Faira out to eliminate earnest money deposits, offer contingencies

A purchase agreement has been signed. The buyer has handed over a deposit. Things are rolling.

But then the deal hits a roadblock.

A property inspection reveals faulty plumbing and asbestos in the home’s duct work. The buyer says the seller must either repair the defects, come down on price or return his deposit — citing a contingency clause he included in his offer.

That type of scenario is par for the course for real estate transactions in many states, sometimes imperiling deals and leaving buyers, sellers and agents banging their heads. But, theoretically, there’s a way to head off these snafus: eliminate the need for contingencies altogether.

Buyers pay to make an offer; transactions are insured against failure

That’s what Seattle-based Faira believes it can do by providing a behind-the-scenes look at a seller’s home to buyers upfront, requiring buyers to pay a fee to make an offer, rather than hand over a deposit, and offering insurance to sellers that pays out if a transaction falls through.

“The goal is to credibly enable sellers to communicate all the facts upfront and save downstream renegotiations, and to enable buyers to select the right house with 100 percent information upfront,” said Faira CEO Kamal Jain, a Microsoft and eBay vet with a PhD in computer science and economics.

“We also remove transaction failure risk by providing both sides affordable ways to protect against costs incurred with failed transactions,” he adds.

Faira, which says it’s closed six transactions so far, also filters offers so that clients only see offers after certain fees have been deducted.

Those fees always include Faira’s “transaction fee.” And if a buyer’s broker is party to the transaction, the broker’s commission is deducted as well.

Faira listings also advertise a higher price to buyers working with agents.

That may not sit well with some agents, but Faira says it’s keen on cooperating with real estate professionals and is even willing to split its fees with listing agents who get their clients to use Faira’s platform. In this scenario, sellers would pay their listing agents, use Faira’s platform and have the option of paying Faira for financial protection.

While Faira may have designed a substitute for earnest money deposits, it remains to be seen whether the startup can convince consumers to conduct what is likely to be one of the biggest transactions of their lives using a new transaction system that may not be easy to understand.

[Tweet “Could this replace earnest money deposits? “]

Earnest money deposits and contingencies

In many states, a homebuyer traditionally must hand over an “earnest money deposit” — often between 1 to 3 percent of a property’s contracted sales price — when signing a purchase agreement, or shortly after. Since the seller may have a claim to the deposit if the buyer fails to fulfill the terms of the agreement, the deposit shows a buyer’s offer is “earnest.”

But there are usually strings attached. Buyers often include “contingencies” in their offers that can allow them to get their deposits back if they pull out of a transaction for certain reasons.

The use of contingencies can vary by state, but the most popular types of strings attached to offers give buyers the option to pull out of a transaction without forfeiting their deposits, or renegotiate an offer, if home inspections reveal property defects (“inspection contingencies”), title issues are uncovered (“title contingencies”) or their financing falls through (“financing contingencies” and “appraisal contingencies”).

Faira thinks it’s found a way to clip all of these strings, while reducing the risk that both buyers and sellers shoulder when entering into a transaction.

Discount prices for unrepresented buyers

The startup provides a range of services for free. They include those commonly offered by for-sale-by-owner (FSBO) companies, such as professional photography, a listing in the multiple listing service (MLS) and a for-sale-by-owner listing on websites that host such listings, including Zillow.

But unlike other FSBO firms, Faira also pays third parties to conduct property inspections and title searches on behalf of a seller client. It then tacks the reports on the inspection and title search, along with other disclosure forms, onto a property’s listing on faira.com.

Two prices are shown on faira.com listings: one for unrepresented buyers and one for buyers working with agents. The price for represented buyers is higher than the price for unrepresented buyers because homeowners who sell to represented buyers typically must give up some proceeds of a sale to cover a buyer’s broker’s commission, Jain said.

Once buyers have seen a property and reviewed its reports on faira.com, they can then make an offer on faira.com by authorizing a credit card hold of $500. These offers must differ than traditional offers in two ways: They cannot include any contingencies; and they are only shown to a seller after certain fees have been deducted (more on that later)

If a seller accepts an offer, a buyer has five days to do their due diligence on the property before signing a no-strings-attached sales contract. Before the five days has elapsed, a buyer must pay a fee that, when combined with the initial $500 credit card hold, will equal 0.5 percent of the agreed sales price.

Revealing facts a priori

Faira publishes buyers’ offers, including those that have been turned down, on faira.com listings. This is intended to foster a transparent bidding process where buyers know exactly how to one-up the competition.

Sellers have 24 hours to accept an offer. Offers that aren’t accepted remain posted on faira.com listings.

Ideally, a buyer could place their full faith in Faira’s disclosures and avoid vetting a typical for-sale property themselves. But even Faira advises against that.

“As with any transaction of huge consequence, we would not recommend that buyers rely on anyone else to do their due diligence,”Jain said.

The purpose of providing title and inspection reports upfront is only to “reveal all the facts a priori,” he said. Buyers should then do their own due diligence to “confirm that everything is as described in the Faira reports.”

Should an inspection paid for by a buyer reveal significant omissions in Faira’s inspection and title reports, Faira will refund the $500 credit card hold.

Faira is betting that providing buyers with upfront inspection and title reports combined with a due diligence period will be more than enough to persuade them to make offers that don’t include inspection and title contingencies.

Replacement for financing contingencies

But what about financing and appraisal contingencies — those contract clauses responsible for instilling so many buyers with enough confidence to offer money they have, along with so much more that they do not (mortgage funds)?

Faira at least partly offsets the risk of making an offering without a financing or appraisal contingency by guaranteeing that a property will be appraised by the buyer’s lender up to a certain amount.

Should seller clients ask Faira to pay for an appraisal of their property for pricing guidance (as they may), Faira guarantees to buyers that the lender-ordered appraisal will value the home at or above the appraisal Faira paid for. These sellers can pay an additional fee to have Faira guarantee an even higher valuation than the Faira-ordered appraisal.

Should seller clients choose not to seek pricing guidance, Faira will guarantee that the lender-ordered appraisal will support the contracted purchase price between the buyer and seller.

If the buyer’s lender declines to fund a loan due to an appraisal that comes up short of the value that Faira guarantees, Faira will return the 0.5 percent transaction fee to the buyer.

There could be a case where a lender-ordered appraisal equals or exceeds the Faira-ordered appraisal but still doesn’t support the mortgage amount needed for a buyer to make good on a contracted purchase price. In that situation, the buyer would lose the transaction fee unless they choose to cover the shortfall in cash. Buyers also lose the fee if their financing falls through for any reason besides an appraisal, such as loss of employment.

“Buyers are responsible for bringing the money they need to close the transaction and if they do not, they will lose the fees they have already paid,” Jain said.

‘Transaction failure protection’

By making property disclosures upfront and requiring buyers to make offers without contingencies, Faira theoretically would head off the possibility of “downstream negotiations” that could turn an attractive offer sour for sellers.

But what if a deal falls through?

Traditionally, sellers can get compensated for their wasted time and trouble by keeping earnest money deposits. Faira says it provides an even higher level of financial protection to sellers by selling “transaction failure protection” to seller clients. Selling this insurance is how Faira actually makes money.

The insurance policy provides coverage that is equal to five times the premium paid by the seller. Sellers can choose to pay a premium equal up to 2 percent of the home’s purchase price.

“So, if your home sells for $500,000, you can pay up to $2,000 and will be reimbursed $10,000 by Faira if the transaction fails,” Jain said.

“In the conventional process, the seller can get the earnest money only after the buyer releases it, and sometimes it results in a dispute between the buyer and the seller,” he said. “In the Faira process, the compensation to the seller is immediate.”

Since Faira doesn’t charge sellers for its other services, including property photos, property listings and title and home inspections, the startup seems to reason that sellers will be willing to pay for insurance that costs less than a typical real estate commission.

Showing offers after broker fees are deducted

Faira also takes the unusual step of deducting up to two fees from offers made through the platform so that seller clients always see offer amounts that are less than what a buyer has actually offered.

The first fee is the transaction fee that buyers must pay to make an offer through Faira. Faira always subtracts that fee from offers. This may have the effect of causing buyers to believe that it doesn’t cost them anything extra to make an offer through Faira (and, depending on your perspective, it doesn’t).

The second fee is the compensation offered by a seller client to a buyer’s broker. This fee is only deducted from an offer if a buyer making an offer through Faira is working with a buyer’s agent.

Faira says it subtracts this fee from an offer to allow sellers to make a fairer comparison between offers made by buyers working with agents, which require a seller to fork over a buyer’s broker’s commission, and offers made by unrepresented buyers.

For example, if a buyer working with an agent makes an offer of $500,000 on a property listed by a seller offering 2.5 percent to buyer’s brokers, the seller will receive an offer of $485,000 — $500,000 minus the buyer’s agent’s 2.5 percent commission ($12,500) and minus Faira’s transaction 0.5 percent transaction fee ($2,500).

By contrast, if a buyer working without an agent makes an offer of $500,000, the seller would receive an offer of $497,500 ($500,000 minus the 0.5 percent transaction fee of $2,500).

While Faira may have designed a system that can stand in for both earnest money deposits and offer contingencies, the startup is asking buyers, sellers and agents to pass on an entrenched transaction framework in favor of a new one that may take some effort to understand.

But Faira’s not convinced this will be an issue.

“The business model may be complex internally … but the process for the customers (buyers, sellers and agents) is simple,” Jain said. “So far, we haven’t had any feedback from customers that Faira is too complex.”

Email Teke Wiggin.