Back-Up Offers are Back in San Carlos.

June 6, 2012

First Runner-Up.

One of the byproducts of a real estate market that is ripe with multiple offers is the re-emergence of the back-up offer.  What is a back-up offer, you ask?  The best real-world analogy to the back-up offer would be the first runner-up in a beauty pageant.  As you know,  when Miss America is unable to fulfill her “duties”, they don't conduct the entire pageant all over again — the first runner-up automatically assumes the role as the new queen.    (The Vice President operates under the same premise, right?)

It's the same principle with the back-up offer in a real estate sale.   After a seller picks the winning offer in a multiple-offer bid, they have the option to put one of the other offers in a “back-up position.”  As the name implies, this second offer is held in place as a back-up to the winning offer — and if the winning offer fails to complete the transaction, the second offer is automatically moved into first place.

There are a lot of misunderstandings about the risks and benefits of the back-up offer, and hopefully this post will clear some of them up.

The Key Points.

When an offer is put into a back-up position, it is agreed by both parties that this offer is essentially “frozen” in time until it is put into the #1, or active position.   That means that the price and the terms (contingencies, close of escrow, etc..) are agreed upon up front and that the clock doesn't start running until the #1 offer is canceled.   Once the first offer is canceled, the #2 offer immediately becomes the #1 offer, and the clock on the transacti0n starts immediately at that point.  Pretty straightforward.

During the back-up period, the #2 buyer is free to continue shopping for another home, and they can cancel the back-up offer unilaterally if they change their mind or if they find a better home elsewhere.

What's in it for the Seller?

There are several benefits to the seller in negotiating a back-up offer.   First, if the #1 offer indeed falls through, the seller has an acceptable back-up contract already ratified, so the house does not have to go back on the market.   Buyers in this market are pretty savvy, and a listing that goes back to “active” status after being a “pending sale”, it can be perceived as damaged goods and thus may not fetch a commensurate price the second time it goes on the market.

But since the vast majority of offers that are accepted actually close, the real benefit of having a back-up offer in place is to keep the #1 offer “honest”.  If you recall from last week's post, some buyers enter a contract with the intent of negotiating their inflated price downward — no matter what the justification.  This is also known as the “bait and switch” approach.   Having an offer in their back pocket empowers the seller to stand their ground if they feel the #1 Buyer is asking for unrealistic concessions.

Are there downsides to the seller?  Sure.  If you're in a rapidly escalating market, the attractive price that the seller accepts today as a back-up offer may be a bargain price in 30 days.

What's in it for the Buyer?

Let's face it — if a buyer is wiling to go to the mat to get a home, it stands to reason that they'd be willing to stay engaged in the process, even if it's on the perimeter, and have a second shot at the house.   That's the key benefit of the back-up offer for the buyer.   They don't have to go through that agonizing process of the multiple offer circus again if Buyer #1 falls through.

And as mentioned above, there's very little risk for the buyer in taking the back-up position, because they can walk away from the deal with no strings while they're still the #2 offer (i.e. they have not been moved to the #1 position.)

Downsides?  It's the exact opposite of downside for the seller.   If the market price drops significantly during the time that the back-up offer is in place, then the #2 buyer is locked into a higher price than they might get if the house went back on the market.   But the likelihood of that happening is pretty low in a short time-frame.

Beware the Non-Contingent Offer.

In this age of multiple offers, more buyers are waiving their contingencies in an effort to make their offer more attractive.  This strategy may yield a big reward in the end, but it's one that requires some careful risk assessment.   Now that you understand the sequence of events that transpire in a back-up offer, it's easy to see how a non-contingent back-up offer carries a special kind of risk for the buyer.

Why?  If Buyer #2 takes a back-up position with a non-contingent offer, and Buyer #1 conducts their own inspections and decides to back out of the deal, wouldn't you think that #2 Buyer would want to review these reports or the appraisal before proceeding ahead without any contingencies?  Of course they would.    Technically speaking, the buyer is supposed to be protected in a situation like this, since these reports are considered to be “new and material disclosures” that may impact the value of the home, which allows the buyer a 3-day window to cancel the offer.

But in my opinion, the wording in the standard purchase contract does not adequately address this particular situation.   And the last thing you want is to have your deposit tied up in escrow while both sides argue over ambiguous wording.   A solution?  Rather than take a back-up position with a non-contingent offer, modify your offer with a short (3-day) contingency period that will allow you ample time to review those inspection reports before you decide to proceed.  It's a very reasonable request, and most sellers understand why you're asking for it.

Bottom Line.

Back-up offers are becoming more and more commonplace in this competitive market, and they're a very effective way to turn a difficult situation into a positive outcome for the seller of the home and their new buyer.  But be sure you clearly understand the terms and the possible ramifications of the back-up offer before you agree to take that step.

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  1. Arn Cenedella on June 6, 2012 at 4:28 pm

    Good post especially info on non contingent back up offers.
    Yes better to have clear contract language.
    That being said, at the end of the day; state law about disclosure and 3 day buyer right will at the end of the day supersede any contract language – ie any contract language that fails to meet state law is invalid, IMHO.

  2. Dave Karow - Redwood City Funding on June 7, 2012 at 2:17 am

    Thanks This is a great post. Well worth a few extra minutes to absorb the details.

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