Chapter 11
How Buyers Behave When Home Prices Are Up
In This Chapter
◆ Buyers’ most common trait
◆ Buyers’ biggest fear
◆ Driving your sale price up
◆ Handling bidding wars
◆ Buyer’s remorse
Prices will come up again. Never before have they gone down and stayed down. Like the stock market, prices go down for a period of time and then rebound to higher levels than ever before. History tells us that, even when there has been a crash in the markets, they will recover. When they do recover, buyer behavior patterns will change dramatically. The power base in real estate will shift away from buyers and back toward the sellers.
When this happens, you may assume that it will be easy to sell your home and that you will do quite well. But even in a climate where most homes are selling at full price or higher, some homeowners can still undersell their properties. If you do not understand buyer behavior patterns when selling in this kind of market, and how to leverage the momentum, you could leave a significant amount of money on the table. It is our goal to make sure that you get every dollar possible out of the market in which you are selling. To us, leaving even one dollar on the table is unacceptable. The financial windfall from selling your home in this market may be the biggest of your life. It is crucial that you take full advantage of it. What a fantastic opportunity for you. We want to make sure that you get the most out of it.
In this chapter, we discuss the behavior, attitudes, and specific scenarios that motivate buyers to pay top dollar.
Buyers’ Most Common Trait: A Strong Sense of Urgency
When home prices are going up, buyers have a sense of urgency that is based on the valid fear that, if they don’t pay a seller’s list price (or higher) now, they will pay more money down the road when prices have risen even more. And they are less afraid of overpaying, or paying a “premium,” because they have confidence that the real estate market is strong and may get even better. Further, buyers believe that the home they buy will only be worth more as time passes, particularly if they plan to live there for a long time.
Sometimes (but not always), when home prices are up, the entire economy is also doing well. The stock market index may be climbing, salaries are high, and jobs are plentiful. This perception—and overall confidence—can drive home prices even higher. Even when the real estate market is up and the rest of the economy is down, it reinforces the flight from the “risky” stock market and into real estate. It becomes the place to put your money.
Because buyers are more actively buying, there are fewer homes to choose from and there is a growing perception that supply is running short. Homes sell more rapidly and everyone is busy and making money, including the mortgage brokers, banks and credit unions, builders, Realtors, appraisers, attorneys, title insurance companies, inspectors, and general contractors. Buyers perceive real estate in this kind of market as an attractive investment.
When everyone is running in one direction, it’s hard to run in the other. The buyers feel validated by the herd that is galloping toward home ownership. The overall sense of urgency among the buyer pool drives prices upward, and sellers reap the benefit if they leverage it properly.
Buyers’ Greatest Fear: Missing the Market
As we’ve said, the buyers’ strong sense of urgency is rooted in a fear of missing the market. If they don’t buy now, they think that they will pay more later and the type of home that they ultimately buy is smaller than the one they can currently afford.
How Buyers Miss the Market When Prices Are Rising
A buyer can miss the market when home prices and/or interest rates have gone up enough over the course of her search to affect her spending power. To understand this concept, think of the monthly payment that she can afford when she began her search. The monthly payment drives everything when applying for a mortgage. If her lender tells her that she can afford to pay $2,500 a month on a mortgage payment, and not one penny more, then that’s it. That’s her monthly budget and she must find a home that will cost her no more than that.
When she first began her search, let’s say that she could afford a $400,000 home with taxes of $375 per month. If she is still shopping four months later and the cost of buying has gone up, she can no longer afford the same size home that she could just a few months ago. Her job is still secure and her salary is the same, yet it can be said that she “missed the market.”
As a seller, it is important to understand that this is the main motivating force for buyers and what creates a sense of urgency to buy sooner than later. Let us offer an example of this and then discuss how to leverage this scenario into more money for your home.
The Incredible Shrinking Home
When home prices are rising as a buyer is searching, the size of the home that he can afford can actually grow smaller. His dollars are literally shrinking. Let’s say that he began his home search in the month of January. At that time, he could afford a $400,000 home. He is able to borrow $320,000 and make a down payment of $80,000. But over the next four months, prices rose at a rate of 1 percent per month. Interest rates also rose—by a half a point—from 7 to 7.5 percent. Now, a $400,000 home is worth $416,242. He still has the same $80,000 for his down payment and the taxes are still $375 per month. Yet, his monthly payment will increase a few hundred dollars, which may now put homes that he could once afford out of his reach.
def·i·ni·tion
A point is equal to 1 percent of the amount of money that you are borrowing. On a $100,000 loan, a point is equal to $1,000. A half a point is $500.
How Monthly Payments Change When Home Prices Are Rising
Difference: $221 per month or $79,560 over the course of a 30-year loan
You can see why this buyer would be highly motivated to purchase a home before prices rise any further.
Driving Your Sale Price Up
Now it’s time to talk about how you can use this climate to your advantage and have it translate into a higher sale price on your own home. If you leverage it properly, not only are you more likely to get full list price but it’s possible that a buyer will give you even more than your list price. When this happens, it can be said that they’ve “paid a premium.” It may be difficult to imagine this at a time when home prices are down and everything is selling under the list price (if it sells at all), but buyers will pay a premium if the right variables come into play.
When Buyers Don’t Mind Paying a Premium
When buyers find the home that is perfect for them, they will walk through fire to get it in any kind of market, but particularly when the market is hot and moving fast. A new home can be an emotional purchase. Buyers have a vision of the place they want to live in and raise their families or retire to and grow old in. When they find it, they will fiercely pursue it. If buyers are worried that one of their competitors will buy it out from under them, they will move into a state of mind where they are prepared to do whatever it takes to get it—even paying above the list price.
A buyer will pay a premium for your home when …
◆ He has fallen in love with it.
◆ He is competing for it against other buyers.
◆ He believes that it is far better to pay a little more today than to pay a lot more a few weeks or months from now.
As a seller, if you have done all the things that we have suggested you do so far—that is, to stage, aggressively price, and expose your home to the entire buyer pool—you should have buyers swarming your home on the first weekend. There may even be simultaneous showings, creating a sort of “revolving-door” atmosphere. This happens because the cycle-one buyers, who are anxious to buy, come in right away. The stage has now been set for a possible bidding war.
def·i·ni·tion
A bidding war is when several buyers make offers, or bids, on the same property, creating ā competitive climate and usually driving the sale price up.
How to Inspire a Bidding War on Your Home
A bidding war can be created when your home is priced attractively (or aggressively) compared to similar homes in the area. Your home must have a better “perception of value” and therefore look like a good deal next to others on the market. This scenario or mentality of a bidding war is similar to that of an auction, where the opening price is low enough to draw more bidders into the competition. Think of eBay, which is essentially an online auction house. The approach is called “reducing the barriers to entry,” which means you have actually expanded your buyer pool and attracted more of them with your low asking price. As the buyers become aware of the fact that there are several interested parties, human nature then takes over and suddenly all the players are caught up in the need to win. When they observe that others want the home as much as they do, their choice is validated and a “sense of urgency” is created around the sale of the property. The energy and competition among the buyers drives them to spend more money than they had originally planned to—hence your sale price is driven up.
Seller Alert
Neither you nor your Realtor can “guarantee” that a bidding war will take place no matter how low you set the price. Pricing is a subjective process and, if it’s done for the express purpose of inspiring a bidding war, it is a dangerous gamble. There is always a small chance that it will not work.
How to Nurture and Handle Bidding Wars
If it appears that more than one buyer has an interest in your home, you may get multiple offers or have a bidding war. It is absolutely critical, at this point, to nurture the process and handle the buyers properly. If you mismanage it, you can lose some or all of them. If you do manage it correctly, you can reap thousands, or tens of thousands, of dollars more in the offers.
Here are the steps to take toward creating and managing a bidding war:
1. Do not sign a contract the minute your home comes on the market. Let all of the cycle-one buyers have a chance, or a big enough window of time, in which to see your home. This goes back to the importance of “exposure.” If one buyer makes you an offer as soon as your home comes on the market, she clearly sees a perception of value and has a tremendous sense of urgency. In fact, she will often submit the offer and tell you that she’d like an answer as quickly as possible and that she’d like you to discontinue showings once the contract is signed. She may even ask you to cancel the upcoming open house. She doesn’t want any other buyers to see it, and for very good reason. She’s getting a deal, and she knows it. It should reveal something to you about how much your home might really be worth if someone wants it badly enough to buy it within hours of it coming on the market. If you accept an offer on the first day of showing, before all of the cycle-one buyers have seen it, you will never know how much you would have been offered on day two, three, four, or five. It could have been substantially more money. In the end, you may have sold your home, but you also may have left a lot of money on the table in the process.
Instead, tell that one buyer that you are very anxious to receive it but that you will not actually be opening and reviewing offers before a certain day or, after the other buyers have had their initial chance—in that first week—to see the home, too. If she still insists on submitting it, you have the option of taking the offer and holding on to it until the designated day. However, we advise our own buyers never to submit their offers until right before the established deadline. This way, it eliminates the concern that the seller will open the offer early and reveal the number to other buyers.
If she is a cycle-one buyer and she truly loves your home, she will wait and play by your rules. Don’t be fooled when she says the offer is only good for 24 hours or she will walk away. She may, in fact, walk away. But, if she does, you can be sure that she was not a cycle-one buyer, or that she didn’t really love your home. In either case, you have lost nothing.
Seller Alert
In many states, a Realtor has an ethical obligation to present any and all offers to the seller within 24 hours of receiving them—unless you, the seller, dictate otherwise. You have the right to delay the moment when you open and review offers. But you may need to give your own Realtor written permission to communicate this to other Realtors and their buyers.
2. As soon as you have been alerted that one or more offers will be coming in, communicate this to all interested parties. After you learn of an offer(s), create a buzz in the real estate community that will hopefully encourage even more offers. Have your Realtor communicate this information to all the Realtors representing other interested buyers. You don’t necessarily want to scare them away. But you do want to gently communicate that there will be a certain level of competition around the sale of your home. This knowledge gives your home a greater perception of value—and the buyers a greater sense of urgency. This is precisely what fosters competition and what drives your sale price up.
3. Set and communicate a date and time when you will review all offers. This is not a mere step in the process. This is actually an extremely important strategy whereby the buyers are asked to wait a short period before submitting their offers. In this time period, they often decide to offer more money than they had planned to a day or two earlier. To begin with, the waiting period gives them some time to breathe and prepare. It provides them the much-needed time to reflect on potentially the biggest purchase of their lives. As they do that, their desire for the home often grows. But, most importantly, the threat of competition grows, too, as more buyers will have the time to enter the bidding process. The fear of losing the home to someone else now becomes very real. The buyers move from a state of mind of simply wanting your home to absolutely having to have it. They are now psychologically prepared to do whatever it takes to get it, which often means paying a premium.
Seller Alert
You may worry about losing a potential buyer if you ask him to wait a day or two to review his offer in order to be fair to all interested parties and review them at once, side by side. Don’t worry. Let’s analyze this buyer. If he is shopping for a new home in what is clearly a “seller’s market” and walks away from something as important as his new home over a minor administrative delay, he was not a cycle-one buyer or, down deep, he did not really want the property. Either way, he is certainly someone with whom completing a transaction and making it to the closing table would be a major challenge.
4. Establish and communicate the same rules and guidelines for all interested buyers. There is one thing that will make a qualified cycle-one buyer, who happens to love your home, walk away from his offer. That is when he feels that he is being treated unfairly or misled, on any level. He may desperately want your home, but he is no pushover. And if you lose him, it may be that he was the right buyer with the best offer.
Blurry, inconsistent, or bad communication can make a buyer suspicious. When the buyer feels this way, he begins to mistrust the whole process, particularly if he believes that you are treating one buyer more favorably than another. For example, never negotiate with one buyer in a vacuum, giving him privileged information that the other buyers do not have. Never reveal what one buyer’s offer is to another buyer. This is called shopping an offer and is perceived by buyers as one of the highest ethical crimes a seller can commit. The buyer’s goodwill and motivation will disappear in a flash if he learns, or even suspects, that something unfair is taking place behind the scenes. While cycle-one buyers will pay a premium for your home, they will only do so if they feel that all buyers have the same information and are playing by the same rules.
Make it clear how the offers are to be physically presented, and how and when you will respond to them. For example, are they to be presented in person by the buyer’s Realtor, or will they be forwarded in sealed envelopes? Will you accept one of them on the spot or will you respond with a counteroffer?
Receiving and Reviewing Multiple Offers
There are several approaches to receiving offers as well as to how they are reviewed. Among Realtors, there are different schools of thought about which ones are the best. We believe that there is no one single best way. The one that you use will depend on the type of market in which you are selling, what the common practice is in your area, how your Realtor advises you, and what you personally are comfortable with. Here are some choices.
Highest and Best, or the One-Step Bidding Process
After you decide the date and time that offers are due, you must also decide if you will accept and sign one of them on the spot, or give the buyers a counteroffer. If you do accept and sign one of them on the spot, that means that you have created a one-step process. This is when buyers submit their “highest and best,” or an offer with their highest price and best terms. The buyers will have just one opportunity to get the home over their competition by submitting the absolute most that they are willing to pay, along with the best terms that they can provide. We discuss the various terms in an offer in Chapter 15.
Each buyer must reflect on and decide how strong her offer is without having any idea what the other buyers offer. She decides how much the home is worth to her and goes straight to that number. One buyer may offer $2,000 above the list price of $425,000 and feel that it’s a very good offer. But the other four buyers may offer $9,000, $11,000, $13,000, and $20,000 above list price. Obviously, the home was worth a lot more to her competition. The other buyers paid a larger premium than she did. Again, cycle-one buyers don’t mind paying a premium when they love a home and they know that other buyers want it, too. Let’s look at the size of the premium that was paid in this example. The real value of the home was at one number, while it sold at another.
The Real Value of a Home Sold in Multiple Bids
In a bidding war, a home usually sells for a premium, or above the real value. Depending on how many bids there are, the real value is usually where the majority of the buyers clustered. If a home is worth what a buyer is willing to pay for it, and the majority of the buyers participating in the bid submitted offers between $434,000 and $438,000, then that is where the approximate real value is. But the home still sold for $445,000. It can be said that the buyer paid a premium of approximately $10,000.
Beware of the Escalation Clause
Once in a while, a buyer who loves your home thinks he can get around the process of competing and attempts to get your attention through a back door. The way he does this is by sending a message to you that, when the bidding war is over, call him and he will beat the winning offer.
def·i·ni·tion
An escalation clause is a term in a purchase offer where the buyer tries to avoid participating in a bidding war by offering a certain amount of money over the highest bid received.
Be careful of this buyer. This is someone who either has not been properly educated to the process by his Realtor, or he simply thinks that the rules don’t apply to him. Whichever description applies, he is a bad risk to do business with. One of the reasons that we are against escalation clauses, in theory, is that the buyer has created a scenario in which the final sale price will be imposed upon him by others. The price could end up being much higher than he anticipated and catapult him outside of his financial comfort zone. Additionally, because he did not choose the number, he may not believe the home is worth that amount. Therefore, his commitment to the deal may not be strong enough to stay with it.
Another reason that we are against escalation clauses is that they go directly against the seller’s golden rule for bidding wars, which is to create clear and fair guidelines that apply equally to everyone. If you have five offers and you allow one of them to include an escalation clause, then the playing field is not level. Further, if you do attempt to level it—by allowing all five offers to include the clause—then it is impossible to determine a winner. Either way, we do not recommend the use of escalation clauses in a multiple bid situation.
The Two-Step Bidding Process
The two-step process is really just a drawn-out one-step process. You and your Realtor will still impose a deadline by which the first round of offers must be submitted. The difference is that you will not sign one of them on the spot. Instead, you will respond to all of the offers with a blanket counteroffer, or simply provide a second round for all to improve their offers, through price, terms, or both. When the second-round bids are submitted, only then are they considered to be their highest and best.
The attitude that buyers often adopt with a two-step process is that they don’t take the first round seriously because they know that they will have another round to submit their final offer. This is why some Realtors find that the first go-around in a two-step process is a waste of time. They also sometimes worry about tipping their hand too early by giving their real highest and best when they aren’t required to until the second round. That goes back to their fear that you will secretly shop their offer, or that it will somehow leak to other buyers and put them at a disadvantage.
On the other hand, there are many Realtors who actually prefer the two-step process because it gives the illusion that the buyers will have more time to think and mentally prepare. You should make the decision with your Realtor and base it on the method that the buyers are most familiar with in your area.
Presenting Offers in Person vs. Sealed Bids
The buyers have no control over how bids will be submitted, received, and reviewed. As the seller, you do. In fact, the choice is entirely yours. The Realtors representing the buyers will usually prefer to present the offer in person to you. You may enjoy this approach as you can sometimes learn more about the buyer through direct one-on-one conversation. The Realtor may not be able to tell the buyer’s whole story in a cover letter. And you may have some questions you’d like to ask in person.
The downside is that, when there are several offers, it can be time consuming to sit through half a dozen or more mini presentations. Remember, when the presentations are done, you still need to review each offer with your Realtor and then contact each buyer with a response. For these reasons, many sellers are advised to request sealed bids, which are simply confidential written offers sealed inside an envelope. They remain unopened until you sit down to evaluate all of them, together, at the same time.
The cover letter becomes much more important in a sealed bid because it’s all the seller has to get an overall description and profile of the buyer. The contract itself is a dry and businesslike document that tells little about who this person is other than her offering price, terms, and financial ability.
Choosing the Best and Handling the Rest
Resist the urge to judge offers with an eye only to the sale price. The best offer in a multiple bid is not always the one with the highest dollar amount. In fact, we have represented many buyers who won a home with only the second or third highest dollar amount. That’s because they worked hard on making their terms as attractive to the seller as possible. If the seller had a special situation that required a flexible closing date, the buyer gave it to him. If his financing package was better presented than a higher bid, the seller preferred to do business with our buyer rather than with a riskier offer.
Look at and consider the whole package. Your Realtor may even write down the strongest and weakest selling points of every offer on one piece of paper. This makes it easier to evaluate them side by side. An offer should be strong across the board. After all, what good is a high sale price if the deal falls apart before closing due to a condition of, or a contingency in, the contract?
The Importance of Backup Offers
When notifying the buyers who lost out in your bidding war, be sure that your Realtor calls each of them promptly with the bad news, thanks them, and asks if they would like to remain as backup offers should anything go wrong with the winning bid. This is crucial. If your second and third offers were strong, and something does go wrong with the deal that you accepted, you should go straight back to them rather than going through the effort, and taking the financial risk, of putting your home back on the market.
If you are forced to market your home a second time, the buyer pool will wonder what happened to the first deal, and ask their Realtors, “What’s wrong with it?” Your property will be somewhat tainted. You may get other offers, but the sale price, this time, may be much lower.
Seller Alert
If the first two offers were close, you can use this to your benefit to make the deal more secure. Make sure that the buyers who won the bidding war know that the second-place offer was similar to theirs. This validates their decision to buy it and the number they chose, and it reinforces that they didn’t overpay. Because the margin between the two offers was so small, it makes their victory sweeter, overall.
Buyer’s Remorse
Once in a while, a buyer gets caught up in the excitement of making an offer on a home that she thinks she loves and that she believes she can afford. Once the excitement of having an accepted offer wears off, she comes back down to earth and the reality of her commitment sets in. She may convince himself that she’s made a mistake, driving her to back out of the deal.
Buyer’s remorse is a characteristic of cycle-two buyers. They have not had enough experience in the home search process yet to have total clarity about value. Therefore, they do not have enough confidence, either, in the decisions they make. As a seller, doing business with them is somewhat risky. Cycle-one buyers are far less prone to buyer’s remorse because—as we’ve said before—they are experienced home shoppers, they understand value, they are ready to buy, and when they do, they are nearly fearless. This is why it is so important to recognize what type of buyer has brought you an offer.
The Least You Need to Know
◆ When home prices are rising, buyers have a strong sense of urgency to buy a home. They fear they will miss the market and worry that if they don’t buy now, they’ll pay even more later.
◆ Buyers will pay a premium when they fall in love with a home and when other buyers want it, too. The way to drive your sale price up is by creating a competition among buyers.
◆ A one-step bidding process is when you receive offers all at the same time, review them, and sign one on the spot. A two-step process usually involves a blanket counteroffer or simply another chance to improve the initial offer.
◆ You can choose to receive offers through in-person, face-to-face presentations made by the Realtors representing the buyers or by asking for the offers to be delivered in sealed envelopes.
◆ The escalation clause comes from a buyer who wants your home but doesn’t want to participate in a bidding war to get it.
◆ Buyer’s remorse usually happens mostly to cycle-two buyers.
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