Avoiding the “Contingency Premium”
“We may be small, but we’re slow.”
–Cal Tech football team slogan.
If you were a home seller, how much extra would you want in order to assume the risk that your Buyer could successfully sell their current home in a timely fashion — the standard Contingency is 60-90 days — in order to be able to buy yours?
An extra 3%?
Maybe 5%?
Ahh, but if you were starting a new job across the country in a couple months and couldn’t risk leaving behind an empty house, perhaps there’s no scenario where a Contingent offer would fly (the premium effectively was infinite).
Seller Motivation, Flexibility
Which underscores an essential truth about Contingencies: namely, the premium varies by Seller and their circumstances.
Relevant considerations include: “How long has the home been on the market?”; “What kind of condition is it in?”; “How much Buyer interest is there at the current price?”; and “Does the Seller have a firm timetable for selling, or can they be flexible?”
The premium also depends on the identity of the contingent Buyer — most significantly, on the market-readiness and salability of their current home (what Realtors call “the backup house”).
At one extreme is the backup house that’s: a) well-prepped and well-priced; and b) imminently about to go on the market — or already is.
At the other extreme is a backup house that’s . . . neither.
Of course, there’s always the potential for a further, complicating wrinkle: what if the Buyer’s Buyer first has to sell their house?? (that is, they’re a Contingent Buyer as well).
There can even be a string of such deals, all linked together, domino-like.
Contingent Offer as Non-Starter
For all those reasons, home Sellers understandably shy away from a Contingent offer.
Which is why prospective Buyers don’t bother making them: the Seller simply won’t consider it.
Based on my (17+ years) experience, I’d estimate that that’s true something like 80% – 90% of the time.
Even if the Seller will entertain a Contingency, there’s another reason that Buyers should try to avoid it: financial cost.
That’s because Contingent Sellers usually require an offsetting inducement.
Surprise, surprise, that inducement is typically price.
Case Study
The way this works out in practice is that someone who wants to buy a home that may be languishing on the market at $500k, from a Seller who’s amenable to a Contingent offer, would likely have to offer full price (or close).
“Small AND slow” may be Ok for CalTech’s basketball team, but it doesn’t work out so well in home sales.
By contrast, assume a non-contingent Buyer could negotiate a deal at $475k.
How does that $25k discount compare to the non-contingent Buyer’s cost to temporarily own two homes?
Given that the Buyer of a $500k home is most likely moving up from a home worth around $300k, you’d guess that their monthly PITI (Principal, Interest, Taxes, and Insurance) is between $2,000 – $2,500 a month.
If they buy the $500k home non-contingent first, then take 4 months to sell their $300k home — a very conservative assumption in a continuing Seller’s market, particularly at lower price points — their additional holding costs come to $8k – $10k.
By my math, $8k – $10k is less than $25k, even if there’s more stress that way (sorry, Buyers) . . .
P.S.: Non-contingent Buyers can reduce (or even eliminate) the time they own two homes by negotiating for a (relatively) delayed close on house #1.
The maximum lead time to close most Sellers will consider is 3 months.
See also, “Compensating for a Buyer Contingency“; “Daisy Chains, Dominoes, & Contingent Offers“; “Contingent Offers: Getting (Very) Comfortable With the “Back-Up Home“; and “Lake Wobegon and Contingent Offers.”
