What is a novation in real estate?

Novation real estate definition

In contract law, a novation is an agreement that with everyone's consent, substitutes a new party for an existing one and releases the original party from the original contract. The old contract does not get handed to someone else. It is replaced.

In real estate investing, "novation" has come to mean a specific deal shape. An investor signs a purchase contract with a seller. Instead of buying the property, the investor markets it, finds an end buyer, and under a novation agreement the end buyer is substituted into the seller's contract at closing. The seller is paid at that closing. The investor's profit is the difference between the price the seller agreed to and the price the end buyer pays, less costs.

A novation example

The numbers below are made up to show the shape. Every real deal has its own.

• A seller agrees to sell to an investor for $250,000.
• The investor and seller sign a novation agreement, drafted by the investor's attorney, that lets an end buyer be substituted into the contract.
• An end buyer agrees to pay $290,000 and brings their own financing, often a conventional mortgage.
• At closing the end buyer's lender funds, the seller is paid, and the settlement statement shows the seller's proceeds, and how the investor's $40,000 appears is set by the title company and attorney.

The appeal for the investor: no purchase funds and no second closing. The appeal for the seller: a retail-price buyer without listing the property the usual way. The cost: two contracts, an end buyer's lender on its own clock, and a settlement statement that has to be right for three parties.

Novation vs assignment

An assignment hands your rights under a purchase contract to another buyer, usually for a fee. The original contract stays as it is; the assignee steps into your shoes and closes on your terms. An assignment fee is often shown on the settlement statement, and the end buyer's lender may see it. Ask your title company how it will be handled.

A novation replaces the arrangement. The end buyer becomes the buyer in a contract with the seller, and the original buyer is released from the original obligation. Some investors use a novation when the end buyer's lender or title company prefers one contract between the seller and the end buyer. Your attorney decides which structure fits.

Which one fits a given deal, and how the investor's compensation is documented, are questions for your attorney. Whether and how the property can be marketed, and by whom, depends on state real estate licensing law; if you hold a license, your broker has a say as well. Nothing on this page answers those questions.

What a novation agreement covers

Your attorney drafts it. In practice the agreement and its addenda usually settle:

• Consent. The seller agrees in writing to the substitution of an end buyer.
• The substitution itself. Who is released, who steps in, and when.
• Marketing and access. Whether the investor may show the property, make repairs or list it, and under what rules.
• Money. What the seller receives, how the investor's compensation is shown, and who pays which closing costs.
• What happens if no end buyer shows up. Whether the investor must close, may walk, or the contract ends by a date.

Every one of those is a legal term, drafted and explained by your attorney. The coordinator's job is to get the attorney the facts, track the draft to signed, and make sure the title company has the final version.

The novation file, step by step

1. Contract in. The seller agreement, parties, deal type. Checklist and calendar built.
2. Novation agreement drafted by your attorney, tracked to signed.
3. Title opened at your title company or closing attorney. Commitment tracked, items cleared.
4. End-buyer contract in. Every deadline from both contracts on one calendar: option period, appraisal, lender conditions.
5. Seller payoff gathered. Mortgage statement and payoff letter, so the settlement statement shows the right numbers.
6. Insurance and signer documents. Entity documents, photo ID, and the end buyer's policy in place for their lender.
7. Closing and after. Settlement statement checked against both contracts, signing, funding, recording, closing packet sent.