The New Normal
Hitting the Reset Button
Things are getting back to normal after almost two years of free fall, but it is a new normal. In the frothy, crazy days of the mid years of the decade just completed, sellers ruled the roost, and buyers put up with almost anything to buy very over priced apartments. If a contract wasn’t signed in a couple of days, there was always the likelihood that a new buyer would materialize. Even if a buyer acted quickly, overbids would appear and the buyer would have to pay more and often lost the deal anyway. It seemed like those go go days would never end. Real estate brokers swaggered and buyer’s lawyers timidly agreed a lot of bad stuff to get deals done. I lost a lot of broker relationships in those days, as I simply refused to go along to get along. But that’s another story. Where are we today?
As I think most attorneys, brokers and mortgage makers would agree, the process of completing a transaction has slowed down tremendously. Buyers are taking their time finding apartments and once located, the contract process takes weeks rather than days. Once the contract is signed, the banks move through the process like tortoises rather than like the proverbial rabbit. And as Martha would say, “that’s a good thing.”
At the moment, many sellers are still in a weakened negotiating position. Prices are down 20 or 30 percent, and buyers are placing conditions on the transactions that most sellers are forced to agree to. Yes, it’s a pendulum, and pendulums eventually come back. But the pendulum in Manhattan will be holding on the buyer’s side for quite some time to come.
The Financing Contingency
When the market was at its emotional peak four or five years ago, the “all cash” contract was the frankensteinian invention of the brokerage community. With an all cash contract, even if the buyer intended to obtain a mortgage, the buyer agreed to waive the mortgage contingency, in order to persuade the seller that the buyer was worthy of the transaction. Under this scenario, the buyer would be obligated to go forward with the transaction, even if the buyer was unable to obtain a loan from a bank. From my anecdotal experience, in most cases, when a buyer agreed to such a provision, the buyer was generally qualified to obtain a loan and things usually worked out. There were thousands of deals (particularly with new construction), where buyers cut the life line of a mortgage contingency. Well those days are over. Time and time again, at various price points, I have seen sellers capitulate and agree to a mortgage contingency. Why?
Financing Has Changed
The previous driver of the real estate boom, that is, the mortgage lenders, are now few and far between. The remaining players in the industry are quite twitchy and unpredictable. Who a “qualified buyer” is changes on a daily basis, and real estate professionals hold their breath waiting for a buyer to be approved. And it’s not just the buyer. Banks are looking over the coops and condos where their loans will reside with a microscope. Issues that banks never even considered, are now grounds not to lend in a particular building. Issue One, particularly with new construction, is owner occupancy. If a sponsor has only sold a few units in a building, traditional financing will not be available.
The message to buyers is clear: except where you are actually paying cash for your apartment, demand a mortgage contingency as a condition of your transaction. In the world we live in today, the inability for a qualified buyer, in good faith, to obtain a loan, should not be the buyer’s problem.
The Funding Contingency
While we’re on the subject, there is a new contingency that should also be required on the buyer’s side of the transaction: the funding contingency. Even if a buyer gets a loan commitment from a bank, there is now the possibility that the bank, at some point before the closing, will decide to pull its underwriting and will not fund the loan. That leaves the buyer high and dry, as a seller may (and often does) take the position that the contingency has been satisfied once the commitment letter is issued, even if the bank ultimately fails to fund the loan. Not fun. It is for this reason, that buyers should insist on a funding contingency as well as a mortgage contingency.
If a bank withdraws its underwriting of a loan, for any reason other than the financial qualifications of the buyer, the parties should agree that the mortgage contingency has not been satisfied. Sellers will grouse about this provision, but will go along with it in most cases. It’s just a mistake for buyers to assume this risk. If the bank says no, the buyer should be able to get out of the deal. That’s not to say that the seller can’t require the buyer to go to another bank and to take other actions. But at the end of the day, the parties have to enter the transaction knowing that they are both dependent on the bank finding its way to the closing table.
Where Are We Today?
In truth, the days of Joseph Campbell type bliss about a buying a particular apartment appear to be over, at least for the time being. What we learned from the crash of 2008 is that when folks are spending enormous amounts of money on real estate, value and investment worthiness come before emotional attachment. If the metrics of the transaction are not right, move on to the next deal. Don’t stretch, don’t overlook the problems, don’t get lazy. As we now know, things can get turned upside down very quickly.
Depending on a buyer’s time horizon, buying an apartment in Manhattan is still a great investment. As long as the buyer proceeds with caution about his or her own ability financial ability and reviews the physical and financial health of the coop or condo carefully, there are deals out there waiting to get done.