There is a lot of chatter in the Forums these days saying that the only way to compete with an all-cash offer is to remove all your contingencies.
Contingencies in a real estate contract are there to help buyers and sellers avoid a bad situation as they move through the due diligence process on a property prior to closing. While a “clean” offer may make it easier for the deal to finalize, it can be a very dangerous expectation to set—especially if you are just starting to invest.
What Is a Contingency?
A contingency is a clause in the contract that defines a condition or action that must be met for the sales contract to become binding. Both parties, the buyer and the seller, must agree to the terms and sign the sales contract, contingencies included, to become binding.
These added clauses enable you as the investor to acquire property on your terms and provide a way out of the contract if things go south. However, since a real estate contract is binding, it is imperative for you to understand how they are used and how to remain competitive when making offers.
Common Contingencies
Contingencies are included to protect time and money, both for the seller and buyer. For the buyer, you are protecting your earnest money as you work through the timelines of due diligence. For the seller, you are protecting your time investment in the current buyer.
Below are common contingencies you can expect to see in a real estate contract.
Inspection Contingency
This gives the buyer the right to have the home inspected within a specified time period, usually 5-7 days. It protects the buyer, who can cancel the contract or negotiate repairs based on what is found in the professional inspection report.
Appraisal Contingency
This protects the buyer and is used to ensure the property meets a minimum value. If the home does not appraise for minimum value and the appraisal was conducted within the timeline designated, the contract can be terminated. Oftentimes, this is linked closely with the financing contingency.
Financing Contingency
Only homebuyers who are obtaining lending make the contract contingent on obtaining a loan. Depending on the type of loan, the lender might require certain property conditions or repairs to make the loan. Like the inspection contingency, you have a deadline to maintain.
Related: How to Craft Real Estate Contingencies to Get the Deal You Want
Insurance Contingency
This protects the buyer, allowing a contract contingent on applying for and receiving a satisfactory insurance commitment in writing.
Title Insurance Contingency
This protects the buyer by requiring that a title company be willing and ready to provide the buyer (and lender, if there is one) with a title insurance policy. The title insurance policy protects the buyer from the possibility that the current or previous sellers didn’t have free and clear ownership of the property.
Sale and Settlement Contingency
This contingency can work in two ways, as either a buyer or seller contingency.
As a buyer contingency, you are asking that the contract be contingent on your selling and settling another home within a specified time. Be prepared for the seller to evaluate your current home listing—is the home on the market, for how much, for how long, etc.—before they accept or counter this contingency.
One way the seller can handle this contingency is to counter with a “kick-out clause.” A “kick-out clause” allows the seller to continue to market the property while under contract with the current buyer. If they find a new buyer, the current buyer has a specified time limit to remove the current sale and settlement contingency or the seller can pursue the new contract
This can also work 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 for a few days, where the seller can occupy the home (with paid or free rent) for a certain amount of time, so they can close on their next property and move.
As you move through the diligence period, keep a checklist of your contingencies and timeline, and don’t get locked into the contract because you forgot to complete a task on time. It may seem like a ton of moving parts; however, with a dialed-in due diligence checklist, good inspector, and lender, you can take care of most diligence and contingency items in the first few days of an accepted offer.
How to Make a Strong Offer With Contingencies
When offering on a property in a hot market, you will want to lower the friction for a seller to say “yes” to your offer. But that does not mean you have to remove all contingencies to be competitive (nor should you!).
Yes, an all-cash offer can be great as you immediately remove the financing contingency and, most of the time, the appraisal contingency.
Understandably, not everyone can do this. So, how can you make your offer more enticing—especially when competing in an all-cash environment?
Here’s my best tip: Ask the seller what they are looking for in their ideal offer. Just pick up the phone (or have your Realtor do it) and ask. This will help eliminate the guesswork, open a dialogue between you and the seller, and help everyone move quickly through the offer process.
Not only that, but you will also make a great impression on the seller if you show you care and then deliver on it.
Here are some other tips to make a strong offer for a motivated seller.
Highest and Best Offer
If you are going to ask for the moon on contingencies and the property is worth it, think about coming in at your best offer immediately and letting the seller know that. I’m not suggesting to overpay, but if your numbers work at full asking, the deal is smokin’, and you must have all contingencies in place, don’t mess around.
Amend the Inspection Contingency
A seller wants to know quickly if you are going to stay in the deal or not. Time is not their friend when they have holding costs on a property.
To be competitive, you can shorten up 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 remedied.
Better yet, if you are using hard money to finance the close, you could even purchase the property completely “as-is.” If you want to supercharge this contingency, combine an “as-is” inspection with a swift inspection period. The key here is having an inspection team that can move quickly, too.
Remove the Sale and Settlement Contingency
As the buyer, you could remove this contingency altogether. Do this if only if you have the ability to qualify for the loan and hold the property with other obligations in place.
I won the offer on my primary home this way by partnering with my lender to ensure I could hold my current property and new property at the same time, allowing us to beat out all other owners who needed to sell a home prior to close.
Related: 6 Effective Tips to Ensure Your Offer Gets Accepted
Be Flexible With the Seller on Other Terms
This goes back to asking the seller directly what they need. What is in it for them? Do they need more earnest money, longer close, shorter close, closing costs paid, a mover, a rent-back?
What will put their mind at ease and make their life easier? What will make your offer stand out?
I put an offer in on Christmas Eve, and won it—not because we offered the highest purchase (I actually was $10K under), but because I offered a flexible close and a free rent-back so the family could relocate to another state to take a job (making their life much easier).
How to Structure an Offer When Competing With All-Cash Bids
Competing against cash is hard. So, here is how I structure most of my initial financing offers to compete with that all-cash bid in a hot market.
- Highest and best number at the start for deals I know that will be highly competitive (no messing around!). Note: I’m not overpaying for the property.
- A reasonably higher earnest deposit
- 3-day inspection and most of the time “as-is”
- Quick close using hard money (or flexible, depending on what the seller needs)
- No sale or settlement contingency
Then, I use other terms as negotiating points as we go through the due diligence process, remembering to always look for the win-win scenario.
And if you lose out on an offer, learn from it!
Ask your team (and the seller’s team) what could have made the offer 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 the second go-around could win you the deal still!
What If You Get Cold Feet?
Now, what happens if you get through the contract contingency deadlines, your earnest money is locked in (or “hard” as we call it), and you find out something that makes you not want to buy the property?
Well, you have two options:
- Continue with the contract, close 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 to close.
Neither are pretty options (and most Realtors will never tell you to back out and lose your earnest money).
But this is a matter of when it will happen to you, not if. This could be a situation where you didn’t visit the property and were unaware of the train tracks nearby, or the changing landlord-tenant laws in the city you just discovered, or some other external factor beyond your control.
Or maybe you blanked on getting an inspection and found something drastic yourself that you just can’t deal with (it’s happened!).
If the situation is bad enough and can’t be remedied through negotiations, losing a grand or two of earnest money could be the least expensive option. My advice, if the deal does come to this, is to communicate your intent early, openly, and fairly to all parties involved, and change your systems immediately (such as your due diligence checklist) to ensure this doesn’t happen again.
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 clear contingencies swiftly, you will become known as an investor who can close quickly. And that is a great position to be in to get more deals.
So, use contingencies wisely to create a strong offer, fulfill your end of the purchase sales agreement on time, and reap the benefits of building a rock-solid portfolio.
Have you ever had to compete in a similar situation? What did you do?
Share your strategies in the comments below.
Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.
