5 Potentially risky home buyer offers in multiple offer situations

Better to take smart risks and focus on winning because, if you don't, your competition will - John Rampton.

In a hot real estate market, multiple offers on a home are the norm. When low housing inventory coincides with too many eager buyers, some buyers will resort to doing "whatever it takes" to win the home.

For some people reading this article and who live in real estate markets that are not in perpetual bidding wars, some of these actions will seem insane and way too risky.

Others, however, who are trying to purchase a home in places like San Fransisco, Boston, Austin TX, and Seattle will be all too familiar with these scenarios. 

Buying a home in a balanced market...how it's supposed to work (in theory at least).

In a balanced real estate market, the purchase process and contract paperwork are structured in such a way as to protect the buyers by including certain contingencies within the offer, i.e. conditions that need to be met for the sale to go through to closing.

Without going into the intricate details of how the home buying process works, here's a quick overview of a typical buyer offer on a home when the market is balanced:

1. The buyer makes an offer on the home. The offer price will be close to the listing price; maybe a little above, or a  little below are the actual list price.
2. The buyer and seller negotiate back and forth and then reach an agreement. They have mutual acceptance.
3. The buyer deposits their earnest money to escrow which becomes part of the buyer's downpayment if the sale proceeds all the way to closing. If the sale fails for some legitimate reason, the buyer can walk and get their earnest money back.
4. The buyer's offer to purchase the home is contingent on a number of conditions.
5. Inspection contingency: an inspection of the home, the property, and the sewer line (and/or septic system and well). In Washington State at least, the inspection contingency allows the buyer to walk from the sale for any reason, even if the home is perfect and gets their earnest money back. It's the buyer's No. 1 "get out of jail' card.
6. Financing contingency: the buyer is buying the home contingent on (1) getting approved for a loan by their lender and (2) the home passing an appraisal.
7. Title contingency: the buyer's purchase of the home is contingent on their review of the title to the property and the home getting a clean (marketable) title with no liens or other issues at closing.
8. HOA/Resale Certificate contingency: when purchasing a home that has a Home Owner's Association (HOA) such as condos, some townhomes, and some housing developments, the buyer gets to review the all the rules and regulations of the HOA, its financial reserves, meeting meetings, a copy of the last Reserve and more.  These are all contained in the Resale Certificate. 

Making offers in a strong sellers' market.

In a balanced market, or for a home that has been sitting on the market, the buyer can usually load up their offer with all the usual protective contingencies mentioned above. However, when a buyer is competing with multiple offers on a house, that same "balanced market" offer will likely be headed straight for the proverbial shredder.

If the buyer wants to get the home, unfortunately, they have to play the game and learn the rules in order to win. It can be a brutal "welcome to the market" initiation and it may take the buyers losing out on a few homes before they are willing to do what is needed to seal the deal. 

As the buyer, you will have to decide whether you want to jump in and do battle or step back on play another day and wait for the next batch of homes to come on the market.

Working with a good Realtor who is a great negotiator will definitely improve a buyer's chances of getting the home but ultimately it will come down to the buyer's comfort level with doing what might be required to get the home.

Note that for the Seattle area at least, in a strong seller's market where the sellers are confident of the home selling quickly, they will set an offer review deadline. The home will usually come on the market in the middle of the week, have open houses at the weekend and set the following Tuesday or Wednesday to review any submitted offers.

This gives buyers time to do their homework and prepare their offer by the review deadline. However, the sellers still retain the right to accept an "early offer" and not wait for the offer review deadline. So make sure that your agent asks the listing agent "if the sellers will be honoring the offer review date

Potentially Risky home buyer offers in order of increasing risk.

Risk Level 1: Including an Escalation Addendum with the offer.

An Escalation Addendum states that you are willing to match and beat a higher competing offer by a set amount of money up to a stated maximum amount

For example, say the home is listed for $500,000 and you, the buyer, can afford to go up to $550,000. Instead of coming in guns blazing and offering $550,000 and potentially over-paying for the home, you can use the Escalation Addendum.

You could, for example, offer $500,000 with an escalation up to $550,000 in increments of $5,000.

If there's a higher offer for say, $540,000, and if the seller goes with your offer you would get the home for $540,000 + $5,000 = $545,000.

The seller is legally required to provide the buyer with a full, unredacted copy of the competing offer that they used to leverage the price to $554,000. They can't just make up a fake offer.

On the upside, the buyer gets the home. However, the buyer risks paying their maximum budget for the home. If you include an escalation addendum in your offer always be prepared to potentially end up paying your maximum stated amount for the home.

Sometimes in a multiple offer situation, the sellers will come back to all the buyers and say "please submit your highest and best offer with no escalation clause". Now the buyer has to decide whether to go all-in or risk not getting the home. It's just like a game of poker, you can guess but you are never certain what cards the other players are holding.

Alternatively, now that you have revealed to the seller how much you can really afford and are willing to pay for the home, the seller might come back and say "The home is yours if you are willing to $550,00 for it" and try and bypass the escalation addendum. 

Level #2: Waiving the Inspection Contingency.

In a balanced buyer-seller market, the buyer's offer is usually contingent on doing an inspection of the home and property after mutual acceptance. Buyers know that home sellers love offers that don't have an inspection contingency because it removes the buyers' primary way of getting out of the contract and walking away with their earnest money.

Therefore, in a multiple offer situation, in order to make their offer stronger, some buyers will pay for an inspection of the home BEFORE making an offer. If the buyers proceed with making an offer, they are agreeing to buy the home as-is and not asking for any repairs, including any of the issues they might have found during the pre-inspection. Most importantly, it is now a lot more difficult for the buyers to get out of the contract if they end up getting cold feet.

Risk level Level-2.1: Some buyers who are pressed for time or who have a lot of faith in their ability to gauge the structural integrity of a home will waive the inspection contingency WITHOUT doing a pre-inspection. And it's not that uncommon.  Even if the home is brand new construction, it is very risky to go this route, even if you are desperate to get the home. You might be in for a rude awakening and some expensive surprises after you move into the home.

Don't rely on your Realtor for their advice on whether you should waive the inspection contingency without actually doing an inspection first. Realtors are Realtors, not structural engineers and trained home inspectors. 

Risk Level 2.2: Sometimes the seller will have their home inspected by a licensed inspector before listing it for sale to address any hidden issues before hitting the market. The seller will then provide a copy of that inspection report to interested buyers in the hope that they will waive the inspection contingency in their offer.

Home inspections can be expensive so it can be tempting for the buyer to accept the seller's inspection report to save some money. However, the buyer has no way of knowing if the inspector who did the inspection was competent and knew what they were doing. For more on this subject, read this informative article.

Risk level 3: Partially, or completely waiving the Appraisal/Financing Contingency.

When there are multiple offers on a home, buyers are always wary of having to compete with the dreaded ALL CASH offer. Sellers love cash offers because they can close quickly and more importantly, the buyer's purchase of the home is not contingent on a lender appraiser, because there is no lender.

Yes, sellers love offers that are well above the list price, but not if there is little chance that the home will pass an appraisal at that elevated price. Savvy sellers know that the highest price is not always the best offer and that they need to consider all aspects of the offer, not just the price. 

As mentioned above in the "balanced" market offer scenario, when an offer contains a financing contingency, the buyer is buying the contingent on getting approved for a loan, part of which is the home passing an appraisal.

For a multiple offer situation, some buyers will attempt to improve the appeal of their offer by trying one of the following.

Level 3.1: partially waiving the appraisal.

When a buyer offers to partially waive the appraisal, they are telling the seller that in the event that the home appraises for less than the agreed-to sale price, that the buyer will bring a specific additional amount of cash to closing.

So, back to that home listed for $500,000 where the sale price ended up being $550,000 because the buyer's offer was escalated all the way up to their maximum price.

The buyer's offer also included an Increased Downpayment For A Low Appraisal addendum (in Washington State) for $20,000. This addendum essentially states that in the event of a low appraisal, the buyer promises to bring up to an additional $20,000 in cash at closing to offset the low appraisal.

If the appraisal comes in at only $510,000, the buyer would then bring that extra $20,000 to closing and the seller would get $530,000 for the home. 

Risk level 3.2: fully waiving the appraisal contingency and by default, the whole financing contingency.  

For buyers who are relying on financing (a mortgage) to purchase their home and who want to make their offer "as good as cash", they will sometimes decide to submit an offer that is not contingent on appraisal, no matter what the appraisal value ends up being.

For the same home purchase mentioned above with an agreed-to sale price of $550,000 and where the appraisal again comes in at $510,000, for the buyer who completely waives the appraisal, they will now have to bring an additional $40,000 in cash to the closing table. The buyer cannot wiggle out of the contract if they don't like the appraisal result. They could try to contest the appraisal but good luck with that, plus since they waived the appraisal, the sellers don't care and the buyer has to move on to closing regardless.

It is important to understand that if the home buyers are fully waiving the appraisal contingency in their offer, they must also waive the WHOLE financing contingency and not include one in their offer.

Why? Because the appraisal contingency is contained within the financing contingency and so to completely remove the appraisal clause, the whole financing contingency must be left out of the offer. The buyer cannot just cross out the appraisal portion of the financing contingency because that leaves the rest of the financing addendum in place. That remaining part of the addendum could be leveraged by the buyer to potentially get out of the contract by saying that they failed to qualify for financing. 

A buyer who is relying on a loan to buy a home and who waives the financing contingency is potentially making a very risky offer:

• How much above the actual market value of the home are they offering?
• Realistically (be honest), will it pass an appraisal at that sale price?
• If the appraisal comes in really low, does the buyer have that extra cash available to make up the difference or are they just crossing their fingers hoping it will pass?
• By waiving the financing contingency, if the buyer loses their job between getting their offer accepted and closing day, are they OK with forfeiting all the earnest money? A lender will not give a mortgage to an unemployed buyer. Not having a financing contingency means that the buyer cannot get out of the contract based on not qualifying for the loan due to their job loss.

Note that if the buyer is relying on a mortgage to buy the home and is waiving the financing contingency so that they look like an all-cash offer, the buyer is still required to disclose to the seller that they are relying on contingent funds and will need to include a Proof of Funds Addendum in their offer. Buyers who pretend they are buying will all cash will be caught out when the seller asks for copies of their banking statements.

Risk level 4: Making the earnest money non-refundable and releasing it to the seller.

Usually, within two days of the buyer and seller reaching mutual acceptance, the buyer will deposit their earnest money to the closing agent (escrow in Washington State) or to their agent's brokerage trust account. If the sale goes all the way to closing, this earnest money will go toward the buyer's downpayment. The sellers do not get access to this money until closing day.

Earnest money is considered a good faith deposit from the buyers demonstrating that they are serious about buying the home and that they are willing to forfeit that money in the event that they break the contract without the right to do so.

The most earnest money that a buyer can legally forfeit is 5% of the agreed-to sale price. In multiple offer situations, the seller will sometimes push the winning offer to agree to depositing 5% earnest money. So for the $550,000 sale above, 5% earnest money would be $27,500.

Some buyers, who really, really want that home, will make their earnest money NON-REFUNDABLE and agree to release the money to the SELLER, not escrow, within 2 days of their offer being accepted.  Some buyers will go a step even further by offering higher amounts of non-refundable earnest money, 10% or higher.

Yes, the buyer is willing to hand over a huge amount of money to the sellers with no recourse for getting that money back in the event the sale fails to close. The sellers get an early, pre-closing windfall are free to do with that money as they please.

If the buyers fail to secure a loan to buy the home for ANY reason, good luck getting that money back. Obviously this strategy is not for the faint of heart and the buyers need to have extra cash in reserve to allow for all scenarios including paying all-cash for the home!

Risk level 5:  waiving the Home Owners Association review.

While not level-5 in terms of being the riskiest, this one only applies to homes that are overseen by  Home Owner Associations (HOA). However,  a buyer who waives their right to do a review of the HOA could be in for a big financial hit after closing.

Buying a condo, in particular, involves doing a lot more due diligence compared to buying a house. A condo buyer's offer usually has a clause stating that their offer is contingent on a full review of the HOA which includes are all documents contained within a giant PDF called the Resale Certificate.

The Resale Certificate contains all the information the buyer needs to make an informed decision as to whether the condo development is well run or they should run in the opposite direction. It contains copies of the rules and regulations (CC&Rs), copies of HOA meeting minutes (a good source for information on current issues), current financial statements plus a copy of the latest Reserve Study (if they actually did one).

So why is reviewing this so important? Because if you waive your right to do so, you could end up buying a condo with a $30,000 special assessment to pay for new windows and siding, the HOA may have very little money in the checking account, is currently in an expensive and protracted lawsuit with the builder, and worst of all, your best friend Fido can't move in with you (there's a NO DOGS policy!)

 Note that the seller must still provide the buyer with a copy of the Resale Certificate even if the buyer says they are waiving HOA review clause.  

A good listing agent will have the Resale Certificate available at the time the condo is listed for sale so that interested buyers can review it before making an offer. If a copy is not available, then it can take up to 10 days to order one.  So now, in a multiple offer situation, when a copy of the Resale Certificate is not available (yet), an eager buyer has to decide whether to waive the HOA review contingency.

So, in summary,  in relation to Potentially Risky Home Buyer Offers In Multiple Offer Situations...

It's a case of risk is relative! A buyer offer with most or all contingencies waived might be a huge risk some buyers, but a lot less risky for others. Factors such as the buyer's financial reserves, the age, and condition of the home, plus how far above the listing price the buyer had to go to win the home will all affect the level of risk.  Know your limits and be willing to walk away and wait for the next home. There will always be more homes.

Here are some additional related articles that you may find helpful:

How Not To Make An Offer On  A Home from Karen Highland describes some of the things to avoid when submitting an offer on a home including antagonizing the seller by submitting a low ball offer. Then she tells you what you actually need to do.

How To Be The Winning Offer When There are Multiple Offers from Bill Gassett details some of the tactics buyers can use in multiple offer situations including waiving the inspection, writing a personal letter to the sellers and using an escalation addendum.

How Does The Home Appraisal Process Work? The appraisal is usually the last major hurdle to clear before moving on to closing. Paul Sian explains the appraisal process in full including what happens in the event of the appraisal coming in low.

10 Things To Avoid When Buying a Home. Sharon Paxon provides a handy list of items that home buyers should be keeping on eye including plumbing and electrical issues and pest issues. Get an inspection!