Earnest money going "hard" after due dilligences? Is it common?

Question

Hello,

I was trying to get a 48 unit complex (rural but stable area with just under 10% cap) under contract. There were 2 offers being considered by the seller (ours and that of another group) and we were asked for highest and best due yesterday. The broker highly suggested that we make the earnest money non refundable at some point in the process, or waive the financing contingency, but my partner in the deal (much more experienced than me) was adamantly against this, saying that we would loose all leverage in case of any misrepresentation/surprises discovered later on in the process.

I was just informed today that the seller selected the other offer, mainly because they agreed to make the earnest money non refundable at the end of a short 7 day inspection period.

I know that the story is not over till it's over, but I was wondering how common it is to make the earnest money non refundable at some point in the process (specially if your offer is financed and not cash), in a multifamily deal? Do you consider this risky if the due diligence was thorough?

Maybe Brian Burke can chime in?

Jean

Joel Owens · Answer

Jean it is typical for as certain milestones are reached with larger properties for the buyer to increase the amount of EM that is non-refundable. The reason is the closer it gets to closing of the buyer backs out the seller loses the other buyers and is the most damaged. The buyer can simply go buy another property.

The market for the seller however might have cooled down and they lose their opportunity to sell for maximum pricing.

As a buyer you do not want large amount becoming non-refundable until there is a high surety of close. The reality is either side can try and tie up EM in courts with attorneys if each side backs out so a settlement is usually reached to end the contract etc.

The other buyer agreeing to 7 day inspection for non-refundable is very strong. I wouldn't do such a thing as there is not enough time to get all reports back. The buyer simply might have done this as a stall tactic to win the deal. Example they agree to backing out at anytime before 7 day inspection ends and make non-refundable. Seller chooses their offer over yours. Winning buyer plans to wait until day 6 and say they need more time or they are cancelling the deal. Seller has committed to them so agrees to an extension etc. It's a way to block you out of the deal.

No legal advice given.

Brian Burke · Answer

@Jean G., it's not uncommon at all...but you have to decide WHEN the money goes hard.

The best scenario is for the EMD to stay soft until you have removed both your DD contingency and your loan contingency.

A more risky approach is for the EMD to go hard after DD but before the loan contingency expires. If you don't get your loan and as a result you can't close, you lose the deposit. This risk may be acceptable if you can either switch to paying cash or you can come up with a lot more down so you can get a loan at a lower LTV (which can be easier to get).

The most risky approach is to have hard money day one.  In a competitive market this tactic is seen a lot. I recently lost a B&F round for the exact same reason...another buyer was willing to put up $500K hard and I wasn't.

I've done the hard money day one myself. It really put me at a disadvantage but I knew I was getting a good deal and I studied it enough to feel 100% confident in the property and my offer. I recently re-sold that property for over $4 million more than I paid for it so the risk paid off...but I don't want to do it again (but probably will at some point).

Only you can reconcile the risk/reward equation for yourself...BUT, if this is your first deal (or even second) I strongly recommend against taking those kinds of risks unless the amount of your EMD is meaningless to you.

Ross Greene · Answer

One idea you could have done is maybe keep the contingencies such as the financing contingency, but remove it after a certain time period? For example : Financing contingency to be removed on day 20 upon acceptance.  Or something similar. This will give you 20 days to MAKE SURE there is no hiccups with your financing and will also give the sellers some comfortability that you wont cancel at the very end of a 30 or 45 day escrow.

Ross Greene · Answer

@Jean G. Basically if you were to say Financing contingency to be removed after day 20 or day 25 you would have UP TO day 25 to cancel if you cant get financed. You just need to make sure you have a really good lender to do this. I trust my lender completely who usually gets me a full underwritten loan and clear to close within 18-22 days. Thus when I put after day 25 financing contingency to be removed it makes my clients offer look very appealing to the seller, but we already were good to close by day 20.

Just a little trick I use to get my clients offers accepted over others yet it really doesn't add much risk anyway. Removing the financing contingency still allows the, inspection, appraisal, financing (for up to 25 days). HOA docs contingency, etc. etc.

Jean G. · Answer

@Joel Owens

I think you're exactly right, the other buyer did this just to get the property under contract, and is probably trying to wholesale it or something like that, and I also believe that they will start causing problems on day 6 of the DD. My understanding is that they did very little due diligence before making the offer. I made it very clear to the broker to call me the minute that the other deal turns fishy and we'll jump right in, so there is still hope.

@Brian Burke

OK, understood. I spent 3 hours at the property interviewing the manager and touring all empty units before making the offer (the property manager said I was the person among all the prospective buyers that asked the most pertinent questions and found all the problems). I was confident enough to offer $10k non refundable upfront as a show of good faith but my partner said that I can go to the casino if I want to gamble :-) Since it is my first property of this size, I listened :-) Also I'm not sure if $10k upfront would have been meaningful.

Let's see what happens...

Jean

Douglass Benson · Answer

I have the "hardness" of my EMD align to my contingencies.  I basically have a 3 stage EMD where one half of the EMD is paid after DD is complete and the other half is paid after financing is approved out of underwriting and it goes hard the day after that payment is made.

Joel Owens · Answer

My properties a wholesaler wouldn't be able to tie it up. They have to show bank funds before even going under agreement. Weeds out a lot of that type stuff real quick.

They might just want to hold for themselves and thought of it as a way to win the deal and ask for an extension later.

Jean G. · Answer

@Ross Greene

thanks for the advice. That leaves me the risk of not being approved for the loan at the end though, right? My understanding of a financing contingency is that I can get out if I am not approved, but not for any other reason. So if I waive my inspection contingency after my sucessful due dilligence, and have say 10 more days after that by which the financing contingency will waive automatically, then there is not way for me to get out during these 10 days after the inspection and before the automatic waiver of the financing contingency?

Please explain if I misunderstood how this works.

Jean

Earnest money going "hard" after due dilligences? Is it common?

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