Things Fall Apart
Things Fall Apart
Reasons a Real Estate Contract May Fail
Not every real estate contract results in a completed sale. Sometimes deals fall apart for the right reasons. Sometimes not, though. Let’s uncover some of the usual suspects.
Not every contract results in a completed sale. Contracts can terminate for a number of reasons, and we’ll discuss some of those in this article.
It’s hard to find good data on how frequent pending sales fall through, but I can say with confidence that it depends a great deal on who the buyer is and the current market conditions. Investors typically have tighter margins and a lower threshold for backing out of a deal, and in times of tight credit, buyers will have greater difficulty getting loan approval.
The Inspection Contingency
A lot of times, the house itself is a big contributor to a failed transaction. The reason is that most sales contracts are contingent upon the home passing inspections.
An inspection contingency works like this: within a specified period of time, a home buyer will cause the home to be inspected by themselves, a licensed home inspector, and/or other qualified professionals (and if required by law, licensed). Prior to the end of said period, the buyer shall provide written notice to seller as follows: either
1. Buyer shall furnish the seller with a written list of specified objections and terminate the agreement.
OR
2. Buyer shall accept the property in its present “as-is” condition with any and all faults.
OR
3. Buyer shall furnish seller a written list of items which the buyer requires to be repaired and/or replaced with like quality in a professional and workmanlike manner.
From a buyer’s perspective, clearly one option stands out among the three as most attractive. In a seller’s case, you’re really hoping the buyer “plays nice” and opts for a different direction. The competing interests in this scenario are why we have the Resolution Period.
During this Resolution Period, whose length is determined in the sales contract, the buyer and seller will reach agreement as to the items to be repaired or replaced by the seller prior to closing.
Essentially what has happened is that the buyer has objected to the contract based on the written list of items furnished to the seller. If the seller agrees to address all of the items on the list, the inspection contingency is satisfied. However, if the seller feels some of those items are unnecessary or out of their budget, then they can refuse to address one or more items. In that case, the buyer and seller must resolve the discrepancy between objections; otherwise, the contract is terminated on the grounds of the items the seller is refusing to remedy.
So that’s the technical and literal side of what’s going on here.
On the practical side, we have two people who have already agreed to a contract in which one or both of them feel compromises have been made.
A seller may be thinking “We’re already selling this house for $10,000 less than we wanted, and now they expect me to fix every little thing. Where does it end?” Or one of my personal favorites, “Don’t they understand they’re not buying a new house?”
A buyer usually sees it more like this: “We’re paying a premium price for this house, so the least they could do is make sure nothing is wrong with the place.” Or, “Why should I have to fix something that should’ve been done already?”
Inspections usually happen within the first few days of escrow, when the emotions of the contract negotiations are still fresh on our minds and the close date seems far away. Those emotions can sometimes get the best of us, especially when the backdrop for this entire scenario is one of the 5 most stressful things you’ll do in your lifetime. That’s why the inspections are one of the usual suspects in a failed contract.
The Financing Contingency
Another big contingency in most contracts is a financing contingency.
Most contracts involving a loan (and 90% of sales do) will be contingent upon the buyer’s ability to obtain the loan. That’s why most standardized purchase contracts will require the buyer to disclose the type of loan they’re seeking when making their purchase offer to the sellers. If the buyer has told us all along that they’re trying to fund part of the purchase with a loan and end up not being denied the loan, then the contingency is not satisfied and the contract is terminated.
There are milestones that the buyer must hit in order to pursue the loan in good faith, but sometimes things happen during the closing period that result in a buyer being denied. A few scenarios could be job loss, unsubstantiated funds, lack of reserves, or changes to the buyer’s credit or monthly debt. Take this hypothetical for example: A buyer is under contract to buy a home and everything looks great until his car breaks down.
What’s a guy to do?
If unable to get to work on time each day, he’ll lose his job and source of income. A bank won’t approve the loan if they don’t see a steady stream of income. The buyer could elect to pay cash for a new car, but what happens if that wipes out his savings? Lack of reserves might cause the bank to deny the loan. Of course he could finance a new car, but that will affect his monthly debt-to-income ratio.
What is a guy to do?!
The Appraisal Contingency
Within the financial contingency is another big offender of failed transactions: the appraisal.
In order to issue the loan, the bank will hire an independent party to appraise the property in an effort to ensure their collateral for the loan is sufficient. The appraiser will look at comparable sales and adjust up or down to arrive at what they deem to be a fair market value.
Quick tangent: how often does a home not appraise? I’ve seen it said that it happens about 5% of the time, but in my experience it seems less often. It also seems like it happens in waves - you’re sailing right along with a good understanding of the market and suddenly six people in the office have appraisal issues within the same week. What, did all the appraisers go to a conference and decide they have to do something about rising home prices? It sounds crazy, but it certainly feels that way sometimes.
When clients ask me, I put it to them this way: we currently have 4 parties who agree on the price (the sellers, the buyers, and their agents), and all we need now is for a 5th party to agree with us. Should be simple, right? After all, what is anything worth? Whatever someone will pay for it.
However, it’s not that easy. Just because someone will pay that amount doesn’t mean anyone should, and that’s what the bank wants to know.
Just like inspections, there are really three options if the appraisal comes back lower than the sales price on the contract. The buyer can terminate the agreement, and the home goes back on the market. The buyer can waive the appraisal contingency and bring additional funds to closing (since the bank will only loan a percentage of the appraised value). Or, the two parties can negotiate a lower purchase price that will allow the buyer to obtain the loan percentage for which they’re pre-approved.
Why would a buyer bring additional funds to closing, and effectively “over pay” for the house?
They may feel like they got a raw deal from an uninformed appraiser. Maybe there’s a home theater with equipment far more expensive than the appraiser’s gap between sales price and appraised value. The appraiser may not be able to consider that equipment in their valuation because it’s deemed personal property, which they’re not required (or licensed) to appraise. Instead of separating those items with a bill of sale, the buyer may feel like bringing the additional funds to closing is a better deal for them. Or perhaps they’re in such a competitive market that they feel fortunate to find a house and will happily a little bit extra to find a home for their family, knowing that in a few months or years, they’ll easily make up whatever equity might be lost on the front end.
Why would a seller agree to reduce the price just because some appraiser says he should?
A lot times, those margins can be made up elsewhere. For instance, if the seller was agreeing to pay $5000 towards the buyer’s closing costs, maybe they are able to renegotiate that out of the deal in order to hold their bottom line. Other times, sellers may believe that a $3000 reduction in price is money well-spent if it keeps them from having to go back onto the market and find another buyer.
Sometimes, though, a buyer simply doesn’t have the liquid funds available to bring more cash to closing, or the seller feels like they had a deal and that’s that, and the appraisal contingency causes the deal to terminate.
Other Contingencies
The final contingency that you’ll see most often is a contingency to sell the buyer’s current home. In this scenario, the buyer is either unable or unwilling to buy a new home unless they can unlock the equity in their current home by selling it. If you’re a seller who’s offered a contingency like this one, you’d be smart to put a performance deadline on that happening. If the deadline comes and goes without the buyer’s home going under contract (or closing, depending on the language in your agreement), the contract terminates and you are free to enter an agreement with another party.
A buyer can offer a contract be contingent upon any number of things - final job relocation approval, ability to build a garage on the property, city approval for a small business variance - but these four (inspections, appraisal, financing, home sale) contingencies are most often the reason in the unfortunate event that a contract fails.
The next two reasons I’ll mention are a little delicate. We don’t like to admit they happen, but I think it’s worth visiting them because number one, they do happen, and number two, I want to dispel any misinformation you might’ve heard elsewhere.
Buyer’s Remorse
The first one is buyer’s remorse.
The real estate market has been very competitive for buyers over the last few years, and people often feel that pressure and allow themselves to make purchase offers they wouldn’t otherwise be excited to make. Whether it’s the excitement of winning a multiple offer situation, or just an aggressive contract on a home that just hit the market, what follows from a buyer experiencing buyer’s remorse is a lack of motivation, communication and performance.
It’s extremely unfair to the sellers when this happens, and it’s a difficult thing to get over when it happens to you, but you are best served to terminate that contract with the unmotivated buyer and find another party who is excited to buy the home.
What I want to make clear is this: there is no such thing as a “right of rescission” in a normal transaction, not in our state, anyway.
I have clients ask me fairly often if the buyer can just decide they’ve made a mistake and not buy the house. I’ve even heard people attach a “cool down period” of 3 days to the idea, but it simply does not exist in the standard contract. That’s not to say that it couldn’t be written into the additional provisions section, or buried within an addendum by a bulk-buying investor, but as far as a state standard similar to a lemon law that exists with cars, real estate transactions do not typically have this buyer protection.
Now, having said that, sometimes you can’t help but realize what’s really going on. We’ve already discussed the protections buyers do have with their contingencies, and when you’re on the receiving end of a one line inspection objection termination, it becomes rather easy to read between the lines.
Agent Incompetence
The other unfortunate reality is sometimes contracts fail due to inexperienced and/or unmotivated agents. (Can’t wait to get the phone calls about this…)
To be totally honest, it’s almost impossible to tell the difference between an inexperienced and an unmotivated agent from a cooperating agent’s perspective. The interactions with either resemble those of a buyer who’s experiencing remorse - lack of communication, missed performance deadlines, and little effort towards creating solutions.
Inexperienced agents may not understand the contract they’re helping their clients execute.
Take performance deadlines for example. Some of them are specified in the contract to roll to the next business day if they happen to fall on a weekend or a national holiday. However, some of the more critical ones do not, and that Sunday due date is an absolute. That agent may have the personal principle that they do not work on Sundays, but if they fail to deliver on a “drop dead” performance deadline, their clients are now in breach of contract and their interest in the property has been compromised.
It’s also true that inexperienced (and unmotivated) agents lack the ability to offer creative solutions in times of trouble.
We’ve talked in the past about the concept of Win-Win. When you’re brokering deals of this magnitude, issues invariably surface from time to time. But when you take the disposition of a Win-Win, cooperating parties can work together to achieve the ultimate goal, which is for one party to sell a house to another.
What if a buyer mistakenly miscalculates the seasoning period for a bankruptcy in their past? They have the credit, income, and assets necessary to qualify for the loan, but they haven’t quite met the temporal requirement that will allow the mortgage company to approve the loan.
Instead of throwing up our hands and asking the buyer “How could you?”, let’s work together to find a solution to the seller’s needs. Maybe it will only be another two months before they meet the requirement, and we can work out a temporary lease that allows the seller to unlock the equity they have in the home and continue to pursue their next purchase.
Of course that will create some additional work for the agents involved, and of course it makes the deal more complex than it originally was. An unmotivated agent will be unwilling to offer this solution, and an inexperienced agent may not even know it exists, and the clients involved become the victims of the circumstance.
The last point I’ll make about inexperienced or unmotivated agents is the simple inability to anticipate issues.
Unless you’ve been there before, and unless you care to investigate, you won’t be able to identify potential issues before they happen. This counts during the offer phase and continues through the close of the purchase. Whether it’s asking the right questions regarding a pre-approval letter, or making sure you have sound advice on an inspection item, it takes an experienced and engaged agent to work a deal to closing.
Get What You Deserve
The agents at The Porter Group are those people. Experienced and engaged. Trusted.
We pride ourselves on owning the transaction for the benefit of our clients. Sometimes we encounter agents who lack the experience or the will to see difficult scenarios through to the end, but by taking a Win-Win attitude and drawing on our decades of experience, we’re able to help our clients achieve their goals and fulfill their dreams.
Deals fall apart, sometimes for the right reasons, but you deserve to work with a team who’s willing to go the extra mile to ensure your success.