PIE IN THE SKY: Bidding Wars To Infinity
Published On: June 8, 2016 Posted by: Jeremy Peterson
The housing market is experiencing a dynamic that is off the charts. Inventory is so low that the days that a home sits on market has reached record low levels. The most recent reading is that homes sit on the market an average of only 10 days in Weber County (look for charts and analysis in another post to come).
These circumstances are putting tremendous upward pressure on house prices. Several of my recent listings began immediately with bidding wars. For a seller this is certainly a good thing. However, it is possible to have too much of a good thing?
Lets briefly explore an example loosely based on a true story. Suppose for a moment that you listed your home for $200,000. Within three days you had 5 offers. Three of the offers are above list price. You submit a multiple offer notice to all the buyers and give them two days to refine their bids with their “highest and best offer”. Two days later the bids look like this:
Buyer 1 – $200,000 and asking $5000 in seller paid closing costs
Buyer 2 – $205,000 and asking $5000 in seller paid closing costs
Buyer 3 – $207,000 and asking $2500 in seller paid closing costs
Buyer 4 – $225,000 and asking for $5000 in seller paid closing costs
Buyer 5 – $221,000 and not asking for any closing costs.
Which offer looks best to you? Just looking at the figures, Buyer 5 appears to have presented the best offer. But then we have to ask ourselves, why was the home listed for $200K? Assuming the listing agent did their job and looked at surrounding sales and projecting some appreciation forward, isn’t Buyer 5’s $221k bid quite a distance from the original list price?
If these buyers were all paying cash, it wouldn’t matter. But in this example, all these buyer’s are using FHA loans to purchase their home. Since they are using other people’s money, the transaction will be subject to an appraisal and the appraiser will have to validate the sales price of the home based on surrounding sales. In fact, appraisers are typically granted a 5% so-called “margin of error” on their valuations without risking professional sanctioning. The cap on this wiggle room, along with the propensity for buyers to use mortgage loans, tends to act as a limiter on how fast a market can run up on pricing. It also means that at any given time, there is a ceiling on how high a home can appraise in value.
In our example above it was determined that the listing could most likely appraise for $207k. If that is the case, what does that mean for Buyer 4 and Buyer 5? If their offer was accepted, the appraisal would likely come in less. The seller could anticipate this but hope for the best. Obviously, Buyer 4 and Buyer 5 probably hope for a low appraisal too.
The question that agents and sellers have to ask themselves is what is the merit of offering prices higher than is bearable by appraisers and lenders. If someone offered $1 Million, would that be the “best” offer in this scenario? At what point does the bidding just become ridiculous?
Such are the circumstances of the housing market we find ourselves in today. While things continue this way, sellers should be mindful that the highest offer may not always be the realistic offer.