For those of you that play sports (or just watch movies about sports- so pretty much everyone reading this), you've probably seen a coach yell at his players to go out there and 'never hold anything back. All in or get out'.
That attitude works. And it works in business and just about all other life applications. But in real estate, sometimes you actually do want to hold something back. In fact, it is oftentimes necessary. Specifically, you may want to hold some money back.
When is a holdback necessary?
Here are just a few instances where the parties should negotiate a holdback:
There's some work or repairs that the Seller is obligated to complete;
The Seller doesn't have permits for improvements the Seller is obligated to provide;
An updated Real Property Report is pending;
Compliance in relation to a Real Property Report is pending or there are compliance related issues;
The house inspection results in a potential issue that needs to be confirmed;
There are tasks to be completed by the Seller that can’t be verified by the Buyer until after closing (i.e. removing items and cleaning up garage prior to completion date);
Any other issue has arisen and both Buyer and Seller want the deal to proceed past Condition Removal or Waiver stage without further delay.
In these instances and more, it may be prudent and mutually beneficial to move forward with condition removal. The Seller knows they have a deal. And the Buyer knows they have sufficient security to deal with the issue.
How much should a holdback be?
The issue then becomes how much the hold back should be. The criteria varies based on type of issue, geography, and risk tolerance. But a few guidelines should be followed:
1. What is the dollar value of the issue? For example, if the Seller has provided a Real Property Report with evidence that the entire property complies except for a small deck, the holdback should be a reasonable estimate by both parties as to the cost to get the deck into compliance and pay for the necessary outstanding permits. Or if the Seller had contractually agreed to purchase and leave behind a new $1200 refrigerator, then you would want a $1200 holdback until you confirmed that was done.
2. What is the risk value of the issue? For example, if the actual dollar value of the issue isn’t easily ascertained, then the only other way to establish a holdback amount is to ‘value’ risk. That is, if your inspection turned up a potential mold issue or crack in the foundation but could not determine whether or to what extent a problem existed (needing further testing or investigation), then you would need to analyse the potential risk. There could be no mold or no foundation damage upon further inspection. But there could be a mold issue or foundation damage. So as a Buyer, you would want to estimate your risk on the high end. What would it cost to repair the damage if it really did exist? Usually the Seller isn’t willing to be responsible for the full amount of any potential costs, so would agree to a holdback that is reasonable in exchange for capping their potential liability. The Seller would be assessing their own risk.
When should a holdback be negotiated?
After determining that a holdback is necessary, and then determining the holdback amount, the question next to arise is when to deal with it. The answer is simple. Now!
That is to say, why wait to deal with it after you have removed conditions? Believe it or not, that’s when most holdbacks are addressed. At that point, neither party has much bargaining power. If the issue is compliance for the Real Property Report, and the Seller didn’t direct their mind to the fact she had failed to get compliance for her deck, then negotiating after the Buyer has removed conditions results in a troubling predicament: she is bound to provide compliance (contractually). Yet she doesn’t have it. She is in breach of the contract.
Conversely, if the Buyer needs to move in on the closing date, has removed conditions, he is in the same weakened predicament. He can’t really just threaten not to close (like he could before he removed conditions). He is bound to an unconditional contract. The breach is not likely ‘material’ such that it would give rise to rescission, so he is bound to close (and then at best claim damages). The lawyers are stuck negotiating well after the matter should have been addressed. Deal with it at the time of contract and prior to removing conditions. So yes. That means getting the realtors to deal with in the contract itself.
So these are the holdback basics. Get these right, and you will avoid a huge headache down the road. Share your thoughts and reach out to me on Twitter @DarrenLRichards or by email at email@example.com
Originally published in the REIN Real Estate Report