What do home sellers want? Obviously, the highest price and the best terms. What do buyers want? The lowest market price possible on the most favorable terms. Both buyers and sellers must understand pricing strategies in the present market in order to reach their goal.
The first method I call the "comparable sales strategy," which is the most common strategy used by real estate agents. The agent provides market data to the seller, which includes past sales of similar properties, properties in contract and current active listings, that are for sale that would compete with the seller's property. The agent then provides his or her opinion of the value of the property and the appropriate list price based on that value. The seller then takes all the facts and the opinion, and makes his or her own judgment as to the appropriate listing price.
The second method I call the "auction strategy." This is a newer strategy for pricing real estate. The auction strategy largely ignores past sales and active listings and prices the property at a level that the agent feels will generate the most offers. The stated objective being to generate an avalanche of competition, creating an auction-like process to drive up the price further than would otherwise occur. This strategy often produces a bidding frenzy of people who think they can buy a property for $1.4 million when it is actually worth close to $2 million.
Agents are fiduciaries; as such, they have duty of disclosure. Presumably, they should be familiar with the market, and provide the seller and buyer with an opinion based on his or her inspection of the property, reports provided by the seller, and the market data of comparable sales in the marketplace. Regardless of strategy, a failure to provide this information to the seller or buyer, if an opinion of value is requested, would be a breach of the agent's fiduciary duty. Further, the agent using the pricing strategy that ignores comparable sales and prices the property based on just what price will generate the most offers, must still provide the seller with a comparable sales analysis so the seller has a basis to evaluate the offers presented.
So the question is, which strategy produces the best results, and what are the disadvantages or risks in using one strategy over another? In a market where multiple offers are common, one might conclude that no matter what the price, the buyers will determine the value. However, not all listings sell with multiple offers in one week. If your home was one of those that failed to sell within the first 10 days of the listing period, then which pricing strategy should you have used? If you had used the auction strategy, then you may be stuck at a less-than-market-value listing price, with no bidding war, and with buyers who may only pay your list price or less. Very few buyers are going to ante up more than the listing price for a home that has been on the market for more than two weeks and has failed to sell.
If you used the comparable sales strategy, and the property failed to sell, you are still in the range of your opinion of value in terms of the list price. Some properties are just looking for the right buyer and take longer than a week to find a buyer who is willing to pay the market value. However, you may fail to generate the buzz of a large number of offers.
It is difficult to analyze from a statistical point of view which strategy will obtain the highest price for the seller. The present market may engender multiple offers regardless of which pricing strategy is used. To determine which strategy creates the higher price, one would need to know what the listing price should have been using the comparable sales strategy, regardless of how the property was marketed. In a rapidly appreciating market with few transactions, often what appears to be a reasonable price at the outset of the listing appears to be underpricing in retrospect. So underpricing cannot be ascertained by looking only at the percentage difference between the list price and final sales price. We can assume in some instances that a property priced at or near what would appear to be fair market value based on comparable sales could be bid up dramatically if there happened to be several buyers bidding in competition for the home.
The auction strategy assumes that buyers are going to ignore or fail to have proper comparable data and will bid higher based on the number of bidders at the auction. Interestingly, often the bidders at the auction strategy listing bid the list price or sometimes even less despite the fact that there are multiple offers. Why does this occur? There are several possibilities. First, they could be uninformed about the comparable sales data. Second, they have the data, but their agent or they themselves failed to accurately assess the value. Third, they are hoping to get lucky by telling the seller a story about themselves, including pictures of the dog and kids, hoping the seller will opt for emotion rather than cash.
This proves that buyers do attend to the listed price regardless of its relationship to market value. Thus, there is a risk with the auction strategy that those who attend the auction will focus on the listed price and then bid in relationship to that price. Ten percent higher than the list price appears to be quite a competitive offer on its face; but in fact, it may be 10 percent lower than the actual market value.
Part of the risk of the auction pricing is one of predicting who is going to bid. How can a seller (or an agent) assess this risk? The seller needs to know the size of the pool of buyers who will make offers on the property. Data for this is based, at best anecdotally, on the sales activity of other properties that have sold. In effect, you need comparable data on the number of bidders making offers on comparable properties. Unfortunately, there is not a source of accurate data for agents or sellers to draw on. To the extent that other agents are willing to share information and if that information is accurate, then you can get some idea of the size of the bidding pool. I recently listed a property for $2.3 million, which at the time was based on the comparable sales strategy. The home sold for $2.9 million with multiple offers. Had it been priced at $2 million, using an auction strategy, would it have sold for $2.9 million?
What should a buyer make of all this? First, prior to making an offer, the buyer should insist on obtaining the market data and the agent's opinion of value based on that data. Second, the buyer needs to access the strategy being used by the listing agent in pricing. Third, if the market is rapidly appreciating then understanding that the comparable data may not provide the proper benchmark for the market value of the property you are making an offer on. Fourth, you need to know your competition. You may need to instruct your agent to prepare different offers based on the number of other offers on the property. Fifth, ground your offer in your financial reality, if you can afford to pay over the comparable sales indication of value and will not be financially impacted if the market corrects, then it may be appropriate to overbid that value to the extent that you deem reasonable. Sixth, just because the last home sold for $700,000 over the listed price, do not assume you need to bid wildly higher than the list price to buy another property. Pay attention to data, not just emotion, frenzy and talk.
This article appeared in print in the 2015 Fall Real Estate publication.