Are Homes The New Toilet Paper? How Scarcity Has Buyers Taking Extreme Steps

• PRINT
• EMAIL
• LARGE
• MEDIUM
• SMALL

Brian Marks was taking out the trash when a real estate agent approached him. The agent said she had been looking at property records when she noticed that Marks and his wife had been living in their house a long time.

"You're an older couple, you're empty nesters, would you like to sell?" the agent asked Marks, a professor of economics at the Pompea College of Business at the University of New Haven in Connecticut.

This is a question the Markses have asked themselves since the pandemic home-buying spree took off last year. Ultimately, they decided they're not ready yet as they don't want to downsize or move to a less expensive area — the two most obvious ways buyers can make money in this market.

But for people who are in a good position to sell, their home is like holding the last pack of toilet paper when COVID-19 first struck. At the height of the toilet paper shortage, people were listing 12 double rolls of Quilted Northern on eBay for $45. But that wasn't the only product that was in short supply. As the lockdown dragged on, other items became scarce, including thermometers, dumbbells and — yes — houses.

Lack of Supply May Be Helping Fuel Demand

In fact, the lack of homes for sale has never been more acute. According to the National Association of Realtors, housing inventory was at a record low of 1.03 million properties at the end of February, which marks a 29.5% drop from last year.

It's the scarcity, for many, that fuels the appetite, says Shipra Gupta, associate professor of marketing at the University of Illinois at Springfield.

There are essentially two types of buyers: those motivated by competition and those that back off because it causes anxiety or raises red flags, Gupta says. In today's market, people weigh advantages like low interest rates and the importance of their own space against the disadvantages—like rising home prices and intense bidding wars.

The catalyst to buying is that there are precious few homes available, so if you want one, you have to ignore some of the downsides.

"The urgency to buy now, even if it means spending more money than you planned on, comes from the fact that people view houses as a scarce resource," Gupta says. "So you're going to have buyers that want to win at all costs."

Some Buyers Are Taking Extreme Steps

For many buyers, there is no line they won't cross to snap up a home. Real estate agents and lenders tell tales of buyers raiding their retirement savings, going tens of thousands of dollars over budget, buying a house online (without ever seeing it in person) and removing contingencies designed to protect them.

Waiving Contingencies

Contingencies are conditions in the sales contract that must be met for the real estate purchase to go forward. Buyers and sellers must both agree to the contingencies for them to be binding. Inspection, financing and appraisal contingencies are among the most common ones in a sales contract. One crucial way contingencies help buyers is to allow them to walk away from the sale with their earnest money if they're not fulfilled.

Earnest money is what you put down before closing to show that you're serious about purchasing the house so that the seller can confidently stop showing it to other potential buyers. Typically, earnest money (which is kept in a separate escrow account) is between 1% to 3% of the purchase price. On a $300,000 house, the earnest money requirements can be anywhere between $3,000 to $9,000.

An inspection contingency, for example, allows the buyer to order various inspections and, based on the results of the report, either negotiate any repairs that need to be done, renegotiate the purchase price or choose not to buy the house without losing the earnest money.

If the inspection report shows that the house has sewer problems, you could end up spending more money than you planned. Having an inspection contingency gives you some options in what you can do moving forward. Without it, you might be left with two unsavory choices: Buy the home with the sewer problems or walk away and lose thousands of dollars.

In this extreme seller's market, many buyers choose to take the risk and sweeten their offer by removing these kinds of contingencies.

"Buyers are writing offers for thousands over the asking price and agreeing to bring the difference to the table should the house not appraise (at the anticipated price)," says Wendy Sweet, principal at Carolina Capital, a South Carolina-based lender. "They are offering substantial non-refundable due diligence fees and waiving the right to do the due diligence."

Gambling with a Short-term Loan

Christy Walker, a designated broker and owner at RE/MAX Signature in Phoenix, also has seen the trend of waiving appraisal and inspection contingencies, but says that while these can pose an extreme risk to the buyer, "there are some other methods that are worse."

One of those methods is getting a hard money loan — typically a short-term loan offered by non-bank lenders. By getting a hard money loan they, in effect, become a coveted cash buyer in the eyes of the seller, even though they're still getting a loan. They're gambling on their ability to sell their current home later and win against other financed offers.

The problem is clear: If the buyer can't sell their original house and they still owe money on it, they could end up paying on two loans (the hard money loan and the original home's mortgage). Hard money loans often come with higher interest rates, which adds to the risk and the cost. So unless you can afford both loan payments, then using this maneuver can backfire.

Beyond hard money loans, buyers go well beyond the listing price to push their offer ahead of the pack.

"I've also seen escalation clauses going upwards of $50,000 above asking price and offers to pay money above appraised value; as well as offers to pay the sellers' closing costs," Walker says.

When Is the Buyer's Risk Too Great?

If today's homebuyers had a mantra, it might be "nothing ventured, nothing gained." But when does the "venturing" become folly and the gains look more like losses after the buzz of winning wears off?

It depends on who you ask.

Some real estate experts say that homebuyers should never go beyond their buying budget. According to Sweet, "We should all live within our means and buy the right house when the time is right. I've been in real estate since 1981 and good deals and the right house come along every day. Patience is a virtue."

Other experts say that going over budget can make sense in certain situations, especially if you plan on staying in the home for more than a few years, which gives you a better chance of seeing returns on your investment.

"This last year has shown us that life is filled with changes," says Bryan Shaffer, principal and managing director at George Smith Partners in Los Angeles. "It is extremely important that you are not overextending yourself or that you are not being unrealistic about timing, as housing is a long-term investment. Over time people usually do well, but markets swing in the short term, so it is very hard to time an exit."