Key Takeaways
- Escrow protects both parties by holding funds and documents until all conditions are met.
- Earnest money deposits typically range from 1-3% of purchase price and are held in trust by the escrow agent.
- The settlement statement must balance to the penny—total sources equal total disbursements.
- Prorations for property taxes and rents are calculated based on the closing date and credited to the appropriate party.
The escrow process is the neutral mechanism that protects both buyer and seller during a real estate transaction. The escrow agent holds earnest money, manages document execution, ensures all conditions are satisfied, and disburses funds only when the transaction is complete. This lesson examines the escrow workflow through a case study of a multifamily acquisition, illustrating how escrow protects the buyer's deposit and manages the complex fund flows at closing.
Key Stakeholders
Opening Escrow and Initial Deposits
Escrow opens when the executed purchase agreement is delivered to the escrow agent along with the buyer's earnest money deposit. The earnest money (typically 1-3% of purchase price for commercial, 1-2% for residential) is deposited into an escrow trust account. The escrow agent issues a receipt and opens a file. Escrow instructions—derived from the purchase agreement—spell out every condition that must be met before closing: due diligence approval, loan commitment, title clearance, survey acceptance, and any seller obligations (repairs, tenant estoppels, financial deliverables). The escrow agent tracks each condition and communicates status to both parties. If conditions are not met within the specified timeline, the agreement may be extended, renegotiated, or terminated with earnest money returned per the contract terms.
Closing Day Fund Flows
On closing day the escrow agent manages a complex orchestration of fund flows. The lender wires loan proceeds to the escrow account. The buyer wires the remaining equity (down payment minus earnest money already held, plus closing costs). The escrow agent then disburses: (1) existing mortgage payoff to the seller's lender, (2) real estate commissions to agents, (3) title insurance premiums to the title company, (4) recording fees to the county, (5) property tax prorations to the appropriate party, (6) transfer taxes to the jurisdiction, (7) lender fees and reserves, and (8) net proceeds to the seller. The settlement statement (HUD-1 for commercial, Closing Disclosure for residential) itemizes every charge and credit. The escrow agent must balance the settlement statement to the penny—total debits must equal total credits.
Case Study: 24-Unit Multifamily Escrow
A buyer acquires a 24-unit apartment building for $2.4M. Earnest money: $50,000 deposited at contract execution. Loan: $1,680,000 (70% LTV). Buyer equity: $720,000 (less $50,000 earnest money = $670,000 wire at closing). Closing costs: title insurance $8,400, survey $4,200, recording fees $275, transfer tax $12,000, lender origination fee $16,800, appraisal $5,500, attorney fees $6,500, escrow fee $3,200. Property tax proration: seller owes buyer $4,800 (taxes prepaid through closing date). Rent proration: seller owes buyer $14,200 (rents collected for days after closing). Total settlement: buyer brings $670,000 + $56,875 closing costs = $726,875. Lender wires $1,680,000. Total funds in escrow: $2,456,875. Disbursements: seller's existing mortgage payoff $1,580,000, commissions $120,000, closing costs $56,875, net to seller $700,000. The settlement statement balances.
24-Unit Closing Fund Flow Summary: Sources: Earnest Money (already held): $50,000 Buyer Wire: $726,875 Lender Wire: $1,680,000 Total: $2,456,875 Disbursements: Seller Mortgage Payoff: $1,580,000 Commissions: $120,000 Closing Costs: $56,875 Net to Seller: $700,000 Total: $2,456,875
Key Takeaways
- ✓Escrow protects both parties by holding funds and documents until all conditions are met.
- ✓Earnest money deposits typically range from 1-3% of purchase price and are held in trust by the escrow agent.
- ✓The settlement statement must balance to the penny—total sources equal total disbursements.
- ✓Prorations for property taxes and rents are calculated based on the closing date and credited to the appropriate party.
Sources
- ALTA — Escrow and Settlement Standards(2025-01-15)
- CCIM Institute — Commercial Real Estate Closing Process(2025-01-15)
Common Mistakes to Avoid
Not reviewing the preliminary closing statement at least 3 days before closing
Consequence: Errors in prorations, credits, or fees discovered on closing day can cause delays or disputes that threaten the transaction
Correction: Request and review the preliminary settlement statement 3-5 days before closing, comparing every line item against the contract and agreed terms
Not verifying that tenant security deposits and prepaid rents are properly credited at closing
Consequence: Missing credits mean the buyer absorbs deposit liability without receiving the corresponding funds
Correction: Verify all tenant security deposits and prepaid rents are credited to the buyer on the settlement statement, reconciled against the rent roll
Test Your Knowledge
1.What is the escrow agent's primary role?
2.What does a closing fund flow show?
3.How are property taxes typically prorated at closing?