If the real estate market can be counted on for anything, it's fluctuation. There are times when buyers have their pick of homes, and sellers must settle for sales prices that are less than what they'd hoped for.
Then there are those times when it's a seller's market, and it's the buyers who have to pay top dollar — or even over asking price — to get into houses. In a really hot seller's market, buyers can end up in bidding wars — essentially a homebuying competition where the highest offer wins.
Why Do Bidding Wars Happens?
That's exactly where the U.S. housing market is currently. Inventory is low; demand from buyers is high; and sales prices continue to surge. In fact, the National Association of Realtors' (NAR) latest monthly sales report released May 21, 2021, says existing-home sales were down 2.7 percent in April — the third straight month of decline. But January to April sales are still up 20 percent, and median existing-home sales prices rose 19.1 percent year-over-year. Those are both record highs.
Total housing inventory (the number of houses for sale) in the U.S. at the end of April was up 10.5 percent from March, but still down 20.5 percent from just a year ago. These are near-record lows since the NAR began tracking the home supply in 1982.
Michael Schiff, a buyer's specialist with Schiff Real Estate Team, with Ansley Real Estate in Atlanta, knows all too well these numbers. During a balanced market there should be about six months of inventory on the housing market. But Michael says in Atlanta, however, there is about a one-month supply.
These are the numbers that lead to bidding wars — a listing that receives multiple offers, and one where the listing agent puts a deadline on receiving the highest and best offers. But how do you win one? "There is strategy behind every single detail," says listing specialist Leigh Schiff. She and Michael are the husband and wife team at Schiff Real Estate Team, with Ansley Real Estate.
Just as not all listings are the same, not all bidding wars are the same either. Sometimes it might just be a threat of another offer. But other times a listing might get three, five or even 20 offers, Leigh says. Lower price point listings tend to have more offers, but she recently sold a home at $1.3 million that had seven offers and went 10 percent over asking price.
Before you make an offer, or even start house hunting, get your money together. Prequalifying for a mortgage is not enough, especially in a seller's market. Prequalification simply means that you have spoken to a lender and provided information about your income.
"It holds no value," Leigh says. Instead, you want to get preapproved for a mortgage, which means your lender has pulled and reviewed your credit, run your finances through an underwriting system, and has approved you for a loan, pending a contract and appraisal. In the Schiffs' case, they go even one step further and ask for credit, income, assets and tax returns from the prior two years to be included in the process.
Some, although not all, lenders are willing to underwrite buyers for any home in their price range, says Michael. That means you won't need to worry about including a financing contingency in your offer (meaning your offer is based on your getting a loan). This is a point in your favor because omitting contingencies makes you a more attractive buyer (more on that next).
Of course, "cash is king," Leigh says. "Especially now that we are starting to see some issues with properties appraising." When sales prices exceed market value, something not uncommon in bidding wars, lenders may not be able to lend you enough money to stay within an acceptable loan-to-value percentage. If you choose to pay above-market value, you'll need to have the extra funds available to cover the difference. But if you can pay cash, you're the optimum buyer in a seller's eye.
It's equally important to put down a substantial amount of earnest money, which is a "good faith deposit" that tells sellers you're serious about buying. In a typical situation, that amount would be about 1 to 3 percent of the purchase price. If you change your mind, you lose the money and the seller keeps it. But if the deal falls through for other reasons, like information uncovered during an appraisal, you get the money back.
During a bidding war, offering a higher percentage of earnest money strengthens an offer because you're less likely to walk away from the purchase — and your money.
In a bidding war, winning isn't just about coming in with the highest offer, it's also about the terms of the offer, Leigh says. To show the seller that you want the home and are willing and able to purchase it almost no matter what, waive contingencies.
Contingency clauses define "a condition or action that must be met for a real estate contract to become binding," according to Investopedia. There are three main types: financing, appraisal and inspection. There can also be contingencies related to time, like how soon the seller needs to move out or that the sale is contingent on your selling your current home. The fewer contingencies, the fewer chances for the deal to fall through.
- Financing contingencies relate to your ability to secure a mortgage. They allow buyers to back out — without penalty — if they can't secure a mortgage. Not including a financial contingency is interesting to sellers because buyers are stating they won't cancel due to finance issues.
- An appraisal contingency states that the home has to be appraised at a value that is at least as much as the price you agree to pay. During bidding wars, however, there is a good chance the appraisal will come in lower than the offer, making it smart to waive the appraisal contingency.
- With a home inspection contingency, a buyer has the option of requiring the seller to make repairs — or lowering the sales price — based on issues raised during the inspection. If neither is agreed to or completed in a certain amount of time, you can back out and recover your earnest money.
The best bet when it comes to contingencies in a bidding war? "No contingencies," Michael says.
Include an Escalation Clause
Bidding on a home isn't like placing a bid at an auction where you have the opportunity to beat the last offer. You probably won't know what other interested buyers are offering. However, it is similar in that you can begin the process knowing your top bid. Your real estate agent can make it clear just how high and how strategic you are willing to get with an escalation clause.
This is a clause in the contract that states you are willing to pay a certain amount more than the highest bona fide offer, Leigh explains. It only goes into effect once the seller's agent shows that there is an offer on the table that initiates the escalation clause. Interestingly, during a bidding war, there may be multiple escalation clauses, each initiating the next, so the escalation clause should also contain a cap — the maximum price you're willing to pay.
Offer a Backup Bid
If you and your agent use all of these tactics and in the end still don't win a bidding war, you may decide to offer a backup bid. Even in the days of contingency waiving, cash on the table and crazy earnest money, things happen. If the winning contract on the house of your dreams falls through, a second-place bid becomes the primary contract. This is great for sellers because they don't have to start the listing process anew.
And if your backup bid ends up being more attractive than the existing contract, the seller cannot terminate the existing contract. But they can become disagreeable enough to drive the first buyer away. All's fair in love and bidding wars.