Why Sellers Prefer Cash Offers

Today’s market continues to see sellers willing to accept all-cash offers in lieu of higher offers that are saddled with a loan. This can be extremely frustrating for buyers, particularly first-time home-buyers who have difficulty saving enough to pay for even 20% of the sales price in cash. Below we discuss why sellers are willing to forego a higher sales price in exchange for an all-cash offer.

The Structure Of An Offer With A Loan

In order to understand why sellers prefer cash offers, one must first understand the structure of a transaction that is accompanied by a loan. In California, most residential real estate transactions are structured so that the buyer must release several “contingencies” before he or she is contractually bound to purchase the property. Two of the largest hurdles to closing a transaction that is accompanied by a loan are as follows:

1 – The Loan Contingency – This contingency exists to allow a buyer to obtain full approval for a loan before committing to purchasing the property. If the buyer does not qualify for the loan, he or she can cancel the contract without breaching it.

2 – The Appraisal Contingency – This contingency exists largely to protect the lender. Banks will typically lend a percentage of funds against the lesser of either the sale price or the appraised price. So, for example, if a buyer is obtaining a loan with a 20% downpayment, and therefore an 80% loan, the bank will loan the lesser of 80% of the sale price or the appraised value. If the sale price is $1m but the property appraises for only $900k, then the lender will loan only $720k. In this situation, if the buyer is unable or unwilling to make a downpayment of $280k (the intended downpayment amount was 20% of $1m, or $200k), then the buyer is authorized to cancel the contract without breaching it.

The two contingencies are often significant hurdles to closing a transaction, and can often result in delays or even cancellation of the contract, placing the seller in the unfortunate position of having to find another buyer.

The Advantages Of A Cash Offer

Cash offers are accompanied by two significant advantages: (1) all-cash offers are not accompanied by the loan and appraisal contingencies, thereby reducing the seller’s uncertainty regarding whether the buyer will complete the transaction and (2) banks tend to move relatively slowly, causing deals accompanied by a loan to take 30+ days to close, whereas cash buyers are able to quickly deposit funds into escrow and close transactions very quickly. The elimination of uncertainty has an intangible value that sellers will value differently, while the quicker close has an easily identifiable monetary value (each day the seller holds the property costs the seller the daily mortgage, property taxes, and insurance costs). As a result, even if an offer that is accompanied by a loan carries a higher sale price, sellers will tend to prefer cash offers in order to eliminate uncertainty and reduce the time it takes to close the deal.

Past And Current Cash Offer Trends

After the collapse of the economy in 2007/2008, cash offers in the real estate industry became increasingly popular. The increase can be attributed to at least three major factors: (1) lenders tightened their restrictions and requirements on funding, thereby making it more difficult for buyers who did not have all-cash, (2) institutional investors with significant sums of cash were looking for somewhere to invest that money, and the drastic decline in real estate prices made the market appealing for long-term investments, and (3) foreign investors with significant funds of cash decided real estate in the United States was likely one of the most stable investments.

Since then, lending restrictions have loosened and there are fewer institutional investors looking to the real estate market. As a result, one would expect the number of buyers making all cash offers to decrease. According to the Washington Post, however, cash offers are continuing to rise as a result of foreign buyers with significant sums of cash. This is due, in part, to unrest in foreign countries such as China and Russia, leading to foreigners putting more of their money into the United States real estate market.

How To Beat A Cash Offer

As a result of the influx of more cash buyers, other buyers will need to be more aggressive in order to eliminate the advantages of cash offers. There are several ways to do so, many of which are extremely aggressive, including the following: (1) waive the loan, appraisal, and/or physical inspection contingency, (2) attempt to accommodate the seller’s timing requirements by offering to “lease-back” the property after the close of escrow, (3) be flexible on the close of escrow date, and/or (4) allow the seller to choose the title, escrow, and other services that accompany an escrow period. While it is difficult to compete with cash offers, it is certainly not impossible.

For more information on how Esquire Real Estate Brokerage, Inc. can help you in the Los Angeles real estate market, feel free to give us a call at 213-973-9439 or send us an email at info@esquirereb.com.