How To Make Sense of A Market That Doesn't Make Sense
11 offers, 25% over ask. 18 offers, 32% over ask. 1 day on the market, preemptive offer 27% over ask. These are the stories we’re hearing all the time in today’s Bay Area real estate market. Dozens of articles are written about it, and funny videos are popping up on YouTube. But if you’re in the market as a buyer or seller, how do you make sense of it all, and make it work for you?
Why Is This Happening?
At a high level, the current market dynamic is a simple function of supply and demand: there is just not enough housing inventory to meet demand. Nationally over the past 14 years, we have run a shortfall in housing starts of ~395,000 units annually. That’s a cumulative shortfall of over 5.5 million homes. I’ll save the in-depth analysis of this issue for a future article but suffice it to say we’re not likely to see a radical shift for years to come.
The Inflection Point Conundrum
A major challenge in this current environment, even for real estate professionals, is that comps (comparable sales) don’t reflect current market values. I typically go back 6 months when running a market analysis on a property. But the market shifted so rapidly starting in late January that today I mostly weight the past 3 months, and there are often few data points to analyze. Appraisers have the same problem, and for a while now we’ve seen a lot more appraisal gaps: an appraisal coming in lower than the sales price. That does not mean the house isn’t worth the sales price (that’s a common misconception) but it does mean that if the buyers are getting a loan they will have to make up that gap with additional cash.
Is This Really Good For Sellers?
Multiple offers and massive overbids are commonplace today. But is that the optimal goal as a seller? The real goal for sellers is to sell at the highest possible price in the shortest amount of time. The number of offers and the “spread” over ask can be false flag metrics to that goal. Here’s why:
While competition is good for a seller’s price, there are rapidly diminishing returns to the number of offers. It’s like “likes” on a social media post. At some point, it’s just bragging rights but no material impact or real value.
With high offer counts, you almost always see wide distribution in pricing. Only a few push the upper bounds of the “highest possible price.” Those are the only ones you need or want to see. Today's pricing strategies are far too often designed to maximize the number of offers, rather than optimizing for price. It’s not necessarily the same thing.
Homes are often purposely priced far below their expected market value. I recently sold a home where the buyers paid $800,000 over ask! (27%, you do the math.) On the surface that sounds crazy, and a massive windfall for the sellers. But if I tell you that the listing price was $600k-$700k under what it should have been, that spread doesn’t mean quite so much. You got a million people to walk into your bar, but you only have one drink to sell.
Pricing low will attract a lot of activity and potentially offers, but sellers and certainly their agents, know they are not going to consider the majority of offers that fall in the middle to bottom of the distribution. So why waste everybody’s time and energy, not to mention the emotional stress for legions of buyers. In my professional opinion, the optimal strategy is to price at the lower end of the range you actually expect to sell in. You will optimize your sale with 3-5 good offers. Beyond that it’s just “likes” on your Facebook page; it’s a good dopamine hit, but it doesn’t put money in your pocket.
It’s important to note that there are still some homes sitting on the market for long periods. Given the high level of competition for homes, some sellers mistakenly believe they don’t have to prepare their property for sale. While it’s true that any house will sell for a price, if the goal is to maximize your sale, always discuss the optimal preparation strategy with your agent. A little investment goes a long way, and you should focus on doing things that will give you a return in the 150%+ range.
What Should Buyers Do?
It is a tough time to be a buyer, but there are ways to mitigate the pain and achieve your goals for a new home.
The biggest stated concern for most buyers is overpaying. Every house has a different value to every individual. I counsel all my buyer clients to identify their “price of no regret” on any property they’re considering buying. This is the maximum price you would be comfortable paying for any given house, and if someone else was willing to pay even a little bit more, you can walk away with no regrets. That isn’t automatically the first offer you need to make, but you should know what that price is in this highly competitive environment.
It’s also important to remember that this is your home, not a stock. While it’s possible, though unlikely, that housing prices will come down slightly, they will never go to zero (like a stock) and over a reasonable holding period of at least 5+ years, housing prices will almost always go up. This becomes even more true as we look at rising inflation and interest rates in the coming years. In this environment, hard assets (real estate) are where you really want to be.