What is a "Contingency" in an Offer to Purchase Real Estate?

First of all, before I write a whole bunch of stuff about contract contingencies, let’s make it perfectly clear that I’m not an attorney. A lot of what I’m saying here has to do with the standard boilerplate California Association of Realtors Residential Purchase Agreement (the “RPA” by C.A.R.), and is a) open to legal interpretation, and b) negotiable, so your contract might be different than the standard I’m referring to.

The dictionary says contingency is the "dependence on chance or the fulfillment of a condition". The RPA purchase contract includes many contingencies that protect a buyer and add risk for a seller, and a few that protect the seller, too. A contingency is something that the contract depends on, conditions that give a buyer/seller an “out”.

Among other buyer contingencies, the RPA includes the following "major" ones:

• a loan contingency,
• an appraisal contingency,
• contingencies of the buyer’s acceptance of HOA reports and the sellers’ disclosures,
• an inspection contingency that includes investigation of the property’s insurability,
• and there is a checkbox that introduces a contingency on the sale of some property the buyer plans to sell.

In the standard language of the contract, each of these contingencies has a deadline by which it must be removed. But everything is negotiable, and if you have specific concerns, you should talk to your representative about the possibility of writing in longer periods or even asking the seller to allow the contingency to remain for the duration of the contract.

For the seller, pretty much the only contingency is that the buyer has to remove his/her contingencies in writing by each deadline or, after a warning and a period allowed for correction, the seller can cancel and move on to another buyer.

The “most major” contingency in the standard C.A.R. offer form, short of a sale-of-buyer’s-property contingency, is the Buyer’s Inspection Contingency. Even though the standard language of the RPA clearly states that the property is sold in its present physical condition (“as is”, and it has always puzzled me why so many banks require the buyer to sign a separate addendum further confirming the purchase is “as is”), there is a Buyer’s Inspection Contingency which grants a buyer a certain number of days to bring the professional inspectors of her choice to the property to investigate the details of the property’s condition.

If the buyer learns of an issue that she isn’t willing to live with, she can, indeed, make a repair request to the seller. The seller can agree to all, part, or none of the requests; in fact, the seller doesn’t have to even respond to the request(s). But if the buyer is unsatisfied, she can cancel the contract as long as she does so within the time limit for the contingency.

If a seller says no to a repair request, the buyer has only two choices: live with it or exploit the contingency and cancel the purchase. Although a buyer has an inspection contingency, she can’t force a seller to fix something unless he has already agreed to do so in the contract. An example of this might be when the seller has agreed in the RPA to provide a clear termite report, but then the pest control company requires expensive work be completed before it will issue a clear report. The seller is under contractual obligation to get the work done because he has promised to provide the clear report already in the contract that has been signed.

The seller’s contingency is pretty much never triggered as long as the buyer completes his responsibilities on time. So even though another buyer might come along and offer more money or better terms than Buyer1, as long as Buyer1 obeys all the contract deadlines (and doesn’t cancel per one of his own buyer’s contingencies), the seller has no option but to sell to Buyer1.

So Sellers, and Buyers! Make sure your representative is carefully walking you through your contract paperwork before you sign so you know exactly what your responsibilities and your rights are. And if there is something you have particular concern about, make sure you communicate with your agent team so they can be sure to do everything possible to propose contingencies in your contract that cover those circumstances.

All Cash vs. Financed: Why Does a Seller Care?

When writing offers for our buyers, we at the Etheridge Team are often asked why the buyer has to spell out how much of the offered price she intends to put as a down payment and how much she intends to finance. If we are offering $500,000 to a seller, why does he care whether that half a mil is coming from my pocket or from a bank? Why is a $490,000 all-cash offer possibly “better” than a $500,000 cash-plus-financing offer?

Today, more than ever, risk is something all parties to a transaction put a dollar amount on.

When a buyer makes an offer, his offer is for a price, yes. But along with the price come many other terms that the seller may assign a dollar value to. The standard boilerplate California Association of Realtors Residential Purchase Agreement (the “RPA”) includes many contingencies that protect a buyer and add risk for a seller, and a few that protect the seller, too. A contingency is something that the contract depends on, conditions that give a buyer/seller an “out”. Click here to read a post about the contingencies in the standard C.A.R. RPA offer form.

If the buyer wants a very long escrow, the seller may be excited about the opportunity to take her time moving out or selecting her new home (point to the buyer), or she may be worried about all the additional risk she is going to have to deal with since the number of days for something to go wrong is increased dramatically (point against the buyer). If a buyer’s offer is contingent on the sale of their current residence, and that property isn’t yet even on the market, that is a very high degree of risk, and if the seller is going to consider that at all, the buyer is likely going to have to offer something more to make it worth the seller’s while. If the purchase is contingent on the sale of a buyer’s property that is going to close escrow tomorrow… well… that is a different story. Clearly the risk is dramatically less in the latter case.

One of the “biggest” contingencies in the RPA is the loan contingency. In the lending climate right now, the rules are changing on a daily if not hourly basis. Yesterday a bank may have been fine making a loan on a property with a broken furnace, or in a neighborhood where 38% of the residents are tenants, or to a buyer whose credit score is 649, but perhaps today that same bank won’t lend in any of those circumstances. A buyer’s qualifications can change from day 1 of an escrow to the day the bank should fund the loan; she could lose her job or she could incur more debt like buying a new car which could possibly render her ineligible for the home loan. Even if you present to a seller all the supporting documents with your offer like a preapproval letter and bank statements proving you have your down payment in the bank, a smart seller knows that’s no guarantee the lender is going to be there when it’s time for them to cough up the dough.

If you need a loan, there is more risk with you than there is with an all-cash buyer, and the more loan you need, the greater the risk. If your offer says you plan to put 30% down but then you decide during the escrow to only put 20%, then you have to get the seller’s permission to modify your terms to accept the additional risk.

Bottom line: the details of your financing plans are material to the seller’s decision of which offer to take. This is why the seller (and the contract) require that you provide supporting documents like a preapproval letter and a copy of a bank statement proving you have the cash for your down payment. A good agent is going to make sure the package you present with your offer makes you and your offer look as strong and reliable as possible, because that just may make the difference that puts your offer on top!

#3 and #4 of 14 Things Buyers Should Know About Property Taxes: Due Dates and Bills

So here are parts III and IV of the 14 Things a Buyer Should Know About Property taxes. Click here to link back to the summary list of the 14 items.

3. Property taxes are late after April 10 and December 10.

This is a reality, plain and simple. Every single April 10 and every single December 10, if you have owned any property during the tax period – as a personal residence or investment/rental, the whole amount due must be paid. It doesn’t matter if you didn’t get a bill. It doesn’t matter if the bill came in the seller’s name, or was forwarded to the seller’s new home by the post office. It doesn’t matter if your bank is impounding (including) a charge with your monthly payment that should cover the amount due (see rule #10). The only exception is if the 10th falls on a weekend and then the due-by date extends to the next business day.

It doesn’t matter who you think paid it, or who you think should’ve paid it (the seller, the escrow company, yourself, your bank using impounds), you should go to the tax collector’s website and check to see that it shows paid and keep on the issue until it _does_ show paid, even if you have to double pay it. Like I said, the penalties are just too hefty, and the county will refund any overage to whoever paid it as soon as everything is cleared up.

4. Property taxes are due whether or not you get a bill.

Another plain, simple reality. You could get no bill, and/or you could get a bill in the former owners’ names. If you aren’t 150% sure the amount due is PAID IN FULL, don’t stop taking action until you are. Possible actions are:

• check the tax collector website to be sure it's paid in full,
• if the website says it is unpaid, and the escrow company on your closing says it WAS paid, get something in writing from escrow and take it to the tax collector's office BEFORE the due date and don't let up until the tax office confirms it
• if the website says it is unpaid, and your bank says it WAS paid out of impounds collected in your monthly payment, get something in writing from your bank and take it to the tax collector's office BEFORE the due date and don't let up until the tax office confirms it, or …
• PAY IT! Pay it a second time if you have to. To repeat: the penalties are hefty, and the county will refund any overage to whoever paid it as soon as everything is cleared up.

#2 of 14 Things Buyers Should Know About Property Taxes: Expect a Supplemental Tax Bill

So here's part II of the 14 Things a Buyer Should Know About Property taxes. Click here to link back to the summary list of the 14 items.

2. Expect a supplemental tax bill

A large portion, if not all, of your property tax amount is calculated on the property’s “assessed value”. The seller’s assessed value started as his purchase price. Thanks to Howard Jarvis and Proposition 13, there are restrictions on how much the county assessor can estimate the property’s appreciation for the purpose of tax assessment (another good reason not to sell properties if you don’t have to when buying up). So while the seller’s property may have appreciated 25% while he owned it, his assessed value may only be 7% above what he paid. In real numbers, maybe the seller bought the property for $500,000 and now it’s worth $625,000, but the tax collector calculates the property tax based on $530,450.

When you come along and buy the property for $625k, it takes the tax assessor’s office quite some time – sometimes six months or more – to get around to reassessing your property at the new value. In the meantime, the tax collector doesn’t realize the property has changed hands and does not realize he can “restart” the property’s value at your purchase price (once again subject to the Proposition 13 restrictions going forward). Until the reassessment, the taxes will be calculated based on the OLD and thus WRONG value.

No matter what, not even if it takes the government 10 years to get around to assessing your property, you owe the amount based on the new value. The difference that accumulates is called a “supplemental” amount, and you will get a bill for that amount shortly after the reassessment. The bill will come with its own deadline, completely unrelated to the regular April 10 and December 10 deadlines, and you must pay the supplement by the deadline. Period.

Don’t be surprised when the bill comes. Don’t be surprised that the amount is calculated based on the new value. Consider yourself lucky that your property is not in New Jersey, where the property tax rates are roughly FOUR TIMES what they are in OC (see rule #12), and just pay it. Try to stay positive. Keep in mind how much interest you are writing off on your income taxes and - with any luck - how much your property is appreciating, and just realize taxes are a cost of your investment. (See your CPA about whether or not your property tax amount is another deduction against your taxable income.) Remember to vote (see rule #13)… y’know, YOU are “the rich” now, you wealthy property owner!

14 Rules Buyers Need to Know About Property Taxes - Part I

14 Rules Buyers Need to Know About Property Taxes
(references are to Orange County California websites)

Here is a summary of 14 things Buyers need to know about (Orange County California) property taxes as well as a full explanation of Number 1. As I post each subsequent item from this numbered list, I will return here and add links to the full information on each number.

As always, I welcome your comments and questions!!

1. Don’t assume your first tax bill will be paid in escrow
2. Expect a supplemental tax bill
3. Property taxes are late after April 10 and December 10
4. Property taxes are due whether or not you get a bill
5. Your tax amounts cannot be known to the penny at closing
6. You should take steps to estimate your tax amount and prepare for it
7. Taxes are made up of a base amount plus special taxes
8. Some special taxes are a percentage of value and some are fixed
9. Mello Roos taxes are not the only special taxes we see in OC
10. There are plusses and minuses of impounding your taxes with your payment
11. It’s free to file a homeowners exemption (and to file a homestead)
12. It’s amazing how much more house you can afford if you choose a lower tax area.
13. OC taxes are among the lowest in the US
14. Vote – many ballot propositions are linked to property taxes

1. 

1. Don’t assume your first tax bill will be paid in escrow
   
   There are so many costs associated with purchasing a home that it’s easy to assume that property taxes must be in there somewhere. (and there are costs of selling, too. Incidentally, these are two reasons it is rarely profitable to “flip” – that is, buy and quickly resell – a property. Capital gains taxes are another reason.) Buyers’ costs can be divided into non-reoccurring and reoccurring. Non-reoccurring costs are costs that can be linked to the purchase and are not ongoing. Some examples of non-reoccurring costs are a physical inspector, title insurance, escrow company fees, and lender’s fees. Reoccurring costs are those costs of which a certain time period’s share are prepaid at the closing and then will continue during your ownership. Examples of reoccurring costs are prepaid mortgage interest, prepaid HOA dues (sometimes for multiple associations), prepaid fire insurance premiums, and property taxes MAY be prepaid.
   
   But usually not! Let’s look at a timeline…
   
   January 1 – beginning of second half of property tax fiscal year
   February 1 – tax bills usually are mailed out by today (*see rule #4!)
   March 10 – one month until tax payment is late
   April 10 – pay property tax by today or be penalized
   July 1 – beginning of first half of property tax fiscal year
   August 1 – bills usually are mailed out by today (*see rule #4!)
   November 10 – one month until tax payment is late
   December 10 – pay property tax by today or be penalized
   
   If your purchase closes between January 1 and February 1 (or between July 1 and August 1), the seller’s share of the property tax for the period is going to be very small. Unless the seller can provide evidence that he has already paid the taxes (unlikely since they are not late until April 11 / December 11), the escrow company will most likely charge the seller for the number of days he owned the property and take the amount they charged him and “pay” it to you the Buyer, that is, put it in your debit column. You probably won’t “feel” it. It will be a small inflow of cash in a statement containing lots of outflows. But the idea is that you now have the seller’s share of the payment in your wallet. If you move into the property before February 1 (or August 1), it is likely you will receive the bill, which will probably still be addressed to the seller. So when the bill comes (and even if it doesn’t - see rule #4!), you must pay THE WHOLE THING.
   
   Of course, there are exceptions, such as when the seller is an overzealous taxpayer and has paid the whole thing already. If he can prove that to the escrow company, then they will charge you the large amount for your share as a closing cost and pay it to the seller who has already shelled out the payment. In that case, you will not need to pay the regular bill. But you should still go online (see how in rule #6) to verify the OC tax collector shows the regular bill as paid, and you should still expect a supplemental bill (see rule #2). If your purchase closes between February 1 and March 10 (or between August 1 and November 10), it is likely the seller has already received the bill, so you will most likely not see one. Nevertheless, the escrow company will probably handle the charges and credits the same way they would’ve handled it if you had closed between 1/1 and 2/1 (or 7/1 and 8/1), charging the seller and debiting you, and thus expecting you to pay the whole thing, just as in the previous paragraph. You are responsible to pay it even though you most likely won’t get a bill. If your taxes are impounded with (included as part of) your monthly loan payment, the bank should take care of it… but you should call them to be sure!!
   
   If you close between March 10 and April 10 (or between November 10 and December 10), the escrow company is likely to charge both you and the seller and send the whole payment to the county, unless the seller can prove he has already paid it. If the seller can’t provide proof, but claims he did pay it, the escrow company will most likely still charge everyone and pay, but then refund the overage to the seller if it turns out after the fact that it really had already been paid. Point is, you will likely see a CHARGE (a minus) for taxes on your closing statement rather than a DEBIT (a plus). NEVERTHELESS!!! You should still go online to verify on April 8 (or Dec 8) that the amount has been paid and prepare to pay it if it shows unpaid unless you can definitively know beyond a shadow of a doubt that escrow has paid it (asking escrow never hurts). Penalties for paying late are just too hefty. Better to pay twice and get a refund than pay late.
   
   If you close between April 10 and July 1 (or between December 10 and Jan 1), then the Seller should have paid the most recent property tax due before the close of escrow. You can go online to verify the bill has been paid.

So stay tuned for the full explanation of #2: Expect a Supplemental Tax Bill.

What Does “Offer Subject to Interior Inspection” Mean?

There are a small percentage of available listings that are listed in the MLS as "subject to interior inspection". That means the seller doesn't want to be bothered with showings, because perhaps the property is occupied by a tenant who doesn't yet know the property is for sale, or perhaps the owner lives there and has a health issue, or there is a divorce going on or .. there could be a thousand reasons. Maybe the seller just doesn't want to have to keep his house clean enough for showing all the time! So you must get your estimation of whether or not you want it and how much you think it's worth by driving by, looking at the MLS photos and description (from now or perhaps from previous times the home was sold), aerial views such as google earth or google maps, and looking at the statistics in the area.

When a buyer writes an offer "subject to interior inspection", he is admitting he hasn't seen the inside of the property yet, and he is making his offer just based on the front facade and the comparable sales. Upon agreeing to the fundamentals of the offer, the owner will then offer the buyer an opportunity to see inside, but until then, he doesn't want his family or his tenant bothered with "lookie-loos" who aren't really qualified to buy under acceptable terms. Then, after the viewing, if there were any surprises, the buyer can propose revisions to his offered price or terms (within an agreed-upon time period), and if the seller doesn't agree, he can walk away, usually with his whole deposit refunded.

Before you offer, the listing agent may do his best to describe the interior, and you will see photos and things on the MLS listing, and the rules of "good faith" deem that you should do your best to use the available information to make an offer you think suits the property. What I mean by that is that it would be unethical to make an offer on the house based on its size and location but high for the neighborhood as if it was all fixed up and remodeled if you already have seen a description and pictures that indicate the property is a fixer-upper.

"Why," you may be asking yourself, "would someone make a too-high offer like that?" Because an offer subject to interior inspection is sometimes the only way you can get an appointment to see a property inside (especially on properties currently occupied by the seller's tenant, because he normally doesn't want the tenant to know the property is even for sale before he has the foundations of a good offer on the table, lest the tenant freak out, give notice and vacate). So you don't want to offer $525k on a property whose condition indicates it is worth more like $450k just so you can get an appointment to see it with the plan to reduce your offer to $440k after the showing. You could be in trouble if the tenant leaves and it becomes clear that you never had any intention of honoring the $525k offer, because you could be found responsible for the now-vacant state of the yet-unsold property, and the vacancy could be costing the owner money!

One thing about an offer subject to interior inspection that is true for most offers but doubly true for this type is that you must be prepared to prove, and include paperwork to the effect, that you are qualified for the offer you are making. This means you must include your preapproval letter. (Check this article out regarding 4 levels of loan approval for more details on specifically what I’m talking about here.) And you must provide bank or securities statements or other verifiable proof that you have the cash you are proposing to put as a down payment and closing costs. Without this important documentation of your qualifications, your offer subject to interior inspection is unlikely to be substantial enough to merit disturbing the occupants for a showing. In other words, nobody is going to take it seriously. But if you really do want to buy something, and you really are considering this property you are offering on, then the need to include that information should not preclude you from offering. In the chance that your offer is accepted, you’re going to have to get the ball rolling on your financing right away, and it will be easiest to get that to happen if you have already done the preliminary preparation.

The bottom line on offers subject to interior inspection is that a smart and gutsy buyer should be open to making them. Properties that only hear these kinds of offers usually sell for less because so few buyers are willing to put up with a requirement to be so bold. But we just do the best research we can, make a real offer in good faith, and then adjust our offer if you are surprised by anything you discover when you get your showing. The seller may agree to any adjustment you propose, they may counter-offer, and they may reject your adjustment. As long as all this is done within the Buyer's Contingency Period (usually 17 days from the original offer's acceptance but frequently negotiated to fewer days), you can cancel the transaction. As long as no costs have been incurred on the escrow (such as an appraisal on behalf of your lender, etc.), it is likely you will be entitled to a full refund of your deposit. (Although, I’m not an attorney and each individual offer to purchase has its own minutia of rules, so please don’t take what I’m saying as any kind of guarantee that you will get your deposit back no matter what if you cancel.)

We at the Etheridge Team are experienced in helping you properly evaluate a property for a possible offer subject to interior inspection. And we prepare a complete package to submit with such offers that tips the odds of acceptance in our favor. Give us a call or comment with any questions!

Does Health Care Bill include 3.8% Sales Tax on Every Real Estate Sale?

I got an email recently expressing outrage about a provision in the Health Care Bill passed recently that subjects every real estate transaction to a 3.8% sales tax.

Here's what snopes has to say about this:

http://www.snopes.com/politics/taxes/realestate.asp

When I read the paragraph in the snopes article that I assume (yes, it's dangerous for me to assume) comes right out of the bill about the 3.8% tax, it sounds like the feds, in 2013, are going to tax...

...the lesser between the two following numbers:

Net Investment Income
-or-
Excess of Modified Adjusted Gross Income over Threshold

If I'm reading it correctly, then:

If EITHER your net investment income is zero, OR your Modified Adjusted Gross Income is below the Threshold, then nothing will be subject to the additional tax.

The other way of looking at it is that you'd have to be BOTH making more than the threshold modified adjusted gross income AND profiting in excess of the allowed deductible amount in certain investments to be subject to any additional tax under this paragraph.

So what is the threshold of allowed non-additionally taxed adjusted gross income?
$250k joint, $125k married filing separate, $200k everyone else.

I don't know what "modified" or "adjusted" mean, specifically, but I assume that it means after certain deductions.

So what is net investment income?
the excess of [certain investment profits including real estate capital gains] OVER [allowable deductions of the certain profit]

With regard to a real estate investment, we are talking about the capital gain that EXCEEDS the $250k/$500k single/married allowed amount. I assume the capital gain in question is for your personal residence, since the $250/$500 is only for a primary residence that you have owned/lived in for 2 out of the last 5 years, right? (the paragraph says "gain from the disposition of certain non-business property")

The bad news is that the 3.8% tax will also apply to not only real estate capital gains above the allowed deduction, but to other investment profits as well, whose allowed deduction amounts I have no idea about. Note, however, your modified adjusted gross income would ALSO have to be in excess of the threshhold or else the whole paragraph is moot.

And, heck, the amount of your real estate capital gain above your allowed $250k/$500k amount is already going to be taxed as capital gain.

So, yes, it's true that this provision in the bill is a new tax, the author of the scare email loses credibility when he/she says this is a "sales tax on all real estate transactions." While snopes can often, in my opinion, be guilty of a liberal slant to their findings, and although I might take issue with their ruling of "mostly false", I must agree that the accusation in the email can also not be judged as "true" either.

I wish the people who start these emails would be careful to be hair-splittingly truthful because it makes the rest of us conservatives look like a bunch of witch hunters who will twist the facts in any way necessary to demonize our adversaries. I think the truth is frequently appalling enough. And when it's not, well, let's be happy our adversaries can be right sometimes.