What is a Novation Agreement? You might ask. Novation is a term used in a variety of industries. According to Merriam-Webster, novation is simply the substitution of a new legal obligation for an old one. While there are many use cases for the usage of novation, the purpose of this article is the use of novation agreements in residential real estate.
Novation in residential real estate usually refers to use of a document called a novation agreement for the substitution of one purchase agreement (and buyer) with another purchase agreement (with new buyer). Put simply, novation is a technique similar to the traditional ‘assignment of contract’ method used by wholesalers in order to find a new buyer and collect a profit (the spread between the price the new buyer agrees to pay in total and what the wholesaler agreed to pay the homeowner). Novation is used by some of the more savvy real estate investors and wholesalers. The main reason they use novation is because it allows them to market the homeowner’s property on the MLS using a realtor whereas they cannot do so if assigning the purchase agreement (traditional wholesaling method). By listing on the market, they gain access to a significantly larger pool of potential buyers and those buyers can use traditional bank loans to purchase the house (whereas assignment of contract requires the buyer to pay cash or cash-equivalent).
The benefit to the homeowner of agreeing to a sale using What is a Novation Agreement? as opposed to an assignable contract is that the wholesaler/investor will usually be able to offer a higher price for the home.
The downside to the homeowner is that they will likely still have to go through the traditional listing and sales process (list on MLS with realtor, inspections, negotiations, lender appraisals and approval processes, etc.).
What are the mechanics behind this technique of What is a Novation Agreement?? It may seem complicated but it’s rather logical once you’ve gone through the process. The basic documentation components of a novation sale (there can be others but I’m going to leave those out for simplicity):
- A-to-B Purchase Agreement – this is the offer the homeowner accepts from the investor or wholesaler. It should be similar to a regular purchase agreement but it will include language related to the Buyer’s ability to Novate the agreement. This document should get submitted to a title company to officially “open escrow”.
- Novation agreement – this document outlines how the novation will work. It is signed by the homeowner and the investor or wholesaler when they sign the A-to-B Purchase Agreement. There is an additional signature line for the New Buyer to sign as well. This document gets uploaded to the MLS along with the listing so that buyer’s agents can see/access it. When a new buyer submits an offer, they will also submit a signed copy of the novation agreement which basically states that they understand that there was a previous A-to-B purchase agreement and that their purchase agreement (offer) will supersede that initial purchase agreement.
- B-to-C Purchase Agreement – after signing the A-to-B agreement and novation agreement, the investor or wholesaler will work with the homeowner to get the house listed on the MLS with a realtor. From here, the sales process is pretty much like a normal sale. The listing agent that the homeowner and investor or wholesaler are working with will submit the B-to-C Purchase Agreement and the Novation Agreement that has been signed by all 3 parties to the title company and the title company will work with all parties to coordinate the closing (which includes handling the receiving and distribution of all of the monies).
So, what is the process with this What is a Novation Agreement?
STEP 1 – Connect with a wholesaler or investor or cash house buyer
- There are a variety of ways to find a local investor but the most common is probably searching on Google or Google Maps for cash house buyers in your local area or nearby city.
- The investor will most likely want to meet with you to understand your situation, goals for the sale, and walk through your house to get a feel for it (layout, curb appeal, condition, etc.).
STEP 2 – Come to an agreement on price and terms of the sale
- The way that novation commonly works is that the investor or cash house buyer will come to an agreement with you regarding the amount of money that you will walk away from the sale with. This is referred to as your ‘net proceeds’ and reflects the amount you will receive from the sale (no fees or closing costs will likely be taken out of this number). They make their money by trying to sell the house for a higher price and then collecting the difference as their profit (plus they cover all of the closing costs, realtor fees, etc.).
- You will sign a purchase agreement with the investor that outlines the price and terms you agree to. This purchase agreement will have language included stating that the agreement may be novated.
- You will sign a novation agreement with the investor outlining the terms of the novation.
- You may sign other documentation such as an MLS listing authorization form to give the investor permission to list and negotiate the sale on your behalf.
STEP 3 – List the property for sale on the MLS
- Depending on your preferences and the investor, the roles and responsibilities around this activity can vary. Typically, you will be required to fill/sign a seller disclosure statement and lead paint disclosure (depending on when the house was built).
- You, or possibly the investor, will sign listing documents with the realtor who will in turn list the house on the MLS. The realtor or investor will likely take the listing photos or have them taken by a photographer.
- There will be showings and/or open houses. You may be required to keep the house clean and tidy and vacate the premises during these times.
- You and/or the investor will receive and review offers, accept an offer, and navigate through the sale (inspections, negotiations, etc.). This is typically led by the investor (working with the realtor) of the What is a Novation Agreement?
STEP 4 – Close and Receive your Proceeds (GET PAID!)
- At the closing of the sale, you will receive your proceeds as agreed upon with the investor. The title company will usually offer you the option of receiving your funds via a certified/cashiers check or via wire transfer.
And that is how What is a Novation Agreement? Works!