Toronto’s housing market is as diverse as its people: ranging in price, size, and location. I pick a Toronto listing or trend to focus on each week and review it with a professional's eye. What makes a house a great pick - and what makes it a pass?
OVERPAYING MAY WIN YOU THE HOME, BUT ARE YOU PREPARED FOR THE APPRAISAL?
I recently participated in two offer nights (a set time/date when all interested buyers make offers or bids to buy a home) where I can confidently say that the winning buyer (not me or my clients) greatly overpaid for their home. Is it just par for the course in this heated January market with dwindling supply? Maybe – but it always leaves me wondering how the buyer got to that point: was it getting emotionally caught up in the heat of the moment during the bidding war or was it bad advice from an agent on what it takes to win the home? My hope is that it’s not the latter as overpaying on a financed asset can get you into trouble.
The trend I’ve noticed over the past few offers I’ve made is that the majority of bidders come in within a certain range – the value range, if you will. This range is (hopefully) attained by the buyer’s agent through use of a comparative market analysis that analyzes past sales in the neighbourhood looking at rates of appreciation and comparable homes that have sold to come up with a realistic value range for the property in question. Typically in a multiple offer situation the value for the home rises within the range based on the number of other bidders you are competing against. For example:
123 Fake St is valued between $650,000 and $675,000 based on comparable neighbourhood sales.
At offer night the selling price should fall higher on the value range with every increase in the number of buyers that are in competition. Theoretically, if there were six offers on a property the home should sell for a higher amount than if there were two offers.
That said, another strategy an agent may talk to their buyers about is stretch pricing: paying 1-2% above the value range for the property in order to secure the home. If I was to recommend this kind of a strategy to my clients it would be on a case by case basis after going over the following questions: is there future potential for this home, does it check most of their boxes, do they understand the risks associated with this, are they just getting caught up in the moment, and last but not least: what is their financing situation like.
What I want to focus on here are the risks associated with overpaying on a property with the main one being that there is a possibility that when the bank comes in to complete their appraisal they may tell you the home is not worth what you paid and that they will only lend you a mortgage for the amount they deemed the home to be worth. (When a home is financed with a mortgage, it’s essentially the bank's home – and in the event that you are unable to pay your mortgage, the bank needs to know that when they sell the home to recoup their money the amount they can sell for matches what they have lent you.) If you’re paying 1-2% over value, I wouldn’t say this situation is too worrisome as long as you are able to cover the difference (and this money cannot come from your down payment if it only meets the minimum required). Where this gets tricky is when I see buyers (as in the offer nights I recently participated in) paying 20% more than what the property is worth.
If this was a cash buyer (a buyer who does not need a mortgage to pay for the property) and they knew they were overpaying, but really wanted to secure the home, then all power to them. What troubles me is that cash buyers are rare, meaning it is more likely the home is being financed and a mortgage is required - and paying 20% more than the home is worth is a pretty quick way to get less financing than you need for your home purchase. And if you don’t have the appropriate conditions in your offer to back out of the deal when you can't secure the financing amount you need (which is likely in a multiple offer situation when you need to compete against other buyers with a condition-free offer), you are still legally committed to buying the home – whether you have the money to pay for it or not. This potentially puts your deposit at risk and you at risk of being sued by the home seller.
Of course, this is only one, more immediate, way that overpaying for a home may hurt you. Should you be able to come up with the extra cash and pay for your home now, you may run into the trouble of not being able to break in when it comes time to sell. Again, you may decide that it is worth paying extra to enjoy life in your preferred home, but it's a decision that you should make with your eyes wide open - and good advice from your agent.
Nicole Harrington is a Sales Representative with Realosophy in Toronto. She specializes in using data and analytics to help her clients make smarter real estate decisions, concentrating on Toronto and the GTA, and hosts her own website: SheSellsToronto.com. Email Nicole