Making an Offer - Strategy, Price, and the Real Estate Agents
Writing in offer is key to the purchase of a new home, and if you're in a hot area of the city you definitely need to know how to structure a good offer in cases of bidding wars. To understand what makes up a solid offer, you have to understand what a solid offer represents. So to begin, we need to understand the goals of the Listing Agent and Buying Agent and what their modus operandi is.
In every real estate transaction, there are two sides: Seller and Buyer. On each side there is a real estate agent --- sometimes this can be the same person representing both sides. If two agents are involved, both agents are paid out of the proceeds of the SELLER and therefore the Buyer is not obligated to pay any commissions. Listing Agent's receive 3.2% of the final sales price for marketing the listing, conducting open houses, and bringing traffic to the home and representing the Seller's interests. The Buyer's Agent receives 2.8% of the final sales price for ultimately bringing in the final Buyer and representing the Buyer's interests. This creates an environment where both sides are equally represented. Sometimes the Seller represents themself as a "For Fale By Owner" and only a Buyer's Agent is involved. Other times there are lawyers only, and no agents, however, 95% of all listings have a Listing Agent that is a real estate broker.
Now, we understand the Listing Agent's M.O.: representing their Seller and commissions. That will truly help us structure our deal because we understand what the Listing Agent wants for their Seller: the highest price for their home, the most qualified individual to purchase the home, and the quickest closing possible to complete the transaction in a timely manner. Each line of the offer should somehow increase one of these to make your offer more appealing. There are several key places in the Purchase Contract that real estate agents in Colorado look for reference:
-Section that explains how closing costs are to be paid (by Seller, by Buyer, or split between both)
-Section explaining purchase price, down payment, new loan amount, and earnest money
-Table of dates and deadlines for understanding timeframe of closing on new property
-Additional Provisions section for any extraordinary circumstances
Additional Provisions can make or break an offer in situations where their are multiple offers. There are three other pieces your real estate agent should know how to use in the strategy of preparing your offer:
---- -Escalation Clause - this is a way of automatically raising your Purchase Price in a case of mutliple bids. It is written in legal-ese, but the jist of the escalation clause says 'my current purchase price is X, if any other offers beat mine, I will raise my purchase price in increments of Y until I reach my maximum price of Z'
----- Appraisal Gap Coverage - this clause is used in conjunction with the Escalation Clause. When a property is super hot, the property price may be bid WAYYYYYY above what it's actually worth. The worst-cast I've heard is a home worth $1.3 million dollars getting bid up to $1.8 million. In this case, there is $500,000 worth of potential LOSS to the Seller. We'll get into this later. So in this case, to cover the $500,000 "gap" in appraisal, we write in a clause that somes something in legal-ese to the jist of 'if the property ends up being worth LESS than my offered purchase price, I will agree to pay X dollars out-of-pocket, in cash, to cover the gap between appraised value and purchase price'. This powerful tool will need an example to help visualize it
----- Post-Occupancy Agreement/Leaseback - this one is easy to understand. Some Sellers are not ready to move out in 30 days or less and need more time to move out. Offering the Seller a rent back period at $X.xx/day allows them to move out, gives the Buyer a small price discount, and increases the appeal of your offer. In some cases, it is a Seller's tenant that needs time to move out because they are leasing the property. In this case, you'll be collecting rent until the lease is completed.
Now that we have a working knowledge of the offer structure, here is the list of priority in the Listing Agent's eyes:
1. Purchase Price
2. Proof of funds (Cash) / Pre-approval Letter (if Financed)
3. Closing Date for quick transaction (10-days, 20-days, 30-days, 45-days)
4. Post-Occupancy Agreement offer
5. Escalation Clause
6. Appraisal Gap Coverage
This is the normal list of priorities, each transaction is different, some pieces may be higher up on the list depending on situation... and your real estate broker should know how to prioritize by CALLING the Listing Agent prior to making the offer.
Now for an example of a well structured offer:
--- Listing Agent has received 11 written offers on a property.
--- Listing Agent not revealing price of offers (but for our example the highest offer is an FHA loan of $400,000 with 3.5% down, with escalation up to $410,000, an appraisal gap of $10,000 in increments of $1,000, with a 14-day rentback)
--- Listing Price was $395,000
Your real estate agent has determined that the value of the home should be $405,000. You really want this house and are willing to pay $420,000 with your conventional loan and 20% down. Your real estate agent writes in an escalation clause up to $420,000 in increments of $2,000. Due to value being $405,000 and your offer being up to $420,000, your agent writes an appraisal gap coverage of $15,000. You offer a 30-day rentback agreement.
Your offer causes a lot of ripple effects due to the legal language:
1. Offer one increases to $401k
2. Offer two increases to $403k
3. Offer one increases to $404k
4. Offer two increases to $406k
5. Offer one increases to $407k
6. Offer two increases to $409k
7. Offer one increases to $410k
8. Offer two increases to a final purchase price of $412k.
9. At appraisal time, the property's true value comes back at $403,000 leaving you with $9,000 to cover out of pocket in cash at closing to make the purchase price stay at $412k as agreed.
10. Tenant stays in property for 25 days and you finally move in on day 26!
It's a little complex, but in the end, this complicated process is what won you the house. Without any element of your offer, you would have lost to the prior offer. If you didn't have appraisal gap coverage, the listing agent would have chosen the safer option of offer one. Without escalation clause, the agent would've chosen a better price of offer one. No rentback, and offer one sounds better so they have more time to move out.
It's not always possible to foresee every scenerio to make your offer the most appealing, but you should definitely have the discussion with your real estate agent prior to making an offer. He/she should be able to tailor the offer in each transaction to be the best it can possibly be. Email me with any questions!! I love talking about this stuff =)