, some on only one party, and sometimes contracts cannot be legally enforced by either party. In this guide, we’ll take a look at the different types of real estate contracts.

Real Estate Contracts

Nothing should happen in real estate without a written contract. Contracts detail what performance is expected of each party. Contracts protect you and your client, enable you to collect a real estate commission, and greatly reduce the risk of getting sued.

Validity of Contracts

To be valid a contract must: be by mutual agreement, have consideration, be agreed to by legally competent parties, have a lawful purpose, and be written.

Mutual Agreement

Mutual agreement is when two or more people or parties agree to something. This can include a seller and real estate agent mutually agreeing to list a house for sale at a certain price for a specific period of time. It can also include both parties mutually agreeing to terminate the listing agreement prior to the expiration date.

Consideration

Consideration is the exchange of one thing of value for another. Consideration must be good, valuable, and equal. In real estate, consideration is usually about money, but it does not have to be.

Legally Competent Parties

The parties agreeing to the contract must be of legal age, sober, mentally competent, not be under duress or undue influence, and enter into the contract freely and voluntarily. Contracts can be between two or more people, corporations such as an LLC, or between a person and a corporation.

Lawful Purpose

Valid contracts need to be for a lawful purpose. Two parties can agree in writing to do something illegally, but the contract would not be valid and enforceable because it is an agreement to do something illegal. An example of an illegal real estate contract would be agreeing to do something that violates Federal Fair Housing laws.

Although contracts can be verbal or oral, oral contracts violate the Statute of Frauds—which requires that contracts be in writing and signed by the parties. A real estate agent who verbally agrees to sell a house in exchange for a sales commission would be unable to collect the commission and end up working for free—in addition to violating the Statute of Frauds.

Forbidden Contract Practices

Real estate agents should follow the letter of the law and the spirit of the law. In a contract dispute, the court will almost always decide that the general public is the victim being taken advantage of by the licensed real estate professional.

Duress

Duress means a party entered into a contract due to a threat or was coerced. Duress can be emotional, physical, verbal, or monetary. An example of duress would be a real estate agent getting a seller drunk before the party signs the purchase offer contract.

Misrepresentation

Misrepresentation can be either intentional or unintentional. An intentional misrepresentation occurs when a real estate agent says something about the property that he or she knows is not true. An unintentional misrepresentation is when agents say something that they think is true, but that—based on professional standards—they should have known is not true.

Fraud

The use of false information or misrepresentation—either intentional or unintentional—by one person or party to gain advantage over another person or party is called fraud. A buyer lying on his or her mortgage loan application is one example of fraud in the real estate business.

Terminating Contracts

A contract can be terminated, or ended, in several ways. In real estate, the best way a contract can be ended is when a sales closes or a lease is signed.

Discharge

Discharge means a contract is ended. In addition to performance, a contract can be discharged by assignment to another party, death of one of the parties, impossibility of performance, mutual agreement, operation of law, novation, partial performance, substantial performance, or rescission.

Breach

A breach of contract is when one party fails to perform what it agreed to do, either entirely or in part. A change in the law, which makes the performance of the contract illegal, does not constitute a breach.

Statute of Limitations

Statute of limitations is the period in which a lawsuit can be filed for a breach of contract claim. These periods vary from state to state. One reason that real estate documents are required to be held for a certain time is to comply with the state’s statute of limitations period.

Injustice

Injustice—also known as unjust enrichment—is when one party to a contract is enriched at the expense of another party. However, if the contract parties willingly mutually agree to something—also known as mutual assent—performance of that contract would not be an injustice.

Outside Circumstances

An outside circumstance is something that happens to the contract outside the control of any party that prevents the contract from being performed. If a real estate investor is specifically buying a rental property, a change in Homeowners’ Association (HOA) rules prohibiting a home to be used as a rental would be an example of an outside circumstance.

Land Description

The way that the boundaries or borders of a piece of land are described varies from state to state. Land descriptions are meant to provide a clear and unambiguous description of a parcel of land. Because all real property sits on land, real estate agents need to be familiar with these different descriptions.

Metes and Bounds

Metes and bounds descriptions are used in conjunction with the Government Survey System and use compass directions and distances. They describe the boundary lines of the land, the angles, and terminal points. Metes and bounds descriptions are often used for land parcels that are irregular in shape.

Lot and Block Number

Also known as the recorded map or recorded plat survey system, lot and block numbers are used to identify lots within a subdivided parcel of land. Subdivisions are divided into numbered blocks that contain a certain amount of numbered lots. Lot and block surveys are usually used in densely populated metropolitan and suburban areas.

Monument and Occupancy

While metes and bounds descriptions use the Government Survey System and compass directions, monument descriptions refer to physical things. A concrete post or a pile of stones are examples of a monument. An occupancy description is vague and relies on what a local community thinks. For example, “all of the land known as the Smith homestead” is an occupancy description because everyone in the community knows where the Smith homestead is.

Rectangular Surveys

Also known as the Public Land Survey System, the rectangular survey system describes parcels of land made up of 24 square miles each. These parcels are divided into smaller parcels of 6 square miles each using baselines that run east and west, and meridians that run north and south.

Description Limitations

Similar to the statute of limitations for contracts, there are limitations to survey descriptions as well that prevent a professional land surveyor from being sued after a certain period of time. Survey descriptions can also vary due to factors beyond the control of a surveyor, such as newer, more accurate measurement equipment, or a physical monument being moved.

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