Making an offer is the most important step in buying a property. A profit is made at the time of the purchase. Before making an offer, you should have determined the purchase price you can still profit at. Before making the offer, your realtor should provide some comparative analysis for you, showing what other properties have sold for. Also, it would be best if you had your own comp analysis from Step 3. Now that you are armed with all this data, you are ready to make an offer. To read more on the art of negotiating, I suggest reading “Never Split the Difference by Chris Voss.”
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In my previous post, “Step 4: Find the Perfect Property and Real Estate Agent“, I talked about narrowing it down to one property. In this post, we will take a look at making an offer. This process is similar to buying a home in some way.
Parts of an offer
An offer is a legally binding document between you and the seller, so treat it appropriately. The offer will consist of: a price, financing, home warranty, earnest money amount, how to handle closing costs, when to close, and contingencies on closing. When making an offer, you should expect the seller to counter the offer. This process can go back and forth several times. If an acceptable agreement is not reached, the offer is rejected, and it is time to start finding a new property. It is important to remember that all items are negotiable. To sweeten a low price offer, you can be generous on one of the other items. If possible, understanding the seller’s needs will help you tune your offer to what they will accept. Offers also have a time limit that they are good for, usually 1-3 days.
When sellers receive multiple offers
When sellers receive multiple offers at the same, a bidding war occurs. The seller has their pick of offers to choose from. They weigh all of the parts of the offer and choose which is best for them. Bidding wars happen when a new property comes on the market. As a real estate investor, you never want to get caught in a bidding war. I tend to look at properties that have been listed for 2 weeks or more. Bidding wars lead to people overpaying for the property.
Earnest money is an amount of money you agree to pay the seller if you do not close to the property. This money is put in escrow at the beginning of the process. If one of your contingencies happens, you get your earnest money back; otherwise, the seller keeps it. The seller uses the earnest amount to gauge how seriously interested you are in buying the property. Technically, earnest money is not required, but every offer has it. It can be as low as $1000 up to 10% of the purchase price. Again, this is a negotiable item. The earnest money and contingencies work together in an offer. The more earnest money and tighter the contingencies, the more appealing the offer is to the seller.
The seller uses the financing to decides if you are a qualified buyer. The offer’s financing section contains information like the amount down, whether you are pre-approved, and for how much. It can also contain particular information about the loan, such as interest rate, type of loan, etc. You should figure out the financing of the property by the time you get making the offer. You need to pre-coordinate with a bank and get pre-approved before ever getting to making an offer. Usually, the financing is a non-negotiable part offer. The more money down, the more appealing the offer. One tactic used for negotiating is to offer cash for the property. This allows the closing to occur very fast, maybe 10 days vs. 45 days. If the seller needs to sell in a hurry, this can be very powerful. Sellers sometimes need to close fast due to moving or carrying two mortgages.
You can request the seller buy a home warranty for you as part of the offer. This home warranty covers one year of breakage such as appliance, HVAC, plumbing, and electrical. If you do not have the seller buy this, you can still buy one yourself. You can also extend this warranty past one year.
Contingencies are your get-out of the offer clauses. These contingencies provide you with a way to get your earnest money back and avoid a lawsuit for breach of contract. You can write in any contingency you would like. The more or broader the contingency, the weaker the offer is. The following are some typical contingencies.
Home Inspection Contingency
- The Home Inspection clause allows you to cancel the contract within 14 days if something is found on a home inspection that you do not like. As a side note, always get a home inspection. It may be the best $300 you will ever spend. If you do not have an inspection clause, you are buying the home as-is. In some states, there are mandatory inspections. It is important to work with your realtor to make sure these get done early. They will hold up closing, which can put you in a breach of contract. These mandatory inspections have to occur whether or not there is an inspection clause.
- The Financial contingency protects you if your financing does not get approved. Without this clause, if you do not get financing approved, you will forfeit your earnest money. If you are paying cash, you do not need this clause.
Home Selling Contingency
- The Home Selling contingency allows you to back out of the offer if you do not sell your house. For instance, if you need to sell your current house to get the money for a deposit and you don’t sell your house, you can not buy the new house. This is a clause that greatly weakens the offer.
Home Appraisal Contingency
- The Home Appraisal contingency allows the offer to be modified based on a professional home appraisal. This clause works hand in hand with the financing clause. A bank will not loan you more money than the house is worth. So if the appraisal is lower than your offer, you will have to make up the difference in cash, negotiate a lower price, or walk away. This clause allows all of that to happen.
- The partner contingency is an unusual contingency sometimes used in real estate investing. It basically says that an unnamed partner needs to agree to the purchase before closing. This partner could be anybody. So if the buyer does not want to purchase the property at the close, they only need to find someone, a partner, to say no. You can read more about this on Investopedia.
Closing costs and date
There are various closing costs involved in buying a house. Some of the higher costs include origination fees, realtor commission, documentary stamps, HOA estoppel, etc. Closing costs vary by state. Your realtor should be able to provide a list of your specific costs. Investopedia has a good list of closing costs. Typically, closing costs are split 50/50 but can be negotiated. Sometimes, the seller will pay all of the closing costs to get a higher property price.
The buyer sets the closing date. In most cases, the closing date is established by the financing schedule but could be anchored by inspections. The closing date is a legally binding date that you have to close by. Therefore, you could forfeit your earnest money by not closing on or before this date. On the other hand, closing dates can and do get moved around. By the time you get to closing, both the seller and buyer have invested a lot of time and effort. Because of this, the seller is often willing to extend a week or two because the financial process is taking longer, but it is their right to cancel the offer if it goes long. One example of this would be if the buyers got rejected by their primary bank and need to find a new bank. This would extend the closing months.
Now, you are armed and dangerous. In the next post, “Step 6: The Process of Closing,” I discuss the steps of purchasing a property from making the offer to closing day.
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