Waive It Goodbye? Cause For Escalation.
Do the details of homebuying contracts affect prices?
I’m sure I have some folks with more real-estate knowledge than I do reading or subscribing here. This newsletter is a question/conversation starter, especially for those readers.
Having gone through the homebuying process in mid-late 2022, and discussing it with a couple of friends lately, we’ve seen a lot of what feels like market manipulation. In other words, things that feel like real-estate people playing you to get you to pay more, or trying to inflate prices by getting people to panic.
The two things that stand out to me as irregular, and which are either not done everywhere or were not commonly done previously, are 1) escalation clauses, and 2) waiving contingencies, especially home inspection. (Maybe sight-unseen all-cash offers are also an example.)
I had never heard of escalation clauses before. It’s basically a way to make your offer more like an auction—like how you pick your highest number on eBay and input that as your bid. Instead of offering $600,000 on a house, for example, you offer $575,000 but add an escalation clause going up to $600,000. So if there’s no other offer, you actually get it for $575k. But if someone offers $599k, you’ll get it for your “max bid” of $600k.
My question is whether this is neutral or helpful (for the buyer) in terms of prices, or whether it does, or is designed to, spark bidding wars and push prices up above their “natural” level.
You see on eBay sometimes when two people really want an item, it will end up selling considerably over its typical value, because the psychology of real-time bidding gets the better of you. It’s almost like gambling. So I wonder if introducing an element of that into homebuying would have the same effect.
The other thing is waiving contingencies. This is basically a way of offering more without adding more dollars. You can waive every typical contingency, but the really problematic one, potentially, is the home inspection. You can see how that could hurt an individual buyer. But you can imagine it also affects the overall process by raising the stakes, and creating the expectation that a competitive offer waives contingencies.
This is (potentially) an example of something I wrote recently: “By making the choice available, we ultimately take away the choice.” In other words, if the rules of homebuying simply stipulate that everyone has to get a home inspection—if, for example, mortgage lenders demanded a home inspection in order to issue a loan, which I’m surprised they don’t—then, well, everyone gets a home inspection.
But once you’re allowed to drop it as a competitive move, the mere ability to do so impinges on your right not to do so. In Northern Virginia, it’s now typical to not get a home inspection, because those offers will simply be thrown out as not competitive. (There is one way around this, potentially—to schedule a long showing with your agent and pay for an inspection during that period, and then, if the inspection is satisfactory, write an offer waiving your inspection.)
So what I’m wondering is, is this really true? What would the housing market in these hot markets look like if you couldn’t write escalation clauses, or waive your inspection, or buy all-cash sight unseen? Would that sort of calm things down and restore order, or does it just not work that way?
More specifically, would prices go up to absorb the risk of across-the-board home inspections? How much would they go up? Or would slowing down the process change the buying psychology and actually reduce price pressure?
I think a lot of people assume realtors love all this panic and encourage it. As a housing guy who believes this really does come down to supply, I don’t really think that. But it’s hard not to entertain the thought.
I know my wife and I kept thinking, and I know a lot of people think, this stuff is market manipulation of a sort. That there’s something fundamentally untoward about a real-estate agent whispering in your ear, you know you can sweeten your offer by waiving your home inspection! Nothing that bad is likely to happen. Look what a nice neighborhood this is! Do you think this house *really* has a cracked foundation or a rotting roof? (Okay, that’s a little bit of an exaggeration, but with one agent in particular we briefly worked with, frankly that much.)
Housing advocates typically argue that while these and other things might affect prices on the margins, they’re all downstream of the housing supply crunch. That they’re symptoms, and not causes. And that the housing market only looks and feels like a bubble because we’ve sharply restricted production of a necessity. In other words, the scarcity isn’t a sales tacit, it’s real.
One thing I don’t quite understand about this is why housing markets everywhere ignited during the pandemic, and why, if the supply shortfall is a long-term problem, so much happened so quickly. The explanation I’ve seen is that enough people left big metro areas for other communities, or started families and looked for bigger places, that the latent supply shortfall became acute, almost everywhere. Current homeowners being trapped by low mortgage rates is another factor. Are there any other explanations that feel more satisfactory?
As I said at the top, I’m curious what real-estate folks, or housing advocates with more knowledge here, think about this. How wrong is it to think that regulations on the buying process could tamp down prices and the general awfulness and stress of the homebuying process?
Related Reading:
Won’t You Be My Agent? (Or Maybe Not.)
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There is nothing new to any of this - waiving inspections and escalation clauses have been very common in Northern Virginia (and other markets) since at least the early 2000's. I've bought three homes that way, the first in 2002. Yes, I do think they increase prices at the margin, and agents contribute to this by convincing their clients it's the only way to get a home; they benefit more if their clients buy something quickly, rather than spend months searching, so they are likely to encourage them to be as aggressive as possible, dropping all contingencies and offering the highest amount they can, through an escalation clause or otherwise. But, I tend to agree that it's on the margins - the real issue is supply and low interest rates (even now, mortgage rates are low, by long-term historical averages). Some states require home inspections, and they don't seem to have fully escaped the price increases in housing.
I bought in the Boston metro in 2019, so a hot market but before the weirdness of Covid. Our experience was fairly smooth but also pretty typical: we submitted about 8 offers before we finally got a hit. Our early ones were probably a little low, we expected a bit more negotiation but it became clear quickly that almost everybody was expecting highest/best (and places were going under contract within a few days). By the end, we actually had cases where we *were* the highest offer and we were not chosen because someone else had waived contingencies. I think in one case the sellers went to a lower offer and got them to raise to ours, but in Offer 7 they literally accepted one that was $5k less than ours but had no contingencies.
For our final offer (which did end up being accepted) we did talk with our realtor quite a bit, who to his credit *did not* advise dropping contingencies. What we did instead was modify them: we increased the earnest money and had a personal letter from our loan officer on top of the normal preapproval documentation, so while we had a financing contingency we tried to demonstrate the strength of our financial position. Similarly, we kept an inspection contingency (though had to get it on short notice since they wanted to have all offers in by like the Monday after the Saturday open house), but we submitted a "no punch list" offer. We still got to make sure it "passed" inspection, but we wouldn't turn in a list of expected improvements.
The play worked because the seller was primarily interested in a smooth sale, so they accepted our slightly higher offer over a competing cash offer and things went through fine. I will note that we did end up with a few things that *technically* we probably should have raised a fuss about: a few fixtures were taken that, legally, should have been left (screwed into the wall, which I believe is assumed to be included unless explicitly excluded in the purchase and sale) and the painting was sub-par, but since we needed to close on time we didn't want to risk derailing the closing by complaining about them (we did not close in person with the seller or their lawyer, they shipped the paperwork in).
In my experience, these things probably add less to the *cost* of homes directly so much as shift the kinds of people who can buy. Individuals/families trying to "do it right" have a harder time getting offers accepted when sellers prioritize selling to the "easy" option of flippers who can buy in cash and don't care about the quality nearly as much because they're already planning to do touch-up work and have the crew on hand. I think increasing supply would help for the people who can afford new construction: those aren't likely to be getting offers from flippers, and maybe if there's more production that encourages more developers to go into net-new builds rather than flips.