Few things are more important to real estate investors in today’s competitive landscape than real estate contracts. Not only that, but bringing them to close. At the very least, bringing a deal to the point a contract is needed indicates a transaction is — more or less — impending. However, a contract is far from a sure thing, and the sooner you learn that, the better. If for nothing else, complacency is better left for your competition.
Bringing your next real estate deal to contract isn’t a sure sign that the transaction will take place. There are, after all, a number of things that can still go wrong at the closing table of a promising deal. In fact, there are three very common reasons real estate contracts fail to be completed.
While nobody expects to see a deal slip through their fingers at the eleventh hour, it’s bound to happen, even to the best of us. However, in educating yourself on the reasons most contracts fail to close, it’s entirely possible to be proactive and make sure the same things don’t happen to you.
To give yourself the best odds of walking away from the closing table with a smile on your face, take note of the most common reasons real estate contacts fail to close, and do your best to head off issues that may present themselves in your own deals.
1. Appraisal Comes In Lower Than The Negotiated Price
A home appraisal, as Discover so eloquently puts it, “is an unbiased estimate of the true (or fair market) value of what a home is worth.” A proper appraisal will account for several valuation factors, not the least of which includes things like gross living space, the year the property was built, and even intangibles like view and location. Due, in large part, to the unbiased nature of your typical home appraisal, this particular home valuation strategy is just about the most accurate form of valuation any property can receive.
As a result, most loan originators and lending institutions will require an appraisal prior to lending. Not surprisingly, said lenders will typically loan on the amount the appraisal comes in at. And therein lies the reason appraisals have a tendency to break contracts in real estate deals: discrepancies in the appraisal value and asking price can bring contract negotiations to a halt. If, for instance, the valuation on a respective home appraisal comes in below the agreed upon sales price, the buyer won’t be able to cover the seller’s asking price. Remember, banks will typically lend on the appraised value of a home.
With that in mind, it stands to reason that home appraisals are one of the single, biggest culprits for breaking real estate contracts. If for nothing else, most buyers are inclined to include an appraisal contingency that — when executed properly — awards them away out of a contract in the event an appraisal comes in lower than the original asking price. Since these contingencies are practically common practice, it shouldn’t surprise anyone to learn that they end a great deal of contracts.
Quite simply, an appraised value that comes in lower than the agreed upon asking price could prevent the buyer in this situation from receiving the amount they need to buy the home. As a result, they would need to make up for the difference. And since that’s not always possible, most buyers will include an appraisal contingency in their contract; one that would allow them to back away from a deal without repercussions.
If you are looking to sell anytime soon, it’s in your best interest to have the home appraised prior to starting negotiations. That way, you are less likely to have a deal slip through your fingers.
2. Home Inspection Reveals Undisclosed Red Flags
The value of a quality home inspection can’t be underestimated. Both buyers and sellers can benefit immensely from being made aware of a home’s shortcomings, or even lack thereof. Owners, on the one hand, can gain valuable insight into their own property they were otherwise oblivious to, and buyers are under no obligation to enter into a deal without accurate information pertaining to the home itself. There is no doubt about it: a good home inspection helps everyone involved.
Having said that, home inspections (like appraisals) are responsible for a great deal of contract terminations. In the event a home inspector reveals undisclosed issues with a property, it’s entirely possible for the new information to render previous contract negotiations moot. If for nothing else, a home inspection contingency should allow prospective buyers to back out of an impending deal if troubling issues are discovered upon inspection — it’s only fair.
It’s worth noting, however, that if a home inspection reveals several worrisome red flags, the contract is under no obligation to be terminated. In fact, not unlike the appraisal contingency I highlighted above, many buyers are advised to include a home inspection contingency in their initial contract. Home inspection contingencies, however, award buyers more options that you need to be aware of.
If your home inspection returns with some troubling information, you don’t have to back out from the contract. This is particularly important for investors looking to receive properties at a discount, as the right inspection contingency could allow you to negotiate a better deal if red flags are brought to light from the inspection. So while you may terminate the contract in the event major issues with the property are brought to light, you also have the opportunity to negotiate the price down, or even have the owner fix the issue on their dollar. Whatever the case may be, make sure your appraisal contingency states as much.
3. Funding Falls Through In The Eleventh Hour
The last reason most real estate contracts fall apart is perhaps the most obvious: funding. At the very least, you can’t complete a deal without the appropriate funding. It’s possible to have funding lined up over the course of a contract, only to lose it at the closing table. In fact, it’s entirely possible for someone that has been deemed qualified to purchase a home by a lender to be declined later. It’s actually quite common for someone that has been qualified for a loan to lose funding due to a change in the lending guidelines, which are always in flux. That said, far too many prospective buyers have made it to the closing table, only to find out their money source is no more. And, as a result, the real estate contract is at risk of falling through. Again, you can’t have a deal without the capital, right?
Fortunately, buyers that lose funding at the eleventh hour are not penalized — that is, if they managed to include a financial contingency in their contract. A financial contingency awards buyers the opportunity to back out of a deal in the event their lose funding, without being penalized.
It’s a sad truth, but a reality nonetheless: real estate contracts are not set in stone. While the very nature of a contract is to assure every party involved that they are going to get what they want, there are certainly exceptions to the rule. In fact, the number of reasons a real estate contract can fall through are as varied as they are unwanted. The three I hit on above are far from the only reasons a real estate contract may not be seen to completion, but they are perhaps the most common.
It stands to reason that those who can not only identify the most common reasons deals fall apart, but also remain proactive in finding solutions, will realize the most success. As an investor, it’s in your best interest to stay ahead of the issues that could potentially derail a deal. If you can do that, you place the odds of success ever in your favor.