Contingent Real Estate Offers—The Efficient Assignment of Risk
There are a lot of theories out there regarding the use of contingencies in real estate offers. Unfortunately many agents and buyers shift towards absolutes, such as “all offers have to be non-contingent in this hot seller’s market” or “the buyers should always have a financing contingency because you never know what the bank might do.” The problem is that “rules” like these do not take into consideration the particular facts of a transaction, property, buyer, or seller.
The best approach is to collect and analyze all of the information available and include any contingencies that are necessary, but only those contingencies that really are necessary. Although this sounds simple, it is not always done that way. Much of this analysis should occur long before the buyer identifies the target property. For example, a well advised client will know the maximum amount of a loan for which they will qualify well before they put in an offer. A good loan officer will provide candid guidance when the buyer is getting too close to their limit. If the loan officer says that buyers should always have a contingency, then the buyer should consider finding a different loan officer. Similarly, a good real estate agent will tell a buyer whether a home is likely to appraise. If it might not appraise, then the buyer should decide whether that matters to them and whether it impacts their ability to get the loan. If they are putting enough down, or they have extra cash to put down, then it may not. On the other hand, a buyer that can only proceed if the property appraises for the full purchase price should consider the inclusion of a contingency even if it could jeopardize their chances of getting the property.
Naturally, sellers will assume the worst when they are evaluating an offer with a financing contingency. After all, why would a buyer ask for the ability to walk away from a transaction if they don’t get financing unless they really believed that there is a material chance that they won’t be approved for the required loan? Although some agents are instructed always to recommend inclusion of a financing contingency, even if the buyer is strong, sellers will wisely assume that the buyer’s finances are in question if the buyer sees the need for a contingency. Thus, a wise buyer will only include a contingency if they really doubt whether they will be approved.
Some overly conservative agents actually warn sellers against accepting a non-contingent offer. The rationale is that sellers should give buyers an opportunity to inspect the property and cancel the deal if they are not satisfied so as to avoid a potential lawsuit. I believe this is unnecessary and unwise, especially in multiple offer situations, because the language included in the PRDS contract that is used in most local real estate transactions is so broad and subjective. Buyer’s remorse could lead a buyer to concoct a reason to get out of the contract under the property contingency, even if there is nothing wrong with the property in the seller’s eyes. This would leave the seller in the unenviable position of having to go back to the other buyers and try to recreate the excitement of offer day.
There is always a cost to the inclusion of a contingency. The key question is whether the actual risk avoided justifies the cost of the contingency.
