Have you ever wondered if making an offer to buy a home is an art or a science? The bottom line is that it is both. Nonetheless, for many, handling an offer can be a mysterious and frustrating process. There is an age-old saying that the seller thinks their home is worth the price of a castle, while the buyer wants to offer the value of a cabin. We work with both buyers and sellers in a number of different types of transactions. Obviously, the advice we give for making an offer will differ depending on what your goals are, the market conditions, and the type of sale (a bank-owned property, a short sale, non-distressed sale, etc.). There are a number of fundamental principles that we can pass along. These fundamental principles are tied to affordability, market conditions, insight, and expertise. Always remember, “Knowledge is key.” Or, said another way, information is power.
Appraisers use three main methods to determine value:
(1) comparable approach (determining the average price per square foot of similar homes in a similar and close-by area, and adding and subtracting to the value suggested by that average given the specifics of a particular property);
(2) cost replacement approach (how much it would cost to buy the land and re-construct the exact property in the same location); and,
(3) income method (how much income one can produce by using a particular property).
Each approach could, and usually does, produce different values and suggest different offer amounts. When buying a house, comparable sales information helps you determine a price range for a particular home. Adding in the various factors like property condition, improvements, market conditions, and seller motivation helps to determine whether a “fair” price would be at the upper or lower limit of that range. You may think or feel a fair price is outside of that range. As a buyer, the “fair” price should be approximately what you are willing to agree on at the end of negotiations with the seller. The price you put in your initial offer is totally up to you and depends on your negotiating style.
There are times when offering substantially over or under the market value is in order. Most buyers start off somewhat lower than the price they eventually are willing to pay. Be aware that, if you start too low, then you send a message that could potentially dissuade a counteroffer. No one appreciates a low-ball offer. On the other hand, if you start too high, you send a message that you really want the home, and the seller may be less willing to agree to fix any discovered problems. Good Realtors® are adept at reading the signs and interpreting the messages, and knowing how to guide you in presenting and negotiating an offer. As you can see, value and offer price are a function of both art (what you perceive and how you negotiate) and science (what data you use).
When we are ready to buy or sell residential real estate, we almost always produce a comparative market analysis or CMA. A CMA is a tool for you to determine how much you want to offer or list a home. It is not an appraisal, it is just the beginning step to determine price. Remember, you do not need to share that CMA with anyone. In fact, as a general rule, the only time I recommend sharing a CMA with the other party is when an offer is substantially below asking and you are justifying a list price or an offer in an effort to encourage a counterproposal. Generally, what we see is that sellers list a little high (sometimes a lot high), buyers offer low, and you try to meet in the middle. A Realtor® can even help you determine the average list to sold price in a given area. It is critical to understand that one can make the value of a property show up just about anywhere he or she wants. Fair Market Value is defined as, “what a ready, willing, and able buyer will pay a ready, willing, and able seller in the open market.” Fair Market Value is not defined by comparables (similar homes sold in a similar area within the recent past), although comparables certainly influence value a great deal. As we all know, home prices can skyrocket and plummet depending on the economy and public sentiment about the future.
Objectively, when we are buying a home, we are attempting to arrive at a value based on the average price per square foot of properties in a given area. Because value goes up and down, the average price per square foot goes up and down. That is why it is important to understand a “depreciating market”, an “appreciating market” and a “stable market”. One must keep in mind that we are attempting to have the parties, both the buyer and seller, agree on an acceptable value under all the circumstances. Of course, that agreement is not where the analysis stops. Please keep in mind that, if a buyer is obtaining a loan, the lender must support the agreed upon value.
Insight & Expertise:
Once the buyer and seller agree on a price, then an appraiser determines for a lender whether the market can support the offer. Recall that a CMA is certainly not a definitive measure of value – it is just an indication. Frankly, the same can be said of an appraisal. An appraisal is one person’s opinion of value that may be used as a tool by a lender to determine its risk in lending money. An appraisal does not really provide you a definitive value because value is not so “black and white.”
Clearly, value is a subjective; however, there are some methodologies and standards for justifying ones perception of value. Value fluctuates, gets determined by emotion, the quality of a particular home, the tastes and desires of a particular buyer in a particular area. Value is also determined by supply (how many homes are on the market) and demand (how many buyers are shopping). In a weak economy, supply tends to be higher and demand lower. If supply is low and demand is high, then value generally goes up. If supply is high and demand is low, value goes down. Moreover, sometimes even in a challenging economy, if you are attempting to buy in a “hot” area, a lot of sellers hold out to get a higher value – sometimes even a value that is not supported by current market conditions. That can produce an anomaly and will drive up the price of homes.
Some of the other factors that affect the price of homes are the condition and style of the property, upgrades, location, close amenities (like shopping, restaurants, health clubs, etc.), the number of days a home has been on the market, and ones desire or need to live in a particular area. In fact, if you compare the average number of days a home is on the market in a particular area with the actual number of days the home you want to buy has been on the market, you can gain some valuable insight into an offer price.
Another huge factor is the motivation of the seller. If the seller is facing foreclosure or some other reason to sell quickly, like an impending job transfer or some other immediate need to relocate, then their willingness to sell for a lower price may increase. Wouldn’t it be nice to have crystal ball?
In summary, understanding the fundamental principles for making an offer on a home will yield better results. At Alaris Properties, we take all of these factors into consideration as we assist our clients. Hiring Realtors® who understand the fundamentals will bring a higher return on your investment.