A preliminary contract is usually signed when buying a new dwelling directly from the developer or project manager. This contract contains more uncertainties than the main contract and is drawn up at a notary’s office. Buyers, therefore, sometimes feel insecure when entering into a preliminary agreement. Silvestras Sušickis, a lawyer at creative real estate projects development and placemaking company Citus, explains why such an intermediate contract is concluded, which risks perceived by potential buyers are real and need more attention, and which are just myths.
The preliminary dwelling purchase–sale agreement, commonly encountered in new construction projects, is between the seller (developer) and the future buyer. Through this agreement, the developer commits to constructing and later selling the dwelling to the buyer by means of a notarial agreement, and the buyer commits to purchasing the dwelling and paying the advance payment after the conclusion of the preliminary contract and the total agreed price after the main contract.
Sušickis: ‘From a legal perspective, a preliminary agreement is not special or complex. However, given its financial magnitude and the fact that most buyers naturally engage in one or more such transactions in their lifetime, several questions arise. The need for such contracts is, however, dictated by the conditions of the housing market, and in some cases, it is even favourable for buyers if the latter do their homework carefully’.
The housing market is dynamic, with many changes in legislation, requirements and client expectations, as well as in the cost of labour and materials, and developers are looking to manage the risks and financial flows of the business most efficiently. As a result, developers usually start selling before construction is complete, but with sufficient project certainty – approved detailed design, financing, timelines and so on. And this principle applies not only in Lithuania.
Sušickis emphasises: ‘The most important goal for buyers is locking in the current price, especially given that demand for housing is expected to grow. Analysts at Citus estimate that the number of prospective buyers in Vilnius alone could reach 10,000. Once these individuals decide to purchase property, prices will increase rapidly. Today, there is a natural selection in the market, with some less experienced or uncertainty-resistant developers withdrawing. However, it is still necessary to assess credibility before concluding a preliminary contract’.
How to guarantee that your dream home is exactly what you purchased
We often buy new construction housing before the construction process is complete and the units are registered. We expect the construction to be completed and finished on time, and the housing will be as it was sold to us – as we have seen in the drawings, visualisations and design solutions.
Sušickis continues: ‘We purchase a dream and give the seller a credit of confidence. There are no major risks of entering a dodgy deal because there are many safeguards in place – from the law’s control and consumer protection mechanisms to the partners’ risk management in the process, such as the banks providing the home loan. However, we must also make a responsible decision: choose housing from reputable, long-established, well-known developers. Such companies protect their reputation and have reliable financial backing, so we can be sure that everything will go according to plan’.
In any case, before signing the preliminary contract, it is recommended that the design number, area, number of rooms, floor, and other features of the property being purchased be carefully checked—they must correspond with the project documentation.
Often, the fact that the preliminary contract specifies the initial area of the future dwelling, which may vary, raises questions or concerns.
Sušickis explains further: ‘Almost everyone evaluates their needs and possibilities – what size they need and what they can afford. It would be problematic if the finished home’s area increased or decreased significantly, for example, by 10–20 sqm. However, it is not worth speculating at this moment. In reality, such changes in the area of the future dwelling are minimal, but the nuances need to be known and considered’.
According to Sušickis, professional and responsible developers manage these changes by meticulous design and by adhering to the approved design during construction. In well-drafted preliminary contracts, buyers will always find a clause on the tolerance of possible changes in the future floor area of the dwelling, which is usually up to 2 sqm.
The floor area of a dwelling under construction can change for several reasons, such as design changes that may occur during construction or the practicalities of the building. However, if the actual area deviates from the initial area by more than the tolerance limit specified in the contract, the buyer can terminate the agreement without any negative consequences. These provisions should be found in the preliminary deal and consulted.
For the same reason – the dwelling size is preliminary and may vary according to the tolerance – the preliminary contract also specifies a provisional, tentative price. The most important indicator when buying a home is the price per sqm, which was agreed upon with the sellers and recorded in this contract. Once the construction is completed, the cadastral measurements have been taken, and the final area of the property has been recorded, the property’s final price will be calculated based on the agreed price per sqm.
Sušickis: ‘As I mentioned, the most important thing is to check if the preliminary agreement specifies the price per sqm agreed upon when purchasing the home. If it is correct and we are satisfied with the allowable variance, we will have locked in the actual price and know that we are managing the budget for our dream home. It is crucial in rising prices, as the likelihood of housing prices decreasing is extremely low. When prices are rising, it is essential that the housing developer cannot manipulate the market situation. Therefore, we must ensure no ambiguously interpretable or unfavourable clauses in the agreement. Choosing a trustworthy developer who will not try to take advantage of the situation is also essential’.
In a preliminary agreement, the advance payment – the amount, the deadline for payment and other conditions – is usually included. Based on the initial floor area, it is usually 15% of the home’s value, but it can be higher. It is not only a legally required deposit of the buyer’s funds in the case of a loan purchase but also a guarantee that the buyer is committed so that the developer can plan its financial flows for the construction.
If we refuse to execute the preliminary agreement for reasons beyond the developer’s control, the advance or part of it may be used to pay liquidated damages.
Different terms for the parties: why are there unequal conditions?
Typically, contracts provide for different responsibilities for the buyer and the developer (seller) in case of non-compliance, which can naturally raise questions.
Sušickis explains the rationale behind these differences: ‘First of all, the different terms – for instance, the amount of liquidated damages for termination of the contract, which can double or more – is determined by the different levels of risk the parties take. In reality, a buyer entering a preliminary contract only risks the advance payment of between EUR 10,000 and 20,000. Meanwhile, the developer assumes liability towards the project’s creditors, construction contractors, and other buyers of the property, and the amount of this liability is often not limited to EUR 10 million’.
Thus, the developer provides safeguards to ensure that the buyers will honour the provisions of the preliminary agreement. This is particularly true when the market is more prone to speculative buyers.
However, Sušickis says these differences between the buyer’s and seller’s terms should not scare the buyer. The developer’s main objective is to build and sell the property, make a profit, and continue investing to not clash with their clients and live off the penalties. Therefore, reputable developers apply penalties only in exceptional cases when buyers knowingly breach the preliminary agreement.
The final step, the notarial sale and purchase transaction
One of the main conditions of the preliminary agreement is the deadline by which the developer will complete the construction work and invite a buyer to sign the main contract. To a greater or lesser extent, this clause should be included in all well-drafted preliminary agreements.
The main fear of homebuyers is foreseeable extension clauses, which allow the developer to extend the deadline for a certain period unilaterally.
Sušickis: ‘This is a legal and reasonable condition. The development of a real estate project is a complex process in which the bureaucratic mechanism can influence the activities of the institutions and services involved, as well as the weather conditions necessary for executing specific construction work. Sometimes unforeseen circumstances arise that may cause construction to be halted, such as unearthing an archaeological site and the need to carry out particular studies. This is why the possibility of extending the deadline is included in contracts and helps to manage the developers’ risks and the expectations of buyers’.
He points out that extending deadlines is costly for the developer, requiring longer payments to the project’s creditors, employees, contractors, etc. As a result, the project’s cost rises, so it is not in the developer’s interest to use this clause. However, paying attention to how it is described is essential: whether it specifies under what circumstances, how many times and for how long the terms may be delayed.
Sušickis concludes: ‘In detailed contracts, technical circumstances are usually specified – including when certain construction work is not feasible – with factors, conditions and cases outlined. Bureaucracy complicates matters, so contracts often include a clause for uncertainty due to numerous recent changes that significantly impact project development, making it sometimes impossible to predict certain conditions. In such cases, the developers’ communication is also essential – whether they proactively, comprehensively and reasonably inform their clients and value and safeguard mutual trust’.
Be the first to comment