Sarah Jarvis Team at One South Realty

at One South Realty

Financing

Investing in Rental Property … A Primer

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Everyone fears a broken toilet at 2 am ...
I may be jinxing myself but I have never had a toilet break at 2 a.m.

“I want to invest in rental property.”
“I want to flip houses.”
“I am thinking about owning some apartments … what the deal with those?”

We hear this constantly.  And we love it because it means someone else is in the nascent stages of realizing what many have known for years – owning property is a fabulous way to build wealth.

Here are some things to consider.

Toilets Never (OK, Rarely) Break at 2:30 in the Morning …

It is amazing how many people have a fear of rental property and summarize their fear by saying, ‘I don’t want to be fixing a toilet at 2 in the morning.’  A quick secret – I have owned rental property for well over 20 years and I have yet to have a toilet break at 2 in the morning (and yes, I realize how badly I am jinxing myself). Have I had inconvenient timing on repairs?  Of course.  I even had a fire destroy a building (and no one was hurt, thankfully) but the unforeseen is the reason you buy insurance.

At the end of the day, the benefits of ownership far outweigh the cost of maintenance.  When you grow your portfolio to a certain point, then you hire a management company and download the burden of maintenance to someone else.

Credit Reports Tell All

If you take nothing else from this article, please take this away – understanding what a credit report is telling you is the number one way to eliminate unnecessary work from your portfolio.  While a busted pipe under the house is an annoyance, its impact is minimal when compared to a habitually late tenant or one who requires eviction.

Every time I found myself in front of a judge filing a ‘Pay or Quit’ notice or Unlawful Detainer, it was because I ignored my inner voice and took a flyer on someone with a marginal credit profile.  All credit is not created equally … you need to understand what cause credit scores to fall and more importantly, why.  I would far rather lease to someone with a bankruptcy or foreclosure than someone with a judgement from a landlord and utility company.

What Feels Comfortable?

I don’t have a great understanding of the retail market and thus, I own no retail space.  I am also not familiar with executive rentals, so I don’t have high end residential properties for lease.  I have a far better feel for 1 and 2 bedroom apartment rents, suburban and urban office rents and 3 bedroom house rents in good school districts.  So guess what I own?  Yep, apartments, some office and several single family homes in good school districts.

If you are going to invest in property, buy what feels comfortable to you.  You will inherently have a better feel for the market and you will worry far less.

Know Finance

The best property owners do one thing extremely well – they correctly finance their properties.

Securing the lowest interest rate for the longest period is important, but sometimes flexibility can be important, too.  Partial releases, renewal options, penalty-free payoffs, floating rates, caps and assumption clauses can all impact finance, too.  Typically, if just a single family home, the Fannie Mae/Freddie Mac investment products will suffice, but when you begin to look into multi-unit properties or acquisition/rehab strategies, finance changes.

Correctly financing your property minimizes risk and increases cash flows.

Management Companies and Tenants

I like to think that there are two kinds of renters – future buyers and habitual tenants – and you need to treat each differently.  Management companies, like Realtors, attorneys, architects, Doctors or accountants, do different things well.  Don’t assume that a management company is good at managing all types of properties.  Know who will best manage your property.

In Richmond, for example, the Downtown market can have student apartments, young professional apartments, ‘work force’ apartments and ‘affordable’ housing in close proximity.  Each of these properties should be managed differently and often times, those who are good at one type are not as accomplished at the other.

Exit Strategy

Buying investment property can be easy relative to the sale investment property.  The number of buyers for a single family home in (say) Brandermill is far greater than the number of buyers for a 12 unit apartment property in Jackson Ward.  It does not mean that you should or should not buy one or the other, it just simply means that it may be easier to quickly unload a single family home than a 12 unit (or more) property.

Likewise, the way you sell each is different, too.  A single family home rental offered for sale should be vacated, cleaned up and renovated to achieve maximum value while an apartment property should be sold while fully leased.  Make sure to manage the leasing of the property well in advance of the sale to give yourself the best chance to maximize the contract price and minimize marketing time.

Summary

I highly recommend ownership of property as a vehicle to wealth accumulation.

Despite the ups and downs of the for sale markets in the last decade, rents have increased substantially and are currently as historically high levels.  Having someone living in your property, making the payment to the bank through the rents they pay and hopefully putting a few dollars in your pocket along the way is one of the most risk free and time tested way of creating wealth over time.

And if your toilet breaks at 2 am you can call me to complain …

Price or Terms – Which are More Important?

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In the real estate business, the focus of almost every conversation is price.

‘How much are they asking for their house?’
‘What is the assessment?’
‘What does Zillow say it is worth?’
‘They paid WHAT?!?’
‘The offer is for HOW MUCH?!?!’

You never hear:

‘I can’t believe the rent back was for 3 days!’
‘The due diligence request was TOTALLY reasonable and allowed for the correct framework for agreement.’
‘Wow! What a shrewdly written escalator clause!’

Listen, the price a property transfers for is obviously important, but it is not the only part of making a good deal. Many other factors contribute to the making of a really great deal, other than what someone paid.

Price or Terms, You Decide

A real estate contract is made up of two things – the PRICE for the property and TERMS under which both sides must abide. It is the former that garners all of the attention but it is the latter that matters more in many cases.

Want to learn some tips about winning in the most intense season of the year? Click to learn more.

Look at it this way – how much space in the contract is dedicated to each aspect?

In Section 4 of Page 1 of the Richmond Association of Realtors Residential Purchase Agreement, you will find the following language discussing price:

“The purchase price of the property is __________, which shall be paid to the seller at settlement, subject to the prorations described herein…

The standard contract then goes on for another 8 pages to cover the other items that go along with the purchase of a home!

Just to clarify – the purchase price is handled with one sentence yet the rest of the contract is 8 pages long. And just so you realize, the contract is 8 pages BEFORE adding the required disclosures and any addenda.

Does that tell you anything?

Did you realize the ‘Standard Provisions’ alone run from A through K? Did you realize that Section #21 is labelled ‘Other Terms’ and is blank? Did you realize we can add as many addenda to the contract as we need to?

Wow.

Terms

The contract cover numerous bases:

  • Financing
  • Inspections
  • Title
  • Numerous Disclosures
  • Closing
  • Fees
  • Representation
  • Default

While it is not standard practice to negotiate each of these individual points in a standard residential contract, there is room to push and pull in order to either create wiggle room or close some outs (depending on which side you are on.) When you begin to examine other types of real estate contracts (commercial property, leases, options, land, new homes) then you introduce elements that fall outside of the generally accepted norms.

At One South, we pride ourselves on having a great deal of exposure to contract structures and practices due to our experience in many different arenas. Here are some things to think about.

Know Your Outs

Getting into a contract is easy but getting out can be hard, expensive, or worse – both!

Knowing on the way in, how you can get out, is important. And while you should not enter into a contract with someone for anything if your expectation is to get out later, if circumstances change and a seller is not in a giving mood, you may have to exercise an out.

In any contract, there are points where contracts can be far more easily ‘blown up’ than other points. Likewise, the closer you get to the settlement date the harder (and more expensive) it becomes. Understand the potential points in a contract where you can extricate yourself without penalty (or even lawsuit) before signing on the dotted line.

Know What Matters to Both Parties

This was an actual event — while driving home from vacation, my middle daughter in the front seat turned to my eldest in the back seat and said, ‘My sunglasses are in my bag in the back. If you get them for me, you can borrow my headphones.’  My eldest reached into the back and, without incident, got both the sunglasses and headphones. This NEVER happens in my house. NEVER. Any request made by one daughter to the other is generates a heated negotiation that usually involves me either turning up the TV or leaving the room.

This time, for reasons I am still unsure as to why they happened, it was different. My younger led with an offer of value to receive value. It was a stunning display of WIN – WIN. As a Realtor, I had never been so proud of my young negotiator.

via GIPHY

 

The lesson is as follows — we all value things differently. My middle daughter does not hate my choice in music nearly as bad as her sister so her headphones were of far more value to the elder one. But since she was sitting in the front seat and we were driving west in the afternoon, sunglasses were important. It was a perfect trade.

For someone who is attempting to sell a home and buy another one, time and flexibility matter. Allowing a seller not only the time, but the certainty to go out a buy their next home is HUGELY important to them. The use of a ‘Rent Back’ agreement is appropriate.

I once saw a seller of a large lot home toss in the John Deer tractor for free … and the purchasing suburbanite with a push mower ate it up! The ‘Bill of Sale’ is the correct tool in this scenario.

Being able to pay in a currency that matters more to them than you is always smart.

The Richmond Association of Realtors offers us over 150 different contract forms to use.
The Richmond Association of Realtors offers us over 150 different contract forms to use.

Understand Contract Structures

A contract is a flexible and malleable instrument … it can do a lot of things. Having been exposed to not only the common practices in the residential market, but the commercial and development market has given us insight into a wide range of techniques.

In the recent spring markets, multiple offers were far too common. Securing the winning offer when 3 or more people are bidding is hard. Most offers in a competitive situation include escalation clauses. Writing an escalation clause that secures the property while simultaneously paying as little as possible is an art.

Another example might be a using study period (in lieu of property inspections) and/or other phraseology to limit exposure for both parties. Often times, limiting both upside and downside is a technique that can provide a framework for a buyer and seller to reach an agreement.

Lastly, when working with buyers that need to sell a property before they qualify for another, the ‘Contingent Upon Sale’ and/or ‘Right of First Refusal’ contract is often required. It is critical to not only understand the differences, but the correct application of these contracts to best serve the client.

I shudder to think of the number of times a bid was lost or a price was escalated unnecessarily from faulty structure or from not understanding contract options.

At the end of the day, trade price for terms and you will win far more than you lose.

Conclusion

This post could have been faaaaaaarrrrrrr longer.

It is hard to say demonstrate competent contract writing in blog form as each set of circumstances is unique. The subtleties and nuanced structures should vary by the parties involved, marketplace conditions and each individual’s goals.

And while expressing what we know succinctly is challenging, I think it is fair to highlight some of deals we have negotiated to give you a sense of the depth of our experience:

We know a thing or two about using the contract to our client’s advantage.

 

 

 

You’re Gonna Be Mad at Us…

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You are about to get really mad at your Realtor … and your lender … and your attorney.

And you know what?  It isn’t our fault.iStock_000013841997_Large_jpg

Beginning in late 2015/early 2016, the way real estate transactions are closed will change and change substantially.  Since becoming licensed in the early 1990’s, this is by far and away the most fundamental structural change I have even seen in our industry.

Dodd – Frank and the CFPB

In 2010, the Wall Street Reform and Consumer Protection Act (also known as Dodd – Frank) was signed into law by President Obama.  With its signing, Dodd-Frank brought sweeping change to the way the financial markets were regulated.  It also gave birth to the Consumer Financial Protection Bureau (CFPB).

Dodd – Frank (and the CFPB) was created in direct response to the financial crisis. It was designed to put more controls in place, as well as harsh penalties for intentional fraudulent practices, to prevent another complete economic collapse on the scale of what happened in 2008.  And as the real estate market (ok, lending) was one of the chief culprits in the meltdown, it too, fell under the changes brought by Dodd – Frank.

Fast forward from 2010 to 2016, and we are now seeing the full impact of Dodd – Frank.  The changes are far from all positive.

The Financial Crisis

One of the main goals of Dodd – Frank was to protect a largely uninformed public from unscrupulous and predatory lenders.

The Dodd-Frank legislation is 848 pages if you care to read it.
The original legislation is 848 pages if you care to read it, but click here for a synopsis.

During the run up to the crash of 2008, a largely unregulated lending market began to create mortgage products which were intentionally disingenuous. These highly leveraged adjustable interest only loan products were not designed to help someone own a home, but to extract as much in interest payments as possible.  The loan products created mortgage time bombs as rates adjusted upwards and payments on the loans increased well beyond buyer’s ability to repay them.

Those who created the loan products were able to insure them against default (which was totally insane and probably the biggest cause of the crisis) and thus carried no risk … which only encouraged riskier and risker behaviors.  Cracks appeared in the financial dam in late 2007 and by summer of 2008, all forms of lending effectively ceased, largely freezing the real estate market in place.

Know Before You Owe

Would 2008 have happened if the borrowers of the world knew what they were borrowing?  Hard to say.

Regardless, it appears that the CFPB does feel that way and thus, the changes now being put in place.  In order to create an environment where consumers were far more certain about the products they were signing on for, the CFPB has adopted the philosophy of ‘Know Before You Owe‘ in an attempt to save borrowers from the evil lenders.

Know_Before_You_Owe___Consumer_Financial_Protection_Bureau
Gotta love when the Federal Government uses logos and catchy sayings

The key to protecting the borrower from the lender, in the opinion of the CFPB, is more time, longer forms and harsh penalties. By completely revamping the lending practices of mortgage originators, the CFPB is effectively forcing lenders to disclose more fully and far earlier than before with extremely large penalties for non-compliance.  Hopefully, consumers will have more time to comprehend the loan products they are committing to and lenders will be far more reticent to push the boundaries of good faith knowing fines exist as large as $1M per day for willing non-compliance.

Disclosure Earlier is Good, Right?

An informed consumer is a better consumer … this cannot be argued.  Forcing the lenders into better disclosure earlier in the process means a better informed client.  Once again, this is a good thing.

In order to force lenders to fully disclose earlier, the CFPB has demanded two major changes.  The first change is in how disclosure happens.  The closing statement that had been used for decades is being replaced by new form that is both longer and in more detail.  Effectively, the Truth in Lending Statement and the HUD 1 Closing Form (aka Closing Statement) are being merged into one mega-form now called the Loan Estimate and Closing Disclosure.  It can be argued that this change is more annoying than structural and will not really have an impact other than some short term confusion as attorneys, lenders and Realtors get familiar with the new terminology.

The second, and far more impactful change, is that all of these documents must be delivered to the borrower a minimum of 3 days prior to closing.  Gone are the days when the HUD would arrive 30 minutes prior to closing and everyone saw it for the first time when they sat down to sign paperwork and made any and all adjustments to the form while sitting at the closing table.  The closing attorney (or title company) had the power to make minor adjustments to the closing statement in real time to fix errors or omissions.  No longer.

Sequential closings are going to experience a ton of problems...
Sequential closings are going to experience a ton of problems…

You Only Hurt the Ones You Love

On the surface this sounds like a great idea … lets get everything ironed out earlier!  Having a chance to review the package well in front of closing feels much better than hoping that the closing statement will be correct when you arrive at closing with movers on the way and your sick kid at your sister-in-law’s house.

But what happens if the statement is wrong?

Any amendment requires the 3 day process to begin anew. Imagine going to a walk through and seeing that a repair was not done correctly and the seller and buyer agree to escrow $1,000 for the repair … guess what??  You gotta wait ANOTHER 3 days to close.  Or what if the builder forgot to show a $2,500 credit for the upgraded appliance package?  Yep, 3 more days…

The ability to make adjustments to the closing statement is now, for all intents and purposes, gone.  In its place is 3 days of pain, stress and frustration while the paperwork is amended, resubmitted and subject to another mandatory 3 day review period.

When you think about the impact this will have on closings where multiple homes are expected to close in sequence, you can begin to see the trouble this will cause.  If any one of the loans in the chain requires modification, it will slow down the process by a minimum of 3 days.

And heaven forbid if you have used an internet lender in a different time zone.  I can’t imagine the pain this will cause.

While I agree with full and complete disclosure, the CFPB has not anticipated the ancillary impact this requirement will have.  Removing the ability to make legitimate modifications to the closing statement is not consumer protection.

Marginal Buyers Lose

The sequential closing is a hugely important part of our the market, especially for buyers who have little equity and are unable to qualify without the sale of their home.  The 3 day right to review will wreak havoc on the closing process that we have all become so accustomed to and understand so well. By outlawing what are benign and minimal, but necessary, last minute changes to the closing statement and forcing a minimum of a 3 day wait upon the parties is either going to:

  • Discourage the practice and force marginal buyers to stay in place
  • Force many last minute panic moves or late closing penalties on the marginal buyer
  • Force buyers to accept incorrect closing statements due to penalties for non-performance exceeding the incorrect costs on the closing statement

I am not sure that this is what the CFPB intended.

Sorry…

I am already rehearsing my apology.

The first time the problems arise (and they will), the buyers and sellers of the world are going to get angry.  ‘What do you mean we aren’t closing for another three days?!?!  The movers are on the way!!!  My new job in Poughkeepsie starts Monday!!’

Sorry.  I really cannot help.

I fully expect to take many daggers because of someone else’s mistakes and there will be nothing that I can do about it.  Nor can the attorney, nor can the lender.

At the end of the day, the old world is no more and we now have a far more regulated and inflexible process that, I feel, will cause more harm to the consumer than protection.  The lending institutions of the world that caused the crash are no more.  Enacting rules to prevent their fraudulent practices is akin to closing the barn doors after the horses are long gone.

But the doors are now closed and those who are left in the barn are now trapped with far less room to maneuver.

 

 

How to Execute a Simultaneous Sale/Buy

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So you want to buy a new home, eh? Great! We can help.
But you have a house to sell, too. Great! We can also help with that.
But you can’t buy the new home until you sell the existing one. Got it.
And you don’t want to settle for a new home that you don’t absolutely love. No sweat.
And you don’t want to move twice. Understood.
And you don’t have to move so if you don’t get what you want, you can just stay put. Noted.

buy and sellSelling and Buying at the Same Time

We hear these statements all of the time … and trust us, we really do understand.

As the market rebuilds itself and more and more people are getting back to a position where the value of their homes has recovered, we hear the aforementioned wishes more and more. But correctly executing the sale/buy transaction is harder than it sounds … and it is about to get harder. Likewise, one person’s best way might not be another’s best way. This is not a ‘one size fits all’ type of transaction.

Let’s look at what to consider.

Everyone is Different

First and foremost — no simple answer exists.

Everyone has a different view of financial risk, and thus, no one solution exists ...

If anyone has a single ironclad way of handling this scenario, I have yet to meet them. Not only is each situation unique, but everyone has a different view of financial risk. What may feel comfortable to one buyer may feel unnerving to another. The possible combination of factors – price, income, equity, interest rates, timing, distance (and many more) – makes recommending a single ‘step by step’ pathway both irresponsible and short-sighted.

At the end of the day, you need to consider many factors. By understanding the concepts and their risk/impact, you will give yourself a framework to help discover YOUR best path.

A Framework for Understanding

Remember, it is a portfolio decision, involving a buy AND a sale ...
First and foremost, you need to realize you are making a portfolio decision. The sale of a home and subsequent purchase of another is nothing more than rebalancing your overall financial picture, at least as it relates to housing, and decisions made on one side impact the other. These two seemingly independent events need to be considered in conjunction with one another and should not be separated. Many people want to look at the two transactions as independent of one another, but they are not.

Unless you are moving from one market to a completely different one or selling and moving into a long term rental, replacing one asset with another simultaneously means similar market conditions on both sides (with some exceptions, obviously.) If it is a seller’s market when you sell, it is when you buy. The reverse is also true. Don’t expect otherwise.

Months of Inventory – Richmond Region

For more information about market conditions, check out our STATS page

Pick a Side

One side of the transaction is more important than the other ...
That said, you have to recognize that one side of the transaction is more important than the other.

Typically, when trading up from the starter home to the 5 bedroom home that will take you through the next 20 years, the home you are buying is more important than the one you are selling.

Act accordingly.

Timing is Everything

The sale/buy is about precise timing.

A properly executed sale/buy means the execution of many complex things all at once – closing, funding the mortgages, payoffs, wire transfers and movers (to name a few.) Make sure your team (Realtor, lender, attorney) is not only experienced, but experienced in working with one another.

A missed date in a sale/buy can get incredibly expensive extremely quickly and guess what – you are the one who carries that risk.

Contingent? First Right?

Sellers in accelerating markets hate both ‘Contingent Contracts’ and contracts with a ‘Right of First Refusal.’  Being either a contingent buyer or first right buyer in most cases, means overpaying, and is a poor strategy.

More on this later.

Liquidity is Power

Many financial advisors have scared their clients by not understanding the housing implications of their advice ...
Liquid assets are your friend. 401k, stock accounts, home equity loans, other retirement funds … all of these have value either as collateral for a loan or in their ability to be turned into cash.

Make sure you fully understand the impact of accessing these assets (taxes, penalties, borrowing rates, vesting) before blindly refusing to use them. It should also be noted that many a financial advisor has scared clients by not understanding the housing implications of their advice. Asking your financial advisor is prudent, but filter that advice they give you.

Use Your Math Skills

Furthermore — remember it is a math problem.

Don't try to save $1,000 on one side to cost yourself $3,000 on the other side ...
Often, we hear clients say ‘well its too expensive to borrow against my 401k’ when in actuality, the cost of accessing assets like the 401k is far cheaper than the alternatives. Don’t try to save $1,000 dollars on one side and cost yourself $3,000 somewhere else. If liquidating a stock position makes you a stronger buyer, seriously consider it.

Use Your Strength

Likewise, the more strength you have as a buyer, the better deal you can drive.

Remember that an offer is a combination of price AND terms. Being a good buyer is more than just price. Down payments, closing dates, inspection, appraisal and sale contingencies are all part of the contract and can make your offer more attractive than someone else’s in a competitive offer situation. The better the home you are buying, the more offers it will generate.

Vet Your Lender

A good lender is a must.

The use of a non-local lender always costs more in the long run ...
If you use an internet lender or some other lender tied to your stock portfolio, money market account or insurance carrier, prepare to have a miserable and expensive experience. I cannot state this loudly enough – the use of a non-local lender will cost you substantially more in the long run. Do not worry about how great their incentives are to get you to use them, don’t do it. Nothing they can offer you will make up for the expense of missing the closing date on a simultaneous transaction. If you are talking to one now, hang up the phone, close your internet browser and step away. Non-Local lenders never ever ever work out. Never. Ever. Never. And, once again,  you are the one who loses, not them. If you take nothing else from this post, remember this point … please.

Penny Wise and Pound Foolish

Beware the tendency to be ‘Penny Wise and Pound Foolish.’

Many times I have seen a seller (who is under contract to buy) make a dangerous decision about an minor inspection item and put their own sale at risk. Buyers are still skittish and being too aggressive on a small item, regardless of how right you may be, means losing big in the end. If you have removed your own contingencies and spent money with your lender, inspectors, insurance broker and appraiser, losing the contract on your house over a small inspection item will feel incredibly foolish in hindsight. Be extremely careful about everything you do that can give your buyer an out when trying to execute the simultaneous transaction.

Do Your Homework BEFORE it is Due

Speed is critical, and so is market knowledge.

Do your homework, get prepared and rehearse!
Minimizing the time between when you find the perfect house, get it under contract and have yours on the market minimizes your risk. Knowing the market means immediately recognizing a good deal and being prepared to act gives you the greatest chance for success. Do your homework, get prepared and rehearse.

  • Keep your home ‘show ready,’ even if not on the market
  • Get pre-approved, not just pre-qualified, and keep it updated
  • Have the ability to go see a newly listed home within 24 hours
  • Be ready to pull the trigger and negotiate quickly
  • Have your team ready and understand the costs

Expect Competition

Expect the best listings to have multiple offers and prepare accordingly ...
In a market starved for inventory, your value as a buyer is far less.

Don’t expect the new listing in the perfect neighborhood to negotiate price much (if any) and don’t be surprised if there are multiple offers. As a matter of a fact, expect the best listings to have multiple offers and prepare accordingly. And the more you lallygag with making an offer, the more competitive offers will magically appear.

Wait or Act?  You Decide …

Waiting makes ‘Trading Up’ more expensive. The long term prognosis for both interest rates and home pricing is heading up. If you are moving up, then waiting until the home you are selling appreciates some more (probably) means buying a more expensive home at a higher interest rate. Yes, your $200,000 home might go up by 5%, but so did the $500,000 home you want to buy. Do the math.

Get Housed Right!

Do not discount the cost of being ‘Housed Incorrectly.’

If a recent job change has created a 90 minute commute or a change in familial status means you have too much (or too little) space, it causes stress. The impact being in a house that no longer fits is not without actual cost or mental/emotional cost. The creation of unnecessary stress and expense is unwise.

Accept the Idea of Moving Twice

Be prepared to move twice.

No one wants to hear this but know that making a decision about your next 10 to 20 years is worth a short term rental or week in a hotel. No one makes their best decision when they are under pressure. Removing the ‘I refuse to move twice’ condition from decision means more and better options as well as a stronger bargaining position. Buying a home that does not fully fit so you didn’t have to move twice means going through the process again … how big of a pain would that be?  Not only would be a big pain, it would be an expensive one, too. If moving twice gets it right, do it.

The Sale/Buy is Harder than Ever!

Similarly, the ability to execute a simultaneous buy/sale is about to change and may force you to move twice.

The implementation of the CFPB’s mandated new closing protocol will occur in late 2015 and change how closings are handled. Many of the changes create timing issues that are going to impact the ability to close consecutive transactions. The old way is no more and the protections that are now built in on the buyer’s behalf takes away about half of the flexibility to correctly execute the simultaneous buy/sell. For sell/buys using highly leveraged mortgages, or closings where multiple people are executing simultaneous buy/sells (think of a long line of dominos,) it will be even harder.

Plan B

Have a backup plan in place.

Do you want the know the best way to lose big in a negotiation? Have no alternative, that’s how. Playing chicken with a lender, mover or builder gets awfully difficult when you have no backup. And know that the your lender, mover and/or builder plays the negotiation game every day … you might play it once every decade. They are better at it than you are.

The Use of Contingent and First Right Contracts

Above, we referenced the ‘Contingent Contract’ and ‘Right of First Refusal’ (ROFL) contracts. In theory, they make perfect sense.  In reality, they don’t get you what you want. Contingent contracts and ROFR rarely work.

First, a contingent contract effectively says to the seller – ‘I will buy your home when I sell mine.’ The seller takes their home off of the market and waits for the buyer’s home to sell. We very rarely recommend for our sellers to accept a contingent contract.  If we do, it is only with draconian constraints and penalties for non-performance by the purchaser. The idea of taking a salable home off of the market during the spring season is colossally stupid and thus, it should not be done without proper protection.

In a ROFL, the buyer effectively says to the seller – ‘I will buy your home when I sell mine, but you can still market the property. If someone else brings you a contract, then I will either figure out a way to buy it or step aside and let the next group buy it.’ Only in the rarest of scenarios do we recommend for a seller to accept a ROFR.

When the market is stout, like it is now, these contracts are basically worthless. A seller is looking for someone without a contingency so they they can get on with their move. In order for you to convince the seller to accept a contingent contract, you pretty much have to overpay to get them to accept your contract.

Similarly, if you are in a ROFR or contingent situation, you have to price your home aggressively or risk losing the property you want to buy. So you end up overpaying for the purchase and underselling on the sale. That is just dumb.

Either way, the contingent contract or the ROFR, the buyer usually pays more and receives less … I am not sure why people try to use these techniques.

Conclusion

At the end of the day, we recommend figuring out how to buy without the use of the contingent contract or ROFL. In this market, these contract structure present risk greater than the reward in almost every case.

If you cannot buy without selling, we recommend selling first and strongly considering the dreaded concept of moving twice. The position of strength you will gain by doing so will far outweigh the short term nuisance. If you can figure out a way to make the timing work, then great, but a temporary move lets you shop from a far stronger position.

And lastly, if you want to move once, make sure you can act quickly and have a backup plan in place, just in case. Know that in doing so, you are limiting your options and placing additional risk in the transaction.  The coming changes to closing practices are going to muck up the system tremendously and create chaos.  The financial penalties to lenders will make them even more cautious than they are currently and the idle moving trucks in your driveway is not their primary concern when faced with up to a $1M PER DAY fine.

Understanding the inherent risk in this type of transaction is key and hopefully, this article has brought to light the difficulty and danger in correctly navigating the simultaneous buy/sell.

Pre-Qualification or Pre-Approval?

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What is this “Lender Letter”?

If you are going to need a mortgage loan to purchase your new home, one of the first questions you will face from your Realtor is “have you been pre-approved (or pre-qualified) for a new loan with a mortgage lender?”   What is the difference? Believe it or not, many mortgage bankers exchange the phrases like they are synonymous, but there are subtle and, in some cases, very important differences. Most home buyers will be asked for a “Lender Letter” to present to the seller and their agent upon submission of your initial offer to purchase agreement. The letter is usually based on information gathered or exchanged related to either a pre-approval or pre-qualification process.

So what is the difference? Here is how I would describe each:
prequal letter_opt

  • Pre-Qualification is a loan officer’s opinion based on verbally supplied information related to a potential borrower’s income, assets, and credit profile relative to a currently available loan product guideline.
  • Pre-Approval is a fully underwritten mortgage loan in which income and asset documentation is provided as well as a credit reviewed and validated by a mortgage loan underwriter who issues a commitment to lend subject to maximum terms associated with interest rates, monthly payments, cash to close, and loan amount, all subject to a ratified purchase agreement and an acceptable property appraisal (whew…that is a lot of stuff!).

So, one is maybe a 15 minute call, and the other is more like a 20 day process.

Chris Owens with Southern Trust Mortgage has a full range of second home and investment property loan products.
Here are links to the other articles in this series about Lender Letters:

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