When it comes to most anything, it’s safe to say California leads the way.  Mario Salvio and the free speech movement at Cal Berkeley in the early 60’s; the environmental movement of the 1970s began following the Santa Barbara oil spill even medical marijuana in the mid 1990’s.  Regarding innovation, it’s hard to argue that California isn’t the world leader given we are the birthplace of the microchip and all that has followed.  When it comes to real estate, California’s no different.  Her licensing is one of the nation’s most respected and stringent.  In fact, a California Brokers license like I have, is honored in more states than any other without relicensing.  (Learn more about Tim here)  So naturally as a leader in so many ways, you would think we are cutting edge with regards to the method or process we us to transact real estate.  This is evident in our use of escrow.

If you’ve ever bought or sold a piece of real estate in California, you know we don’t use mortgages rather, a deed of trust (a cutting edge benefit to the lender) and we don’t use an attorney to close. California is an escrow state.  This means that there is a neutral 3^rd party at the center of a real estate transaction (Picture Rich Uncle Pennybags from the Monopoly game with a bag of cash in one hand, keys to the property in the other, crossing his arms and handing the keys or the money to the buyer and seller).  This is fundamentally what escrow does.  Unlike many states where closing is done at a table with lawyers, buyers and seller sitting across from one another, California relies on an escrow service to conduct and facilitate the transaction.  Escrow generally runs smoothly so most people don’t give it much thought, but that doesn’t mean it isn’t rife with potential problems.

Let’s start with the question: What is escrow in the first place?  Escrow is at the center of the process, essentially the hub of the real estate transaction wheel.  Once a contract has been negotiated the broker(s) send the paperwork to escrow.  The escrow company, as dictated per the terms of the agreement, receives the contract, assigns an escrow number and “opens escrow.”  Escrow then sends instructions to the parties restating the terms agreed to in the contract: Price, timelines, closing date, earnest money to be deposited, financing terms if any and commissions.

Escrow will order the Natural Hazard Disclosure Report, any homeowners association documents and the preliminary title report.  Eventually they will coordinate the preparation of an estimated closing statement for the lender and at the end arrange the signing of loan documents with a notary public.  Escrow then notifies the title company who sets up and records the deed.  Upon confirmation of the recording of the deed at the county recorder’s office, title sends the money back to escrow where they tally the final figures, payoff any liens and distribute the proceeds to the appropriate parties.  There is no “meet at the closing table” and there are no lawyers involved.  It’s very efficient as compared to the “old way of doing things” as it is done in many Eastern and Midwestern states.  California once again is leading the drive towards a better way of doing things.  Alas however, there are some flaws.

I recently completed a rather persnickety transaction that exemplified some of the problems with the escrow system.  First is the issue of the property condition and possession.  As we neared closing a final verification of property condition or walk through, was performed.  (Search for your dream home here) This is designed to ensure the home is in substantially the same condition at closing as it was when purchased.  But as it turned out, the seller left personal belongings behind so the house really wasn’t fully empty at closing.  Yikes!  Problem 1: How does a buyer know if the seller isn’t required to be out prior to closing, that the seller has everything out or is even out at all?  Answer: They don’t.  Unlike sitting at a closing table where the seller has moved and the home is ready for turnover and keys are exchanged for cash, with the escrow system the buyers have no know way of knowing if the seller is actually out.

The second problem is the property condition.  With the walk through taking place in the days leading up to closing and with the seller still in the home, you can’t really see everything.  I once had a walk through where the home looked fine, but once we closed and the seller moved out we found a large potted tree had leaked water on the wood floor and underneath was ruined.  What then?  Fortunately, the seller was still in town, recognized the issue and agreed to pay the buyer to have the floors refinished.  But what if they would have already left?  How would the buyer collect?

The third issue is regarding possession.  With escrow the buyer’s loan funds, the down payment is in and everyone is ready for the close but the seller doesn’t actually have the money, it’s still with escrow.  It’s not until after the close that escrow sends the money to the seller.  Let’s say it’s the end of the month and the recorder’s office is backed up, not at all uncommon.  The recording eventually happens but not until after the escrow’s wire cutoff through the Federal Reserve Bank.  Huh?  That’s right, wired funds must pass through the Federal Reserve and they close around 2 pm Pacific.  So the deed is recorded and the buyer is the legal owner and ready to take possession of their new property, but the money hasn’t been deposited into the seller’s account yet.  This just happened to me and making matters worse, it was the last day of the month which also happened to be a Friday.  So not only did the buyer get the property before the seller received their proceeds funds, the seller had to wait until the following Monday to get their money!  And lest you think this rarely happens you’d be mistaken, it happens quite often.  Unlike a closing table where the keys are exchanged for the money, escrow always and by definition has to set up the recording and then record the transfer all before seller gets their money.   In the transaction I just closed, the seller was livid that the buyer was going to have the keys before they had their money and wanted me to hold the keys and not give them to the buyer, even though the property had recorded and the buyer officially owned it!  Thankfully in that example, escrow was able to rush the file through and beat the wire cutoff with just minutes to spare.  That didn’t stop the seller from giving me an earful however.

So it goes that California’s use of escrow may in fact be the most efficient method of exchanging real estate for money, it is not without a certain amount trust that everything will work out right and everyone will do and perform as they should.  Something that traditional closing easily avoids.