Safeguarding Specific Investments in Real Estate Purchases

Abstract

This paper deals with real estate sale contracts between private actors. During contracting which proceeds incrementally, parties cannot ex ante fully determine the "price" of the exchange, because they usually lack the information to do so. Therefore; if the buyer commits himself to buy, he necessarily has to rely on the seller's reciprocal commitment to sell when he specifically invests his resources in the further development of the contracting process. In this context, the seller is in a stronger bargaining position, as he not only has the real estate, but also all the relevant information, on the basis of which the potential buyer grounds his acquisition decision. On the other hand, compared to the seller, the buyer is more vulnerable towards opportunistic behaviour, as he necessarily has to undertake highly specific investments in the preliminary phase, in order to be in the position of making an informed decision. Due to the asymmetry of specific investments in the pre-contractual phase, the weak contractual party has to face, at most, the risk of being subjected to the typical hold-up problem, as the stronger contractual party might have an incentive to exploit the bilateral dependence in order to expropriate the rents accruing to the specific assets. All these sets of circumstances are generally perceived as a 'bundle of complexity' which can lead to serious difficulties in the bargaining as well as the contract formation processes, hindering parties from making rational decisions based on cost-benefit analysis. This article wants to compare the usual real estate purchase procedures in Italy and Germany, pointing out efficiency traps in the course of such transactions, and especially focusing on pre-contractual bargaining situations in which parties have specifically invested their resources. It further argues that the danger of opportunism arises especially during the preliminary negotiation of agreements, and should be considered to be directly proportional to the degree of asymmetry among parties' initial transaction-specific investments.