Embarking on the journey to upgrade homes, I’ve discovered that acquiring a property with contingencies feels like receiving a no-cost call option. In the worst case, you might not make anything, but in the best case, you could purchase a home below market value.
In my three latest home purchases, I omitted real estate contingencies, primarily because of the robust San Francisco housing market at the time. Including financing or inspection contingencies might have made my offers less competitive.
Fortunately, after a solid price surge following the 2020 pandemic, the market has paused, making homes more affordable and coinciding with a tech stock rebound. This allowed me to submit an offer with inspection contingencies to acquire a home.
Deposits and Contingencies
When your offer is accepted, an earnest money deposit of 1% to 3% of the home’s value must be sent to an escrow company, safeguarding both parties. But beware of scammers! Always verify wiring instructions with the escrow company.
Contingencies, which are specific conditions in your offer letter, protect your deposit if the bank doesn’t lend or if there’s serious undisclosed damage. There’s usually a deadline for these contingencies, after which the deposit is at risk if the purchase doesn’t proceed.
Sellers often prefer offers without contingencies, but may have no choice in a weaker market. For inexperienced homebuyers, at least a home inspection contingency is advised.
A Free Call Option to Profit from a Home
So why liken buying with contingencies to a free call option? Call options are financial agreements allowing the purchase of an asset at a particular price within a specific timeframe. When applied to real estate, this means having the option to buy at an agreed price with profit potential as time progresses.
Strategies to maximize potential profit include extending contingency durations and the escrow period whenever possible. Part of a typical offer document highlights the various real estate contingencies you can leverage.
Why Longer Contingency Duration Benefits the Buyer
The lengthier the contingency period, the more valuable it is to the buyer. More time allows for better-informed decisions, whether in the real estate market or hypothetical investments like the S&P 500 index.
Examples of using a free call option to purchase at a lower-than-market price or letting the purchase contract expire at no cost demonstrate how changes in market conditions can influence these options.
Considering Opportunity Cost, Time, and Stress
While there’s minimal financial downside with contingencies, there is the cost of your time and any related stress. Depending on your comfort with the process, you may or may not find the effort worth the potential gains.
My Own Experience with an Escrow Extension
I’ve personally used an escrow extension strategy during my current residence purchase in June 2020, amid economic uncertainties due to the pandemic. This allowed me more time to gauge the market and negotiate with the seller.
Analyzing Probabilities of Closing
If your offer is accepted with contingencies, it’s worth examining the probabilities of closing on particular dates and actually purchasing the home. These factors will influence how you might invest your funds during the escrow period.
For example, given the stock market momentum, I opted to invest a significant portion of my house payment in stocks. This decision can be seen as gambling, but for me, it’s a calculated risk due to my overall financial position.
In conclusion, thinking like an options investor when buying a home can offer you extra financial advantages. Leveraging offers with contingencies can be a strategic move in home purchasing, a tactic I wholeheartedly endorse.
