by Michael Repka
As a company that is at the forefront of marketing to the Mandarin-speaking community, we love the high level of emphasis that many sellers and their real-estate agents place on "cash offers." Because many foreign investors and recent immigrants lack the requisite credit and income history in the United States to qualify for many banks' mortgage programs, they often pay in cash. Virtually all sellers see this as an advantage — and it is — but query, what is the appropriate premium to place on a cash offer?
In practice, many real-estate agents and their clients try to utilize rigid rules to analyze the relative value of a cash offer over an offer that needs financing. For example, one agent confidently explained that "offers that require financing should be discounted by 1 percent when they are compared to cash offers."
It is not this simple. Sellers should analyze the two key advantages to cash offers, certainty and timing, in light of their personal circumstances and the particular facts surrounding the transaction and the buyer.
Certainty: One of the biggest advantages to a cash offer is that it is more secure than a transaction that needs financing. There is no risk that the bank will deny the buyer's loan. There are no restrictions imposed by a lending institution or government guarantor/agency. No need for an appraisal or concern that a low appraisal will derail the transaction.
While some offers that require financing should be discarded or highly discounted due to risk, other financed offers may include very little risk at all. In fact, in today's historically low-rate environment, many buyers that could pay cash would prefer to finance a portion of the purchase to secure the low-cost funds or because they want to deduct the interest on their personal taxes.
Thus, the real question is: How much risk does the financed offer entail? The most telling answer to this question is provided by the buyers themselves. If they feel very secure about their ability to procure the requisite financing they will have, or should have, written the offer without a financing contingency. On the other hand, if they think there is material risk that they will have trouble with the financing, they will have, or should have, written the offer with a contingency that gives them the right to get their deposit back if they can't get the financing.
Beyond the inclusion of a financing contingency, sellers should consider the amount of the down payment, the size of the loan and the quality of the pre-approval letter included with the offer. Also, sellers should consider any transaction-specific factors that commonly raise problems with banks, such as long seller rent backs, pending litigation or buyers with short U.S. credit histories.
Timing: Cash buyers can close as fast as two days and they routinely close in seven to 10 days, which is often seen as a benefit to the sellers. Buyers that require financing, on the other hand, generally need between 21 and 30 days to close. While this may make a difference to some sellers, many others would be willing to wait the extra two to three weeks if the non-cash offer were preferable for other reasons. Generally, the additional carrying costs involved with the added three weeks are fairly de minimis given the scope of the deal, and many buyers are willing to cover these additional costs when asked.
When a home is currently occupied by the seller, there may be little if any advantage to a seven-day close in light of the seller's need to pack and move. While this is often handled by giving the seller a period of time after closing as a free rent-back, the transaction could be structured with a more traditional escrow period.
Tax consideration: In an effort to make their offer more appealing, some buyers purchase a home with cash and then borrow against the property to obtain funds at a low rate and with the hopes of deducting the interest on their personal residence. It is important to note that the IRS only permits homeowners to deduct interest on the first $1.1 million (assuming no home-equity debt) of "acquisition indebtedness," which is defined only to include loans put on the property within 90 days of the purchase.
Deal structuring: When buyers and their agents are faced with the unenviable challenge of competing against an all-cash offer, they should look for ways to assuage the sellers' concerns about security and timing. There are many deal-structuring approaches that can render a financed offer as strong as or stronger than a cash-offer. However, these techniques require the buyer to assume added risk. But then again, the buyer is in the best position to determine just how much risk their offer truly entails.