At times we overpay for things, whether it’s a tech gadget that just came out, a name brand that’s really the same thing as the generic label or the latest hyped product that we just “have to have”. This happens in retail stores, on eBay, in supermarkets and even in real estate – especially lately as inventory has shrunk and prices have been climbing.
Appraisers definitely need to be realistic about the way the market is shifting, but at the same time sometimes buyers simply offer too much for a house – which is why the appraisal comes in lower than the contract price. Today let’s consider some reasons why buyers offer more than a property is worth.
10 reasons why buyers sometimes offer too much on a property:
- Value: In an increasing market buyers figure the house will be worth more soon.
- Emotional Attachment: Buyers fall in love with a property and meet the seller’s price even though the price is clearly too high for the market.
- Competition: If buyers offer conservatively in a market with very little inventory, someone else is going to have a better offer. This is why buyers are sometimes offering at list price or above even when the list price is too high.
- Strategy: Some buyers offer at higher levels hoping for a lower appraisal (or they are willing to pay the difference between appraised value and contract price simply for the security of getting a contract accepted).
- Fear of Rejection: Buyers get burned-out from having offers rejected, so they begin to get more aggressive with their offers.
- Cash & Financing: When there is so much cash in the market, financed offers need to find a way to be more attractive to sellers, so higher contract prices are a natural pathway for buyers. This is especially true with FHA or other nearly-100% financed offers (It’s less painful to offer more when you’re not spending your own money, right?).
- Easy Money: It’s really cheap to borrow money right now, so buyers can afford larger loans. This means offering $10-20K above list price doesn’t make much of a difference in a monthly mortgage payment.
- Good Deals: Many buyers remember how high prices used to be, so offering more in today’s market still feels like a deal because current values are far lower in the post real estate “bubble” burst.
- Cap Rates: Investors are focused on cap rates instead of nearby sales. This means they can essentially ignore other sales and pay more for the property than a regular buyer because the cap rate makes the investment work.
- Fear of Being Left Out: Some buyers are frantic about making a purchase because they want to buy now before they are priced out of the market.
Questions: What else would you add? What do you see happening in the Sacramento market (or your market)? If you have multiple offers at a seemingly unrealistic price, when does that become the market instead of just prices that are too high? I’d be curious to hear your insight below.
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Ryan:
As usual, I appreciate the honesty of your blog. Allow me to suggest reason number 11: high rents. In many parts of Sacramento, it is cheaper to buy than rent.
For example, where I rent, Harbor Oaks on River Plaza (by Garden Highway), a one-bedroom on the little lake runs about $1200 per month. This is significantly more per month than the PITI on a nice home ( depending on down and mortgage). However, inventory is low, and for many of the reasons you listed, people are lined up to buy what I consider overpriced houses.
Yes, investors want to maximize return, but let me relate what happens when greed overrides common sense.
Here at Harbor Oaks, there are about 500 units generating about 500K monthly after estimating salaries for a small staff, taxes, and a 10% vacancy rate. BUT 20 apartments are leased to a “corporate entity” that lets them on a short term basis to “executives”. Sounds OK, right.
At 1:00 AM Sunday, March 24 we heard gunfire and screams from one of the “executive” suites. Three young men were shot with one dead. Turns out, the unit was rented nightly (illegal) and the “renter” was charging admission to a stripper show. Many of the participants came from the Bay area where minors can’t get into strip clubs. But back to CAP rates.
The property owners, Demmon Partners, have not kept up with roof leaks and dry rot. Imagine what will happen to their CAP rate after the families of the wounded and slain kids take Demmon Partners to court. A lawyer friend of mine estimates that the
owners could take a 30 million hit, especially if the families’ lawyers file in the Bay Area. And since I believe Demmon Partners sells stock, I would imagine stockholders will also get in line to file lawsuites related to due diligence.
Bottom line, five shots were fired. That’s a rate of six million per cap.
Ricardo
I think you’re right about the cost of renting vs. owning in many areas. It’s amazing how buying a house can actually save money (but then home ownership can also cost quite a bit of money too). Yikes on the complex you mentioned. It sounds like a good time to find a new place to rent. It makes a huge difference when landlords effectively manage a complex or house vs. letting things run wild. I hope things improve soon. Thanks for the comment and story.
Very information. If buyers keep these ten reasons in mind maybe they will be less likely to offer too much for a house or at least understand the reasons for why they are offering too much. Currently, I believe many people are offering too much because of reason number five, fear of rejection since there are now usually multiple offers on one home.
Thank you so much Amanda. I appreciate the comment as well as the mention on Twitter. 🙂 I think you’re right about that. I find in light of low inventory, there is fierce competition among buyers in certain neighborhoods and price ranges. When you add in buyers who are putting less money down, they really almost have to offer above list price (or a reasonable value) to get into contract. Otherwise sellers may very well pass on the offers.
It’s interesting out there. Thank you again.