(CORE) Current Issues in Washington Residential Real Estate 2022-2023

Video script:

Let's talk a bit about the escalation addendum. The escalation addendum is a great way to compete in the market that we've had for years running now. It's almost difficult to make any offer without including this form in certain markets throughout our state. As a result of its continued consistent use, there have been issues that have come up over time as it has had such attention.  To deal with the issues the form has undergone a couple changes.  The first one I'd like to cover is previously the escalation addendum stated in item two that the escalation would be kicked in or activated by a competing offer. It laid out what is defined as a competing offer. It is critical for a competing offer to be arm's length written on similar forms and with a reasonable closing time.The idea of course is an escalation addendum shouldn't be activated by an offer that is not a true representation of a buyer who is willing to close with relatively similar terms as the offer the buyer who wrote the offer with an escalation clause is putting forward.  One of the changes in the form states that in order to activate the escalation addendum, the seller must provide a copy, a complete copy, including all the addendums and documentation to the buyer when they sign the offer with an escalation addendum. Previously it simply stated that the escalation addendum would be activated by a bona fide arm's length written offer, but did not explicitly state a full and complete copy be provided to the buyer who included the escalation addendum. This is important for both buyers and sellers. If the seller wants to receive the higher amount in the escalation addendum they have to provide a full copy of the competing offer otherwise there will be an issue regarding the final purchase price. Without it, the final purchase price will be the initial offer amount and the escalation clause will not be valid. This would be devastating to the seller, because so many escalation clauses are worth much more than their initial offer amount. For example, it's common to have a property in the Seattle area with an initial offer amount of $950,000 and escalation clauses ending at $1,050,000 to $1,100,000. Now in this instance, not including the competing offer could cost the seller $100,000 to $150,000. 

It's important to note that while the competing offer needs to be generally similar, it can include conditions such as a buyer's pending sale, financing addendum or inspection addendum.

Another change in the form is after the buyer is provided with the competing offer they have a period of time to review it, exactly 3 days.  During the 3 days the buyer is meant to determine whether or not the competing offer meets the definition of competing offer that’s in the form. That list includes bona fide, arm's length, written on similar forms, enforceable, purchase price paid in full at closing, closing in 60 days or less (that’s the default if not changed), and is not contingent on the sale of the buyer's property. It's important that we note the difference between contingent on the sale of the buyer's property and the notification that the seller has a pending sale. If you're looking at NWMLS forms we're talking about 22B for a contingency for the sale of the buyer’s property, and 22Q for the buyer's pending sale property contingency. 

If the buyer's not satisfied with the competing offer meeting the requirements in the form they need to respond with form 35EN, notifying the seller they are not satisfied. The seller can either not respond or respond to the notification. Failure to respond will nullify the escalation clause and the buyer will close at the original purchase price without escalation. The timeline for response is two days. If the seller responds back to the buyer they can just terminate the agreement. 

There’s another provision within the 35EN form, that's the response to this notification of receiving the competing offer, and that is the calculation that the seller or listing broker has done to come up with a final purchase price. If the purchase price calculation is incorrect or the buyer disagrees with the math then they have an opportunity to respond. The seller in turn will have the exact same options that they have should they disagree with the offer being a competing offer, and that is termination or acceptance of the new calculation. If the seller doesn't respond they're going to end up back at the original purchase price without the escalation. As brokers we just have to be super vigilant in making sure that we always respond within the required timelines. Missing a timeline in the case of an escalation addendum or forgetting to attach documentation is going to be extraordinarily costly to our clients.

The changes to the form are clearly designed to eliminate any issue regarding the final price the buyer is paying for the property. Having an argument at closing regarding the correct purchase price isn’t the time to hash it out, and it’s important the parties are clear when they come to agreement.

Ways that we can ensure everything is clear is timely and consistent communication with all parties in the transaction. As long as we follow all of the timelines provided in the documentation and communicate with our counterparties, we’re more likely to have a smooth transaction. Make sure to provide to the seller or the buyer clear communication as to the final price and clearly label the delivery of the competing offer along with the purchase and sale agreement. 

As is always the case with any addendum, we need to communicate to our buyers and sellers the pros and cons of using it. For buyers, in recent years, the escalation addendum has essentially been a necessity as I mentioned at the beginning of the video, because in order to compete, you need to have a tool to have a sliding purchase price based upon the competitive landscape for a particular home. We still need to be able to tell them why they're using it. Now the benefits are that in the event that the property is less competitive, an escalation addendum can ensure that while a buyer is willing to pay a higher price they will only pay a specified amount greater than the next highest offer. This has the effect of limiting the price the buyer will ultimately pay compared to what they may have been willing to. Of course, there's always the flip side to that. When there is a highly competitive situation, the buyer's purchase price can and will often be driven to the highest amount they are willing to pay. You might see that as a negative, but it's important to point out that the buyer does have full control over what the maximum amount is they're willing to pay. I think the biggest argument to the negative regarding this form is you may have a situation where there are perhaps 6 to 10 offers on a property and your buyer as well as one other buyer deem this property to be very valuable to them. In this case, you can have two competing parties driving themselves into a higher purchase price when the general market doesn't necessarily value this property in the same way that they do. So what you could have is an extraordinary situation where two people are out of balance with market pricing and therefore in a few years it may be more difficult for the new buyer to sell at an adequate value.

Video script:

As prices throughout our state have gone up it has become more and more common to provide offers that are either all cash, or at least the appearance of all cash, and a greater need for receiving funds that may be contingent on some event. What I mean by that is it could be a gift from a parent or grandparent which the buyer is relying on to assist them in purchasing the property. Another common source of contingent funds is the sale of stocks or bonds. Any contingent source of funds that doesn't include the financing contingency, the home sale contingency, or a pending sale contingency needs to be disclosed on form 22EF. EF stands for evidence of funds. The need for this form and its use is set forth in the purchase and sale agreement. The language states that the buyer is not relying on any contingent source of funds unless it's defined in the agreement. Now attaching 22 evidence of funds addendum will take care of the required disclosure. The state has made it a priority to emphasize this form should be included in all transactions that require cash.

We have to ask the buyer in what form they have their closing costs and down payment funds. Is it in their bank or is it in another form, be it a gift from another family member, stocks that I already mentioned, stock options, upcoming bonus, bonds, or perhaps retirement accounts? It could also be money they are expecting from selling a boat, car or some other already owned asset. 

In order to be classified as non-contingent, the form states: 

“The buyer currently has in their possession and for which there is no contingency, such as financing (NWMLS Form 22A or equivalent), sale of the Buyer’s property (NWMLS Form 22B or equivalent), or pending sale of Buyer’s property (NWMLS Form 22Q or equivalent).”

We need to be mindful that the form is clear that the buyer doesn’t need to re-disclose contingent funds they have already disclosed through other means, the financing addendum showing a loan, or the sale of their current property. What constitutes a non-contingent funds is money in a  USA financial institution, cash, in the buyer’s name.

Contingent funds in the form is defined as:

“Funds that buyer does not currently have, but expects to receive from another source prior to closing, and for which there is no contingency, such as a loan, proceeds from the sale of other property or stock, retirement funds, foreign funds, a gift, or future earnings.”

As is stated in the definition provided by the form, there is a need to disclose loans for which there is no contingency, meaning those not included in the form 22A or other type of financing contingency. The default number of days to disclose evidence of non-contingent funds is 3 days, but of course, many buyers are including the evidence along with their offer to remain competitive.

An important provision in item two of the evidence of funds addendum indicates the buyer has to notify the seller and receive their consent if they use the non-contingent funds they are providing as evidence for anything besides the purchase of the property. Practically, this means the buyer is tying up the non-contingent funds and restricting the use to the purchase. If the buyer doesn't provide notice of the evidence they said they would provide, the seller can go ahead and terminate the agreement at any time prior to the evidence being provided. This means if the buyer doesn't provide the evidence within the allotted time, say, 3 days and the seller doesn't say anything and the buyer provides that evidence on day 5 the transaction will continue forward as agreed.

In item 3 of the disclosure of contingent funds, there's an important time provision to make note of, that is, the evidence the buyer has received the contingent funds needs to be given 10 days prior to closing. The important part of this time provision is there has been a update to the purchase and sale agreement providing a legal definition to how we count time from closing backwards. In this case, we are counting backwards from the date of closing, 10 days prior in default. Now, the new provision in the purchase and sale agreement says the first day before closing is day one, and we count backwards from there. if however, we land on a public holiday or weekend we will advance forward to the first business day. Practically, if the 10th day in the past from the closing day is a Saturday the deadline becomes Monday.  The counting of time back from closing does not change the other time provision in the contract which states that 5 days or less are business days and 6 days or more are calendar days. Another part of counting backwards is if the closing day falls on a Sunday we would move the closing day to the next business day. So let's say there was a mistake and closing was a date on a Sunday. This means the next business day would be the actual closing date, perhaps Monday, provided it's not a holiday. We would then count backwards from Monday. This makes day 1 in the counting to be Sunday, then Saturday then Friday 3 etcetera. Of course, only if we were counting more than 5 days.

In item four of the evidence of funds addendum is very important. It says should the buyer fail to close on time because of contingent funds, the buyer will be in default and seller will be allowed to whatever remedies which were agreed on the purchase and sale agreement, most commonly the forfeiture of earnest money by the buyer. 

 We need to make sure we don't fall into the trap of avoiding this form just so we allow our buyers to avoid disclosure and the timelines that provide risk for default. We really can't avoid it anymore because the purchase and sale agreement is clear that the buyer is not relying on contingent funds when they sign form 21. So any reliance on contingent funds to the contrary of what they signed could open the buyer and broker up to legal action. 

It’s helpful to provide proof of funds to solidify the offer to the seller as they evaluate their options. Importantly, you should be mindful to remove the account details (the account number) when providing a copy of a bank statement proving funds are non-contingent.

The 22EF is helpful in giving a buyer an option to provide the evidence of non-contingent funds that isn’t immediately sent over with the offer should they need to get a letter from their bank stating funds are available. They may choose to do this in case they don’t want to share with the seller exactly what’s in their bank account. One of the reasons a buyer may be reluctant is if they have more money in the account than is needed for non-contingent funds and they don’t want to disclose that fact to the seller and compromise their negotiation or financial flexibility.

There are cases where a buyer could disclose the loan they are receiving from a family member or even a financial institution on the 22EF. A buyer may choose to do that if they don't want to have a financing contingency and all of the protections that it provides. That would remove any low appraisal protection. It would also remove any protection a normal financing addendum would provide such as being contingent on receiving the loan. If the buyer was unable to receive the loan from a family member or a financial institution their inability to close would constitute default and whatever was chosen in the form 21 whether that was the seller's election of remedies or forfeiture of earnest money. If the buyer wants to be that aggressive and skip the financing contingency as well as all  its protections, it's important to lay out the risk the buyer is taking.

Fortunately, the form lays out the opportunity for the property to be appraised even if it's a family member providing a loan to the buyer. If a buyer does choose to take the additional risk of disclosing loans on this form without any of the formal protections of a financing addendum it's best practice to write down that you discussed with them what those risks are and receive confirmation that they are aware of the risks and would like to move forward. Email of course is the easiest way to do this. 

When providing evidence to the seller in a timely manner we have to be really careful that we fill out the form properly because if it is a loan, a traditional one, those funds typically are provided on the day of closing by the financial institution and therefore you can't leave the form blank where it says how many days before closing you'll provide evidence of the funds. Otherwise, the buyer is stating they will have in their bank account all the funds necessary from the loan 10 days prior to closing. This of course isn’t going to happen because a financial institution is not going to provide a loan that goes directly to an individual's bank account ten days prior to closing. It doesn't mean the seller should terminate the agreement as a result of failing to provide evidence, resulting  in the loss of earnest money or other remedies, but the  buyer could lose the ability to purchase property.

When it’s a competitive situation, it’s best of course to provide proof of funds so there is no question as to the buyer’s financial ability. Documentation is a flexible term since the form is basically requiring evidence from their financial institution which should include the date of the balance, the amount, and the name of the individual matching the buyer line of the purchase and sale. Many times it’s a quick download of a pdf or even a screenshot of the account.

Video script: 

The inspection addendum is being used less as the market is so competitive for homes. However, this is not a normal situation, so there is very little legal history for disputes when there isn’t an inspection performed. It's often being waived in order to make a buyer's offer more competitive or the form is being skipped and substituted for a pre-inspection. It's certainly a benefit to the seller to have their home pre-inspected and not have a contingency that is associated with the condition of the property. It also serves to make the offer more competitive as you reduce the number of ways a buyer can back out of a purchase. However you're forfeiting information, and that information could indicate problems which are detrimental to the overall value of the property. It's very important for a buyer to make an offer with full knowledge of what they're about to spend a lot of money on. They need to know the condition of the property so that they are prepared for expenses that are likely to arise due to the condition. and that's critical because in a competitive market buyers are often extending much of the cash, or all that they have available towards the purchase of the property and the closing costs. This doesn't leave a lot of leeway to absorb large expenses that are unexpected, such as the types of things that you would find during a home inspection.

 I think the form provides a really interesting line from the very beginning. That is the inspection contingency is “subjective satisfaction” for all the inspections of the property. This is the main reason why it's beneficial to sellers to have a pre-inspection or have this form waived. “Subjective” means that the buyer can walk away if they feel like it. 

The only people that are allowed to inspect the property are licensed home inspectors, the buyer themselves or someone that is exempt from licensure by the state. Those people exempted include: licensed architects, engineers, electricians, plumbers and pest inspectors. But those inspections have to be limited to their area of expertise. That means a pest inspector isn't qualified to do a full inspection of the property if they are not licensed as a home inspector, but they can, of course, inspect for pests. 

The buyer, if they have an inspection contingency, can bring in as many inspectors as they deem necessary to perform a thorough inspection of the property. 

One of the changes that was made a while back and which were covered in a previous core class is that buyers should not provide the inspection report to the seller, unless it's requested. So the form at least from the NWMLS now provides a provision for the seller to provide their preference. And importantly, checking the box regarding what they prefer, either receiving the inspection report or not doesn't constitute a counter-offer. That is really helpful so we don't have to go back and forth again and have the buyer provide an initial next to their acknowledgement of what to do with the report. 

Remember, don’t provide additional details of the report, even if it’s needed to trigger additional inspections of the property. If that’s necessary to allow additional time for the buyer to further investigate the roof as an example, only send along the portion of the report stating the recommendation for further inspection by the initial inspector.

If you're not sure what should happen during a buyer's consideration to purchase a property, this form has a description of all the things the buyer is allowed to inspect and they should consider.  For example, what is the structural condition, the mechanical condition, general condition of the property, considering zoning codes, inspecting for hazardous materials, checking for pests and doing any soil or stability inspection that might be needed should the property be on a slope or insecure ground. If there are any questions they should engage with plumbers, electricians, roofers etc. If a buyer looks into all of these items they are going to know very well what they're getting into prior to purchasing the property and as a result, know what expenses they are likely to incur at least in the near-term. And as mentioned earlier in a video this can help the buyer budget regarding their cash outlay as they compete with other buyers for properties. 

From the perspective of a broker it's important to keep records of conversations with the client. This is one of those times where documentation can really come in handy. It's important to document that you have discussed with them the risks associated with waving an inspection contingency. It's also smart to ensure that the buyer responds and acknowledges that they are voluntarily waiving the inspection contingency. 

That's why it's important to include the form 35, inspection contingency even if you do waive the contingency. That's because there is a way on the form, the last clause of the  addendum, that allows you to check that the buyer waived the inspection contingency which of course they have to then sign. 

If you do include the contingency in an offer it's critical to follow timelines for notification or you lose the benefits of the contingency. This means we have to notify the seller in an appropriate amount of time as to the decision of the buyer after inspection. The same applies to the seller: they have to follow all the timelines or they will be forfeiting some of the rights they have under the contract. 

Another key provision in the inspection contingency is it allows the buyer and licensed inspectors access to the property. Any access allowed to the property is in the contract be it for the inspection or for appraisal. That's why we have to include either a financing contingency or evidence of funds when there's a loan involved because appraisers will need access to the property. So as a purchaser they need to recognize that should they not include the addendum, they will not have the right to inspect the property.