Somebody learned the hard way this week.
Thankfully, I was on the other end of the transaction.
This is the age-old tale of “risk versus reward,” but I would never, ever, ever tell my client to accept a conditional deal when he or she has multiple offers on the property…
“Risk Versus Reward”
That was the title of my presentation in Grade Twelve economics class.
I took a stick of chalk, went up to the blackboard, and ignited a debate that lasted all class.
I told everybody in the room that they had $10,000 to invest, and I put three options up on the wall:
1) 50% chance of $20,000; 50% chance of $0
2) 10% chance of $100,000; 90% chance of $0
3) 75% chance of $12,000; 25% chance of $6,000
We took a poll, and the results were almost 1/3 for each option. We debated the options for quite some time, until finally one student spoke up and identified that both options #1 and #2 have an expected value of $10,000, and option #3 has an expected value of $10,500, thus that is the correct answer.
Despite this conclusion, people still debated! “Go big, or go home,” said one kid in reference to why he would take the 10% chance of $100,000.
Another person identified that option #1 was basically playing “Double or nothing.”
But after all the debate, we voted again, and the results were still about 1/3 for each option.
Everybody has a different risk tolerance, and it comes out in all areas of life.
Whether you’re talking finances, or deciding whether to cook up those chicken breasts that expired four days ago – we all assess risk.
One risk in my line of work that I would never advise anybody to take is to accept a conditional offer when you are reviewing multiple offers on your property.
A firm deal comes with 100% certainty.
A conditional deal comes with 0% certainty, and only estimates, guesswork, and complete conjecture when two parties to a deal talk about what will likely happen.
The best way to explain this is by using an experience I had this week, but I will change the names, numbers, and places since this house is still on the market and I don’t want to affect the outcome for the seller.
I represented a buyer in the Yonge & Sheppard area who was looking at a house priced at $1,649,000. This house was very attractive, and well-priced, and I explained to my buyers right away that this house would end up with multiple offers.
I told them that we would be looking at a price of around $1,760,000, just based on my own assessment of value and “gut feeling,” if you will.
Offer night came along, and there were two offers, plus ours.
My clients told me that they wanted to make the offer conditional on home inspection, even though a pre-inspection had been completed, and I told them that they had a zero percent chance of being successful with that offer.
It’s true. I don’t care what the outcome says (math is not my strong suit), but ask any agent and they’d agree with my calculation.
We made our offer for $1,760,000, and I prepared to tell my clients, “I’m sorry, but we didn’t get the property.” And then an odd thing happened: the listing agent called me and said that we had “the most attractive offer,” and that he wanted to know “how serious” our condition was.
What?
They weren’t seriously thinking about accepting a conditional offer, were they?
I told the listing agent that my clients had some question about the electrical work in the house and that they wanted to conduct an inspection of their own. I added that I had never had a deal fall through before, and I didn’t plan on it now.
They were sold.
The sellers accepted our conditional offer, even though they had two other offers on the property.
From what I’ve heard, via the third-hand real-estate grapevine, the other two offers weren’t that far behind ours.
My buyers conducted the home inspection, and it revealed a few major issues.
In fact, these issues were so major that it meant my buyers wouldn’t be able to get home insurance for the house in its current condition.
We consulted a few experts, talked to a lot of insurance brokers, and in the end my clients decided to walk away from the deal.
They were 100% within their right to do so.
Now, where does that leave the sellers?
Well that’s the unfortunate part of this story.
Don’t get me wrong – I feel bad for the sellers, but I work for my buyers, and only my buyers. If my buyers felt uneasy about completing this transaction, then I have to advise them to pull out of the deal – a deal that I was shocked we ever made in the first place!
The sellers have two options:
1) Get in touch with the agent who had the second highest offer and see if the buyer is still interested.
2) Re-list the property.
Both options are going to cost the seller dearly, and that is why you NEVER accept a conditional offer. There are simply no guarantees.
Let’s assume for argument’s sake that behind my offer of $1,760,000 was an offer of $1,745,000, and an offer of $1,685,000. Recall that the list price was $1,649,000.
Best case scenario – the potential buyer who offered $1,745,000 comes back with the same offer.
Worst case scenario – the house is re-listed and the sellers get $1,649,000.
So here is the (rhetorical) question: why would you, as a seller, risk $96,000 to gain an extra $15,000?
Why would you take a conditional offer for $1,760,000, when you have a firm offer of $1,745,000, knowing that the worst case is a re-list and sale of the asking price?
It makes no sense to me, and I would never advise (or allow) my clients to accept a conditional offer if they had a firm offer close behind.
In this case, what if the buyer with offer #2 has already bought elsewhere? Or cooled off?
What if buyer #3 isn’t interested either?
Then the house goes back on the market, and people wonder why?
Was there something wrong with the house?
Did the sale fall through because there’s something we should be worried about?
The buyer pool will take notice, and you could end up with less than the original asking price! It’s not likely, but it could happen.
If you’re a risk-taker, then maybe you’d be the one to say, “What are the odds of the deal falling through? Why would we leave money on the table? Let’s take the highest offer!” But I believe you take the sure thing, and avoid a real estate atrocity.
I’ve seen this situation before in an extreme case of a bidding war gone bad.
My colleague had twenty-seven offers on his Hayden Street condo last year, listed at $299,000, and the highest offer was for $375,000 – an utterly stupid price for this condo. The second highest offer was for $345,000, and then there were 25 offers in between $299,000 and $345,000.
The $375,000 offer was conditional on Financing and Appraisal, and my colleague did the right thing: he told his client to take the $345,000 offer, which was unconditional.
Why?
Well what if the bank didn’t appraise the property at $375,000? Then the buyer wouldn’t get financing, and the deal would fall apart.
Sure, a property is “worth what somebody is willing to pay for it,” but we all laughed at the $375,000 price. It was a joke, and there’s no way a bank would come in and uphold the value.
My colleague knew that this $375,000 offer was worthless, and he tossed it aside.
They took the unconditional offer of $345,000, and never looked back.
That $375,000 price looked mighty tasty to the buyer, and those with less common sense might say, “You left $30,000 on the table!” But that money was never there to begin with. What if you had an offer for $1,000,000,000 conditional on the moon crashing into the sun? Would you take that offer?
When our conditional offer was accepted earlier this week, I told my clients very bluntly, “I want you to know that if the tables were turned, and we go to sell your Leslieville house in two weeks after this deal goes through, there is no way I’m going to let you accept a conditional offer!”
They understood.
I guess they got lucky that their conditional offer was accepted, and in the end, they were granted extreme flexibility in a market that doesn’t usually allow any.
As I said at the onset – everybody’s risk tolerance is different.
But combine risk-tolerance with emotions, and you never know what you’re going to get…
Anonymous
at 7:54 am
With all due respect David, I think what intrigues me is that in a way, this story that you have proves that you are wrong in some circumstances. If your clients had taken your advice and went in with an unconditional offer, they would have a pretty big problem on their hands.
This just goes to show that sometimes a pre-inspection simply isn’t enough, and that perhaps just because a lot of people are crazy in this market (imo prices are severely inflated in relation to incomes, but that’s another debate) doesn’t mean that you have to be crazy too. Eventually someone will get burned.
Does this make you reevaluate whether or not you’ll tell your buyers to go in unconditionally if there are multiple offers in the future?
David Fleming
at 9:59 am
@ Anonymous
In theory, yes.
But there is more to the story which I didn’t include in the post, because I can’t.
Although you’ve made me realize that what I wrote has some flaws…
George
at 9:53 am
I think people tolerate more risk in hypothetical situations than they do in real-life situations. Very few of those classmates of yours will ever take $10,000 and bet red in roulette, so I don’t buy that they would truly gamble on an all-or-nothing investment. It’s different when it’s your own money. That’s why nearly all of us have insurance on everything important to us. If someone is truly a risk-seeker, they would forgo insurance and lobby against healthcare, welfare, etc.
Your point about the bank appraisal is interesting. How often does an aggressive unconditional offer backfire on the bidder in the sense that a bank will not appraise the property at the full value of the bid?
Moonbeam
at 10:01 am
Baffles me why clients don’t take the advice of their agent….
Pen
at 10:26 am
“I would never, ever, ever tell my client to accept a conditional deal when he or she has multiple offers on the property…”
David, read your blog often and tend to agree with you most of the time, I have to disagree with you here on all counts.
Your buyers’ elation at having a winning bid, had you convinced them to make it unconditional, would have defalted quickly upon learning weeks later that the house was uninsurable and therefore unable to close without remedy (Clause 10 of the APS) at significant cost to either them or the sellers. It possibly could have wounded your relationship with them as well. The sellers too were saved unexpected grief even though their sale price is likely to be less. They in effect have lost nothing as per above.
Personally, I encourage my buyers to always insert a remedial inspection condition where there are multiple offers even is the sellers have one. It has worked very well and protects them from exactly this type of scenario whereby the seller’s inspection was obviously inadequate. This is the real cautionary tale.
On the Hayden Street type scenario, size of deposits and the questions pertaining to financing asked by the listing realtor of the buyer’s rep when a property’s offer price is well above market value go a long way in determining the buyer’s afforability. Financing is available on the amount of mortgage required and not the price of the property. This too has worked to the advantage of my sellers.
David Fleming
at 11:44 am
@ Pen
As per my reply to Anonymous below, there is more to the story which clears up most of the objections in the comments. Unfortunately, I can’t share it.
I realize now that telling half a story makes me look like an idiot, but I have to continue working with my buyers, and I don’t want to impede the sale for the sellers.
Lesson learned!
Joe Q.
at 10:39 am
Were the results of the inspection shared with the sellers and are there now any legal obligations about disclosure? The sellers are now showing the house with a decent looking pre-inspection even though the house is in fact un-insurable. Isn’t that mis-representation?
Jeremy
at 11:07 am
Is it possible that the other two offers were also conditional?
Marina
at 4:11 pm
There is an interesting experiment done to show real risk tolerance vs. hypothetical.
First, the experiment asks:
If you could have $X guaranteed, or have a 50% chance at $1 million (and 50% nothing), what would you choose?
Most people choose the guaranteed $X once it goes above $250,000 or so (unsurprisingly, how low they go depends on income).
The second experiment asks how much people are willing to pay, out of pocket, for a 50% shot at $1 million.
Math dictates that they should pay up to $500,000 (based on expected value).
In reality most people will will not pay more than $1,000.
Tiny
at 7:47 pm
I received 4 offers within 3 days my condo was on market. 2 offers were above my asking price, 1 was slightly below my asking price and 1 way below my asking price. The highest bid was a firm offer and the second highest had all sorts of strange conditions that led us to believe that they wanted to put in loopholes so that they can back out any time they wanted to. So, obviously, I took the firm offer which was also the highest bid. Since we signed the deal on a Sat. evening, the buyer was to give me the certified cheque as the deposit on Monday morning. The next day, I got a call from my agent telling me that the buyer was backing out from the deal. I was tempted to sue but I couldn’t afford to waste time on this any more. So, my agent had to go back to offers I rejected. Fortunately, I managed to get an offer that was about my asking price.
This experience is a very valuable lesson.
Ralph Cramdown
at 10:47 am
First, let me say that I really appreciate these stories from the trenches. If you can fill us in on more details later on without breaching confidences, we’d appreciate that, too.
Second, $15,000 buys an awful lot of remedial electrical work!
Chuck
at 7:18 pm
@Tiny
I had a house for sale years ago at Bathurst and St. Clair, 10 offers on it, where the winning buyer came into our office to drop the cheque off and said he didn’t want it anymore.
Same scenario – do you sue offer 1, or just say “screw you” and move on? We chose the latter.
We called offer 2 – they changed their mind. Offer 3 already had another offer on another house, and offer 4 bailed. I called Agent #5 and they ended up taking it for a few thousand less than the winning offer. What a strange situation.
Vincent La Fiura, Broker
at 5:16 pm
It should be noted from a sellers prospective that when dealing with multiple offers and not having home appraised properly could lead to the deal not closing. Both buyers and sellers should understand the appraisal process and how far lenders are willing to go. Here is another great read about multiple offers, that I would share.
http://www.mytorontorealty.com/blog/p/multiple-offers—toronto-real-estate-blog
Anonymous
at 3:04 pm
My husband and I have low risk tolerance, and even though the bank is quite willing to give us the money, CMHC usually asks for a physical inspection. In this case, how can I take the risk of making an unconditional offer? What if CMHC comes back to say that they value the property at less? I will have to shell out money from somewhere to cover the difference. Don’t you think people should not put themselves at risk by making unconditional offers?
AvgDd
at 12:18 am
Wow, as I read this article, I was completely stumped that this real estate agent is flaming his buyers for doing the right thing. It’s like he wants his clients to buy any garbage just so he can get his commission.
This guy is disgusting.
Conditional offers are almost mandatory for buyers that need approval from banks, otherwise buyers may not get the approval and lose their deposits.
Kathy
at 12:17 pm
We accepted an offer conditional on financing and NOT on inspection – the house is only 16 years old and in great condition.
The buyers had the inspection and came back with a laundry list of “defects” all minor, no structural damage or anything that would prevent them from getting it insured.
We rebutted all the minor defects – most of them are just indicative of the age of the house.
My questions is – can they back out if they have the financing?They are trying to.
Thanks.
Westcomb Chrome Jacket
at 6:26 am
There is little free thinking at all.
Westcomb Chrome Jacket http://www.westcomba.com
JD
at 7:29 pm
LOL…reading your article, says how greedy and cunning some realtors are.
Your clients, that you claim you work for, had the foresight to predict a situation and get an insurance for it. And guess what – it paid off! Had they listened to your advice, they would be stuck with a property that would cost them a lot of money. But, of course, that would have been their problem, and not yours, right? Because you contract with them stipulates you are not liable and cannot be sued for that.
Now I guarantee you this, if you are made liable by law, when providing faulty advice when doing a real estate deal, you would be singing a different tune and the name of your article would be “Always Give A Conditional Offer”.
You just got lucky that your client were smart and prudent.