The US may be facing economic uncertainty, but the country’s $1.2 trillion commercial real estate market is staying surprisingly afloat, supported largely by the need for industrial and retail spaces in an everything-on-demand economy where warehousing is the new trend driving real estate and business.
Savvy investors eyeing investments in the world’s largest real estate market will find it necessary to closely study a critical component of real estate transactions—the process of using earnest money, also known as a “good faith” deposit, and how it can give prospective buyers a serious advantage in cinching their next big deal.
Today offering the right amount of earnest money can be the deal closer in a US property sale.
This is especially true in hotter US commercial real estate markets, such as Nashville, Tennessee; Dallas-Fort Worth, Texas; Atlanta, Georgia; Tampa, Florida; and Austin, Texas—identified by the Urban Land Institute as the top five commercial real estate markets in the US in terms of affordability, population growth, amenities, and longevity.
Something investors and buyers will have to navigate in the earnest money process is that there is no country-wide standard rate, so finding out how much earnest money is needed for commercial properties in your area of interest—along with state-specific expectations and best practices—is paramount.
That’s where we come in. We’ve prepared a comprehensive, straightforward guide to understanding the pivotal role of earnest money in a successful CRE property sale in the US.
In this article on earnest money for commercial real estate, we’ll cover:
[Considering some commercial real estate properties for investment in the US but can’t come up with the earnest money deposit? Sign up for Duckfund to quickly get low-cost soft deposit financing with flexible payment terms.]
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Earnest money, also known as a soft deposit or “good faith” deposit, is money that buyers put down on a property prior to the closing date to demonstrate to sellers that they are serious about seeing the sale through.
Akin to getting pre-approved on a mortgage, paying earnest money in the US shows that a buyer is serious and very likely to push through with the sale.
In the event that the buyer fails to complete the purchase and the deal falls through, the seller can keep the earnest money as compensation for their time and effort, or earnest money may also be refunded to the buyer, depending on contingencies agreed by both parties in the purchase contract.
On the other hand, if the sale is successfully completed, the earnest money is put toward the purchase price or utilized to cover the closing costs.
The purpose of earnest money is to demonstrate the buyer's commitment to purchasing the property and to give the seller assurance that the buyer is serious about the transaction.
Essentially, earnest money helps to establish trust between and protect both parties involved in a real estate transaction.
The earnest money is held in an escrow account—a legal arrangement in which a third party temporarily holds property or money until particular conditions have been met—until the transaction is completed, at which point it’s either applied to the buyer's closing costs or refunded if the buyer backs out of the transaction for reasons outlined in the purchase agreement.
You may have heard the terms “escrow account” and “trust account” used interchangeably in the past. In essence, their function is similar, but their purposes are different.
In an escrow account, the funds are deposited into a bank account managed by an escrow agent during the real estate buying process, where they are held until the contract terms of the sale have been agreed upon and finalized. The funds will then be paid to the seller of the property.
In a trust account, trust funds are held by a trustee and are payable to the beneficiary when certain conditions are met, such as a marriage or a death. A trust account can also hold funds payable for future services, such as for a lawyer held on retainer.
So when someone says they are “in escrow,” it means they have deposits held in an escrow account.
It can be easy to confuse earnest money with down payments and option fees, which also have to be paid in the process of purchasing a new home or commercial real estate space in the US, but the three payments serve very different purposes.
Option fees, also known as inspection fees or “due diligence” fees, are a non-refundable payment that can be applied to the final sale price of the property after closing. This payment (around $500 on average in the US) grants you an option period, typically lasting between seven to 10 days, during which you can conduct building and home inspections and assessments on the condition of the property. Paying the option fee gives potential buyers the right to terminate the contract before the option period concludes.
Both the option fees and earnest money must be paid to the escrow agent or title company.
Meanwhile, a down payment is a portion of a property’s purchase price, which the lender demands from the borrower only in a mortgage transaction, and not when the buyer is paying in cash. A down payment assures the lender that the borrower will be able to make the regular mortgage payments, helps the lender to reduce risk, and affords the borrower more favorable loan terms.
An earnest money deposit is crucial to getting the inspection and negotiation process underway, option fees give buyers the right to terminate the contract before the inspection period is over, and the down payment is necessary in closing the deal with a mortgage loan.
Though not mandated by law, earnest money is considered the norm in most US states when it comes to closing a home purchase or a valid real estate contract.
Most real estate attorneys, real estate agents, and loan officers will advise buyers to show their serious interest by paying earnest money.
The amount of earnest money to be paid is generally calculated as a percentage of the purchase price and can vary depending on the real estate market and other factors.
Typically, earnest money in the US is between 1% and 5% of the purchase price. In more expensive markets, earnest money deposits can go as high as 10%.
Thus, how much earnest money is needed for commercial property in the US varies from state to state, along with earnest money practices in general.
"It all depends on the market conditions, however, typically 3% of the purchase price is a rule of thumb," Chris Stuart, president of PLACE, Inc., and former CEO of real estate brokerage franchise network Berkshire Hathaway HomeServices, told U.S. News.
However, some states, such as Alaska and New York, consider 10% as the status quo for earnest money deposits. The same is also expected in the luxury housing market of South Florida. "If you want your offer to be considered seriously, you need to put down 10% of the purchase price," said Elena Bluntzer, a real estate agent with ONE Sotheby's International Realty in Coral Gables, Florida.
On the lower end of the spectrum is Iowa, where 0.5% to 1% is considered the norm for earnest money deposits.
Meanwhile, some states also accept specific amounts alongside percentages. For example, earnest money in Nebraska is either 1% to 2% of the property’s purchase price or a fixed amount from $500 to $2,000.
Another practice is paying earnest money in two different escrow deposits, which is the preferred implementation in states like Illinois and Rhode Island.
According to real estate agent Dennis Bowers, with Compass in Naples, Florida, a buyer could pay a smaller deposit (around 1%) within the initial three-day window after contract signing and then pay a second, larger earnest money deposit “after your due diligence period or any contingent period you have."
Together, the earnest money deposits would amount to about 10% or more of the purchase price.
Meanwhile, in California, there is a law limiting the amount of earnest money that is awarded to the seller if the sale does not push through—a maximum of 3% of the purchase price. Because of this, most earnest money deposits in California do not exceed 3%.
Though not required by law, paying earnest money is a common practice across almost all states as it facilitates a smooth and sure sale transaction.
However, in Arkansas, earnest money is not typically necessary for a sale to push through, and even when it is used, there is no set amount expected.
Check out our comprehensive list of earnest money calculations by US state:
Earnest money should be paid after both buyer and seller have signed the purchase agreement, which will specify the exact amount of earnest money required and the deadline for the payment.
Typically, earnest money is paid within a few days of the contract being signed, though timelines change according to state-specific practices.
When calculating the earnest money due date, it’s important to remember that 1) weekends and holidays are included in the official day count and 2) the deadline is extended to the next business day when the earnest money due date falls on a legal holiday or weekend.
Earnest money in the US is paid to the title company or escrow agent, the reliable third party entrusted with safeguarding documents and funds necessary to the transaction until the deal is successfully completed.
Besides knowing how much earnest money is needed for commercial property, it’s important to be aware of the different payment methods available to commercial real estate buyers and developers.
While some states like Texas still accept cash payments, states like Colorado do not. Ensure that you conduct individual research on the earnest money payment methods accepted by the state you’re looking at investing in.
Below are some of the the payment methods accepted for earnest money:
Earnest money demands by sellers make sense, but investors with cash flow issues may find it hard to provide these funds, especially when some earnest money deposits come up to 10% or more of the purchase price.
While the current lending market has limited business owners' ability to obtain this money, viable financing options are still readily available in the US market and beyond.
CRE investors might want to consider the following four financing solutions when it comes to securing earnest money loans:
1) Traditional commercial real estate loans—these can be secured with a good credit history and a profitable business, but the application process can be lengthy and cumbersome;
2) Small Business Administration (SBA) loans—these cover down payments and earnest money deposits for borrowers who don’t meet bank credit demands; instead the loans are taken out against another asset or your home;
3) Peer-to-Peer (P2P) lending platforms—these connect buyers to individual lenders based on credit scores and lending criteria, and though they process loans much faster than financial institutions, interest rates are higher; and
4) New digital financing solutions—these skip credit checks and instead ask for a temporary, removable commitment from the lender until the sale goes through or the deal is terminated. Driven by AI-powered algorithms, these digital solutions mean that you get access to financing within 48 hours, upon approval.
Duckfund’s online LLC payment method is one such digital financing solution that takes the red tape out of the earnest money loan financing process.
Here’s how it works.
Duckfund sets up a limited liability company (LLC), which acts as the legal entity for the purchase and protects your personal assets. You sign a call option agreement for the full membership stake in the LLC, with the option to buy the property at a later date and you pay a low upfront fee of only 2% of the deposit size per 30 days. A purchase agreement is then signed in the LLC’s name and the earnest money deposit goes to the real estate agent’s escrow account.
After you’ve done your due diligence, you can decide to either terminate the deal (you lose only the fee and not the full earnest money deposit) or buy the property (you transfer the earnest money deposit to Duckfund to pay for 100% of the LLC shares and become the legal LLC—and property—owner).
Yes, earnest money in the US can be refunded.
If a sale does not go through for any reason, the earnest money may either be kept by the seller or refunded to the buyer, depending on the contract’s stipulations. As a general rule in the industry, the buyer gets the earnest money back if the seller reneges on the contract, and the seller keeps the earnest money if the buyer defaults.
While there are other situations that can halt the sale process and cause disputes over earnest money in the US, these are some of the most common scenarios. Even still, it is important to remember that earnest money practices vary according to state, so ensure that you check with the state’s official guidelines.
Interested CRE investors and buyers should consider working with experienced real estate attorneys to ensure that the sale process goes smoothly and everyone is legally covered. Handling disputes is also much easier with real estate lawyers as they will take over all the formalities and legalities involved.
There are several ways that prospective buyers can protect their earnest money deposits:
Again, working with a good real estate lawyer can take the headaches and confusion out of the entire commercial real estate buying process and ensure that everything is secure and legal. Interested commercial real estate developers and investors can contact the individual state’s real estate commission for further guidance.
The world's largest real estate market is a tempting pie for CRE developers and investors, but the investment process can be fraught with confusion and stress.
Having a good understanding of how much earnest money is needed for commercial property, as well as the ins and outs of the entire process, can greatly enhance an investor's chances of closing a successful real estate purchase in the US.
[Bolster the growth of your commercial real estate portfolio with Duckfund, which lets you access low-cost, flexible, and fast earnest money financing solutions easily and within 48 hours, with high approval rates, low-interest rates, and easy applications.]
