To Win a Bidding War, Accept More Risk
As any buyer in today’s housing market knows, it’s tough out there. Real estate bidding wars (known formally as “multiple offer situations“) are common. Here is some insight that may help you win a bidding war on a house, in Seattle and wherever else there are more home buyers than sellers.
HOW TO WIN A BIDDING WAR, or Multiple Offer Situation
The lousy-for-buyers market of 2014 continued into 2015, and into 2016, and into 2017, and now into 2018…. Historically low inventory and historica
lly low interest rates (now on the rise, having an impact?) have created the perfect storm for multiple offers. If you’re looking at a close-in home in good condition, you’ll likely face a bidding war, where the seller receives more than one offer. In matters of war, preparation is the greatest of all virtues. You must be prepared to compete against other buyers in order to win a bidding war (while not overpaying or making a costly mistake). Here’s how.
SKIP CONTINGENCIES, ASSUME RISK
The key to preparation is understanding the related factors of risk and reward in a contract. Every contract requires a home buyer to deposit earnest money into escrow, usually 1-3% of the sale price. This money is applied towards the purchase at closing. The buyer must either buy the house and close, or forfeit the earnest money to the seller.
If the buyer wants the earnest money back, the buyer must have some excuse for not buying. One type of excuse is an open contingency. A contingency is an event that must occur before the buyer is required to close. Contingencies, like the inspection contingency, are common. The inspection contingency gives the buyer the right to inspect and approve of the house’s condition. After inspecting, the buyer can terminate the contract with a full return of the earnest money.
But even where there are no contingencies, a buyer can always walk away at any time, even the day before closing (an extreme example of “buyer’s remorse”). If that happens, the buyer simply forfeits the earnest money to the seller. So a buyer includes contingencies in the contract in order to reduce the risk of losing the earnest money.
If you make one of several offers on a house, the risk of losing your earnest money is directly related to the reward of having your offer accepted. And that is of course an essential first step in buying the Dream Home! To increase the chances of having your offer accepted (the reward) you must be willing to increase the chances of losing your earnest money (the risk).
To a seller, the perfect offer has no contingencies at all. If your offer has no contingencies, you have a strong incentive to close because the only alternative is loss of your earnest money. And more than anything else, every seller wants to close. So consider submitting an offer without contingencies.
DON’T SKIP YOUR DUE DILIGENCE
Does this mean you close your eyes, make a great offer, and hope for the best? Of course not!!! Due diligence remains an essential part of the home-buying process (and I’ve got a great checklist). This is an expensive and complicated asset that can require significant further investment — this is financial and life planning of the highest sort.
Don’t skip your buyer due diligence, just move it to the pre-offer stage. By doing so, you’ll know that yes, this really does look like the right home, so you can make your big offer with confidence.
SKIP THE INSPECTION CONTINGENCY BUT NEVER THE INSPECTION
The inspection contingency is undoubtedly a seller’s least favorite contingency. It not only allows the buyer to walk away with the earnest money, it also provides the buyer with an opportunity to renegotiate the terms of the sale. For example, if the roof is failing, it would be common for a buyer to ask for a new roof prior to closing, or else the buyer might walk. And boy, do sellers hate to renegotiate in order to satisfy the inspection!!
But it would be absolutely foolish for a buyer to forego the inspection entirely. The only thing worse than missing out on the Dream Home? Buying it, only to discover it is a cash-sucking, time-consuming, stress-inducing lemon of a house. Not every story with a run down house has a happy ending.
So a prudent and aggressive buyer, willing to assume a little risk but not too much, will do a pre-inspection of the home. A pre-inspection is an abbreviated version of the full inspection, usually without a written report. The inspector counsels the buyer about any major concerns. The buyer then makes an offer, with the appropriate insight into the house’s condition, without an inspection contingency. That will be a significantly stronger offer than one with such a contingency.
SKIP THE FINANCING CONTINGENCY BUT MAKE SURE SELLER KNOWS ABOUT YOUR MORTGAGE
Another contingency that may be omitted is the financing contingency. Under the financing contingency, if the buyer’s financing fails such that the buyer cannot complete the purchase, the buyer gets to walk with a return of the earnest money. Oh boy, do sellers hate it when financing fails on the eve of closing….
Unlike the inspection, there is no way to get the reward without assuming most of the risk. If you are absolutely confident in your financial condition and your ability to get a mortgage, then you may want to consider skipping the financing contingency. But if your financing fails, it’s your problem, not the seller’s, and you will forfeit the earnest money.
Note that you should not simply omit the financing contingency form. The form contract states that a buyer has the money on hand to complete the purchase, unless the buyer includes the financing contingency form. If you simply omit the form, you are telling the seller you don’t need a loan. If in fact you do need a loan to complete the purchase, you have breached your contractual promise. The seller no longer has to sell you the house and can simply keep your earnest money instead. To avoid that lousy outcome, you need to revise the form offer so that you inform the seller you are getting a mortgage, but if it fails you will forfeit the earnest money. An attorney should draft this new term in the contract.
SKIP THE TITLE CONTINGENCY AND THE SELLER INFORMATION CONTINGENCY
There are a handful of other contingencies that can be eliminated from the offer, if you are willing to assume the attendant risk.
The standard form contract includes a “verification of seller information” contingency. This allows the buyer to walk if the buyer determines that the seller or listing agent provided inaccurate information about the property. Removal of this contingency (which should be done by an attorney) will strengthen the offer. At the end of the day, a buyer should confirm anything of importance and shouldn’t rely on the seller or listing agent anyway.
It is common to include a title review contingency. In many instances, a seller will provide a title report to any potential buyer. If that is the case, your attorney can review title report (only an attorney is qualified to do so) prior to making the offer so that you can exclude this contingency.
GO AS BIG AS YOU CAN ON PRICE
Obviously, assuming all of the risk alone won’t make you a winner. Price is of course the most important term. If you’re competing, forget any notion of getting a “deal” on the property. Decide how bad you want it, and offer that amount. The best way to pay as much as you need to without paying too much is through use of an escalation addendum.
MAKE SURE YOU THINK IRRATIONALLY TOO
Sellers are of course people, and far more emotion can be invested in a home than any other asset. So at the end of the day, the winning factor for two otherwise equal offers may be something that otherwise doesn’t make much sense. For example, if you are using an escalation addendum, don’t open your offer below list. Believe it or not, some sellers are offended by that simple fact. There is lots of other good insight on winning a bidding war by thinking like a seller from our colleagues at the Findwell blog.
DOES THIS MEAN I’LL WIN A BIDDING WAR?
Unfortunately, no. But you will have at least done everything you could to have the best chance at success. Sadly, life doesn’t always reward the best effort.
DISCLAIMER: This post is not legal or professional advice and you should not rely upon it. If you are going to employ the above insight in drafting an offer, you should hire an attorney to fully understand the legal risks you are assuming in order to to have the best chance at winning a bidding war without opening yourself up to catastrophe.