Brokers

A deep dive into Triangle real estate: Broker and real estate lawyer speaks out on due diligence, other issues

Editor’s note: Today marks the launch of expanded real estate – corporate and commercial – by WRAL TechWire’s Jason Parker. Look for future deep dives into real estate on Fridays.

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RALEIGH – The Triangle’s real estate markets have been highly competitive for two years, and very competitive for the better part of a decade.

So much so that Matt Fowler, the executive director of the Triangle Multiple Listing Service, TMLS, told WRAL TechWire this week that based on the data that TMLS tracks on a monthly basis, one would need to look back more than seven years to find data that would suggest a balanced, normal, and healthy market.

Still, the hyper-competitive real estate market that led many to prepare for bidding wars earlier this year appears to have slowed, in part, in June, with some form of pause in the marketplace during the month as home buyers, home sellers, agents, and others involved in real estate transactions figured out what a rise in interest rates and continued ongoing inflation might mean for the future of housing markets.

Despite the pause in the for-sale market, rents continued to increase in June.

But now, many home buyers may re-engage in the Triangle’s real estate market, because there very well might be opportunities for buyers to find deals as the market has moved in such a way that while it is still a seller’s market, there are indicators that buyers may have more options now than just a few weeks ago.

One factor: buyers are pulling out of more deals than at any time in the last 16 months, and sellers are dropping prices about five times as often as they were a year ago, according to the latest data gathered by national real estate brokerage firm Redfin.

A deep dive

WRAL TechWire spoke with Roger Bernholz, the vice president and general counsel of local Triangle-based real estate firm Coldwell Banker Howard Perry and Watson (HPW) about what’s happening right now with North Carolina real estate law and in the current market conditions.

The transcript below has been lightly edited for clarity.

WRAL TechWire (TW): Redfin’s report cites nearly 15% of transactions nationwide fell out of contract in June – but in Raleigh MSA, only 7% did.  What’s different about our local market than other markets and than the national trends?

Roger Bernholz (Bernholz): There are few communities that are being so highly rated for a large number of factors that are important to people.  What should we expect when consistently ranked as one of the best places to live and work. The stronger the demand (ongoing multiple offers) when linked to the extremely high, non-refundable due diligence fees being paid in many of the transactions, must certainly prevent buyers from cancelling deals.  Also, we have a sophisticated brokerage community and that yields fewer unprepared buyers and sellers.

Home prices ran hot in April – but has the market changed since?

Buyers backing out

TW: Still, that 7% cited in Redfin’s recent analysis is lower than previous Junes – though remains the highest monthly percentage since February 2021 – what are the market conditions that are factors here?

Bernholz: It is likely that higher interest rates are tightening some people’s borrowing power and accounting for a few more fall-throughs on financial issues.  And there is no question that some buyers are finding they have agreed to buy a house that they determine has previously unknown serious problems that the seller will not correct and elect to terminate the contract and lose their due diligence fee. However, when a house has material problems that are shared with the seller and listing broker, those problems must be permanently corrected or disclosed in any sale to new buyers.  So, the buyers are not powerless in these situations.

Prices are dropping for many homes in Raleigh area; listings are growing, too

The role of due diligence

TW: In this market, why might a deal fall through?  

Bernholz: I hope the high due diligence fees and other serious concessions buyers are having to make are decreasing.

The history of those fees is quite dramatic.  When we revised the NC REALTORS/NC BAR sales contract in 2010, we knew it would be market sensitive.  Indeed, the form explicitly allows a $0 due diligence fee because it was believed that would be the number in a serious buyer’s market, and it was when the form was introduced to the market.  In many, many transactions for some years, no or very low due diligence fees were paid.

We now are seeing just how market sensitive those fees are.  When many buyers run out of ability to compete with price, they use that non-refundable fee to attract and potentially induce the seller to contract with them.  Many brokers have been disturbed to see buyers lose large due diligence fees in the deals that do fall through and some have advocated for capping the fee, but the form is likely to remain market sensitive and keep the buyers and sellers in charge of their transactions.

Current, standard form

The current contract form contemplated a somewhat more evenly balanced negotiation of post-contract issues arising from the buyer’s investigations in doing their due diligence.

Bernholz: There is a standard form to document repairs and improvements the seller agrees to make after a request by the buyer.  However, the contract form since 2010 has always made clear that the property is being sold in its current condition. Generally, the buyer these days is not able to determine what that is until they are already heavily committed by the high due diligence fee.  We are seeing more sellers agree to a pre-marketing inspection that is provided to buyers and that could also certainly be a good adjustment in the market and also be a strong factor reducing fall-throughs.

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History of due diligence

TW: So, wait, help us understand.  What is the due diligence period, and what is the due diligence fee?  And why do they exist in North Carolina contract law?

Bernholz: I was chairman of the NC Realtors Residential Forms Committee in 2009-10 that drafted the revised form more than a decade ago after more than a year of study and exploration of what was going on in other states.

We particularly looked at the Texas and Georgia forms, I believe, at that time, which had similar terms.  The concepts are very much akin to an option style contract.  The contract form in that regard is also very similar in style to the commercial sales contract that REALTORS have used in North Carolina for many years before the residential form was heavily revised in 2010.

(Editor’s Note: The NC BAR and NC REALTORS Standard Offer to Purchase and Contract Form was revised again, recently, with the new form taking effect as of July 1, 2022.) 

Wake County real estate prices up in May even as lending activity, competition decrease

Previous form, decision for due diligence

Bernholz: The previous contract form attempted to establish broad standards for certain aspects of the condition of the residence and a few other matters. This routinely yielded disagreements, sometimes quite serious, between buyers and sellers over whether the standards were or were not met.  This was viewed as an inefficient and troubling condition in the process.

The decision was made to have a process in which the buyer would pay a negotiated due diligence fee that was intended to compensate the seller for taking their property off the active market for a negotiated period of time, the due diligence period, and give the buyer the right to terminate the deal for any or no reason and get their earnest money deposit back. In reality, the buyer could negotiate any number of matters with the seller in order to be as satisfied as possible. In any event though, it created more certainty for the seller that once the due diligence period had elapsed, the buyer was more strongly committed to the deal because their earnest money deposit was then at risk if they did not complete the purchase.

One more change…

Bernholz: One more change that was also included was to make the due diligence fee and earnest money deposit all that the buyer had at risk in the deal if they could not or elected to not complete the purchase.   It was believed that this was the most efficient and understandable process for most people and gave them more certainty about the outcome in a range of circumstances.

Secondly, the revised contract also eliminated the loan condition for some of the same reasons. Big arguments would arise over whether the buy And, it was perceived that the buyer could and would negotiate a due diligence period that would allow them to be confident about the financial aspects of the deal, primarily their ability to obtain the loan they need, or be able to get out of the deal at a reasonable cost (moderate due diligence fee only).  Earnest money would be returned.

This also was strongly promoted for the benefit of sellers.  The buyer’s loan condition basically extended all the way to closing and robbed sellers of any real certainty of whether the buyer would be able to close.

So why would contracts fall apart?

Bernholz: Fall-throughs often occurred near the closing date.

Although in a buyer’s market, it was typical that the due diligence period extended all the way to closing, the general idea was that the due diligence period would “normally” (more balanced market) end a couple of weeks before closing, and give the Sellers time to be more confident about putting their home into a moving truck. We saw several years of that leading up to the pandemic. But of course, now we are seeing the effect of the opposite market condition and sellers have been demanding contracts with no due diligence period, essentially binding the buyer to the deal without any significant financial or condition of the property contingencies.  Earnest money deposits were made almost unusual.

Data shows Triangle’s housing markets may have cooled in June – except for renters

The role of rising interest rates on local housing markets

TW: What role, if any, would rising interest rates possibly play?  

Bernholz: We have not seen added loan conditions to my knowledge.  This would require a custom addendum to the contract from an attorney and are generally not occurring in resale transactions. New home sales see more of that and different contract forms are used..

No buyer should be surprised that they cannot afford the house they have contracted to buy. This can and should be determined in advance.  So, buying power is being moderately constricted and people who are in a hurry and not careful to be very clear about their financial abilities might get surprised and be unable to buy what they contracted to buy.

However, interest rates are historically (like real history, not recent history) low.

I closed many mortgage loans on houses in the 1980’s and early 90’s at 20% to 12% interest rates. So, the extent to which we all have been spoiled by the recent run of unbelievably low mortgage interest rates is being reflected in some leveling of demand.  In my opinion, however, it is still the situation in our market that he who hesitates is lost. With credit card interest rates still around 18%, mortgage money remains inexpensive.

Keep in mind…

TW: So what else should North Carolinians know about real estate right now?

Bernholz: It is the nature of markets to go up and down.  For the 25 years I have been in the real estate business in this market, a down market has mostly been reflected in slower price appreciation and longer times on market.

There was some decline in value in our market during the great recession, but it was small in comparison to the places that saw 50-70% declines in value. We believe and hope that was a highly unusual situation foisted upon the world by inadequately regulated Wall Street bankers.

However, I do not see such a dramatic situation arising in the Triangle market in the foreseeable future. With all we have been seeing on the business, athletic, e-sports, educational and employment fronts and with the amount of inflow we are seeing in new residents, it is easier to remain confident about investment in the American Dream of home ownership here.

 

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