Earnest money deposits have become so important that CRE investors looking to build successful portfolios cannot ignore them.
Given the importance of earnest money deposits in today’s CRE market, it’s safe to say that slow and steady certainly does not win the race. Rather, the winning investor is invariably the one who can move as quickly as possible to meet the seller’s earnest money deposit (EMD) requirements with ease.
These days, though traditional opportunities like office spaces struggle, industrial spaces and data centers are still booming, and multifamily is set for a recovery. Moreover, new opportunities are opening up in film studios and parking lots.
Said differently, the opportunities in CRE are still massive for investors willing to pounce on them and gain a competitive advantage through quick and consistent access to EMD.
In what follows, we will listen in on what the experts are saying about earnest money deposits and their importance in today’s CRE market. We’ll cover:
[Do you want a quick and consistent source of earnest money deposits for all your CRE deals? Sign up for Duckfund and get EMD for any deal in just 48 hours with no credit report required.]
“It's part of every deal; It's part of every transaction,” says Stash Geleszinski, a managing director at Capstone, the largest privately held multifamily investment sale firm in the US, when asked about the popularity of EMD
If EMD has become so popular, real estate investors must know what they are dealing with.
Simply put, an earnest money deposit (also known as a good faith deposit) is an amount of money that the hopeful buyer of a property must pay to show that their interest is serious and expressed in good faith.
It is often expressed as a percentage of the selling price of the property. For example, if the earnest money deposit required is 5%, then an intending buyer of a $10 million property will have to pay $500,000 as EMD.
EMD became popular as sellers (and their real estate agents or realtors) became tired of prospective buyers who were only doing market surveys or just expressing casual interest. With EMD, they can know who the serious buyers are and focus on dealing with them more exclusively.
In terms of intent, it is similar to sellers requiring that intending buyers are preapproved for a mortgage before they can continue negotiation for the property. The aim is to sell the property on time.
Buyers have also embraced EMD as a way to gain a competitive advantage in the market. “Imagine someone proposing a $5,000 EMD for a property worth $1,000,000. You won’t be surprised if the seller does not take them seriously and ask them to get out,” said Stash.
The implication is that buyers who can offer a higher EMD can gain an advantage over those who can’t. And with many CRE markets becoming more competitive, EMD has provided a selling point for buyers who want to stay above the fray.
We should also differentiate earnest money deposits from other deposits in the real estate market.
First, EMD is not the same thing as a due diligence fee.
The latter is a fee paid by an intending buyer who is requesting that the seller take the property off the market while they carry out due diligence on it.
Due diligence can include getting a title company to verify the seller’s title or inspecting the physical conditions of the property.
As seen above, it is non-refundable, common only in a few states, not negotiable, and usually between 2-3% of the purchase price.
A buyer can pay both EMD and due diligence fees since both serve different purposes. While the EMD is necessary to even get to the point of inspection and negotiation, due diligence fees can be used to extend the inspection period and make the seller put the property off the market during that period.
Second, EMD is different from a downpayment.
The latter is required when the buyer is purchasing the property with mortgage financing (also called home loans in residential real estate [RRE]). It is a deposit that shows mortgage lenders that the investor can repay the mortgage loan.
EMD and downpayment can coexist. EMD is required before the buyer can negotiate, inspect, and agree terms with the seller. After the deal has been agreed, a downpayment may be required if the buyer is using mortgage financing.
As seen above, down payments are usually non-refundable and are only designed for real estate deals financed with a mortgage.
Both CRE investors and home buyers have to make down payments. In addition to conventional mortgages, government-backed FHA loans (for home buyers) also require a down payment.
As Stash mentioned above, EMD is now part of every real estate transaction. In other words, it’s now the norm, especially in commercial real estate.
Nevertheless, it might interest you to know that the payment of an earnest money deposit is not a legal requirement. One implication of this is that there is no standard EMD requirement at the national or state level (more on this below).
However, though it is not a legal requirement, sellers are not wrong to ask for them. There is no law preventing sellers from demanding EMD. So far, all court cases have been regarding whether a buyer can get a refund in certain cases (more on this below).
“There are three things needed for success in the CRE market today: capital for earnest money, good investment profile, and access to senior debt/proof of funds,” said Anna Kogan, CEO and founder of Duckfund.
In summary, it might not be a legal requirement but it is a norm that has become important to success in CRE investment.
EMD requirement varies from one seller to another.
Though there is no national standard, research by Duckfund has revealed that there are a range of norms that persist in every state. As expected, hotter markets will have higher requirements due to greater competition.
By familiarising yourself with that range, you can know the amount of earnest money you should prepare when bidding for properties in that state.
We can summarise the nationwide survey by considering the states that fall into certain popular ranges:
We should also mention the case of Illinois and Rhode Island where you can pay EMD in two installments – after contract signing and due diligence.
In Rhode Island, you will pay between 1% and 2% after the contract signing and between 3% and 20% after the due diligence period. If you are in Illinois, you will pay $1,000 (for properties worth less than $1 million) or $10,000 (for properties worth more than $1 million) a day after contract signing and 5% or 10% after inspection and contract negotiation.
Also, sellers in Nebraska ($500-$2,000), Indiana ($1,000-$10,000), Iowa ($1,000), South Dakota ($500-$5,000), and Maryland ($500-$1,000) accept payment of EMD in fixed amounts as an alternative to calculating it as a percentage of the purchase price.
Note that these figures are what you can expect to pay on average. For certain high-end, hot, and competitive properties, there is always a possibility that the EMD requirement can be higher than average.
Even if the seller requires 5% of the property’s price, for example, competition among intending buyers might mean you have to propose 10% to gain an advantage. In this case, the actual EMD will be higher than the EMD required by the seller, a point that Stash made above.
“In a seller’s market, larger earnest money deposits can be necessary to compete with other buyers,” according to SmartAsset. “However, it’s best to understand the dynamics of your local market before making a good faith deposit since you may live in a pocket with less competition. Or, the property you’re looking at might be in its sixth month on the market and recently dropped its price. In that case, the seller might accept less generous offers.”
Though the EMD requirement is set by the seller, the money is not held by them. Earnest money is to be deposited by the intending buyer into an escrow account. The escrow is a third-party agent (can be a title company, real estate broker, or real estate attorney) who holds the money and disburses it when certain conditions have been met.
EMD can be paid to the escrow account through cashier’s check, certified check, personal check, and wire transfers. The acceptance of cash varies from state to state – it is accepted in Texas but not in Colorado.
Source: WallStreet Mojo
The escrow releases the earnest money deposit if the deal succeeds. Once released, it can be used to pay the transaction’s closing costs or as part of the downpayment for the property (if the buyer is using mortgage financing).
If the deal does not succeed, what happens to the EMD will depend on certain factors.
Buyers and sellers often sign a Real Estate Purchase Agreement that contains a list of contingencies. When any of these contingencies are actualized, the buyer can opt out of the deal and get a refund of EMD.
Stash mentions title and environmental contingencies as examples of why the buyer can opt out of a deal.
A title contingency means the buyer can cancel the deal if a title search shows that the seller does not have title to the property. An environmental contingency gives the buyer the right to cancel if certain environmental conditions are not met.
Some other common contingencies include:
However, a contingency will only apply if both parties approve them while signing the purchase agreement or sales contract. An unspecified contingency will not apply and a refund will not be processed.
Refunds will also be processed to the intending buyer if the seller withdraws from the deal at any time before closing.
“Given the access to multiple properties thanks to digital listings platforms, CRE investors now have a variety of options for potential acquisitions,” said Anna.
However, “while it is critical to have access to multiple deals at once to choose the most lucrative one, it is also important to move very quickly in a competitive market.” This is because “If there are several bidders for the deal, the first to come up with the deposit eventually wins the deal.”
Said differently, quick and consistent access to earnest money deposits is now one of the key ingredients to winning at CRE investment in the US. This is why Stash said that offering $5,000 EMD for a $1 million deal won’t cut it in today’s competitive market.
But where will CRE investors get quick and consistent access to EMD? Banks are not quick given their bureaucracy and stringent requirements (including requests for credit reports). Online lenders often have predatory interest rates that can eat into the profits of investors.
SBA 504 (a) loans are not quick (imposing stringent requirements just like the banks) and SBA 7 (a) loans also require credit score and collateral.
What then can CRE investors do?
Duckfund was created for this very reason – to provide quick and consistent access to EMD for CRE investors of all stripes.
With regards to speed, applications can be completed within 2 minutes and funds will be available in 48 hours. Unlike banks and SBA loans, Duckfund will not request a credit report or impose stringent requirements.
What’s more? You can request multiple EMD financing applications from Duckfund. This allows you to pursue many deals at the same time and build a winning portfolio. This is unlike traditional lending platforms where you have to pay off one loan before you can get another.
Since Duckfund caters specifically to CRE investors, it offers a very competitive financing fee (paid upfront) that will not eat into your profits.
Duckfund also uses a low-risk approach that makes EMD financing seamless. Once your application has been approved, we will open an LLC that will sign the purchase contract with the seller and transfer the EMD to the escrow company.
When you repay the EMD loan, you will be given a 100% stake in the LLC. On the other hand, if the deal collapses and the EMD is refundable, Duckfund will recover the EMD from the escrow and cancel the purchase agreement. You won’t have to do anything.
Anna believes that openness to new opportunities in the CRE market and finding appropriate financing options will be key to succeeding in today’s CRE market (and even in the housing market).
With Duckfund, you can leave the inefficiencies of traditional lending options behind and enjoy the benefits of creative financing specifically targeted toward CRE investors.
[Do you want to build a profitable CRE portfolio? Sign up to Duckfund for quick, convenient, cost-effective, and consistent earnest money deposit financing that will give you an advantage over competitors.]
