It’s official. I lost my first overbid in this crazy San Francisco property market.
The property was a single family house, 3/3, on a small lot, overlooking a park asking $1.299 million (picture). I’ve known the listing agent for a while and she mentioned that $1.35 million would get it done, but I was thinking $1.2 million instead. She had two other over-asking offers, but I couldn’t muster up the courage to bid more than $1.315 million.
It wasn’t a big loss because the property didn’t tug at my heart. I figure, if I’m going to be spending more than a million bucks on a property, I better be excited, or else why bother. Yes, property prices are crazy out here in San Francisco, but this price point is actually relatively good value.
I’ve been agonizing over paying down my existing rental property mortgages or leveraging up to buy more property. The jury is still out, but I’m willing to at least prospect around to see if there’s anything I like before making a decision. Besides, I figure this latest house hunting experience will provide good educational content for other folks looking to buy in a hot property market.
THE FEAR OF A FINANCING CONTINGENCY
As a negotiations samurai, the number one thing you need to care about is what the opposing side cares about. I’ve asked 10 listing agents what is their seller’s #1 concern and they all said: financing contingencies and whether the buyer will be able to get a loan. Don’t listen to reports by the media on the return of loose credit standards. Credit is SUPER tight e.g. contracting income doesn’t count, only counting 75% of my rental income, assigning only a 1% return on my CDs for asset based underwriting even though they are returning 3-4.2%, etc. I definitely recommend shopping around.
A typical, strong property offer includes a 14-day financing contingency, and a 30 day close. The 14-day financing contingency is to protect the buyer from losing their 3% downpayment of purchase price just in case he loses his job or can’t get a loan. The reality is, the financing contingency is often used as an escape hatch for any excuse, not just a financing one. For example, the buyer may have found another property during this time period, or is simply experiencing buyer’s remorse. The second escape hatch is the inspection contingency.
When you hear about properties receiving “all cash offers,” not all the buyers really have all cash. Instead, some of the buyers go the no financing contingency route to equate their offer as all cash. If you’re confused, think about the situation from the seller’s perspective.
If the buyer does have $1 million bucks cash to pay for your $1 million house, he’ll go through the process of putting down the 3% deposit, go through an inspection, increase the deposit further by a certain amount in escrow, and then finally pay for the entire property when legal documents and title are signed and exchanged. During this process, the buyer can pull out at any time. S/he would just forfeit the deposits made along the way. Even the deposits can be fought over if the buyer wants to really get contentious.
If another buyer has a no financing contingency offer, that means the bank has already approved the loan in full and the seller doesn’t have to fear the buyer not getting a loan because the bank’s underwriter already deems the buyer and such a property worthy. A no financing contingency offer is clearly stated by the bank via a letter.
Whether the buyer pays all cash or the bank pays all cash is the same to the seller. Think of the no financing contingency offer as your bank willing to buy the property itself. The buyer and the bank have a financing arrangement after close that is none of anybody else’s business.
HOW DO YOU PAY ALL CASH FOR A PROPERTY WITHOUT HAVING ALL CASH?
If you don’t have all cash in the form of savings and/or liquid securities, you are still eligible to pay all cash in the seller’s eyes. The bank just needs to do its due diligence on you before the offer, which is why it helps if you’ve been a long-term client with the mortgage institution. Due diligence includes the last two years of W2s, last two pay stubs, all brokerage accounts, all CDs and savings accounts, understanding all liabilities and assets, your credit score and credit history, the likelihood that you will continue to remain employed or receive income after financing, and financial track record with the institution.
Banks want to continuously make money through an interest rate spread, and offering a no financing contingency option helps them win business, especially with the refinancing market down over 75% YoY.
To get no financing contingency follow these steps:
1) Ask your mortgage lender whether they do no financing contingency offers. Larger banks with wealth management departments should be able to help more easily.
2) If they say “yes,” ask yourself whether you really don’t want an escape clause because you are 200% certain you want the home. You do have the inspection contingency to fall back on as well, but this is another thing you might wave if the seller’s recently had an inspection done with a report from a reputable inspector. You will most likely lose the 3% deposit if you decide to back out from your offer after the initial signing.
3) Ask your mortgage lender what extra documents are required from the seller in order for them to do due diligence before the offer date. Sending the title is definitely one of the documents to ascertain current legal ownership of the property. Sending all other disclosure documents including the pest inspection, general inspection, agent’s inspection, and anything else is a good idea. The bank’s main concern is whether you are good for the loan, and then whether the property is worth its price.
4) Make sure all your finances are in order like you would for any mortgage loan. The mortgage application process is as stringent as ever. If you do not have any W2 income, you can basically kiss your ability to get a mortgage goodbye. The only saving grace is if you have a lot of assets. Banks will then use an asset-based income stream. For example, for every provable $1 million in liquid assets a bank might grant you $30,000 in income in their underwriting calculation. It depends from bank to bank.
5) Make absolutely sure you’ll have a job during the closing process, or a solid income stream for as far out as possible after closing. Nothing is worse than getting into huge debt and then finding out your main source of income disappears. Build multiple income streams!
NO CONTINGENCY FINANCING STRATEGY
I plan to use the no financing contingency strategy for properties I absolutely love that I could pay in cash by liquidating stock and bond holdings. Paying 100% in cash is a last resort because of the sub 3% financing I’m being offered. The other good strategy is just not even write no financing contingency in the offer, but to write “all cash,” and then get financing with the bank if you know they have agreed. I do not think tying up most of your liquidity in property is a good idea. Stay diversified!
From the bank’s point of view, I’m a riskier borrower as an entrepreneur compared to a W2 earner. But from my point of view as an entrepreneur, I’m less risky because I’m living in risk already and thriving. I can’t get fired unless I fire myself. Besides, my total compensation is structured so that I have a strong safety net because I have passive income, contracting income, deferred compensation in the form of W2 income, and entrepreneurial income. We all know that there’s no job security anymore anyway.
If you’re looking to buy a property in a hot market, don’t forget to remind yourself about the great housing crash of 2007-2010. If you’re buying in a non-prime location, far away from a major employment hub, then be prepared to lose 50%. If you’re buying in a prime location, then still be prepared to lose 25%. Getting in a bidding war based on emotional desire is a losing proposition. You must have a base line number where you are willing to walk away.
Over the long run, I think most property owners will be fine. It’s the short run which can really do a doozy on homeowners if they have to bail during a correction. I’m looking to buy a new home to live in and rent out my existing home to unlock some cash flow. If the properties appreciate in value – as I think they will over the next 10 years – I’ll be happy. If they don’t, then I’ll at least have created fond memories.
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Updated for 2020 and beyond.