Understanding Novation in Real Estate

Novation means replacing the original contract with a new one. In simple words, Novation is replacing someone or something in a contract with someone or something else.

And it happens quite often in both residential and commercial real estate transactions.

When a contract is renegotiated, it is not as simple as striking it out and replacing it with the new terms. You cannot get a verbal agreement for the changes, either. 

All parties must agree to the replacement and sign to show their agreement or the new contract is not valid; only after that the old contract then will become invalid.

Novation in real estate is often used in regards to the transfer of complex property leases and similar cases. 

It can be used in replacing one party with another in a contract or agreement, or it can be used to substitute new terms or contracts in place of old ones. 

May arise when one party is experiencing financial or operating difficulty in a real estate transaction.

An example of novation in real estate is the sale of property with unpaid mortgages. When selling a property that is mortgaged to a bank, the seller, the buyer, and the bank must agree on the terms of the sale of the property. 

The assumption of responsibility by the buyer for mortgage payments must be previously accepted by the bank, usually after an extensive background and financial check on the buyer.  

Some of the many things that can be changed by novation:

Property rent/price.

Lease terms.

Names of the purchaser, seller, landlord, etc.

Earnest money amount.

Closing costs.

Effective date.

Novation is quite common — and can be quite complicated — in commercial real estate because there are often more parties involved. 

Every time something is changed in a contract — and it will happen often — a new contract must be produced and signed by all involved parties.

An example of residential real estate novation –

A buyer has made an offer on the house. An inspection report indicates that the fence around the pool is not high enough to meet regulations. 

There are two options: 1.) The owner can replace the fence, or 2.) The sale price of the house can be renegotiated lower so that the onus of the new fence will be on the buyer. 

The buyer and seller both agree to a lower price on the home, and a new agreement mentioning the new price is presented to both parties for signatures. 

The old agreement is nullified, and the transaction moves ahead with the new agreement.

It is important to note that a novation invalidates the previous contract. For all intents and purposes, any prior contracts do not exist, and the new document is the only one that matters in the future, or until another novation is made.

The crux being, contract negotiations are common in real estate, but they can only be validated with a signature, not a verbal agreement.