The real estate investing market is an extremely competitive market - and in competitive markets, the chances of both winning big and losing it all are magnified. So the name of the game for most investors is reducing their risk exposure.
One of the best ways they can do this?
Due diligence contingency clauses.
We’re going to break down the importance of adding and keeping due diligence contingency clauses in every contract you sign. We’re going to talk about the protection they offer investors, and why you should almost never waive this clause, with very few limited exceptions.
The Importance of Due Diligence Contingency Clauses
Due Diligence Contingency Clauses (also known as Inspection Contingency Clauses) are baked into a property’s sale contract that allow investors to back out of a real estate contract without facing penalties if a property inspection uncovers significant problems with the property. This clause acts as a safety net for investors, protecting them from unforeseen events that could have a dramatically negative impact on their investment.
Real estate transactions are complex and multifaceted, and inspection contingency clauses can help you navigate through the uncertainties that may arise during the process.
Protections Afforded by Due Diligence Clauses
Financial Protection: One of the most significant benefits of due diligence contingency clauses is the financial protection they provide. Many properties that seem, “too good to be true” are exactly that. By adding a due diligence clause to a contract, if you do encounter a serious problem with the property, you’re giving yourself a backdoor; back out or renegotiate terms without incurring financial penalties.
Legal Protection: Due diligence contingency clauses also serve as a legal shield for investors. Without this clause, some property owners may be able to legally enforce the sale of their property (depending on the contract structure) even if there are significant problems uncovered upon inspection.
Due Diligence: Including contingency clauses in your contracts encourages thorough due diligence on your part. When you know that you have the option to back out of a deal based on specific conditions, you're more likely to conduct comprehensive research and inspections to ensure that you're making the right decision. This reduces the likelihood of encountering unpleasant surprises after the transaction has been finalized.
Leverage in Negotiations: Due diligence contingency clauses can also give you an advantage during negotiations. If you discover issues with the property during inspections or encounter financing difficulties, you can use the contingencies as leverage to renegotiate the terms of the contract. This can result in more favorable terms, such as reduced purchase price or seller concessions.
Why You Should (Almost) Never Waive Contingency Clauses
Waiving contingency clauses can significantly increase the risks associated with real estate investments. In most cases, it's in your best interest to keep these clauses in place to protect yourself from unexpected events and potential financial losses.
However, there might be rare situations where waiving a contingency clause can be strategically advantageous. For example, if you're competing against multiple offers in a seller's market, waiving certain contingencies may make your offer more appealing to the seller. Still, it's crucial to carefully consider the risks involved before making such a decision.
Here are some reasons why you should almost never waive contingency clauses in contracts;
1. Loss of Deposit: If you waive contingency clauses and an issue uncovered on inspection makes the investment completely unviable, you can lose your deposit. This is a significant financial loss that can be easily avoided by keeping this contingency clause in place.
2. Legal Liability: By waiving the inspection contingency clause, you may expose yourself to potential legal liability if you cannot fulfill your contractual obligations. Keeping contingency clauses in your contracts can help protect you from potential lawsuits and legal disputes.
3. Increased Risk Exposure: Remember how we talked about how the key to real estate investing is to minimize your risk exposure? Waiving the due diligence clause is the exact opposite of reducing your risk exposure.
Waiving contingency clauses significantly increases the financial risks around real estate investing. If you discover problems with the property after waiving the inspection contingency, you’re on the hook.
The only time we’d recommend waiving the due diligence clause is if;
1. You’re an experienced real estate investor
2. You have deep knowledge about the property you’re looking at
3. The property you’re looking at is off-market and a seriously good deal
4. You have the financial resources to absorb any potential major problem with the property
5. You need to move quickly
Due diligence contingencies are one of the best ways to shield yourself from risk in the real estate investing world; and investing is a balance of risk and reward.
To further help you minimize risk, Realeflow’s software is built to help you identify the best off-market properties before any other investor - and to approach property owners with an offer that addresses their pain points.
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