The role of earnest money deposit, EMD, when you're making your offer

OK guys today I’m going to talk about the earnest money deposit or what is commonly referred to as EMD.

When you are making an offer on real estate there are three major components of the offer;

Price

EMD

CONTINGENCIES OTHER TERMS AND CONDITIONS

Everybody seems to think that PRICE is always going to be the issue. This is not necessarily the case. In order to understand the investor or cash Flipper offer we need to be able to compare it with a standard citizen/civilian or what I refer to as the retail offer.

I am going to start on the retail offer

With a retail offer, you have price, earnest money deposit, contingencies such as an inspection, as a result of an inspection, the repairs and the sale/financing is subject to the property appraising at a above or at the sales price (unless the buyer is prepared to pay the difference, should the appraisal fall short of the sales price). The bank/lender will only finance X percent of the appraised value, regardless of whatever price the parties may have agreed-upon.

The appraisal

In the event of the appraisal being less than the sales price, one of two things happen. Either, the seller and buyer needs the agreed-upon price to the appraised value, or, the buyer needs to make up the difference between the appraised value and the selling price, in cash.

Most buyers, do not pay cash for a home property purchase, but will finance their purchase. As part of the financing process, the bank/lender will order an appraisal to be performed by an independent licensed appraiser. The burden of paying for the appraisal will fall squarely on the shoulders of the buyers.

The Home Inspection

Prior to the appraisal a home inspection needs to be conducted. This home inspection is typically paid for by the buyer. The inspectors job is just like it sounds, inspect the home and look for stuff that’s wrong or needs to be repaired. These inspection reports are quite detailed, with the inspector identifying issues with the home which need to be repaired. It is then up to the buyer and seller to negotiate what items are going to be repaired and who is going to pay for them. This process in itself can be quite arduous and stressful for the both the buyer and the seller. 

In many instances the lender will also require a copy of the inspection report and as a condition of making the loan will insist or may insist that certain items be repaired. After all the property they are lending money on, will be their secured asset.

How long does the process take?

When a retail or civilian offer is made on a property, you have to take into account the inspection, the repairs which need to be conducted, the appraisal, the costs associated with all of these activities and of course, this means time. It takes time to conduct the appraisal, it takes time to conduct the inspection, it takes time to conduct the repairs and so in many instances the civilian a retail sell could take upwards of 45 to 60 days before it can be consummated. For the real estate agent and the seller it means waiting. For the seller, this is an uncomfortable time, a waiting game only to see everything fall through and for the deal not to close.

Uncertainty

With the retail, civilian offer there are so many uncertainties, which I often referred to as moving parts. The more moving parts you have, the greater the likelihood of some kind of breakdown.

BOM (Back On Market)

I have purchased a lot of real estate as a result of B0M, back on market. This is a situation where the property was under contract, the seller thinks they have it sold, and for whatever reason the deal fell through. The seller believed that their day would come, the real estate agent was looking forward to their payday and earning their commission and then all of a sudden something untoward happens. 

There are all kinds of reasons for a sale to fall through;

• The buyers if they are a married couple get divorced.
• One of the parties or the buyer loses their job.
• The buyer and the seller could not agree upon the repairs that were required to be performed as part of the home inspection who's going to pay and what is going to be repaired?
• The property failed to appraise and the seller was unwilling to lower the price, and the buyer did not have the cash to make up the difference.
• Despite assurances made by the loan officer the bar fails to qualify for the loan, and the list goes on and on.

The above reasons are just a few that given to me by listing agents, when I would ask why the deal was canceled and was on back on market.

Who gets paid and when?

With the exception of the appraiser and the home inspector, in real estate nobody gets paid until the deal closes and is records. The parties typically involved are the seller, the listing real estate agent, the buyers' real estate agent, the buyers' loan officer, the loan broker. Don’t forget escrow and title companies, title officers. In private or off market owner direct transactions pretty much the same people are stakeholders with the exception of the realtors. Again as I said earlier, nobody gets paid until the deal closes, funds, and is recorded at the assessors office. A lot of people often referred to having to go to title or the Lauri's office to close. Technically they're just signing paperwork. A real estate transaction is not closed, until the requisite paperwork is submitted and it is officially recorded at the assessors office. Once there is a confirmation of recording, then the funds are distributed. 

No close = No money

Like most people, real estate agents live paycheck to paycheck. In this instance, from closing to closing. Listing a property, taking the subsequent phone calls, Negotiating dealing with uncooperative tenants or non-responsive buyers and sellers, showing properties can sometimes feel like a thankless job. Especially since you can do this over and over again with seemingly no reward in sight. When buyers and sellers come together then as the realtor on both sides you have to shepherd the transaction through the various steps, there could be nothing more disappointing than the failure of the deal to close. Now the realtor has to start the process all over again.

Retail Transaction Milestones

In a retail transaction there are many milestones which need to be successfully reached, prior to a successful conclusion. Failure to reach any one of these milestones could mean the end of the transaction and the sale not being consummated.

So if you get the message, you should understand that a retail sale transaction of real property can be arduous, costly, and time-consuming process.

So now, let’s compare the retail sales transaction to the investor transaction. As I demonstrated, a retail transaction has many hurdles, and can take a protracted period of time sometimes in excess of 45 days.

In comparison, most cash investor deals close within 10 to 15 days. My average has been eight days to close, I've even had deals close in as little as three days. So let’s get into the investor real property transaction in more detail.

The shortest distance between two points is a straight line.

The investor real property buy transaction should represent this.

You have the same elements, such as price and earnest money deposit but that’s really where the similarity ends.

Investor deals typically are all cash, or utilize private hard money lenders, which is practically the same as cash. Many of the elements which are related to the typical retail sale transaction are eliminated, namely; no inspection, no repairs, no appraisal and no financing approval. In the case of a private mortgage lender PML companies such as Lending Home, who specialize in this type of activity they have their own internal processes associated with the valuation of the property. These entities are asset based lenders, if the borrower cannot pay, or defaults, many of these companies have their own systems in place to complete the renovation, sell the property and earn all the cream cheese.

No Appraisal No Inspection Close in 10 days or Less - Cash

Since the transaction is all cash the need for an appraisal is eliminated, the investor is buying the property or should be buying the property as is no, repairs, therefore there will be no need for an inspection.

Looking at this from the sellers or a listing agents perspective this is one heck of a deal. First of all everyone’s going to get paid within 10 to 15 days, there’s no appraisal, so we don’t need lender approval, there is no inspection, no inspection means there’s no need for any costly repairs, Negotiation about how much and who is going to pay so saving of money and time. You can see that the Investor sale transaction process for real property is completely streamlined. 

The real estate listing agent home owner can keep their fingers crossed and wait and hope that the retail sale will close, or, they can sell the property to an investor and have what is virtually a sure thing.

Too Many Bad Wannabee Flippers

The biggest challenge today is sorting out the wannabee flippers from the real flippers who have been flipping for years. It has been my recent experience, that the Wanabee Flipper ties up the property often times offering higher than list price to tie up the contract then after walking the property, they go in for a second grind. Professional real estate agents have gotten wise to this tactic, and so now when you call a listing real estate agent and tell them that you are an investor, investing for more than 20 years, you are met with a lot of cynicism and need to establish credibility.

How about 10% of List Price for EMD?

You can see that the investor offer removes the unknowns, time consuming variables which lengthens the time to close,  and remove the costs and uncertainty associated with the retail civilian transaction.

A big EMD gets attention! If you are serious about closing it doesn't matter.

Now there are only two other elements left earnest money deposit and price.

As a homeowner seller, you can take the higher price, but it doesn’t necessarily mean that the property will appraise, and that the buyer will be approved by the lender or even be able to perform. In many instances the home seller might not even find out or know for 60 days! In my early days of selling flips, I would call title to obtain a progress report and in some instances, the buyer had not even had the appraisal performed within a week of closing!

Today, if I accept an offer it is contingent upon the appraisal being performed within the first nine days of acceptance or the deal is dead.

Home Inspection versus As Is

As a home seller, in a retail or civilian transaction, you’re more than likely to have to participate in a home inspection and any deficiencies found in your home may need to be repaired at the you expense.

What happens if you need a new roof, or windows need to be replaced, or, how about the sewer line that connects your property to the main municipal sewer? I only bring this up because I’ve seen this happen to homeowners in real life.

A lot of property can be in such poor condition that they would never ever qualify for any type of conventional loan, FHA loan, or loan from anybody. The buyer can only make a cash offer on the property because it will not qualify for financing.

This type of property is perfect for the investor. Don’t forget you’re not the only investor. Which means it’s going to be competitive, there are always people who think they know better than you, who are less conservative and who will offer more than they should because they become emotionally involved. That’s okay my personal philosophy is; "no deal is better than a bad deal". There have been instances where my offers were accepted even though my offer price was way less than other offers.

The power of earnest money

Now let me first of all explain to you the earnest money is not required by law. For whatever reason in the world of real estate transaction earnest money has become part of the transaction process of purchasing real property. Earnest money means exactly that, you are showing that you are earnest in making your offer.

Now technically earnest money can take the form of anything that the seller sees as something of value. It could be a painting, it could be one of your old shoes, before the giant crash people would even accept IOUs.

What I have discovered over the last several decades of real estate investing is that the earnest money deposit, specifically the size of the earnest money deposit gets everyone's attention!

I can literally offer thousands of dollars less than my competitor investors, yet still win the deal simply because my earnest money deposit was substantial.

$1,500 or $15,000 EMD?

I have never done this but I know of other investors who knew they were going to definitely close on the property within 10 days, the purchase price would be the earnest money deposit! Now does that get your attention?

OK now is the time for me to expose a myth.

A lot of homebuyers and want to be Investors seem to think that, “if I don’t close the transaction I will lose my earnest money deposit“, and in fact, this myth is also shared by a lot of realtors who have been in the business for many many years. Let me tell you one thing, I have been involved in hundreds of real estate transactions, and not all those transactions were consummated successfully and I have never lost an EMD.

Why do you ask? Simply, earnest money is part of the purchase price of the property.

Earnest money is not required by law, but more of a custom or tradition in real property transactions.

When a buyer and seller are in agreement and the transaction does not move forward even once the due diligence period has expired, earnest money is typically sitting in the trust account, and the holder or owner of that trust account is supposed the be the neutral party neither favoring the seller or buyer. The trust account holder, cannot take sides and will not take sides. In the event of the parties coming to a disagreement regarding the disposition of the earnest money, or in fact Any part of the transaction, the holder of the trust account will do nothing and the earnest money will sit in trust.

The seller of the property still wants to sell the property.

As a buyer if you don’t close on the transaction, you cancel the deal, the earnest money sits in the trust accounts. The seller continues to market the property to find another buyer.

When the property sells, you inform the trust company that’s holding your earnest money deposit and they will release the EMD to you. I am sure, that you’re asking why. The answer is simple; earnest money deposit is part of the purchase price of the property. Once the property sells to another party the seller has been made whole. Which means the earnest money deposit has to be returned to you, or whoever put up the earnest money.

So let’s say you have earnest money deposit with the property, you cancel the transaction and you want the earnest money back, but the seller’s agent and or seller disagrees. What is their recourse. The sellers recourse in most instances is arbitration, in which case both parties need to agree on a third-party arbitrator and both parties need to pay for the arbitrator prior to going to arbitration. And until the arbitration is resolved the seller is precluded from selling their property. I will cover third-party EMD agreements another blog.

Most sellers see common sense, and agree for the return of the earnest money deposit to the buyer and continue on with their life to sell the property. It is the real estate agent who gets bent out of shape, and then some instances want the EMD released to the seller.

In the state of Nevada both parties can opt to move forward with arbitration, which cost money and prohibits the seller from trying to sell their property, or, Or the seller Ken agreed to the return of the EMD to the buyer and life moves forward.

No Deal is Better than a Bad Deal

Just because you have earnest money on deposit somewhere it does not mean that you have to follow through with the transaction and that you will lose your earnest money deposit if you do not. Quite the opposite. I tell every buyer even on the day of signing, if they don’t feel good about the deal do not sign!

Hey listen I’ve even had some sellers change their mind on the day of closing. So it’s all fair. As a seller you can change your mind, and as a buyer you can change your mind. Nothing is set in stone. Now this does that mean you’ll have a lot of people pissed off at you, yes! There are so many people who are paid on the closing and they’re going to be mad because it means they’re not going make money. Well let me tell you something I don’t care, as a buyer or seller, I’m not going to lose money or do a deal that I think could end badly because nobody cares about me, they just care about themselves.  You do not want to make this a habit but if you discover you made the wrong call, or you need to change your mind because circumstances have changed, it's OK.

What I want you to know is that when you make an offer make the offer with a compelling earnest money deposit which gets the sellers' attention. And don’t worry you’re not going to lose your earnest money deposit.