Here’s the conclusion of my article about buyer and seller contingencies in sales contracts. These are contracts contingent on buyers selling their existing home and sellers finding a suitable replacement home. This is the mark of a normal housing market, and crucially required to increase inventory.
Create More Inventory with Contingencies – Part 3
As Part 1 and Part 2 explained, before the crash of 2008 our housing market was long accustomed to adding buyer and seller contingencies into sales contracts for homes. Sellers are usually also buyers of their next home, and most buyers have an existing home to sell. Contingencies allow a sale to close only if the seller has found a suitable next home, and if the buyer can successfully close the sale of an existing home.
Without contingencies, potential sellers are afraid to list their homes for sale because with limited inventory they may be unable to find another home, and could become homeless. On the other side, well qualified buyers usually need to coordinate selling their existing home in order to purchase.
It’s a cycle, and without contingencies it’s a broken cycle. Inventory can only increase as agents guide their clients back into the old ways of relying on these contingencies, and restore the market to its normal condition. Part 3 now examines, what are the costs and risks?
What’s At Stake with Buyer and Seller Contingencies
When a buyer asks for a sales contingency, time is mostly what’s at stake for the seller. Ordinarily, taking your home off the market, counting on a single buyer to make it all the way to closing, means you have to qualify your buyer. But when that buyer asks for a sales contingency, you now have two levels of qualification required: the marketability of the buyer’s house, and the purchasing power of THEIR buyer (the second-level buyer). You have to assess this additional risk.
Granting a sales contingency usually calls for a larger amount of earnest money. Not only this, but the earnest money often “goes hard” – which means it irretrievably transfers to the seller – either as soon as the contingency is granted, or at a specified stage in the closing process. If the buyer defaults on the stipulations, that money is lost.
A seller’s potential lost time if a buyer fails to make it to a successful close is compensated by adequate earnest money. Sellers usually also have plans to buy, so lost time can also have a leveraged effect on their plans beyond a simple “time off market” value.
Granting a 30-day sales contingency at the beginning of selling season may be worth it to you, because if things fall through you still have the summer market to sell in. However, granting one towards the end of the selling season may mean your risk is higher because you could be pushed to next year if the deal falls through.
Ideally, all risk on all sides is paid for. If you list your home for sale based on a suitable-housing contingency to allow you to find your next home, this risk to the buyer will affect how your potential buyers negotiate with their own requirements.
Most sellers won’t grant a sales contingency unless a buyer’s home is already under contract – usually already past its inspection contingency and ideally past the appraisal contingency. Failing this, earnest money may have to go hard immediately. If buyers can’t show that their existing home is very likely to close, sellers take on more risk, which means harder money.
Diligent agents have to make sure the fundamentals of both sides are sound. When parties ask for contingencies, they make confidential information available to the other side. Each side needs to be sure that the other party is acting towards a successful transaction.
If my client is a seller and is asked for a sales contingency by a potential buyer, we’re now dependent on that buyer’s house selling, so I have to make sure that the buyer’s house is strong enough to close. But I also I have to know that whoever makes an offer on my buyer’s home is strong enough to close. So I have our buyer, and another buyer at a second level to consider.
If our buyer’s home is not through appraisal yet, I’ll run my own Comparative Market Analysis (CMA) to see how the house is positioned in the market. I’ll also get permission to contact the loan officer for the other buyer in the chain, the second-level buyer, to make sure financing is strong.
I’ll also consider if the lender itself is strong. Many deals have fallen through in recent years because large lenders have been incompetent, and agents have learned who can make it to closing and who can’t.
Two good agents representing a buyer and seller each protected from risk by contingencies can help keep the wheels of a normal real estate market turning smoothly. Such a transaction can come to a successful close where no one forfeits money and everyone wins.
Contingencies are necessary for increased inventory.
