Monday, May 5, 2014

WEAPONS OF RISK AND EXPENSE

In a market where multiple offers are common and cash buyers are showing up in huge numbers, it is becoming increasingly difficult for buyers to get financed offers under contract. 

We are 125 days into 2014, and by my count, I have written 24 offers for financed buyers this year that have not been accepted.  Every one of those was a multiple offer situation.  

This is a stunning turn of events.  The Denver real estate market remains as hot as any in the country, and I am amazed every single weekend at the massive numbers of buyers out swarming the market as I am showing homes. 

Because the same question comes up week after week – “How do I make my financed offer more competitive?” – I am going to share a number of strategies that have been effective in 2014.  Keep in mind that many of these strategies involve risk, and they are not for everybody.  But if you find a property that is truly worth competing for, here are some winning negotiating tactics than can help you break free from the pack:

INCREASED EARNEST MONEY – The earnest money deposit is effectively a down payment on your down payment.  If you purchase a $300,000 home with a 10% down payment, your total down payment is $30,000.  If the seller is requesting a $5,000 earnest money deposit, that $5,000 is held upon contract acceptance by a neutral third-party title company and credited to your down payment at closing.  Earnest money is refundable under numerous scenarios, including a cancellation of the contract based on inspections, appraisal, title, HOA documents, or the inability to obtain financing. 

Increasing the earnest money deposit does not necessarily create more risk for a buyer, since that money is generally refundable (unless otherwise specified in the contract) based on the triggers outlined in the paragraph above. 

Increasing your up-front deposit, say from $5,000 to $10,000, can imply a seriousness to the seller which is helpful in your negotiations without greatly increasing your risk.  It’s still credited to your down payment, and it’s still refundable, but it implies a higher level of commitment. 

Some buyers are going as far as committing their entire down payment ($30,000, in this case) as earnest money.  That’s dangerous, because it’s a lot of money, but obviously effective in standing out from the crowd.

STAGGERED EARNEST MONEY RELEASE – Ready to step it up?  Offer to allow portions of your earnest money to go “hard” and become non-refundable early in the process.  For example, if you have a $5,000 earnest money deposit, propose that $1,000 of the earnest money go “hard” after inspections; $2,000 goes “hard” after the appraisal; and the balance goes “hard” upon loan approval. 

Yes, you are now committing real money that will be lost if the deal doesn’t close.  Can you lose money under this scenario?  Absolutely.  If you want to compete, however, you may need to accept this risk.

PAY TO PLAY – Ready for some real craziness?  Then how about letting a portion of your earnest money go “hard” and become non-refundable the minute the seller signs the contract? 

In the scenario above, with a $5,000 deposit… you could propose that $1,000 goes “hard” upon acceptance; $1,000 goes “hard” after inspections and the balance goes “hard” after the appraisal. 

This means before any inspection, before any appraisal, before you really have any detailed information about the property (other than what is available through public records and the MLS), you are committing non-refundable money (at least $1,000, in this case) to the transaction. 

If you choose to do this, you had better be confident about your financing, because you are putting your neck (or wallet) out from day one.  For serious buyers only.

THE “AS IS” SALE – This has become increasingly common in 2014, and I actually wrote about this back in February (when I listed and sold a home “As Is”, before it was trendy).  If you have a comfort level with the condition of the property, we include a clause in the contract that says “Inspections are for buyer’s information only.  Seller shall NOT be asked to make any repairs.” 

This takes pressure off the seller, but remember, the seller has virtually all of the leverage here.  An “average” offer isn’t likely to cut it, and if the home has serious defects, your only recourse is backing out of the contract altogether.

NO APPRAISAL CLAUSE – In a market with double digit appreciation, appraisals are an issue.  That’s because appraisers look backwards, at past sales, while buyers are looking at present demand (or even projected future value) when throwing themselves contractually at new listings. 

2014 will go down as the year of appraisal hell for real estate brokers.  Truth is, it’s really hard to get homes to appraise in this market, where values for lower end homes have been going up as much as 1% per month. 

The lender will only finance based on the lower of the contract price or appraised value.  So what does this mean in real life?

If you offer $300,000 for a home and propose a 5% down payment, your down payment is $15,000 and your projected loan amount is $285,000.  But if the property appraises for $290,000, the lender is only going to lend on 95% of the appraised value, or in this case, $275,500.  Since the contract purchase price is $300,000, your down payment requirement just went from $15,000 to $24,500.  If you don’t have the money to cover the difference, and the seller won’t lower the price (in a hot market, he won’t), you’re dead.

So buyers who have sufficient reserves for an increased down payment (or buyers who are on good terms with their parents, who may have the money) are increasingly waiving the appraisal contingency, which obviously is highly appealing to a seller who wants top dollar and minimal risk. 

And what seller doesn’t want top dollar?

THE ESCALATOR CLAUSE – Are you scared yet?  If the previous suggestions haven’t put a good shock into you, maybe this one will.  It is essentially the real estate equivalent of the “nuclear option”. 

An “Escalator Clause” written into an offer essentially says that the buyer agrees to beat any bona fide written offer submitted by a certain deadline by a fixed amount, say $1,000, all the way up to a certain capped limit.

What does that look like in real life?

If a property is listed for $250,000 and there are multiple offers, it is increasingly common to see clauses that say “Buyer agrees to beat any bona fide purchase offer submitting in writing by 12 p.m. tomorrow by $1,000, up to a maximum cap of $262,000 (or whatever number you are willing to go to).  Buyer agrees to waive appraisal objection rights and, in the event of a low appraisal, shall bring in any additional required down payment funds from a lender-verified source, with confirmation of such funding provided to seller and seller’s agent within 24 hours of receipt of appraisal.”

There are other variations of how that can be written, but you get the idea. 

This is serious stuff, and it’s not pleasant to talk about.  It is my sincere hope that you won’t have to break out these “weapons of risk and expense” in your negotiation… but it’s possible you may need to.

In 19 years as a broker, I have never seen more cutthroat competition among buyers than I have seen in 2014, and frankly, if you are working with buyers, it sucks. 

If you are looking to buy in 2014, you have to ask and answer two questions:

Where do I think prices will be a year?
Where do I think interest rates will be in a year?

If, based on your own study and research, you believe the answers to these two questions are “higher than today” and “higher than today”, you may need to break out and carefully incorporate these strategies in your next negotiation.

Because there’s a good chance the buyers you are competing with have already done so.