The Real Estate Market Recovery Faces Its Latest Threat

The Real Estate Market Recovery Faces Its Latest Threat

A housing recovery may be under way, but there’s an obstacle that appears to be slowing down the rebound: the unusually high number of buyers who walk away from their contracts.

An average of nearly 18% of signed contracts on existing home sales were canceled during the three months ending July, according to data released this month by Capital Economics, an independent research firm. That’s the highest all year and the most since May 2010, when that figure reached 23%; in the five years before the housing slump started, the average never went higher than 10%. Separately, 36% of Realtors are reporting some kind of problem with a contract, including cancellations, delays and renegotiations of the sales terms, according to August data by the National Association of Realtors. That’s up from 30% earlier this year.

The latest setback comes as home sales are rising. Existing-home sales increased 7.8% in August from a month earlier and rose 9.3% from a year prior, according to data released this morning by the NAR.

Ironically, the recent pickup in home sales is contributing to rising contract cancellations. As more buyers compete over a limited inventory of for-sale homes, some are bidding aggressively to get the seller’s attention, but not assessing whether they truly want the house until they’re in contract, says Bryan Sweeley, a real estate agent in Santa Clara, Calif., with ZipRealty. This strategy could make it more likely that buyers will walk away from homes if red flags are raised in an inspection or the appraisal, he says. As we previously reported, appraisals have been derailing home sales in cases when the appraised value of the home comes in lower than the purchase price the buyer and seller had agreed to.

Tight lending requirements are also contributing to contract cancellations, says Paul Diggle, property economist at Capital Economics. As more buyers move off the sidelines to purchase a home, they’re finding they can’t qualify for a mortgage, he says. (Data from the Mortgage Bankers Association shows that mortgage applications for home purchases have been relatively flat most of the year with some increases posted in recent months.) While buyers are encouraged to get preapproved for a mortgage before making an offer on a home, it’s not a requirement. But skipping this step opens them up to the possibility of being denied a mortgage on a property that they’ve already entered into contract on.

To be sure, contract cancellations don’t necessarily mean those buyers are leaving the market, experts say. In some cases they’re making offers on other homes or working on a new contract with new terms on the same property in question.

Still, for sellers, canceled contracts can range from a slight nuisance to a major setback. In most cases, they extend the time sellers spend trying to unload their home. It may also set them back financially if the seller has moved out of the property in anticipation of the buyer moving in.

But it’s buyers who can incur the biggest financial setback when walking away from a contract—which can include losing the deposit they’ve paid on the home. Upon signing the contract, buyers typically put a small percentage of the purchase price down to be held in escrow. Paul Howard, a buyer’s broker in Cherry Hill, N.J., says buyers should ask their agents to include contingency clauses in the contract that state the buyer can walk away from the home if financing falls through or if the inspection or appraisal of the home isn’t satisfactory. (Some transactions might require additional contingencies.) In most cases if they abandon the deal based on a contingency clause in the contract, buyers should be able to get their deposit back.