Whether an economy is flourishing or failing, certain individuals will discover opportunities to capitalize on the current economic climate. In today’s tight lending market, it seems that all-cash buyers may be those individuals. As most residential and commercial investors wait on the sidelines for a more positive lending environment, those who can provide funding upfront are finding the market to be more than agreeable.
The Commercial Mortgage-Backed Securities (CMBS) market, which has historically produced a number of lenders eager to compete for loans, has been dry since late 2007. In fact, only $12.2 billion of commercial loans were securitized in the first nine months of 2008, which means this year could produce the lowest rate of securitized commercial loans in 10 years, according to Commercial Real Estate Direct. This has led institutional and commercial investors to secure financing through alternative lenders, namely savings and loans banks. However, many banks are requiring significantly more equity upfront, sometimes requiring a down payment of 30 percent for the loan to even be considered. Others are requiring developers to pre-lease a higher percentage of housing, office and retail units—usually around 70 percent—in order to finance a new project. Even if all these requirements are met, however, most lenders are not likely to loan more than 65 percent of a property’s value. Add higher interest rates and shorter amortization periods and you have the perfect formula for a hostile lending environment.
The residential market is even worse than the commercial market. Anyone with less than impeccable credit will find it difficult—if not impossible—to obtain any loan, let alone a loan with favorable terms.
Capitalizing with Cash
Though most investors must wait for the lending environment to turn around, those with cash on-hand can capitalize on the first buyer’s market that America has seen since 2003—one in which all-cash buyers are all but guaranteed to be the winning bid on properties, from foreclosed single-family homes to underperforming shopping centers and any property in between that features an owner desperate to sell.
Sellers know how just how poorly the lending environment is, and if lenders can’t trust a buyer enough to provide a pre-approved loan, then sellers have no incentive to risk a protracted closing process, only to possibly see the deal fall through before it is completed. Working with an all-cash buyer, the seller is assured that sufficient funds will be available.
There are other incentives that favor all-cash buyers. A typical closing for a buyer who requires financing is 30 to 45 days for a residential property. If an all-cash buyer is ready to sign on the dotted line and write a check for the full amount, the seller need not worry about appraisal or loan funding contingencies, which can be tedious and often cause a promising sale to fizzle. This is especially true of loan funding contingencies, as pre-qualified buyers may still be denied their loans if their financial situation or employment status changes or was incorrectly reported. Appraisal contingencies are also risky in such a volatile market. A property may not appraise for the actual purchase price, leading a lender to ask for more money down from the buyer or a discounted rate that reflects the appraisal price from the seller. Eliminating these contingencies expedites a property’s closing, which can happen in as little as three days with an all-cash buyer.
Purchasing a property with cash assures the seller that the buyer is serious. When it comes to bank-owned properties, this can be essential. The very nature of auctions assures that some people will bid with little to no intention of actually purchasing. Many banks have been burned in the past by investors who bid on numerous properties, but only intend to follow through on the ones that produces that best deals for them, as they do not have the money to purchase all of the properties. Because of this, many banks will reject a bid if they feel the buyer is untrustworthy. Being an all-cash buyer is one sign that puts a bank’s mind to rest because it knows the buyer has the means to purchase the property. For this reason alone, many bank-owned listings will specify “cash buyers only.”
Though one may argue that having the cash on hand is not the same as actually handing that cash over, it is a step in the right direction that makes a seller confident the deal will close. The importance of this good-faith mentality cannot be overemphasized. A serious seller only enters into a negotiation with a buyer because he or she believes that it will result in a closing. Until escrow has closed and the check has cleared, however, that deal has a million different ways of falling apart. This can result in lawsuits, hefty fees and, in some cases, a seller that becomes so disenfranchised with the sales process and so distrustful of buyers that the property is pulled off the market.
In order to avoid the headaches, stalled plans and a losses from property devaluation, many sellers will readily accept a lower bid from an all-cash buyer over a generous bid that would require financing.
All-cash buyers are clearly primed to take advantage of the down market, which should last throughout most of 2009, if not 2010. Not only can they purchase assets at significantly lower prices because of the real estate bust, but they can do so with little to no competition from investors who must secure financing, which eliminates a lot of the marketplace. Even with these advantages in place, however, all-cash buyers do face some limitations.
For one, many who traditionally invested in stocks and bonds are pulling their money out in favor of a more stable, long-term investment vehicle like real estate. So even though the standard competition for assets may have exited the market, another group is looking to take its place, as many paper-based investors have seen what large sums of cash can get them in this marketplace.
Another limitation is the mentality of som sellers. Despite the lack of demand and fewer buyers, many sellers aren’t willing to accept that realistic asking prices today are significantly lower than the inflated prices of years past. Instead of accepting the lower prices that both the market and, traditionally, all-cash buyers demand, sellers who aren’t in a bind are simply pulling their properties off the market or standing firm in their asking prices, even if it means that the properties won’t sell for two or three years. In turn, all-cash buyers who have certain buying criteria, which usually include a prime location and a reasonable price, may not be able to find what they are looking for, despite a lack of competition within the market.
In such tough economical times, it is often said that cash is king because it is the one commodity that everyone wants and no one can get. This statement is still accurate by today’s standards. However, as with every deal that seems too good to be true there are still limitations that all-cash buyers face. Before plunking down a significant amount of cash in an outright sale, all-cash buyers should be sure to conduct their own due diligence. This will allow all-cash buyers to evaluate their financial status within the current marketplace, how that status would be affected if they invested large sums of cash into real estate and whether they can afford, both psychologically and monetarily, to deal with any fallout that may occur from a change in their financial status or the marketplace.