Buyer Frenzy and Bad Decisions
“Number one, cash is king… number two, communicate… number three, buy or bury the competition.” – Jack Welch
One of America’s most prominent business executives, Jack Welch, uttered those words in May, 2009 during the depths of our country’s most recent recession. He was discussing business strategies for companies to survive during what was, at the time, a very uncertain economic period. I came across that quote as I was considering the current, highly competitive, housing market and couldn’t resist the irony that much of Mr. Welch’s simple advice applies in today’s robust market as well.
Under any objective analysis, Denver is currently one of the hottest real estate markets in the entire country. As anybody driving I-70 to/from the mountains or I-25 between Fort Collins and Colorado Springs will attest, we have seen a population explosion in conjunction with our expanding economy. Much of Colorado’s in migration is being fueled by young professionals (first time homebuyers!) looking to purchase a home in the $200K-$350K price range. Record low supply of homes combined with record high demand has created a “seller’s market” the likes of which Colorado has not previously experienced.
The sizzling hot Metro Denver housing market has certainly been a boon for most sellers. This is particularly true for sellers who have actually been able to either: a) identify and buy a satisfactory replacement property in the same market; or b) relocate to a softer market within Colorado or outside the state. As a result, Metro Denver buyers and their REALTORS® have been faced with the exhausting and frustrating prospect of aggressively competing to buy a home.
Current market conditions have created a frenzied climate where buyers are willing to do anything to compete against, in some cases, dozens of other buyers for a single property. Sellers are able to consider multiple competing contracts and subjectively select the “best” offer for them. Conversely, buyers are forced to guess at what may ultimately constitute the “best” offer in the eye of any particular seller. While “price” may be the first thing a seller considers, it is only one of many factors. After all, even the most frenzied buyer can only go so far “above list price” to compete.
All of this has led to some risky buyer “concessions” that may make a buyer’s offer more competitive, but often puts both buyers and their REALTOR® at significant risk.
Cash is King and Other Buyer Concessions
According to Mr. Welch’s sage advice, “cash is king.” The primary way that buyers are attempting to distinguish themselves is through “all cash” offers. A full price, all cash offer is often pretty enticing for a seller as it typically represents a strong buyer and avoids the possibility of a late Loan Objection. An “all cash” offer is perfectly appropriate as long as the buyer is making the appropriate representation in Paragraph 4.4.2 of the contract.
If a buyer is offering all cash “funds that are… immediately available” they better actually have those funds or the buyer is in breach of contract upon execution. “Available funds” is not “mom and dad have promised to buy this house for me” or “my stock options vest in 2 weeks.” As a REALTOR®, be very careful in the representations you allow your client to make with respect to cash offers.
If a buyer requires a loan, but is still willing to waive their loan contingencies, a REALTOR® needs to be clear in the offer that the buyer does NOT have “funds that are immediately available.” Again, this should only be done with very significant caution as the Loan Objection is arguably the most powerful buyer contingency in the Colorado real estate form contracts. REALTORS® should take extra precaution to warn their buyers in writing that there are potential consequences to waiving Loan Objection.
In order to present clean, competitive offers, buyers are also waiving other traditional contingencies. Two of the more prominent contingencies being waived are Inspection and Appraisal. Clearly a contract with no Inspection or Appraisal condition should be pretty attractive to a seller, but they should only be offered by a buyer with very significant written caution from the REALTOR®. The waiver of either contingency carries grave risks for most buyers including, obviously, the forfeiture of their Earnest Money. This is particularly important considering Earnest Money deposits being offered by buyers has also increased substantially.
Another competitive buyer concession occurring frequently is the escalation clause or “highest and best” clause. Under this scenario, a buyer’s price offer is to match and beat any valid competing offers by some specified amount of money. Again, these types of clauses are perfectly acceptable and often very attractive to sellers entertaining multiple offers.
When drafting escalation clauses, REALTORS® need to be cautious and warn their clients of the potential implications of such offers, including the immediately binding nature of the offer on the buyer upon seller’s acceptance. Importantly, REALTORS® need to make sure they are putting an “outside” cap on their buyer’s total price exposure (“not to exceed”). Also, make sure buyers are considering all implications escalation clauses may have on pre-qualification, loan availability, appraisal and other additional costs.
Mr. Welch’s second piece of advice is “communicate.” This should be a fundamental component of every transaction. As REALTORS®, we intuitively understand that consistent communication leads to successful real estate transactions and strong professional relationships.
Communication during transactions in this hot market is even more critical. REALTORS® working with buyers need to explicitly communicate to their clients the benefits/pitfalls of making offers with substantial buyer concessions. Make sure your buyers understand the commitments they are making – and the rights they are waiving – when they execute an offer. To the extent feasible, put your warnings in writing/email to your clients prior to their execution.
Proper communication to buyers up front can also help avoid buyer fatigue. After losing bids on 38 consecutive houses (or even two!), it is likely the buyer is going become weary of the process. It is critical to initiate early communication to set everyone’s expectations. This market is certainly not for every buyer’s tolerance. To the extent it makes more sense for your qualified buyer to sit on the sidelines and wait for better market conditions, communicate that to them. And finally, make sure you are accurately communicating all terms and conditions to the seller when making an offer. “Cash in hand” is not “cash in the client’s Dad’s mutual fund.”
When representing sellers, make sure they understand that the best offer isn’t always necessarily for the most money. There are other buyer concessions that can be valuable depending on the seller’s individual circumstances. Make sure you are communicating the whole “picture” to your sellers as they are considering multiple offers and the various qualifications of many buyers. Make sure they understand the implications of entering back-up contracts and are realistic about their home’s value on appraisal and the buyer’s expectations on inspection. Finally, if a buyer has a loan objection, make sure your seller client understands the buyer’s broad, subjective authority to terminate the contract so the seller can consider that with other competing offers prior to contract.
Mr. Welch’s third piece of advice is to “buy or bury the competition.” This speaks for itself, right? Eliminating your competition is obviously not the best policy for you or your client to compete in this market. “Burying” your competition may find both you and your client a home, but neither of you will like the square footage or views.
All kidding aside, from my perspective, “burying the competition” goes to the traditional adage of working hard and working smart. As REALTORS®, your time is your money and leveraging it to work with any buyer must to be done intelligently. Make sure your buyers are qualified and committed to the process (particularly in this market). If they are qualified and committed, both of you must be prepared to act immediately on new listings and think creatively about structuring your offers and deals.
If you are working with a seller, just get a sign in the front yard. You’ll have 42 offers by the end of the weekend!
General Counsel | Colorado Association of REALTORS®