My last post on multiple offers sparked reaction from agents and consumers alike. As a follow up, I’ll consider these comments and further clarify my own thoughts on the subject.
In heated markets, it’s not uncommon for listing agents to list houses for sale with an asking price that is well below the home’s true market value. Agents take this approach to generate a lot of interest and buzz about the property and to hopefully get multiple buyers competing for it. It’s not uncommon to see a house that is worth $440,000 listed for $399,999. This leads many people to believe that a buyer who pays $440,000 for this underpriced listing is overpaying because they paid 10% above the list price. In this case, it’s actually the low list price that makes it look like consumers may be overpaying.
An agent responding to my post rightly points out that the house I was discussing in my last post was underpriced for the area (it sold for 24% above the list price). So the buyers didn’t necessarily over pay by 24%. In order to understand the actual premium paid, if any, we need to ascertain the home’s true market value and measure this against the actual price paid
While it is important not to overstate the magnitude of a potential overpayment, I also heard from consumers who shared personal buying experiences that confirm my view that not understanding the risks associated with overpaying is far more problematic.
Let’s walk through why. Most buyers who win multiple offers do so in part by removing their condition on financing. In the moment, this seems like a relatively low risk decision that can make the difference between winning and losing the house of your dreams.
Suppose you have 5% down and the bank has pre-approved you to spend up to $500,000 on your first home. You appear to be in good shape to make a firm offer of $450,000 on the home you want to buy. The problem with removing your condition on financing is that many buyers miss a small clause in the pre-approval they received from their bank. The clause typically states that the pre-approval is conditional on a satisfactory appraisal of the property.
It is critical to understand that the bank is only going to finance the purchase based on what they think the house is worth, not what you agreed to pay for it. If you decide to make a firm offer to purchase a home for $450,000, and the bank’s appraisers determine that the house is worth $425,000, the bank will only finance the property based on a value of $425,000. This means that you would be responsible for coming up with the $25,000 difference between the price you agreed to pay and the appraised value of the home.
Looking at some of the prices being paid in our current market surge, I am concerned that consumers are more vulnerable to the risks of overpaying right now, particularly in a multiple offer situation. Multiple offers are quite common in our market today. While it may be wise to steer clear of very unreasonable situations (think 10 or more offers), it will often be necessary to bid against a few buyers in many of Toronto’s neighbourhoods. The best thing a home buyer can do is to ask their buyer agent to prepare a Comparative Market Analysis for the house they plan on competing for - and to insist on getting this analysis in writing. It’s your agent’s responsibility to tell you what the house you are competing for is actually worth.
After that, it’s up to you to decide if you want to pay a premium to own that house, and if so, how much of a premium. You may find that the home has rare upgrades that are critical to you. Or perhaps the neighbourhood boasts particularly good schools. Whatever your calculations, you need to keep in mind that you may run into difficultly if your bank’s appraisal is below the price you agree to pay, and weigh this risk accordingly. Think through your pricing decision carefully and look for your buyer agent to provide you with ample support on this critical aspect.
September 9, 2009Buying |