If you’re at all involved in the real estate market lately, you have probably heard a lot about “contingencies” (also referred to as “conditions” in other parts of the country). You might have also heard about all-cash offers, “non-contingent” offers or “waiving contingencies,” especially if you’re in the Bay Area. Many of my first-time homebuyers, and even experienced homebuyers, are commonly confused by this complicated-sounding term. If you’re one of them, this post is for you…
What are contingencies?
A purchase agreement in California can be contingent (conditioned) upon any number of things. The main contingencies people are referring to when talking about contingencies in the Bay Area are: inspection contingency, appraisal contingency, loan contingency, and contingency upon the purchase or sale of the buyer’s/seller’s property.
For example, an appraisal contingency means that the agreement to purchase the property is contingent upon the home appraising for at least the amount of the purchase price. In other words, the buyer is not obligated to purchase the home, and can cancel the agreement, if their appraiser determines that the value of the home is less than the agreed upon price. (The buyer might also be able to renegotiate the purchase price, under certain circumstances that I won’t get into here.) Without this contingency in place, the buyer would be contractually bound to complete the purchase even if the appraiser determined the value to be less than the agreed purchase price.
Likewise, an inspection contingency means that the buyer can conduct an inspection (physical inspection or otherwise) and isn’t obligated to purchase the property for the agreed upon price if they are not satisfied with the results of their inspection. Without this contingency, the buyer would be obligated to purchase the property for the agreed upon price regardless of any findings from their inspection.
Contingencies must be satisfied within a certain time frame, specified in the purchase agreement. For example, a buyer and seller can agree that the buyer has 7 days to conduct an inspection to their satisfaction and remove their inspection contingency. If the buyer does not remove this contingency after 7 days, the seller can choose to cancel the contract (upon adequate notice).
Why would someone waive a contingency?
In short, a contingency can be reduced (e.g., 7 days reduced to 3 days) or waived entirely in order to make an offer more attractive to a seller.
For instance, if the offer is contingent upon the buyer conducting a satisfactory inspection within 7 days, the seller faces a risk that, in 7 days, the buyer may choose not to proceed with the purchase for some reason (e.g., “cold feet”), in which case the seller must find another buyer. At that point, the home may have been on the market for weeks, which can be harmful to its marketability (i.e., difficult to get the best possible price and terms). This situation can make the seller very nervous and lead them to reject this offer, particularly if they have other offers that are similar in price.
In contrast, if the buyer removes some or all of the contingencies, the seller knows that the deal is more likely to go through. This is how buyers are able to compete against all-cash offers or offers that are higher in price. (The reality in this market is that more likely than not you will be competing against other buyers.) From the seller’s perspective, an agreement with fewer contingencies is, in most cases, more likely to be performed. Without an inspection contingency, the buyer can’t get “cold feet” and back out of the deal; without a loan contingency, the buyer is still contractually obligated to purchase the property even if they can’t obtain a loan. If these contingencies are removed and the purchase isn’t completed for some reason, the seller may seek damages from the buyer for breaching the agreement. This provides the seller some comfort when deciding to accept an offer and take their home off the market.
What are the risks involved in waiving contingencies?
I’m not saying that you as a homebuyer should waive your contingencies. Rather, you should weigh the risks involved and determine your own risk tolerance and whether the benefits outweigh the risks for you in your unique situation.
Among other risks, a homebuyer who decides to waive an inspection contingency could later uncovering something that affects the value of the property and not have the right to back out of the contract or renegotiate the purchase price. This could be something like discovering a huge crack in the foundation, a large termite infestation, or a dangerous neighbor. Without an inspection contingency in place, the buyer is nevertheless contractually obligated to purchase this property. This could mean they might need to spend thousands of dollars more than what they had anticipated – money they might not have – in order to make the property safe or habitable.
One thing that can help mitigate this risk is having a property inspection prior to making an offer. Often times, a seller will provide inspection reports to all interested buyers at the outset. Many homebuyers decide to rely on the seller’s inspection and forego their right to conduct their own inspection, especially when the report is from a reputable, licensed and certified inspector. That said, the inspector works for the seller in such a case, and it would be difficult to come back to the inspector later to complain that he missed something. Alternatively, the buyer may get their own inspection done prior to submitting an offer, but this can be costly for a property that you may not end up getting.
While reducing or waiving contingencies can be an effective strategy to winning in a multiple offer situation, there are many different risks involved in doing so. I highlight only a few here and make several generalizations for the purposes of this post. Homebuyers should always discuss the risks and benefits of waiving contingencies in detail with their real estate agent prior to making the decision to waive any contingencies.
Please contact me if you would like to discuss your particular situation.