REAL ESTATE DOLLARS AND SENSE

In a typical California real estate transaction, the California Association of Realtors (CAR) Residential Purchase Agreement (RPA) provisions for contingencies to allow a buyer to back out of their contractual obligation to purchase a seller’s property without losing their earnest money. This earnest money or “good faith” deposit is a substantial amount of “at-risk” money that is limited by California law to no more than 3% of the purchase price of the property. In this issue of Real Estate Dollars and Sense, I will walk through the most common forms of buyer contingencies.

Section 3I of the RPA describes the terms for the Appraisal Contingency. The intent of the Appraisal Contingency is to protect buyers and their partner (i.e. their Lender) from overpaying for a property. If a property does not appraise for (at least) the purchase price of the home within the Appraisal Contingency period (17-calendar days from Contract Acceptance by default), a buyer is well within their right contractually to renegotiate the price of the home or cancel the contract and receive their earnest money back. The Appraisal Contingency is probably the single largest perceived risk or pain-point for a seller. For this reason, buyers sometimes choose to submit offers to sellers with no appraisal contingency in place as a way for their offer to stand out in competitive markets. This, however, does not come without risk. Specifically, if an appraisal comes back below the contract purchase price with no Appraisal Contingency in place, the only buyer recourse would be to either renegotiate the purchase price of the home or to increase their down payment to bridge the gap between the reduced loan amount from the lender (given the lower appraised value and the loan-to-value (LTV) ratio) and the contract price of the home. This may or may not be a deal-breaker for a buyer depending on a buyer’s available funds and their propensity to increase their cash outlay for their new home purchase.

Section 14B(1) outlines the time period (17-calendar days from Contract Acceptance by default) within which a buyer is contractually obligated to satisfy themselves with the condition of the property. While a home inspection by a licensed and qualified home inspector is typically a good place to start, further inspections by electricians, plumbers, HVAC technicians, pool/spa repairman, mold specialists, roofers, and structural engineers may be required, to name a few. In addition to the physical home, there is other material information that buyers would be wise to review prior to removing the Inspection Contingency. For example, for homes in planned communities, a review of the HOA Meeting Minutes and HOA Financials can provide valuable information on any dues increases or special assessments and ensure that HOA reserves are adequately funded.

Section 4 of the RPA provisions for the situation where a buyer is only able to complete the purchase of their new home (or “upleg”) after the sale of their current home (or “downleg”). This is typically the case when the equity of the downleg is required as the downpayment for the upleg. The Sale of Buyer’s Property Contingency contractually allows for a period of time wherein a buyer must successfully close on the sale of their current home. If a buyer fails to sell their home within this timeframe, a buyer may cancel their upleg purchase contract and receive their earnest money back. The extent to which a seller may accept an offer with a Sale of Buyer Property Contingency provision in place depends on several factors. First off, it is highly market dependent as sellers (all things being equal) would rather accept an offer from a buyer that does not need to sell their current home as this adds risk to their transaction. Secondly, it depends upon how far along a buyer is in the sale of their downleg. For example, a buyer that includes a Sale of Buyer Property Contingency in their offer but has not yet listed their property for sale will have a difficult time getting their offer accepted. On the other hand, a buyer whose downleg is in escrow with all contingencies removed and is a week away from closing escrow will have much more success in getting their upleg offer accepted with this contingency in place.