Avoid the competition.
As a realtor, this is what I focus on: finding properties that my clients can buy at a discount and improve or, at the least, buy without getting into a bidding war.
How can you avoid the competition? By staying away from the move-in-ready HGTV gems and pursuing properties that might need a little work. The fall-off in competition when you look at properties that need even an iota of cosmetic fixing — it amazes me.
Here’s what you do: search your local listings for homes that didn’t immediately sell. In LA, that means homes that have been on the market for even just a week, though the timeline is probably different in your market. These homes may need a new coat of paint or an upgrade in the kitchen. If your agent can’t help you navigate these kinds of cosmetic fixes, get a new agent.
Also consider out-of-the-ordinary property types. My favorite move is to buy a duplex instead of a starter home. There’s less competition in the multifamily sector, and a duplex gives you options. You can rent the second unit to a tenant to defray the cost of your mortgage, or you can live across both units. Maybe one side is your primary living quarters and the other side is a home office/screening room/guest house. Get creative and have some fun!
Communicate with the listing agent.
If you’re a buyer, tell your agent to do this, and if you’re an agent, you better be doing this.
You want to be in touch with the listing agent a little more than you think is necessary for three reasons.
One: you need to understand what the seller wants. Sometimes you don’t get much of an answer, but by asking, sometimes you find out that the seller wants a longer escrow or a lease-back after the close of escrow. Knowing what the seller wants allows you to put it in your offer which will make your offer stand out.
Two: you need to understand this listing agent’s process. Some agents present offers to their sellers as they come in. Some agents have an offer deadline, as which point they present to the seller all offers at once. If you don’t know the listing agent’s schedule, you might screw up your chances of winning the bidding.
And three: you want to be a familiar voice. Call the listing agent to ask a few questions, to let her know an offer is on the way, to let her know you’ve submitted the offer. You want as much humanity behind that offer as possible, and you won’t have that human connection if you just quietly traipse through the open house and never call.
Write a letter.
In the Los Angeles market, letters are very common, but hardly any buyer understands the purpose of the letter.
The purpose of a letter is to assure the seller that you are the most reliable buyer. One aspect lacking from the offer itself is an indication of how you, the buyer, will perform during the escrow process. This really matters to the seller; most sellers would prefer a slightly lower offer with slightly worse terms from a buyer whom they know will close the transaction than a better offer with better terms from a super flakey buyer.
How do you communicate to the seller that you’re the most reliable buyer? In two ways: 1) you mention how financially secure you are, and 2) you convince the seller that you love their house so much, nothing could cause you to cancel the contract.
The trick is to wrap these two messages into a pleasant, not-pushy letter introducing yourself to the seller. You’re going to say what you do for a living, and this is where you subtly hammer home your financial stability. If you’re been at the same company for many years, if you’ve recently been promoted, if you’ve won an award for your achievements — share these things.
When it’s time to gush over how much you love this particular property, don’t take this as an opportunity to kiss the seller’s butt for their choice in paint color or furniture. Instead, tie the home into your future plans. If your interest in the home is tied to a child or a future child or an aging parent, then you clearly won’t let a plumbing problem or a financing hiccup prevent you from closing on the transaction. Talk about how the second bedroom is the perfect nursery for your expected child, that your current child is already obsessed with the back yard, that the location is perfect for visiting your ailing mother. Tying the property into the significant elements of your life will demonstrate a sincere motivation to complete the transaction.
Write a clean offer.
To put it simply, don’t give the seller any reason to discard your offer. That means:
- Include a pre-approval letter from your lender.
- Include a proof of funds.
- Offer at least the customary earnest money deposit for your market; in Los Angeles, that means 3% of the purchase price.
- Offer an escrow period no longer than what’s customary – unless, of course, you know that the seller prefers a longer escrow period.
- If you can afford it, offer with a 5% down conventional loan instead of a 3.5% down FHA loan.
- And really, especially in markets like Los Angeles, offer with at least 10% down.
- And most importantly, don’t include any extraneous contingencies. Don’t write an offer contingent on a certain repair being made or contingent on you selling your property first. Keep your offer short, simple, and clean.
Shorten or remove contingencies.
If your offer is accepted, the first thing that happens is you put a small amount of money — in Los Angeles, it’s typically 3% of the purchase price — into an escrow account. This is your earnest money deposit. It’s money you’re putting on the line to show that you’re serious about buying this house.
A typical home purchase contract has three contingencies, and a contingency is like an out, an escape hatch. If any of these three contingency aren’t met, you, the buyer, are allowed to cancel the contract and get your earnest money back.
Contingencies protect you from losing your earnest money. Let’s discuss the three contingencies typical in a home purchase contract and when it might be prudent, as a buyer in a very competitive market, to shorten or remove them.
First up is the inspection contingency, which gives you, the buyer, the right to inspect the home with professionals of your choosing and cancel the contract if you don’t like what you see. This contingency is really important because most homebuyers aren’t contractors or plumbers or foundation specialists, and it’s important to get those kids of guys into the home to check it out and make sure you’re not buying any structural problems.
I don’t recommend removing this contingency from your offer unless you’re a pro. If you’re a seasoned home flipper or a contractor and you really know your shit, you can do without an inspection contingency. For all other buyers, I recommend keeping an inspection contingency in your offer.
However, you can shorten the inspection contingency length. Each contingency has a length attached to it, a number of days within which the buyer has agreed to clear the contingency. Once a contingency is cleared, it can no longer be used to cancel the contract and get the earnest money deposit back.
In Los Angeles, the inspection contingency period is customarily ten days. If your realtor has good relationships with home inspectors and roofers and the like, you can get your inspections done in less than ten days, even in this busy market.
Also, the fine print of the California Residential Purchase Agreement describes exactly what steps need to be taken when a contingency isn’t removed by its deadline. Long story short, a savvy agent can squeeze a few more days out before his client’s earnest money deposit is actually at risk.
My advice here is: work with a smart agent who knows how to shorten your inspection contingency while keeping your earnest money protected – and then shorten the inspection contingency period in your offer to make it more appealing.
Next up is the appraisal contingency, which allows the buyer to cancel the contract if the home doesn’t appraise for the agreed-upon purchase price. This contingency exists because lenders lend based on the purchase price or appraised value, whichever is less. Let’s go straight into some numbers to see how this plays out.
Let’s say you’re buying a $500,000 home with the conventional minimum 5% down. That means your lender agrees to lend you 95% of $500,000. So your down payment is $25,000 and your loan amount will be the remaining $475,000.
Now let’s say the appraisal comes in low at $490,000 instead of $500,000. This means the lender will lend you 95% of $490,000, which is $465,500. Without an appraisal contingency in place, you’d be responsible for covering the difference between this loan and the purchase price — so you’d be on the hook for the remaining $34,500. If you don’t have that additional money in the bank, you’re kinda screwed.
Conversely, let’s say you’re buying the same $500,000 home, but you’re putting 20% down. So you’re putting $100,000 down, and the lender is supplying $400,000. If the home then appraises for $490,000, it doesn’t actually affect your down payment. The lender will still lend you $400,000 for a $490,000 home because you’re still not even close to the minimum 5% down payment.
I hope these numbers demonstrate that it’s actually okay to remove the appraisal contingency if your financial situation allows for it. If you have extra money in the bank to cover the additional funds you might need to close, or if you’re making a large enough down payment, a low appraisal won’t be a dealbreaker, and you can submit an offer without an appraisal contingency. Make sure you’re working with a solid agent who can run the numbers with you and help you make the best decision for your situation.
Finally, common contingency number three: the loan contingency, which allows you to cancel the contract if you aren’t successful in acquiring a loan.
If you’re doing this the right way, you’ll be pre-approved before submitting offers, so why is this contingency even a thing? Well, it’s to protect you in case the unexpected happens. It typically takes a month to close a home purchase, and it’s possible that, in that month, you might lose your job or something else might happen to impact your borrowing ability. This contingency is your out in the event of the unexpected.
My advice is, don’t remove this contingency. If you’re making an all-cash offer, then obviously you won’t require a loan contingency. For all offers requiring financing, though, I recommend keeping this contingency in place.
Offer more money.
Price is the most important factor for almost every seller. So really, the question is, when does it makes sense to offer more money? A couple of points here:
Firstly, keep in mind that the asking price is meaningless. It’s a piece of marketing. It’s a number that a listing agent came up with in the hopes of selling the property for as much as possible. Some properties have a low asking price to attract more attention; some properties have an unrealistic asking price. You need to offer on what the home is actually worth and what the home is actually worth to you.
To get a sense of what the home is actually worth, look at recent sales. It’s easy enough to do this with Redfin or Zillow or Trulia. Look for recent sales of similarly sized homes in the same neighborhood, and then focus on the price per square foot. You might have to do some math, but this will give you a sense of what the property is actually worth. And remember that we’re in a rising market, so you should actually expect to pay a little more than what comps from three or six months ago suggest the property is worth.
And again, don’t lose sight of what the property is worth to you. The home might be worth more to you if it’s very close to your work or your child’s school. Maybe you need a private bedroom for an in-law and this home has it. Keep perspective. $10,000 is a lot of money, but amortized over 30 years at a 3% interest rate, it’s actually only $42.16 per month.
Use a fancy clause.
Important disclaimer: I am not a lawyer, this is not legal advice, and you should consult with a lawyer before entering any contract.
The first fancy clause to discuss is the escalation clause, which says something like:
Buyer to pay $5000 above the highest offer up to $560,000. Seller must supply a copy of the highest bona fide offer.
An escalation clause allows you to put your cards on the table but still not overpay for a property. Let’s say you fall in love with a house that has a $500,000 asking price. You run your own numbers and realize you’d pay up to $560,000 for the house if need be — though obviously, you’d much rather pay less.
You can put in an offer at $560,000 with this clause written in. If the next highest offer is, say, $508,000, then you’ll win the bidding at a final price of $513,000. If the next highest offer is $540,000, you’ll win the bidding at $545,000. And if somebody offers more than your absolute maximum, well, then it wasn’t meant to be.
The trick here is to really determine your max offer – the price beyond which you’re happy to walk away. And you want to determine a step-up — that’s the $5,000 sum in this example — that will compel the seller to take your offer over the others. The lower the price-point, the lower the step-up, and vice-versa. If we’re going after million-dollar-plus homes in LA, we’ll be using a step-up closer to $20,000 or $30,000.
And here’s our second fancy clause, the appraisal gap clause, which says something like:
In the event the appraised value comes in below Purchase Price, Buyer agrees to pay up to $20,000 over appraised value not to exceed Purchase Price.
This appraisal gap clause allows you to write an offer with an appraisal contingency in place but specify the appraisal shortfall, or gap, that you’ll cover. This language allows for a $20,000 difference between the appraisal and purchase price, and you can change the dollar amount to your liking.
For example, let’s say you’re offering $500,000 on a home, and doing some math, you realize you can afford to purchase it so long as it appraises at $480,000 or above. You would use the above language to indicate that, even though an appraisal contingency is still in place, so long as the property appraises for at least $480,000, you’ll proceed with the purchase.
And one last tip: you can use the escalation clause and the appraisal gap clause together to write a bulletproof offer that also protects you as the buyer. Be sure to work with an agent who understands how to use this language in a purchase contract.