If you’re a real estate investor, you’re likely familiar with the ‘Agreement for Sale’ document. If you’re not, or if you’re not a real estate investor and you’re looking to be one or are interested in real estate investing, then you’re in the right place. Because today we’re going to be talking about how investors can use the agreement for sale document as part of their investment strategy. We will also be answering some commonly asked questions around what the agreement for sale document actually is.
In a few words, the Agreement for Sale document is a way to buy property with seller financing. If you don’t know what that means, stick around…we’ll explain in a bit.
But before we do, let’s take a look at the history of the Agreement for Sale in Canada, and why real estate buyers relied on it to buy real estate.
Brief history of the Agreement for Sale document
Originally, the Agreement for Sale document, AFS for short, was a very popular way to buy a property with seller financing, i.e. the seller handles the mortgage process instead of a bank or private lender. This was a common method of purchasing real estate because, historically, banks would not approve a mortgage application unless the applicant had a 50% down payment!
Shocking, right? And understandably, this requirement would have made it virtually impossible for most people to purchase real estate or enter the market. This was also difficult for sellers because they had limited buyers to receive offers from. So, if a seller wanted to sell a property, they would be more motivated to offer seller financing to the buyer.
Thankfully, this requirement was amended by the Canadian government in 1946 in an effort to help returning WWII veterans own homes.
The amendment came in the form of the Canada Mortgage and Housing Corporation, also known as CMHC, which acts as an insurer for financing and mortgage lenders. The CMHC made it possible for lenders to give out more loans to people as banks and lenders were protected in case a borrower defaulted on a loan. This insurance led to the reduction of the required 50% down payment by half, to 20%-25% of a home’s purchase price required as a down payment. This in turn made housing more accessible to Canadians looking to own a home.
As it became easier to qualify for mortgages with banks or private lenders, fewer real estate buyers relied on the Agreement for Sale to purchase real estate. And while the AFS is no longer as popular as it once was, there are still benefits to using it when buying or selling real estate.
But before we talk about these benefits, let’s examine the AFS contract a little more closely.
1. What is the Agreement for Sale Contract?
The AFS, also known as the ‘Offer’ or ‘Offer to purchase’ is a written, legal contract between a buyer and seller where the buyer agrees to pay the purchase price, over a set period of time, and upon its completion the seller is obligated to convey title to the buyer. This process is defined on the contract as “by way of agreement for sale”.
The Land Title office then denotes this real estate transaction as an Agreement for Sale by adding “RP” or “Right to Purchase” next to the title on the property.
Some key things you need to know if you plan on using an AFS to buy or sell a property:
- As this is not a very common method of purchasing real estate anymore, it is very important that you work with a lawyer who understands and supports the agreement for sale strategy. Additionally, it is very important that you remain in control of drafting the AFS document.
- If you’re the seller, you will need to make it clear that the seller’s lawyer is taking care of the AFS document…at the buyer’s expense. However, if you’re the buyer, you will need to add a term to the contract that specifies the buyer’s lawyer is providing the AFS form.
- If your investment strategy is to buy-and-hold property, then you would likely not be using the agreement for sale document. We’ll discuss the types of situations that would call for an AFS strategy below.
- The Agreement for Sale document is not the same as the ‘Agreement for Purchase and Sale’ document. The latter is more commonly used in typical real estate transactions where financing is acquired from a bank or private mortgage lender.
- Some mortgage lenders do not allow assumption of an agreement for sale, so it’s crucial to ensure that the relevant parties have written confirmation from their lenders regarding this.
There are a few things that will also need to be included in an agreement for sale contract:
- the ‘by way of agreement for sale’ distinction mentioned earlier – listed under the Purchase Price on the contract
- An agreement for sale ‘financing schedule’. This will outline all the relevant deadlines and financial details involved in the transaction.
Depending on whether you’re the buyer or the seller, some of the important details your AFS contract needs to include are:
- Insurance, taxes, upkeep and repairs
- Items of default
- Remedies payouts
- Interest rates and how they will be calculated
- Who is responsible for keeping existing financing up to date, and what happens if it isn’t.
2. How does Agreement for Sale work?
As mentioned earlier, the AFS is a way to purchase real estate with seller financing. Seller financing is essentially just that – instead of searching for a bank or private lender that will approve you for a mortgage or financing, you, as the buyer, negotiate financing terms with the seller directly.
Additionally, because the buyer is not assuming the seller’s mortgage, if it exists, the buyer does not need to be concerned with how big or small the seller’s mortgage is. What does matter to the buyer, however, is the amount that they owe to the seller. This owing amount to the seller is called the “unpaid seller’s equity”.
Two key things you need to know about seller financing with an AFS contract are that:
- The buyer takes possession of and controls the property, but the title remains in the seller’s name.
- The seller is responsible for making their usual mortgage payments to their bank or mortgage lender.
Title remains in the seller’s name:
This is very important because it is a differentiating factor between using an AFS to acquire seller financing and assuming a seller’s mortgage.
Seller makes mortgage payments:
Because the title remains in the seller’s name, they are ultimately the ones responsible for maintaining their existing mortgage and making regular payments as they usually would. The difference an AFS brings to this scenario is that the seller receives payments from the buyer under the agreement for sale contract. The seller can then use these payments to make their regular mortgage payments.
But what about the buyer? If the title remains in the seller’s name, how does the buyer protect themselves? A buyer’s lawyer has the right, but not the obligation, to register a caveat against the title at the Land Titles office. The caveat claims an interest in the property as the buyer, but the buyer will not get title until the full purchase price is paid to the seller.
3. When to use AFS?
The Agreement for Sale is a creative real estate investment strategy and holds several benefits for both buyers and sellers. Below we discuss some of these benefits, and when a situation will likely call for an AFS strategy.
For buyers, there are a few situations where using an agreement for sale as part of their investment strategy can prove to be beneficial. These situations include cases where:
- Buyer needs a new mortgage but cannot qualify for one with a typical bank or lender who usually have strict criteria in place for approving new mortgage applications. In this case, it can be easier for an investor looking to buy property to acquire financing from the seller of the property they wish to buy.
- Buyer cannot assume a seller’s mortgage. With a few exceptions, real estate buyers typically cannot assume a mortgage without qualifying. This presents a similar problem to the earlier point about qualifying for a mortgage.
- Buyer wants control of the property right away. The ability for the buyer to have instant control over the property is powerful for a number of reasons because it allows the buyer to:
- Sell the contract to someone else
- Lease-option the property to a tenant buyer
- Sell an option without a lease
- You have a property you want to sell but don’t want to use a realtor or pay commission.
- You want to avoid the payout penalty on your mortgage
- You have negative or low equity in your property.
- Market value is down, and you want or need to sell your property quickly.
- You cannot afford to make your mortgage payments, and/or property management payments anymore. With an AFS, the buyer becomes responsible for managing the property, and you can use some of the payments you receive to pay off your monthly mortgage payments.
- You want to secure a return on investment from the property. The AFS allows you to lock in the cap rate at the time the contract is signed. This can be beneficial depending on the market values at the time you sign the AFS contract.
Some potential drawbacks for buyers and sellers as a result of the AFS contract can be:
- For sellers, a big concern could be that the buyer cashes you out of the transaction. In other words, they pay the amount they borrowed from you in full before the term of the AFS ends. This could mean that your profit portion is based solely on the cap rate component, or the difference between the price at which you purchased the property and the price at which you sold it. The benefit or drawback from this depends on whether you, as the seller, are happy with the difference amount you got.
If, however, as a seller, your plan is to use the AFS to receive interest payments from financing to the buyer, and avoid the buyer buying you out, you might want to consider adding a penalty clause to the contract. This would be similar to the one included in mortgage contracts with banks or private lenders where they set a penalty if the borrower pays the full mortgage back before the amortization term ends, thus leading them to lose out on potential interest they could have earned.
- As with typical lenders, there is the danger that the borrower, in this case the buyer, defaults on the loan they borrowed from you, the seller. It can be very time consuming and expensive to take the defaulted borrower to court in an attempt to recover your property.
These potential drawbacks can be prevented, or at least prepared for, with lots of communication before signing the AFS contract. Both parties must be comfortable and agree to the terms and conditions set out in the contract. And of course, trying to trick people or taking advantage of them is not a good way to get into real estate investing.
To sum up, the agreement for sale contract is a way for real estate investors to buy property without having to qualify for or assume a seller’s mortgage. For sellers, the agreement for sale strategy can be a way for them to keep the title to the property without having to pay their mortgage lender a payout penalty. It also helps them pay off their mortgage payments using the payments they receive from the buyer.
The AFS is not a very popular investment strategy, so it is crucial that both parties be working with lawyers who understand and support the agreement for sale strategy.
When it comes to clauses in the contract, perhaps the ones that will be of most concern to the buyer and seller are:
- The interest rate for the loan given to the buyer by the seller
- The amount and frequency of payments
- The term of the agreement for sale contract.
As always, with any real estate or financial transaction, make sure you get good professional advice, do your due diligence, read the paperwork before you sign it, and most importantly do it all in good faith!