CRES Risk Management Webinar: Preventing Claims in this Hot Seller’s Market – Part 2 (Nevada)

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Escalation Clauses, Appraisal Addendums, and More

In a hot seller’s market, there are increased risks for real estate professionals. And we’ve uncovered more of them in looking specifically at Nevada.

In this webinar, attorney Kathryn Holbert, from Farmer Case & Fedor, and Dave Miller, who manages the CRES Advantage Home Warranty Plan, discuss how real estate professionals can prevent claims in this fast-selling, low inventory market.

This informative webinar covers:

  • Tactics buyers are using to secure a property
  • Why appraisers are being cautious 
  • Why it’s important that the buyer and seller fully understand the consequences of their actions
  • Escalation clauses – how they work and what to watch out for as a real estate agent
  • Purchase agreements and how they differ between Northern Nevada and Southern Nevada
  • Appraisal addendums
  • Why home inspections are important, even if the buyer has to pay for it themselves 
  • How to explain to your client, as a buyer’s agent, that you missed out on a property
  • The value of home warranties 

Like Kathryn says, “Risk can never be eliminated. It just has to be managed appropriately”. If you’re a real estate professional who wants to manage your risk, prevent claims and protect your real estate business, watch the full webinar to find out more here:

Video Transcript: Preventing Claims in a Hot Sellers Market, Part 2: Escalation Clauses, Appraisal Addendums, and More

Laura Prouse:

Thank you for joining us today for part 2 of preventing claims in a hot sellers market. I’m Laura Prouse from CRES Insurance Services. Today, we welcome attorney Kathryn Holbert from Farmer Case & Fedor. Kathryn has been defending real estate professionals for 15 years throughout the state of Nevada and is a very active member of the CRES legal panel.

Along with Kathryn, we have Dave Miller, Regional Vice President with Fidelity National Home Warranty. Dave manages the CRES Advantage Home Warranty Plan. When CRES E&O insurance clients purchase a CRES Advantage Home Warranty through Fidelity, you can reduce out-of-pocket claims costs up to $5,000. 

Dave Miller:

Kathryn, what is just your overall temperature of how crazy the market is in Nevada right now?

Kathryn Holbert:

On a scale of one to 10, we’re a 12. It is really crazy. And there is a flood of people that are coming in from California. An interesting issue is that they’re bringing cash. It used to be that if you wanted your offer accepted, make it all cash. That is not even working anymore.

So that’s the baseline now wherever you’re starting to try to get an offer accepted. I’ve spoken with numerous brokers that are getting 50-60 offers on a house. And the inventory is incredibly low.

So not only are there a lot of people trying to buy properties, but there aren’t a lot of houses out there to buy. The builders are starting to build again, which is good news, but still the inventory is very low.

Dave Miller:

What are some of the tactics that you’re seeing from buyer’s agents to make their offers more desirable? 

Kathryn Holbert:

Beyond paying all cash, you can waive inspections and waive any request for repairs. You can just try to increase your purchase price through escalation addendums. Or you can do it with the appraisals.

One thing I’ve definitely seen is that in 2008, the appraisers got into a lot of trouble. So, all the appraisers are very cautious right now in this market. And basically nothing is appraising even for the list price. And everybody knows going into a transaction that this isn’t going to appraise. 

Escalation clause: a form is better – but use with caution

Dave Miller:

Let’s talk specifically about the escalation clause. What’s the objective of this? Is there a preferred way to use it, do you write it into an offer, or is it a separate form? 

Kathryn Holbert:

What happens a lot of times in that you’ll get multiple offers. The sellers’ agent will then send out an email advising, “we’re in a multiple offer situation. Everybody please submit your best and final offer.”

An escalation clause is essentially a tactic to submit a best and final offer upfront. So, you’re letting the seller know “my offer is X, however, I’m willing to be the next highest offer you get by X number of dollars up to a certain point” or it can just be open-ended. 

I typically will see that on an additional term section of the offer. There will just be that kind of sentence, but I don’t recommend that.

In this case, a form is more appropriate. And the reason for that is I want clear communication between the buyer and the buyer’s agent. The buyers need to fully understand what they’re doing and the consequences. Because the reality is the buyers can offer to pay up to 10,000 more than the purchase price and still not get this property, because somebody else may have an escalation addendum.

If the buyers don’t put a cap on it, they don’t control the purchase price — and they need to be aware of the consequences. So, I prefer a form that both seller and the buyer sign. 

The other advantage of using a different form like an addendum that you’re attaching to the main purchase agreement is that it actually allows the seller to accept your offer but reject your escalation addendum.  The escalation addendum would have to be triggered by the buyer, or the seller would have to give you the offer that triggers that addendum.

I think the form is a good idea if you’re representing sellers in that situation, particularly where there are not only multiple offers, but multiple offers with multiple escalation addendums.

  • You can then in that case say, “we’ve got multiple escalation addendums situations. We’re rejecting all of them.”
  • Or, the seller could actually say, “I’m rejecting your escalation addendum, however, I’m countering your offer, but I’m just countering at this purchase price.”

That’s hard to do if you’ve just got all of that – or a little sentence — in the additional term section. If you’ve got a whole separate addendum form, it’s much easier for everybody to walk through it and say, “we’re triggering this, we’re not triggering this.”

Dave Miller:

Any other notes or comments on just the best practices for using that form and how to possibly stay out of trouble?

Kathryn Holbert:

Absolutely:

  1. The escalation clause form is not something you should use in every case.  It’s something you very much have to think through. 
  2. It’s a practice that’s frowned upon by the compliance divisions of both the Realtors® association and more particularly the Nevada Real Estate Division. So, brokers and agents beware.

These entities don’t like the practice primarily because there isn’t a uniform form that everybody is using. And not everybody is doing it the same way. Not everybody is handling it the same way when they’re representing the sellers.

The division isn’t saying you can’t use it, but they’re saying use it with caution. And I think that’s a good stance to take. As an agent, your broker needs to be aware of when you’re using an escalation addendum, and it’s worth a five-minute phone conversation with your broker:

  • “These are the circumstances. This is the property. This is the list price. This is what we want.”  Your starting point with all of this is you’re setting a purchase price. You’re submitting an offer that already has a purchase price. In reality, that should be a fair, reasonable offer. The only reason you’re even using this addendum is this property isn’t going to sell for a fair, reasonable price.
  • “If we do this escalation addendum, I think it may give us an advantage that may work.” 

So, you’re kind of trying to jump ahead of everything. You should have a conversation with your potential buyers.  How far are they willing to go with it?  Have the conversation with your broker. Then, you take the time to make sure you present it right. 

Dave Miller:

Let’s just say, for example, there are 15 offers on the property. One agent gets their offer accepted, but  14 agents and buyers did not get their offer accepted. Are those agents more prone to be in a lawsuit, because they were the buyers’ agents and didn’t get their buyers the property?  Are they now more  susceptible to claims because their offer wasn’t accepted?

Kathryn Holbert:

It is a difficult conversation that I have been having with brokers because the real estate division doesn’t like these escalation addendums. The associations don’t necessarily like these escalation addendums, but there are people using them. And there are brokers that don’t like these escalation addendums. I have been told that there are brokers that simply will not consider an offer if it has an escalation addendum.

I think that’s problematic. If you’re representing a buyer or potential buyer and you say, “I don’t like escalation addendums. I don’t want to use one.” Then, your buyer finds out that the person that got the property that they fell in love with and really wanted got it because they used the escalation addendum. Yes. I think you’re running a risk.

The majority of the time, it’s your own client that sues you and initiates the lawsuit.  I think that if you’re an agent representing one of those 14 buyers whose offer didn’t get accepted, they’re going to want to know why.

The agent that’s representing the seller who chose which offer to get accepted doesn’t have to tell you anything. They don’t have to explain to you the reasons why. And in most cases they don’t, they just say, “we’ve chosen to take another offer.” 

But as the buyers’ agent, you’re going to have to explain to them and show them you did everything you could to get their offer accepted.

In today’s market, that may include the proper use of one of these escalation addendums.

Dave Miller:

Are there Northern Nevada forms and Southern Nevada forms? 

Kathryn Holbert:

Southern Nevada area is the Las Vegas metropolitan area, basically Clark County. And the realtor® association is the Nevada Realtor® Association LVR.

They basically put out all the forms that everybody in Southern Nevada is familiar with and uses. 

Northern Nevada, which is Washoe County, the Reno/Sparks area has got a different association and they use different forms.

The purchase agreements are different. There is a statewide Nevada Real Estate Division which really puts out one form, the seller’s real property disclosure form. 

The rest of the transaction forms are done by the individual realtor® associations. And the forms are not exactly the same, but you have to be aware of how your own form is set up. And if you are dealing with somebody in another part of the state, their forms might be different.

The addendum form for this escalation addendum is not put out by either association. So those forms that you do see out there are basically done by brokerages that have created their own form.

I personally have worked with a couple of different brokerages both in the north and the south to help them develop their own form. Each individual brokerage needs to work with their risk management attorney to help them develop this form (or not use it at all). If you’re not going to take the time to work with legal counsel and develop a good form, just don’t use escalation addendums.

Appraisal Addendums

Dave Miller:

Great advice. Let’s move to two of the appraisal addendums. What are you seeing and what’s happening when the offers are coming in higher than the appraisal?

Kathryn Holbert:

The addendum we were just talking about is tied to everybody else’s (other potential buyers’) purchase price. So, that’s what you’re competing against and what you’re escalating. Where is your purchase price relative to everybody else’s purchase price?

When you get with the appraisal addendum, you’re escalating your purchase price based on the appraisal price (which nobody has at the time that the offer is made). Your purchase agreement contains  provisions related to the appraisal. And there are various contingencies of what happens if this property doesn’t appraise.

You have to be aware of what those specific things are, and you can just write in your terms in the addendum. “We’ll pay $10,000 over appraised value because you’re changing contract terms that already exist, and they’re already contingent.” 

Your tactic as a buyer could be, “I’m paying all cash and I’m waving all appraisal contingencies, I don’t care what it appraises for, I’m not getting an appraisal.” You just set your purchase price, and you don’t worry about the appraisal.

If you’re going to get an appraisal, you have to address the appraisal contingencies. Now, the appraisal contingencies that are already in the contract may be sufficient.

Generally, they give you three options:

  1.  “We’ll just go ahead and pay the purchase price regardless of the appraisal”
  2. “We’ll renegotiate”
  3. “We can counsel the contract.”

The purpose of the appraisal addendums or additional terms that I’m seeing is basically to pre renegotiate. 

Since everybody knows you’re going to end up in the renegotiation process because it is not going to appraise, we may as well address that upfront, which is not a bad idea at all as long as it’s done correctly. So, typically what I’ll see though is just a short sentence in there that again says we’ll pay $10,000 over the appraisal price regardless.

And that may be sufficient in some cases, but it may not be sufficient in some cases. At the very least, you need to say we’re exercising option B of the contract. You have to reference the contract terms and say, ”we’re leaving A, we’re leaving C, but on B, we’re changing B slightly to say we’re pre-renegotiating and this is what we’re willing to do.”

You have to get the appraisal, and then the addendum is triggered. But the initial offer you submitted  does not have a good purchase price. And that can become very problematic, because everybody needs to know what that purchase price is: The title company, both the buyer, the seller, the lender, whoever else may be involved.

Both of these procedures are a way to get to a final purchase price. But everybody needs to understand and remember that at some point in time, we need a new addendum that clearly sets forth this is the purchase price that we’ve agreed to because the appraisal came in at X number of dollars or that we executed this addendum.

This new addendum to the purchase agreement is where both parties sign and agree to the final purchase price.

“As Is” Sales, Inspections, and Home Warranties

Dave Miller:

We’re in an epic sellers’ market.  Sellers know they’re likely to have maybe 15 offers. They can be picky and offer the house “as is.” Buyers can get their own inspection, but the sellers aren’t going to fix anything. And, there’s not going to be a home warranty. What are the dangers in this real estate market?

Kathryn Holbert:

It’s problematic. Obviously, if you’re representing a seller, they don’t want to pay for anything. So, it’s okay to say we’re waiving this and we’re waiving that. The problem comes when you’re representing the buyer.

And as a buyer’s broker, you might ask for things in your initial offer. It might get countered back saying, “no, we’re not paying for any of that.” Or, you may talk to your buyer and say, “we probably need to waive this to have our offer even considered.” 

As the buyer’s agent/broker, you can say “we’re not going to make you pay for any repairs. We’re not going to make you pay for a home inspection. We’re not going to make you pay for a warranty.” 

However, you need to be having that conversation with your buyer about still proceeding with these items. You should still get a home inspection.

And if the home inspection is horrific, the buyer wants to reserve the right to back out entirely based upon that home inspection. And the buyers can still get the home warranty – they’re just going to have to pay for it.

So, in really all of those circumstances, you shouldn’t be waiving these items. The seller isn’t going to pay for them, so the buyer needs to. And I think that needs to be clear in a strong offer: “we’re not going to make you pay for any of this stuff, but we still want to do it for our protection.”

If you’re representing the seller, you should never have a problem with them getting a home inspection. The only issue could be timing, because the home inspectors are crazy busy too. (In Nevada, I’ve been told they’re now scheduling maybe two weeks out.) Well, if the sellers want a 10-day close, and you’re not going to have time to get the house inspected, that may be an issue and something you have to decide.

A home warranty should not be a timing issue. It’s usually something that can be done in a day or two. And especially if you’re not getting an adequate home inspection, you want to make sure you’ve got a home warranty.

So that is something that I would never waive. I would just say in this particular market, you’re going to have to pay for it, but you should still get it.

Dave Miller

A home warranty is perhaps the most important, or one of the most important parts of the purchase.  Because after the sale occurs, the warranty will cover appliances, systems and such.

If you’re a CRES Insurance client and you purchase the CRES Fidelity Home Warranty, it could help reduce your out-of-pocket claims costs if you’re named in a lawsuit.

If you’re representing the sellers, it could provide them with up to $50,000 of Sellers E&O insurance. In a competitive market where you’re trying to get listings, using the warranty to give those sellers up to $50,000 of E&O coverage is a great value. 

Any final thoughts, Kathryn?

Kathryn Holbert:

Risks can never be eliminated. They just have to be managed appropriately. And there are ways to do that. That starts with being aware of where the pitfalls are.

Laura Prouse:

Kathryn, thank you so much, really valuable information. And to everybody who’s watching, thank you for watching. 

This blog/website is made available by CRES Insurance Services for educational purposes to give you general information and understanding of legal risks and insurance options, not to provide specific legal advice. This blog/website should not be used as a substitute for competent legal advice from a licensed professional attorney in your state. Claims examples are for illustrative purposes only. Read your policy for a complete description of what is covered and excluded.

Originally Published June 10, 2021

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