Rolling the Dice on San Carlos Real Estate.

March 19, 2011

Managing Your Risk in Multiple Offer Situations.

Last night I was involved in yet another bidding frenzy on a San Carlos home for sale.  In this particular sale, we were one of 8 or 9 offers that were competing.  A couple weeks ago, I represented a different client in another San Carlos transaction that fetched 6 offers.  And I would be remiss if I didn't mention the home on La Mesa that sold a few weeks ago with somewhere between 14-16 offers (depending on who you ask.)   Say what you want about the economy folks, but multiple offers are back with a vengeance in San Carlos.

When a home buyer makes the decision to forge ahead in a multiple offer purchase, the first question that always comes up is “How do I make my offer stand out?”   The obvious answer to that question is to throw more money at the offer — either a high offer price, or a bigger down payment, or both   But you knew that already!   And frankly, in a hotly contested multiple offer your first offer should be your best offer, because you may not get a second look.  So short of hitting the lottery or robbing a bank, throwing more money on top of your best offer is not an option for most people.

So setting the financial part of the offer aside for now, what other part of the offer can be altered to make it more attractive to the sellers?    The next likely target are the contingencies.   Obviously, the fewer contingencies that are in an offer, the more attractive that offer is to the seller.   But before you think about waiving your contingencies, it's important understand what you're giving up, and whether it's worth the risk to do so.

What's At Stake?

Before we dive into the what's and why's of contingencies, it's important to understand what is at stake when you make an offer on a home.   When you are putting pen to paper on an offer, one of the first clauses you'll encounter is the Liquidated Damages Clause.  This is a buyer-friendly paragraph that basically puts a cap on the amount of a seller can recover from the buyer if the buyer defaults on the purchase of the home (outside of the contingency period).  In the PRDS contract, which is commonly used in local transactions, that amount is set at 3% of the purchase price.   If that figure sounds familiar, it should — it's most likely the same amount that you'll be asked to put down as a deposit, and that's not by accident.  A good listing agent will insist on having enough funds to cover liquidated damages already in escrow.

The reason I point this out is that there's a common belief with new home buyers that once you remove contingencies on a home (or waive contingencies when you write the offer) you're obligated to buy the home no matter what.   You're not…you can back out of the deal the day before close of escrow if you wish, but you run the risk of losing your 3% deposit if you do.   So essentially, that 3% is what is at stake in this discussion.   On a $1M purchase, that equates to $30,000 — no small change, but it's a whole lot less than a $1M mistake.

Waiving the Property Condition Contingency.

The Property Condition contingency affords the buyer an agreed upon period of time after the offer is accepted to conduct any and all inspections, and to do any outside research (permits, police records, etc..) on the home and the area.   If, within the contingency time-line, the buyer finds anything unacceptable with condition of the home, they're free to get their deposit back and walk from the deal.  So what if you decide to waive this right?

Good listing agents will normally make a complete disclosure packet available to potential buyers before they write an offer.  This packet usually includes a pest inspection and property inspection that are conducted by licensed professionals.    So when the buyers read through the entire disclosure packet, they should have a pretty decent idea about the condition of the home.

So in this situation, what's the purpose of getting your own inspections done when you already have an inspection in hand?  Usually, it's not to go back and ask the seller for a concession — remember, you're in a multiple offer scenario and you're trying to make your offer as attractive as possible.   Most people are looking to see if there's a major discrepancy in the two reports — perhaps a condition that was overlooked by the seller's inspector.  That's certainly possible — I've read hundreds of inspection reports and no two on the same house are ever the same.

So when you're contemplating waiving the property condition contingency, what you're really betting on is this:

There won't be a newly discovered condition with that will cost more to fix than 3% of the purchase price.

In the case of our example house, that amount is $30,000.   Is it likely that you'll encounter a undisclosed condition that will cost that amount to fix?  The two highest ticket repair items on a house are usually the roof and the founation.   For $30K, you can replace the entire roof and still have about half left over.  And if the inspector actually crawled under the house and visually inspected the crawl space and foundation, it's unlikely he will miss a condition that will cost anywhere near that much to repair.

So for some buyers, waiving their property condition contingency might be a risk they may be willing to take.

Waiving the Finance Contingency.

This clause makes the contract contingent on your ability to secure a loan for the house based upon the terms that you outlined in the purchase contract (loan amount, interest rate, terms, etc..)   The risk in waiving this contingency goes down as the amount of your down payment goes up.  Why?  You're borrowing less money from the bank, so probability of getting that loan is higher.

On the flip-side, if you're only putting down 20% on the purchase it's extremely risky to waive this contingency, especially if the price of the home gets driven upward in the bidding frenzy.   With a conventional loan, the bank will loan 80% of the lesser of either the sales price or the appraised value.  So, if you are at that 80% threshold, even a marginal appraisal can put you in a bad position.

So well qualified buyers who have a large down payment may opt to waive this contingency too, since it's highly likely they'll get a loan to purchase the property.

It's Your Choice.

I always recommend that my clients retain their contingency rights in a contract, and that waiving these rights is not in their best interest.   All reputable brokerages will do the same.   However, you ultimately have the right to assume as much or as little risk you're willing to take to get the house you want.  Just make sure you discuss these options in detail with your Realtor and your loan broker before you decide to roll the dice…



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