It’s no secret that in this current real estate market homes are selling for over list price and significantly in some markets. But are you actually overpaying for the home by simply paying more than the list price? A lot of buyers have the misconception of seeing the list price of a home and comparing it to something like buying an expensive TV or even a car. They see the price shown and automatically think internally to themselves, that’s the price and I am not going to pay one penny more than that. However, this self-limiting belief is an incorrect way of thinking when it comes to buying a home. This is because the list price of a home and the actual value of a home are not always the same, they can be completely different, and much more complicated. First, let’s look at what exactly is the list price of a home.
Generally, a home’s list price is determined based on recently sold comps of similar homes in the same neighborhood. We’re talking sold homes in recent months to a year of the same style, type, and size of homes in the immediate neighborhood. The listing agent will gather the most recent sales data and present the sold price range (low, avg, and high) for all similar home comps. The listing agent and seller will discuss and compare the features of the sold homes vs the seller’s home and determine approximately what price range the seller’s home is in. The seller will then decide on a specific price at which they will list their home for sale on the market.
In special cases, the list price is purposely set as a strategic sales tactic. The seller will list the price of the home significantly lower than even the lowest comp on purpose. Why would they do this? They want to create a flood of interested buyers who believe this home is on SALE! As you can imagine in this market, there will be cars lined up outside their home and tons of showings in 1-2 days. The goal with this sales strategy is buyers will create a bidding war and hopefully the purchase price will skyrocket beyond the expectations of the seller. For example, let’s say a home is listed $25K less than the lowest comp. Buyer A sees this awesome home on sale and wants to do what he believes is enough to have a chance at getting his offer accepted. However, he sets a price limit based on his own principles of not wanting to overpay “$X” above the list price. Buyer A ends up putting in an offer that is $20K more than the list price, believing he’s got a great offer because it’s way over the list price. Buyer B sees the same home and reviews the comps. He sees that the home is listed at $25K under the lowest comp. And then he sees that this same home could be valued at another $25K if it was in the avg range, and possibly $50K more at the highest range. With this information, Buyer B does not fall for the seller’s low list price as the actual home’s value. Instead, Buyer B realizes that the actual starting price point of this home should be at least the lowest comp which is $25K more than the list price. Therefore, Buyer B decides to offer $35K over the list price. Whereas many other buyers similar to Buyer A will offer too low above the list price because psychologically they are not able to bring themself to significantly overpay above the list price. Seller receives multiple offers and Buyer B ends up winning, while Buyer A’s offer is rejected and instantly thinks “That’s crazy! Who’d offer so high! I would never overpay that much for that home.” But as we know, Buyer B didn’t actually overpay $35K, in fact, his purchase price more than likely appraised just fine as supported by the comps.
Alternatively, you may encounter sellers who just have a certain number in their mind, significantly beyond the highest comp, regardless if they can’t justify it with sales data. These are the sellers that for whatever reason believe their home is the best on the block and should set the market for their neighborhood. These are the listings that if you’re worried about overpaying, once you see the comps steer clear as the list price is already grossly overpriced compared to the similar homes around it.
So in general, the list price of a home is what the seller believes their home is worth in the current market. As a buyer, you can’t and shouldn’t simply accept the list price of the home as the actual value of the home. You must act as a private investigator and carefully critique the home’s condition along with doing your own price comparison against your own comps of similar recently sold homes in that neighborhood. Your buyer agent can provide these comps to you. Discuss with your buyer agent if the condition of the home matches the list price in comparison to the comps. You may find that the home is either priced just right, at the higher end, at the lower end, or way off the chart in either direction. When reviewing comps, you will have a feel for what a home’s actual value in this market is and also potentially what is the most a home can be worth in that neighborhood, if there is an opportunity to force appreciation through updates. This gives you the information needed to come up with an offer price that you’re both comfortable and competitive still.
A word of caution though, in this fast-moving market that we’re in comps may not be up to date as pending home sales that haven’t closed yet are not counted. Meaning a buyer could be offering to pay more than what comps are showing, but by the time appraisal happens new comps supporting the purchase price may be available. This is one of the challenges of trying to determine a home’s value based on actual sales, the data points are lagging. Another thing to keep in mind, if you are financing your home, the lender will send an independent 3rd party appraiser to evaluate the value of the home as well. Think of it as a 3rd party price check, so technically as long as your purchase price is equal to or less than the appraised value of the home, did you actually overpay a home’s value even though the list price was lower?
What if you’re still losing out on offers, then should you consider overpaying beyond the highest comp? Possibly, if it’s within your financial means and comfort level. With the competition in the market right now, there are many buyers who are offering more than the highest comp and even including appraisal gap protections to assure sellers that they will not renegotiate the purchase price even if the appraised value is less than the purchase price. My personal feelings on this, are you as the buyer understand your financial situation the best. If you are in a good financial situation where you can afford to pay a little more to beat the competition in this market. Then yes definitely consider overpaying up to your comfort level to secure a home. However, only do this if you are absolutely in love with the home, neighborhood, location, school district, and intend to live there long term at least 10 years. You have to make sure that you will have no regrets paying a little higher to be able to own a home that you will truly enjoy. In addition, with the interest rates being at historic lows, paying a few thousand dollars more may not make much of an impact on your monthly mortgage and finances. To illustrate an example, a home where the highest comps is around $300,000 and interest rate is 3%, if you increase your offer price an extra $10,000 more in hopes of getting an accepted offer. That extra $10,000 would only be about a $50/month increase in your mortgage. Is that going to cause you financial heartache and constant buyer’s remorse? If yes, then don’t do it. If it makes little difference to you and this is the home for you and your family for years to come, then you may want to put out your highest and best offer at a chance of securing this home.
Some other things to consider: appreciation, amortization, and interest rates. Appreciation of a home’s value over time is not guaranteed and it should never be the sole reason you buy a home. However, homes should at least increase to pace inflation. Also if a home is located in a neighborhood or city where people want to live, good schools, near new businesses, shops, restaurants, and new developments that are either already built or coming soon. It would be a safe assumption that this home’s value will appreciate along with the progress of the overall neighborhood. Another often overlooked detail of home buying with a loan is amortization, which is paying down your home over the 30 year loan period with fixed payments every month for the life of the loan. When you live in your home for the long haul, you’ll eventually be paying down your loan with future dollars in say 5 to 10+ years where they are actually worth less due to inflation. This is a benefit for you, as your debt and payments will be fixed, and you’re paying with dollars that are weakened. This the power of leveraging loans and amortization. Lastly one of the biggest factors motivating buyers right now, mortgage interest rates are at historic lows. Many buyers are attempting to purchase a home and lock these rates in for the long haul. If you miss this opportunity and rates increase even 1% that can quickly reduce your purchasing power. Which can completely change the type of home, neighborhood, and location where buyers can afford.
What about the elephant in the room, the real estate bubble that some are talking about? There are many who believe the current real estate values are peaking and a correction is coming soon. However, the reason values are high right now is due to the severe shortage of supply of homes vs the great number of buyers looking. Buyer competition and demand are so great right now that homes are selling as soon as they are listed. Many markets only have a 2 month supply of inventory. The new construction build market is not doing much better than the existing home inventory market. The number of new builds has severely declined over the past 10 years. It’s only just recently that new construction builders are busier than ever, as buyers find that existing home inventory is non-existent so they move over to new construction. Not helping the situation is the extreme increase in lumber and other material costs. In addition, many builders now have a shortage in labor and increased labor costs as they are trying to build as quickly as they can. If the supply of homes available was normal and home values still showed a high % of growth, then that would point more towards a bubble happening. The truth is no one has a crystal ball, however, you must be willing to think worst-case scenario. Say you overpay $10K or $20K above the appraised value of a home, so you are starting off already overpaying a bit for your home, and then the market corrects further reducing the value of your home. Your home is only worth less on paper. Just like stocks, you’ll only actually lose money if you sell in that instant. Are you going to enjoy your home any less? Are you going to have major buyer’s remorse to the point that you sell? If you bought with the right intentions, within your financial means, and you intend to stay in that home for 10, 15, 20+ years. Guess what, you’re going to ride that correction out just fine and if you bought in a great location then you might get a bonus and have significant appreciation gains.
Hopefully, this article provided you with some different perspectives on how you as a buyer look at a home’s price vs its value. And if you should consider overpaying as well as your potential long-term effects. Good luck out there and happy hunting! Thank you for reading.