There is a lot of buzz in the forums these days saying that the only way to compete with an all-cash offer is to remove all its contingencies.
Contingencies in real estate contracts are meant to help buyers and sellers avoid worst-case scenarios after they go through the due diligence process on a property before closing. While a “clean” offer can make it easier to finalize a deal, it can be a very dangerous expectation to set – especially if you’re just starting to invest.
What is a contingency?
A contingency is a clause in a contract that defines a condition or action that must be met for the contract of sale to become binding. Both parties, the buyer and the seller, must agree to the terms and sign the contract of sale, including the contingencies, for it to become binding.
These added clauses enable you as the investor to acquire the property on your terms and provide a way out of the contract if things go wrong. However, since a real estate contract is binding, it is imperative for you to understand how to use them when making offers and how to stay competitive.
general contingencies
Contingencies are included to protect time and money for both the seller and the buyer. For the buyer, you are protecting your earnest money by working through due diligence deadlines. For the seller, you are protecting your investment of time in the current buyer.
Below are common contingencies you can expect to see in a real estate contract.
inspection contingency
It entitles the buyer to inspect the home within a specified time period, usually 5-7 days. This protects the buyer, who can cancel the contract or negotiate repairs based on the findings of the professional inspection report.
valuation contingency
This protects the buyer and is used to ensure that the property meets the minimum value. If the home does not appraise for the minimum value and was appraised within the stipulated time frame, the contract can be terminated. Often, it is closely tied to the financing contingency.
funding contingency
Only homebuyers who are availing the loan make the contract contingent upon availing the loan. Depending on the type of loan, the lender may require certain property conditions or repairs to be made in order to make the loan. Like the inspection contingency, you have a deadline to maintain.
Connected: How to prepare for real estate contingencies to get the deal you want
insurance contingency
It protects the buyer by allowing a contract contingent upon applying for and obtaining a satisfactory insurance undertaking in writing.
title insurance contingency
This avoids the need for the buyer to be willing and ready to provide the buyer (and the lender, if any) with a title insurance policy. The title insurance policy protects the buyer against the possibility that the current or previous sellers did not have free and clear ownership of the property.
sale and disposal contingency
This contingency can work in two ways, as a buyer’s or seller’s contingency.
As a buyer contingency, you are asking that the contract be contingent on you selling and subletting your second home within a specified time. Be prepared to have the seller evaluate your current home inventory—the home has been on the market, for how long, for how long, etc.—before accepting or contesting this contingency.
One way sellers can handle this contingency is to counter with a “kick-out clause.” A “kick-out clause” allows the seller to continue marketing the property under contract with the current buyer. If they find a new buyer, the current buyer has a specified time frame to remove the current sale and settlement contingency or the seller can pursue a new contract.
It can also serve as a seller contingency, where the seller will close on the property based on finding a replacement property to move into post-close. A buyer can counter this clause by including a “rent-back” provision, where the seller can occupy the home (with paid or free rent) for a certain period of time, so that they can move to their next property. Stop and move on.
As you move through the due diligence period, keep a checklist of your contingencies and timeline, and don’t get locked into a contract because you forgot to complete a task on time. It may sound like a ton of moving parts; However, with a dial-in due diligence checklist, good inspector and lender, you can take care of most of the due diligence and contingencies in the first few days of an accepted offer.
How to make a strong offer with contingencies
When offering a property in a hot market, you’ll want to reduce friction in order for a seller to say “yes” to your offer. But that doesn’t mean you have to forego all contingencies in order to be competitive (nor should you!).
Yes, an all-cash offer can be great because you remove the immediate financing contingency and most of the time, the valuation contingency.
Obviously, not everyone can do this. So, how can you make your offer more attractive—especially when competing in an all-cash environment?
Here’s my best tip: Ask the seller what they’re looking for in their ideal offer. Just pick up the phone (or have your realtor do it) and ask. This will help eliminate the speculation, open up a dialogue between you and the seller, and help move everyone through the offer process faster.
Not only that, if you take care of yourself and then follow through, you’ll make a good impression on the seller as well.
Here are some other tips for making a strong offer for the motivated seller.
highest and best offer
If you’re going to ask for the moon over contingencies and the property is worth it, think about getting in your best offer right away and let the seller know that. I’m not suggesting paying more, but if your numbers work on full demand, the deal is smoking, and you should have all contingencies covered, don’t mess around.
Modify inspection contingency
A seller wants to know quickly whether you will stay in the deal. Time is not their friend when they have holding costs on assets.
To be competitive, you can shorten the inspection period to 3-5 days. You can also make your offer “as is” and only ask for major health and safety items to be addressed.
Better yet, if you’re using hard money to finance the close, you can buy the property completely “as is.” If you want to supercharge this contingency, combine an “as is” inspection with an accelerated inspection period. The key here is an inspection team that can also move quickly.
Eliminate the sale and settlement contingency
As the buyer, you can remove this contingency entirely. Do this only if you have the ability to qualify for the loan and have the property with no other obligations.
I partnered with my lender to win the offer on my primary home in a way that ensured I could keep my current property and new property at the same time, allowing us to beat all other owners Found those who needed to sell the house before closing.
Connected: 6 Effective Tips to Make Sure Your Proposal is Accepted
Be flexible with the seller on other terms
This goes back to asking the seller directly what they need. What’s in it for them? Do they need more honest money, a longer closing, a shorter closing, paying closing costs, a mover, a rent-back?
What will put their mind at ease and make their life easier? What will make your proposal special?
I made an offer on Christmas Eve, and won it—not because we made the highest buyout offer (I was actually under $10K), but because I offered a flexible closing and a free rental return so that Families can relocate to another state to take up jobs (making their lives a lot easier).
How to structure offers when competing with all-cash bids
Competing against cash is tough. So, here’s how I make the most of my opening financing offers to compete with that all-cash bid in a hot market.
- Highest and best numbers initially for deals I know this will be highly competitive (no messing around!) Note: I am not overpaying for the property.
- reasonable excess earnest money deposit
- 3-day inspection and most of the time “as is”
- Close immediately using hard money (or flexible, depending on what the seller needs)
- no sale or disposal contingency
Then, I use the other terms as negotiating points as we go through the due diligence process, always remembering to look for a win-win scenario.
And if you lose an offer, learn from it!
Ask your team (and the vendor’s team) what could have made the offering stronger. Take notes and follow up on that deal every week until the property closes. Contracts fall through all the time. Your ability to follow up and make an even stronger offer in the second go-around may still get you the deal!
What if you get cold feet?
Now, what happens if you get through the contingency deadline of the contract, your earnest money is locked up (or “hard” as we call it), and you discover something that makes you want to sell the property? Don’t want to buy?
Well you have two options:
- Continue with the contract, close on the property, and deal with the issue yourself.
- Back out of the contract, lose your earnest money, and maybe risk getting sued by the seller for closing.
Neither are pretty options (and most realtors would never ask you to back out and lose your earnest money).
but it’s When it will happen to you, no If, This could be a situation where you didn’t visit the property and were unaware of a nearby train track, or were unaware of the changing landlord-tenant laws in the city, or some other external factor beyond your control.
Or maybe you blanked upon receiving an inspection and found yourself stuck with something you just can’t deal with (it’s happened!).
If the situation is bad enough and cannot be resolved through negotiation, losing a grand or two may be the least expensive option. My advice, if the deal comes to this, is to state your intention quickly, openly and fairly to all parties involved, and immediately change your systems (such as your due diligence) to ensure that checklist).
conclusion
Contingencies can protect you, your earnest money as the buyer, and your time as the seller, as you work through the due diligence progress. If you can head off contingencies fast, you will be known as an investor who can make quick closures. This is a good position to get more deals.
Hence, use contingencies wisely to make a strong offer, fulfill your end of the purchase sale agreement on time, and reap the benefits of building a rock-solid portfolio.
Have you ever had to compete in a similar situation? What have you done?
Share your strategies in the comments below.
Note by BiggerPockets: These are the views expressed by the author and do not necessarily represent the views of BigPockets.
