What happens if a buyer doesn’t deposit earnest money? If you’re a commercial real estate (CRE) developer, you may not have considered this question, but the answer might make or break your next deal.
Earnest money, also known as a good faith deposit, is a common requirement in many parts of the United States.
In competitive markets such as Texas, Georgia, and North Carolina, realtors typically insist on an earnest deposit for potential buyers to draw out serious bidders. This amount can vary drastically state by state in the commercial real estate market.
If you’ve never had to deal with this type of down payment before, you may find yourself grappling with some important dilemmas, such as:
So, what to do?
Well, like with many things in life, the first step is knowledge. Once you know what the benefits of making such a payment are, or what happens if earnest money is not paid, then you’ll be in a better position to take the next step.
This article aims to answer that important question by assessing the implications and risks of not making an earnest money deposit.
Why risk finding out what happens if you don’t deposit earnest money? Sign up to Duckfund and we’ll put you on the fast track to an earnest money deposit without the need for credit checks or bank statements.
From a seller’s perspective, an earnest money check makes perfect sense.
Many real estate agents will tell you that the property market in the United States is extremely competitive right now, in both business and residential sectors.
Properties often receive multiple offers, sometimes for figures above the sales price. Residential buyers may want a home inspection, while business investors want to conduct their own checks, which take up considerable time and expense.
Sellers need a way of filtering out time-wasters and earnest money is a useful solution.
In the commercial real estate market, this is particularly important as investors often go head-to-head when it comes to snapping up CRE property that has seen a rental growth of as much as 20% in some states, according to the National Association of Realtors.
Earnest money, then, determines which investors are serious, and those who are wasting the seller’s time.
Depositing earnest money is a straightforward procedure.
Potential investors transfer earnest money funds via wire transfer into an escrow account, normally managed by a real estate broker. The amount depends on the property’s location, ranging from between 1% and 5% of the purchase price in Colorado and Texas to up to 10% in fast-moving markets.
The first investor that makes this payment has priority on the property ahead of rivals.
The escrow agent holds the funds until the transaction completes, when they’re either released to the seller as part of the deal, or refunded to the buyer for previously outlined reasons.
Having earnest money in escrow protects sellers from damages or losses in the event of a buyer default.
Should the investor pull out unfairly, then the funds cover the costs of taking the property off the market and any due diligence checks that have taken place.
Yet, that only covers sellers. What happens if you don’t pay earnest money? What are the consequences?
Earnest deposits for commercial real estate tend to be substantial figures.
CRE prices have been rising steadily in the United States since 2008, so even just a few percent of the purchase price amounts to a lot of money. Yet the earnest money figure can vary hugely across the United States.
A $1 million office building, for example, could demand a $100,000 earnest down payment in New York thanks to the common 10% percentage applied, yet a building of the same value in North Carolina might only command a tenth of that figure.
As an investor, it might be tempting to negotiate a way of skipping this stage with the seller, especially if the funds aren’t readily available, however this may jeopardize the deal or even put you in legal trouble.
So what happens if a buyer doesn’t deposit earnest money? Let’s take a closer look.
Let’s start with the worst-case scenario for what happens if a buyer doesn’t deposit earnest money. If you’ve signed a purchase agreement that stipulates this payment, then not following through with it can constitute a breach of contract in the eyes of real estate law.
Contract breaches can lead to lawsuits seeking damages, which typically result in a lengthy legal process which you’d likely lose.
It might even be difficult to find a law firm that will represent you in such a case. Most real estate attorneys would simply point to the signed sales contract and tell you that you’re obligated to make the earnest money payment.
Earnest money acts as a form of financial protection for the seller: if the buyer backs out for no reason, then the vendor is often entitled to keep the amount as compensation for the losses they’ve incurred.
Justin Daniel is a real estate agent for eXp Realty based in North Carolina, where every property transaction has some kind of due diligence or earnest money element built into it. He stresses the importance of earnest money there.
“Not having any earnest money in place is a liability to the seller as the buyer has no skin in the game. This means they can walk away from the contract at any time, leaving the seller in a troublesome spot.”
Sellers with multiple offers to consider are thus more likely to opt for a deal where the buyer is willing to put their money where their mouth is – and avoid the risk of getting caught cold should the investor walk away further down the line.
Even if the seller doesn’t pursue legal action should you not pay earnest money following an agreement to do so, they’ll almost certainly terminate the purchase contract.
This will, of course, mean you lose the right to purchase the property, allowing other interested parties to come forward and stake their claim.
In a competitive CRE industry, reputation matters. Sellers, and lenders for that matter, often agree to do business with investors if they have a history of honoring commitments.
Should you not pay earnest money following the signing of a real estate contract, then be prepared for the blow to your reputation that comes with it.
Word spreads quickly in the marketplace and future sellers may hesitate to do business with you.
Even if you haven’t signed an agreement, signaling your interest then not showing your funds can lead to you acquiring a reputation for flakiness among real estate agents, which may affect future deals.
In a tough CRE market, it’s easy to dwell on potentially negative scenarios. It can also be misleading.
What happens if a buyer doesn’t deposit earnest money in Florida, for example, is different from a situation where a buyer didn’t deposit earnest money on time in New York.
Instead, we can concentrate on the positive outcomes of paying earnest money, which include the following benefits.
Property purchases are built on negotiations between buyers and sellers: a deal can often break down at the first sign of mistrust between the two parties.
Making an earnest money deposit, then, is a powerful move for you, as the buyer, to make. The seller is now more likely to regard you as serious and motivated, which could lead to favorable terms or concessions during negotiations.
CRE investors typically wish to avoid drawn-out buying processes. They tie up time and capital that they could use for other business transactions, including real estate purchases.
If you’re one of them, then you can move things along by making earnest money payments. The seller will see that you’re serious and will likely instruct their team to work toward an earlier closing date, including completing a title search and relevant paperwork quicker than normal.
Putting money down shows that you’re capable of demonstrating good faith to sellers who will probably see you in a positive light
This counts for a lot in the CRE industry where referrals are commonplace between both buyers and sellers. You may find that a positive reputation helps you when pursuing your next purchase.
Let’s not forget the most important benefit.
Being the first to make the payment puts you ahead of your rivals and secures the property for you in all but name. You might have to be quick, though. In some deals investors are extremely quick in putting their money down, so it’s best to make the payment as soon as possible — unless you wish to find out what happens if you don’t pay earnest money on time!
Once the checks are complete and the terms of the contract are met, then you’re on your way to getting the keys and adding a valuable slice of real estate to your portfolio.
Now that we know what happens if the buyer does not deposit earnest money, you may wish to know whether this amount is refundable.
Unfortunately, there’s no universal ‘yes or no’ answer. Instead, a refund will come down to whether you or the seller have followed the terms of the purchase contract, including stipulations known as ‘contingencies’.
If the seller doesn’t meet the terms of the contract, then the amount is refundable.
If, however, the buyer fails to follow the terms, or backs out for a reason not listed in the contingencies, then they risk losing the money.
Let’s look at some examples of contingencies and get a clearer picture of what they may entail.
Appraisal contingency. When the home appraisal is lower than the agreed buying price, then you have the right to back out – or negotiate a lower price.
Inspection contingency. A property inspection might show some serious defects that you weren’t aware of, in which case you can refuse to buy the property.
Financing contingency. Should you not qualify for financing then this clause means you don’t have to continue with the purchase.
Existing home sale contingency. This gives the seller a get-out should you need to sell your home to finance the sale and the home buying process is blocking the completion of the CRE transaction.
Remember: each CRE purchase is unique, so some or all of the above may not apply to your deal. Always seek legal advice concerning earnest money refunds to find out where you stand.
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