Novation Real Estate: What Is A Novation In Real Estate?

Published on June 9, 2023

Novation Real Estate: What Is A Novation In Real Estate?

Novation Real Estate: What Is A Novation In Real Estate?

Most real estate transactions are complex. The parties involved may request changes in the contract terms based on negotiation before the deal closes. In this case, a novation may be necessary. 

But what exactly is real estate novation? Is this necessary for the protection of all parties involved? Find out the answers in this comprehensive blog!

What Is Novation?

What Is Novation?

Novation is the replacement of an old obligation or contract with a new one. This legal instrument allows the transfer of all the contract benefits of the original party cited in the original agreement to another party not included in the old contract. This is so you can avoid changes made in the valid previous contract through verbal agreement.

In other words, a novation can nullify an original contract and, as mentioned, replace it with a new contract of proximate or equal value. 

Novation can be used for real estate, financial market, buying and selling a business, and other applicable real estate contracts. 

What Are the 3 Types of Novation?

There are three major types of novation you can choose from should you decide this legal tool is needed in a transaction. They are the following:

  • Standard Novation: A standard novation is the most common type of novation to create a new contract. This is when both parties agree to amend the existing terms or add new terms to a contract to form a new contract. Changes to closing costs, purchase price, real estate agent fee, and other results of contract negotiations can occur.
  • Delegation: Delegation occurs when transferring the benefits and contractual responsibilities of the original creditor to the new creditor. The original debtor is discharged from their debt to the first creditor and is bound to the new creditor. The original debtor is release from any obligation to put simply.
  • Expromissio: Expromissio occurs when there are three parties involved in the agreement or transfer of contractual rights. This includes the transferee, the transferor, and counterparty. The novation process would only move forward if all three of them agreed. 

What is Novation in Real Estate?

Novation in real estate is most commonly used in contract agreements. In real estate novation, the old obligations of all parties involved can be replaced or amended with new terms, or all the burdens involved in a transaction, like liens, unpaid mortgages, etc. can be transferred to a new party not previously included in the old agreement. If one party disagrees, a new legal agreement would not be made.

As is with other novation types, this nullifies the old contract.

Common Original Contract Elements that Change with Novations

Common Original Contract Elements that Change with Novations

Novation in real estate can be used in property purchase agreements, rental agreements, and other contract types involved in real estate. Some of the terms that were renegotiated through real estate transaction novation include purchase price, name of buyer, landlord, or seller, deposit amount, closing costs, effectivity date, rent amount, terms of complex property leases, moving in or moving out date, etc. 

A novation in real estate occurs to clarify, negotiate, or renegotiate the elements above so the new contract can be edited accordingly. 

Novations vs. Assignments

Novation and contract assignment in real estate are almost the same, that's why many individuals are confused between the two. Generally, both assignment and innovation occurs in real estate to bring a new party to a transaction or agreement. 

However, assignments only transfer the rights and benefits of the original parties to the assignee or new party, whereas in novation where a new purchase agreement is created, all the legal obligations and rights, including debts are transferred. In an assignment of the contract, the assignor is still legally responsible for the burdens as well as other terms.

Another difference is that novation requires a third-party approval while an assignment transfers without anyone's involvement. It is for this reason why real estate assignment is used for subleasing a rental property or real estate investing. The property is subleased to a new party, but the original party or one party is still part of the same lease agreement.

Novation in Residential Real Estate vs. Commercial Real Estate

There is no major difference between the technicalities of residential transactions and commercial real estate novation. However, commercial real estate transactions novation is proven to be much more complicated because of the involvement of more parties. 

On the contrary, a residential real estate novation only involves two parties most of the time — the seller and the buyer. It is easier to gather these two individuals to negotiate and change the terms during ovation in real estate occurs. 

Commercial real estate novation also involve legal entities most of the time which further complicates the process. It would be twice as hard to get the signatures involved, much more make them agree on major changes.

In most cases, delegation novation is used for commercial real estate transactions while standard novation is used for residential contracts. 

Examples of Real Estate Novation

Examples of Real Estate Novation

To ensure that you understand how novation occurs in real estate, we have listed some in-depth examples below.

Home Price Renegotiation

The home price is one of the most common elements renegotiated during the novation and creation of a new agreement. This is when the buyer and seller have a mutual agreement to change the purchase price in the lease terms for whatever legal reason. Here are some specific examples:

  • A change in purchase price because an inspection of the property revealed that the borders of the property infringe on an adjacent home.
  • A change in purchase price because an inspection report revealed major structural issues like a leaning foundation, overflowing septic system, asbestos, etc.
  • A change in purchase price if the seller refuses to make repairs or renovate the home after issues have been identified. This often results in a lower price with the mutual consent of the involved parties.
  • A change in purchase price when it is discovered that the selling price is way higher than the appraised value of the property during the real estate transaction.

In all instances, standard novation is necessary and applicable.

Lease Transfer

In a leased property, if a tenant wants to be out of the original lease by transferring the agreement to another party, novation replaces the tenant with a new party. 

For example, if a tenant signed a one year rental agreement with the landlord but has to relocate to another state for work six months before the lease ends, a new lessee or the hopeful leasing party can take over all the financial, legal, and contractual obligations of the previous leasing party. Of course, this requires the approval of the landlord. But most of the time, they would agree to avoid financial or operating difficulty.

Changes in Earnest Money Deposit

If the buyer suffers from financial issues and can no longer pay the exact down payment amount, he can negotiate with the seller to adjust the required down payment. Of course, the mortgage would also be adjusted based on the down payment. 

Frequently Asked Questions

Is Novation a New Legally Binding Contract?

Yes. Novation is a new contract that is meant to replace an old agreement. Once a novation occurs, the old contract is nullified and all the rights and obligations are transferred to a new party. Note, though, that novation is a consensual replacement of the original contract. All parties from the old contract should agree on the novation agreement. 

Is Novation a Deed or Agreement of the Parties Involved?

Yes. A novation is a deed that binds the parties involved in a new agreement. It transfers one party's rights to another party and the terms of the contract can also change. It also transfers the burdens of a transaction such as delayed mortgage payments and other debt obligations.

Summary: Novation Real Estate

Novation agreements in real estate are legal instruments that individuals can use to nullify an existing contract or agreement. As discussed in this blog, the standard novation is the most common novation implemented during residential real estate transactions.

Novation can be used in real estate to change the purchase price of a property, transfer complex property leases, change the amount of earnest money deposit, and more. 

Now that you already know about novation and how you can use it in your real estate transactions, you may want to focus on finding more deals. Here at Property Leads, we offer highly motivated leads generated from SEO. We sell them exclusively to reduce your competition.

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