Written by Ashley Molson, Esq.
Why should an Investor care about Novations?
Let’s jump right in, shall we?
What is it:
The short story and simple definition of a pure novation in a real estate investment contract by way of an example is…
Buyer One enters into contract to buy Sellers’ Home for X price. Within the contract, among other documents, there is a clause that states, the buyer has the right to “novate” that is, to step out of the legal position as the buyer of the Sellers’ property once a new third party buyer (Buyer Two) enters the picture and fully executes a new agreement with the original Seller for Y price with its one new terms. Once this third party buyer / seller agreement is signed, Buyer One’s legal obligation to buy the property from the Seller is extinguished.
You’re probably wrinkling your forehead saying, “okay, so what’s in it for me then?”
Well…
In a real estate transaction using the novation strategy the paperwork signed between Buyer One and the Seller also include a requirement that the Seller agree to pay Buyer One Z amount, which is usually represented or hinged upon the difference between the original contract price between Buyer One + Seller(X) and the new contract price between Buyer Two + Seller(Y) = Z.
Buyer One get’s Z amount at closing while the seller is guaranteed by Buyer One receiving proceeds in the amount of X less any closing costs or payoff fees they need to pay such as their current mortgage, transfer taxes, property tax prorations etc.
Before I go any further into Novations, there are a few points I’d like to make to investors right out the gate:
- A novation is a tool and legal strategy
- A novation is not a singular contract
- A novation is a thing that happens
- Implementing a novation strategy requires participation of all parties involved in the transaction
- A novation requires a specific set of documents to be drafted and executed
- A novation cannot happen behind closed doors behind the sellers’ backs
- Novations are not for everyone
- Novations are complicated
- Novations are uncharted legal territory in the world if Real Estate Litigation
- Novations are not for the wary
- Novations should not be used if the deal can be assigned traditionally
When should an investor use a novation?
Novation strategies are used by investors when a seller wants too much money for the property that a traditional assignment or fix and flip cannot justify.
Buyer One must evaluate the property to determine if the property has any secret value that can be revived by doing a few repairs here and there on the property and that the cost to do the repairs is minimal compared to the value add.
Why have I as an investor not seen this before?
Novations are a strategy being used only by a few investors and it’s becoming more and more popular. They’re complicated though and there’s a lot of education needed before you venture into doing a novation deal. You need the right combination of team, knowledge, risk aversion, paperwork, parties to the transaction and of course, the right deal / opportunity
You may have seen a novation structured as a Joint Venture between the Investor and Seller, and even though it’s being called a novation it still technically can be seen as a joint venture.
In summary
Novations certainly aren’t going anywhere and we predict they’re going to become more popular. Molson Law Firm is prepared to begin working on novations with their investor clients as of today, but as a requirement our novation self study course is required before we can be retained to do a deal together. If you’re interested in the course, send us an email or DM us on social media at @realestatelawnj / ashley@molsonlawfirm.com
This post is for educational purposes only and is not intened to be legal advise and does not create an attorney client relationship between the reader and the attorney writing.
