Real Estate MattersThe truth about non-contingent offers
by Michael Repka
Silicon Valley real estate buyers often face a quagmire: Should they take the risk of submitting an offer that is not contingent upon obtaining financing approval or a property inspection, or take the risk of losing the house because their offer is not competitive with the other buyers in a multiple-offer situation?
While many real estate agents are quick to speak in absolutes on this issue, either believing that a competitive offer always has to be non-contingent or a well-advised buyer should never take on that much risk, the correct answer is a resounding "it depends." The key is managing the risk and analyzing the situation.
Analyzing the transaction
It goes without saying that sellers like "clean" offers and will gravitate towards offers with fewer contingencies or "outs" between the offer date and the closing. However, the true cost to a seller of accepting a contingent offer is directly tied to the cost associated with a buyer backing out of a transaction. In multiple-offer situations the real cost is often quite high because a failed transaction will result in the property coming back on the market after the excitement and competition has subsided.
However, the opportunity costs may be much lower if there is one offer on the table. Therefore, it is inherently logical and economically rational for a seller to demand a higher premium for a contingent offer when other offers are on the table.
While consideration of the number of offers in play is a good start, the analysis should not stop there. A prospective buyer should consider their intended use and personal circumstances. For example, the amount of protection from a property-inspection contingency would be significantly less to a buyer that intends on razing the current structure to build their dream home when compared to the protection afforded to a buyer that thinks the home is in move-in condition. Also, buyers should carefully review disclosures and inspection reports in search of "red flags." Significant items such as foundation cracks or settling, disclosed or noted water damage or a musty smell should dissuade buyers from assuming extra risk.
Utilizing superior information
The party with access to superior information is often in a better position to handicap risk. For example, when a buyer submits an offer that is contingent upon obtaining financing, the buyer is inviting the seller to speculate into the buyer's ability to perform. Even with a pre-approval letter, the seller runs the risk of having to bring the property back onto the market weeks after the initial excitement has died down. Naturally, the seller will have a cautious level of skepticism.
If the buyer has the strong credit, good income and sufficient reserves required by the bank, he may be paying a hefty premium in terms of increased purchase price to compensate the seller for an assumed level of risk that is overstated. Thus, this strong buyer may be better off assuming the risk of submitting an offer without a financing contingency rather than increase the purchase price to induce the seller to accept a risk that they may overstate.
What will the purchaser do during the inspection period?
Occasionally, a buyer will submit an offer with a property-inspection contingency yet they have no interest in paying $400 to $500 or more for an additional inspection. This buyer should consider the wisdom of weakening the offer when no additional reports are forthcoming.
Additionally, the well-advised buyer will consider the reputation and financial strength of the original inspector. If the original inspector is reputable and satisfied the standard of care imposed on home inspectors under California Business & Professions Code Sec. 7196, then it is unlikely that another inspector will find material defects missed by the first inspector. If the original inspector missed something that would be uncovered by a reasonably competent inspector then the buyer may have a cause of action against the original inspector.
Alternatives to contingent offers
Before submitting a contingent offer the buyer should consider whether there are less objectionable alternatives. If the buyer is concerned about the cost to repair the roof then they may want to ask the seller if the buyer can get an estimate before submitting the offer. If the buyer needs to sell another property to purchase the target property then they may want to consider whether an option to purchase the home would be a better way to go.
In the end, the real question isn't whether a buyer should or shouldn't submit non-contingent offers. Rather, the real question is: When is the risk justified in light of the potential benefit to the buyer?
Michael Repka, managing broker and general counsel for DeLeon Realty, Palo Alto, formerly practiced real estate and tax law in Palo Alto. He serves on the Board of Directors of the California Association of Realtors. He can be reached at MichaelR@DeLeonRealty.com.