What it’s like to buy a house in a historic market…
With median days on market of 6 days, 1-2 year price increases of over 30%, written business tripled, and new listing inventory consistently dropping, what used to be described as a real estate market would be better described now as a prison yard riot. You might be moseying along, looking for your “forever home”—that you’ll spend at least the next 5-7 years in—and get approached behind by some murderous prisoner (cash buyer) with a shoddily-crafted prison shank (escalation clause). Next thing you know, you’re lying on your back, bleeding out, wondering what went wrong. While someone else moves their furniture into YOUR HOUSE.
This is a slight dramatization. But only just. For my buyers reading this, you know this to be true.
So, since I love a good underdog story, and I believe that there is always a way to get what you want (even with the odds against you), I’m going to first offer the perspective of a buyer in this prison riot/real estate market. I will do an article on sellers next month.
For buyers, they are learning all sorts of real estate nomenclature right now:
- Contingencies: Appraisal, financing, inspections, sale of property, etc.
- Appraisal gaps
- Escalation clauses
- Bridge loans
- Debt-to-Income (DTI) Ratios
- And all the potential negotiation points within a contract
I figured since they’ve been forced to learn all of this, all of you should, too. I’m nothing if not equitable.
So, drumroll, please…….Contingencies.
What is a contingency?
In a nutshell, it is something that has to happen before something else can happen. If you want B, then you have to do A, first.
For each contingency, there will be, A.) the action necessary for completing the contingency named, B.) the person responsible for paying the costs associated with said action, and C.) the timeframe in which the action must be completed.
Sale of Buyer’s Property Contingency –
Ex: You own the house you live in and have a mortgage on it. You want to buy another house. Your lender says that your DTI (Debt-to-Income Ratio) cannot support two mortgages. So you have to sell your current house before you can buy another one.
This is one of several contingencies within most contracts. In this case, you would have to make an offer on the house you want to buy and make it “Contingent Upon Sale of Buyer’s Property (Not Presently Under Contract).”
This used to be fine; expected even, in many price ranges. People used to do this out of a desire for comfort when their income would support two mortgage payments. But because the buyer pool is so drastically gigantic now, and the listing inventory is so absurdly low, people are putting comfort to the wayside and are doing whatever they have to to buy a house.
So this means they’re waiving every contingency they possibly can because every contingency removed is an obstacle in front of closing the property removed. And sellers like that. In a seller’s market, a seller gets what a seller wants. (It’s ok, buyers. We remember 2008-2011. Even if the sellers don’t. Your time will come, like it always does.)
So what other contingencies can you waive, and what are the potential risks with doing so?
Appraisal contingency –
This is the contingency clause that says the property must appraise for the contract price. It’s your “out” if the property appraisal comes in low. So be wary of using this one. The thought of waiving this 3 years ago would have been absolutely abhorrent.
Another thing to consider when waiving this contingency: Are you using a loan to purchase the property?
Because if so, the property appraisal amount requirement is not really your call, it’s the lender’s. (Depending on the amount of your down payment, but that is an extremely large amount of money—20%+, in most cases—so we won’t get into that).
Since the bank is the one providing the money on it, if the property doesn’t appraise, then they will require 1 of three things:
- The seller drop the contract price to match the appraisal.
- The buyer pay the difference between the appraisal amount and the contract price; called an “appraisal gap” and we will discuss that later. OR,
- Cancel the contract.
Financing Contingency –
This clause says “this deal is contingent upon the buyer receiving financing by “x” date.” If you waive this contingency, you better have a way to purchase the house without financing.
Inspections Contingency –
The “As-Is; Where-Is” purchase. RISKY BUSINESS. And I don’t mean Tom Cruise sliding around seductively in his business casual underwear, either. I mean you are rolling the dice and hoping against hope that everything is ok with the property. I would not recommend this for a new buyer or someone that doesn’t have a ton of savings, income, or contractor-level knowledge/contacts. No one wants to close on a house and then come home to a slab leak or something even worse.
Now. The dreaded “Appraisal Gap.”
This clause says “If the property doesn’t appraise, I will pay the difference in cash.” But don’t say it like that! Leave yourself some form of an escape route or safety cushion.
Word it like this instead: “If the property appraisal comes in lower than the contract price, I will pay up to “x amount” of dollars over the appraisal amount.” That creates a built-in stopgap so you know exactly what the worst scenario looks like. You leave yourself open to a lot of unknown, potential loss without doing so. God forbid the appraisal comes in $50,000 below contract price and you have exactly $50,000 in your account. So you just drained your life savings to pay $50,000 OVER appraisal. Your savings are gone and you have more negative equity than I would ever recommend.
I’d be remiss if I talked about all of this stuff without also talking about the dangers of purchasing a home over appraisal price. And that source of danger comes from the cyclical nature of real estate. I don’t know if what goes up MUST come down, but I know it always has. We’ve been on a 10-year average cycle for real estate over the past century or so. And we’re about 10 years past the trough of the last down market. Does that mean the bottom is about to fall out? I have no idea. I’m just giving you information. You do with it what you will.
The questions to ask yourself, before offering an appraisal gap, is:
“How much money do I have?”
“How much money am I ok with putting toward negative equity?” And,
“How long, realistically, am I going to stay in this house?”
If you have enough money to spend some on the emotional purchase of a home with negative equity, and you are convinced you will be in the house long enough to outlast a market cycle, then go for it. If you are not, then don’t. Rent, if you have to. The amount of money you’d spend extra on a home, to net you negative equity and your dream home, would likely be far more than the money you’d pay a landlord for the time you decide to wait it out.
Escalation Clauses
Yucky.
I don’t even like typing that.
What is it? It’s a clause that says, “We will increase our offer over any competing offer by increments of “x amount” up to a total purchase price of “x amount.”
Why do I hate this?
Because. It’s violating confidentiality. It’s cheating. It’s not cool. It’s ambiguous and goes against fair play in every possible sense of the word. This isn’t an eBay auction and we aren’t software bots that give people an unfair advantage. Don’t worry. I won’t tell you how I really feel.
But for what it’s worth, even the Oklahoma Real Estate Commission says, ON THEIR OWN FORM, “Disclaimer: Please note that use of an Escalation Addendum is not recommended by the Oklahoma Real Estate Commission due to the difficulty presented to a Buyer in verifying Competing Offers.”
I agree with the governing authority of real estate in Oklahoma. We don’t agree on everything. But we do on this.
Now, how can a buyer make their offer more appealing without selling their soul and sacrificing their livelihood, dignity, and life savings?
Well, I’ll start off by saying: Price is not everything.
They call them contract termS, plural, for a reason.
- Be flexible on the closing date/time/location. The sellers are likely about to turn around and be buyers on their next property. So if you keep that in mind and tell them you’re willing to work on their schedule, then they might just feel indebted enough to you to accept your offer. And by agreeing to close at the same title office, you can usually save a little bit of money.
- Offer the seller extended occupancy of the property. Maybe it’s a few days that you work out with them on an occupancy agreement to give them time to close on their next house without having to do the moving truck/closing dance. Just make sure liabilities are discussed and that the occupancy agreement is not just a handshake deal. Make sure Risk of Loss is not transferred with the deed, but with possession. If this stuff doesn’t make sense, talk to your agent. Or me, if you don’t have an agent. I’ll be your agent.
- Increase your earnest money amount and maybe even consider making a portion of it nonrefundable. This sounds scary. But I promise you, it’s less scary than going $35,000 over appraisal, offering an appraisal gap, or waiving the appraisal contingency altogether.
In closing, get creative where you have to, but wait if you can. “All good things come to those who wait.” Right? Guys? Right, guys?
Seriously though, I feel for all of my buyers and anyone who’s been looking in this market. I’m here for anyone who needs help. Or just needs someone to cry to and listen. Hang in there.