Original article published by Business Insider
Written by Jim Probasco
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In real estate, when the demand for homes in a particular area exceeds the available supply, you have what's known as a seller's market. This can be very difficult for buyers, who might find themselves competing with several others who are all interested in purchasing the same property. These situations frequently lead to bidding wars, which can push the final sale price much higher than what the seller was initially asking.
What is a Bidding War?
A bidding war is a competition between two or more potential homebuyers for the same property. Buyers offer increasingly higher amounts of money and other perks for the right to purchase the home.
"Bidding wars are fueled by a lack of available housing," says Doug Wagner, a Realtor in Dayton, Ohio.
"Although first-time homebuyers historically make up 40% of the market, builders, who put up $300k+ homes, don't cater to them," Wagner says. "As more and more buyers vie for fewer and fewer houses, they find they have to compete — hence a bidding war."
The combination of a lack of housing stock, multiple buyers, a desirable location, and a growing number of real estate investors who can pay cash help foster a bidding-war environment. Bidding wars are common during seller's markets and in markets with certain traits such as low turnover, or where the home is significantly undervalued.
Statistics from the Feb. 2022 Realtors Confidence Index Survey supported the notion that a bidding-war environment existed nationwide at that time. It found:
- In February 2022, properties spent an average of 18 days on the market versus 20 days a year ago, indicating a hot, fast-moving market.
- Realtors reported an average of 4.8 offers per home sold, versus 4.1 years over year.
- Forty-eight percent of respondents reported that offers were above the list price, versus 46% in the prior month.
- Cash offers made up 25% of homes sold, versus 22% year over year.
How a Bidding War Works
In a neutral housing market, when neither side has a significant advantage, an offer to purchase a home typically consists of the following elements:
- Offer price: The amount you are willing to pay
- Financing: How you plan to pay for the property, i.e., cash, conventional mortgage, VA mortgage, etc.
- Deposit: Also known as earnest money
- Closing costs: How they are divided up or who pays what
- Closing date: When the buyer would like to complete the purchase
- Contingencies: Conditions under which the contract would be null and void
- Home warranty: To guarantee appliances and systems in the house are in good condition (not always included)
In a bidding-war environment, things are different.
Mike Opyd, the owner of RE/MAX NEXT, a real estate brokerage in Chicago, says that when properties are receiving multiple offers and often selling the same day they hit the market, "we are not typically submitting an initial offer like we would in a similar situation with a slower market."
When submitting an offer on a house when multiple offers are expected, Opyd emphasizes the need for buyers to put everything on the table right away to get it accepted. This often means including an escalation clause to an offer that says the buyer will automatically increase their bid above the highest competing bid by a set amount up to a maximum limit.
When submitting an offer on a house when multiple offers are expected, Opyd emphasizes the need for buyers to put everything on the table right away to get it accepted. This often means including an escalation clause to an offer that says the buyer will automatically increase their bid above the highest competing bid by a set amount up to a maximum limit.
In a bidding war, agents say these are some of the key elements where buyers will need to allow for some flexibility:
- Offer price: It may have to include an escalation clause.
- Financing: If cash isn't an option, go conventional with a preapproved loan.
- Closing costs: Don't expect the seller to pay any of your closing costs. You may even need to pay some of theirs.
- Closing date: Find out what the seller prefers and try to be flexible.
- Contingencies: While you want to protect yourself, such as making the sale contingent on financing, your options may be limited.
- Home warranty: More "as is" sales occur in a bidding war, fewer repairs (other than major defects revealed by inspection) are offered, and seller-provided home warranties are less common.
While an escalation clause can be very helpful, it isn't always wise for a buyer to offer one. Here are some pros and cons real estate professionals see in offering an escalation clause:
Pros of Escalation Clauses
- Offer protection for buyers against competing bids —Lauren Reynolds, real estate agent, Compass
- Lets the seller know you mean business and are serious about the property —Laura Adams, real estate agent, Aceable
- Since it is "automatic," an escalation clause avoids a lot of back and forth —Jenna Richardson, chief operating officer, Real Estate House International
- Can be used to induce a seller not to "shop around" and accept your offer —Richard Grossman, president, Avenue 8
Cons of Escalation Clauses
- The danger of buyers over-leveraging themselves financially —Matthew Arakelian, real estate attorney, Ligris & Associates
- It may be prohibited in some states —Nancy Almodovar, chief executive officer, Nan and Company Properties
- Some sellers won't accept them —Michael Nourmand, president, Nourmand & Associates
- Some areas require an attorney's involvement and the removal of all contingencies — Phillip Salem, real estate agent, Compass
9 Ways to Win a Bidding War
In addition to an escalation clause, agents recommend a variety of other tactics that can put you "first in line." These can be as important as the price you pay, depending on the seller and their wants and needs.
1. Find out what the seller wants
In setting a strategy to win a bidding war it's sometimes easy to forget the role of the seller. Remember, the seller decides which offer to accept. Does the seller want a quick closing? Do they want to occupy the home for longer than normal (30 days)? Are they concerned the appraisal won't support the selling price (appraisal gap)? Find out the answers to these questions and plan accordingly.
2. Get a preapproval or precommitment for a mortgage
"House shopping without a preapproval is the quickest way to lose the bidding war," says Richardson. "Preapprovals are a step up from a prequalification and say that the lender has physically verified what was verbally discussed. It shows that you've done the work and are serious about your home purchase."
Arakelian says providing a precommitment rather than a preapproval could give you more of an edge. "Some lenders are underwriting a loan at the time of pre-approval so the buyer is already essentially approved at the time of offer submission (except for an appraisal)," he says. "This gives a buyer a leg up on those with regular preapprovals."
3. Be flexible with the timing
Arakelian also has some advice for buyers when it comes to dates: "Selling a property is much easier than buying in this market, so a buyer with flexible dates and terms will garner considerable favor with a seller who still needs to find a new home."
4. Offer a large earnest money deposit.
"If you have to finance, put more money down for the deposit — rather than 10%, put 20% down," says Talia McKinney of the real estate firm SERHANT. "It can show to the seller you are willing to risk more of a deposit should something happen with your financing and shows more confidence in your offer."
5. Be a cash buyer.
Recall that cash offers made up 25% of homes sold in February 2022, according to Realtor.com. Real estate referral company, Homelight, reported 31% cash offers in 2021.
"If you have cash, use it," says McKinney. "There is no risk to the seller in terms of you not moving forward with a cash purchase."
A true cash offer is one in which the buyer does not end up with a mortgage but pays for the home with savings, proceeds from the sale of their existing home, or a gift.
6. Offer concessions to the seller.
Richardson lists several concessions that, in addition to an exclusion clause, are popular with sellers:
"Offer to pay a portion of the seller's closing costs. Let the seller choose the settlement attorney and/or make a joint decision on inspectors or contractors performing the repairs. Accept the home `as-is' and waive the right to ask for repairs. Allow the seller to remain in the home after closing for a set period of time rent-free."
7. Offer an appraisal gap guarantee
With an appraisal gap guarantee, if the negotiated price exceeds the home's appraised value, you have to make up the difference.
"Sellers want to know that if they sell to you that you'll actually get the home," says Ken Pozek, chief executive officer of the Pozek Group.
8. Write a 'love letter' to the seller
Some would-be buyers write a personal note to the seller, making their case for why their offer should be accepted.
Polly Watts, Vice President at Sundae recalls one such note: "A buyer wrote a note explaining that they had a few children in the household with special needs, and the letter detailed how that house met all their specific needs. It helped to get additional eyes on their offer and they were able to secure the home."
9. Make the offer as 'clean' as possible
Wagner says that when all is said and done, sellers want a "no-hassle" transaction. "Cash is king," he reminds, primarily because it is relatively hassle-free. He and others point to one Achilles heel with escalation clauses, their complexity. That's why, he says, a lower cash offer with no escalation clause might beat out an escalation-clause offer.
What to Do if You Lose a Bidding War
Bidding wars are a fact of life in a seller's market, and each has only one winner. So what do you do if you lose?
Richardson suggests a backup offer. "If anything falls through with the first buyer, the second buyer — the backup buyer — is now next up to purchase the home. Buyers should consider backup offers because if the property comes back on the market, another bidding war could ensue, a backup offer avoids that because the backup offer immediately becomes the primary offer."
Avenue 8's Grossman believes the best way to win a bidding war is to avoid it in the first place.
"We worked with a buyer who fell in love with a home in the East Village except the seller wasn't going to respond to bids until after the first open house had taken place," Grossman says. "In this instance, we asked the seller's broker to 'reprice' the apartment that they would honor even if subsequent offers came in higher. They came back at a number 10% above asking, our buyer agreed to it, we went to contract quickly, and other buyers were left wondering why they didn't even get a chance to bid."
