How to Get a Higher Close Rate in a Red-Hot Real Estate Market
The durability of the now two-year-old housing boom has upended just about everything about the process for buyers and sellers.
Despite consistently dwindling inventory and rapidly accelerating mortgage rates, the time houses spend on the market is close to historic lows. The average is 47 days – but there are markets where the list/open house/offer timeline can be less than a week.
How can a buyer find an edge? Here are a few things to think about.
Set Realistic Expectations
The market is changing quickly, so you need to be clear about what you can afford.
Consider:
Closing costs – 2-5% of the home’s value
Down payment – 20% standard means you don’t have to pay private mortgage insurance
Credit score – this will impact your mortgage rate
Taxes (also called impound) – will you include these in your mortgage amount?
The big unknown here is the value of the home. It’s not uncommon to see houses go for tens or hundreds of thousands of dollars above listing price, especially in the California and Hawaii markets. You need to thoroughly research your target area and understand what homes are selling for. The guidance of a real estate agent is critical here, but you’ll want to do your research, too.
Make Yourself Competitive
What used to be a rarity – the all-cash deal – is becoming more common in this market. If you’re not able to Venmo the home’s owner, at minimum, you need to get mortgage pre-approval. Taking the next step of a pre-underwritten loan may also be a good idea. Pre-approval is not a guarantee that you’ll get a mortgage. Pre-underwriting means that the mortgage company has evaluated your financials and committed to writing a mortgage up to a specified amount.
Mortgage lenders generally want to see the past two years of income and work history, and if you receive W-2 income, you’ll most likely need to provide recent pay stubs and W-2 documents. Self-employed individuals must jump through a few more hoops. In addition to work history, you’ll most likely have to submit tax returns and other documents to verify and confirm income as lenders view self-employed workers as more risky borrowers (even though this may not be true).
On top of your income and employment status, lenders will want to know your debt-to-income (DTI) ratio. This allows them to see how much of your current income is going towards debt to determine how much additional debt they feel you can handle while still being able to pay them back. The DTI calculation is relatively simple as it takes your monthly income and divides it by your monthly debt payments. So, if you earn $15,000/month and pay $5,000 towards debt, your DTI ratio would be 33%. A typical number lenders look for borrowers to stay under is 40-45%.
Another strategy to use in addition to pre-underwriting is taking advantage of a rate lock. Given that interest rates are rising, a rate lock can guarantee your rate for a set period, generally 30-60 days. However, there is a tradeoff as this strategy can get expensive if you don’t find a home within the specified timeframe and request an extension. The fees are generally a percentage of the total loan amount.
Time Is of the Essence
Online listing services are either the greatest thing the internet ever served up, or an open door into a descent into madness and frustration. You’ll likely have both reactions at some point. Keep in mind: You need to see the house, neighborhood, parks and playgrounds, schools, and shops in person. Pictures, digital walk-throughs, etc. can’t tell the whole story. You’ll get familiar with your target neighborhoods quickly, but you need to see every house you’re thinking of offering.
You want to do this as soon as the listing goes up as possible – the first weekend the house is open to prospective buyers if possible.
Think Through Your Must-Have/Live-With Risk Profile
From the seller’s perspective, if they can get an offer with no contingencies, it’s more attractive than the same amount of money – or maybe even more money – because the likelihood of it going through is higher. So as a buyer, you may want to think about giving two of the protections that are usually built-in to the deal.
Home Inspection: This protects you against something seriously wrong with the house that isn’t reflected in the price. Forgoing this means you could have hidden costs and pay much more than the selling price.
Appraisal Contingency: If you give up this contingency that allows you to back out of the deal, and the home appraisal comes in lower than your bid, you’ll have to make up the difference in cash. Your lender will write a mortgage for the appraised value. Appraisals are based on previous similar sales, and in this skyrocketing market, the data lag can be detrimental.
The 1031 Exchange Investor
For the real estate investor who is considering a 1031 exchange, it may prove difficult to find a replacement property. In an effort to defer the long term capital gains taxes, the 1031 exchange rules require investors identify up to 3 new properties within 45 days of selling their existing property. This can be challenging when real estate values are so elevated. If you sell your property for a high price, you’re likely buying another property at a higher price too.
What we’re hearing from these investors is they want to cash in on the substantial increase in value that their properties have seen over the past two years. Their longer-term tenants that have been in place for a few years are paying rents that are well below current market rates. Many of these real estate investors are hungry to find a replacement property that can exchange into to help provide them with potentially higher rental income and higher cash on cash returns.
Multifamily, apartments and self-storage buildings have the potential to keep up with market rates because as old tenants move out, the land lord/property manager can bump the rate up for new renters. In an environment like we’re in, this can be a great way to keep pace with inflation.
Many accredited investors are foregoing their own search for a replacement property all together and are considering using a Delaware Statutory Trust (DST) as a way to satisfy their exchange requirements. DSTs offer third party managed, institutional grade real estate where the investor is a passive owner and has no management responsibilities. They can be a great solution for investors seeking to defer their capital gains taxes and potentially reduce their obligation as a property owner.
Conclusion
For a buyer and investor, it’s a frustrating time to enter the housing market. Given the likelihood that interest rates will continue to rise and inventories will not increase dramatically anytime soon, you’ll need to be strategic, prepared, and fast-moving. Do your research, set your expectations, and get your ducks in order.