The Anatomy of Overpricing - Why Sellers Overprice Their Homes

I promised more on the topic of house prices, so here it is. I’m going to open this with a comment that may seem obvious, but many sellers forget:

“A house priced at market value will always sell.”

This is true regardless of the market conditions, house condition, neighborhood, etc.  So, what exactly does “market value” mean? In real estate, market value is the most probable price that a property will sell for in a free market, assuming:

1. A knowledgeable and willing seller who is not under undue pressure to sell and is acting in his own best interest;
2. A knowledgeable and willing buyer who is not under undue pressure to buy and is acting in his own best interest;
3. The property has been exposed on the open market for a reasonable time.

Most people would probably say, “I already knew that,” yet they still price their home too high. Let’s take a look at some things that cause many sellers and agents to overestimate the market value:

Not accounting for current market conditions: From a historical perspective, real estate always appreciates over the long-term. However, since the peak in mid-2007, median home prices have dropped 20% in King County and 17% in Snohomish County. That means a house that would have sold for $400,000 in King County at the peak in 2007 may sell for closer to $320,000 now. Since we’ve been in a rapidly appreciating market for such a long time, it’s difficult for people to grasp the fact that their house is worth less now than it was a year or two ago.

Basing your asking price on a single high-priced comparable sale: Sellers typically want to get top dollar for their house. Buyers typically want the buy at the lowest price. One mistake that sellers often make is that they find one house in their neighborhood that sold for significantly more than other similar houses sold for, so they automatically figure that they can get the same price for their house. They insist on pricing their house based on that one sale, even if their agent recommends against it. Then they blame their agent when no buyers show any interest. (It could be partially the agent’s fault as well—Maybe they shouldn’t have taken the listing to begin with!)

It’s possible (although rare) for a house to sell for significantly more than other comparable houses. Here are some examples:

• The house may have been priced above market value, but maybe the buyer’s agent convinced the buyer that the house was a good price because the buyer’s agent would receive a high than standard commission on the sale. In this case, the buyer was uninformed (unknowledgeable).
• Someone wanted to move next door to an elderly family member to care for them and none of the other surrounding houses were for sale at the time. The seller had overpriced the house and was not highly motivated, so the buyer had to pay the seller’s price or not get the house at all.
• The amount owed on the mortgage was more than the house was worth and a financially well-off family member purchased the house to get the owners out from under the debt and protect them from damage to their credit (this is rare, but is has happened).
• The seller could have sold the house on very attractive terms. I recently purchased a property where the seller carried back a note for three years at zero percent interest. I paid significantly more for the house than I would have otherwise, because the financing terms were very good.
• The house had a unique feature that a particular buyer was willing to pay extra for.
• The seller inflated the selling price in order to give the buyer a “buyer’s bonus”. Builders do this often, but individual sellers sometimes do it as well. For example, a seller may inflate the price $20,000 and give it back to the buyer in the form of a buyer’s bonus, which can go toward the buyer’s closing costs and/or to the buyer as cash at closing. There are certain limits to this depending on the type of financing the buyer is acquiring.
  
  You may be asking, “How is this a benefit to the buyer? Doesn’t it still come out the same?” If someone purchases a $300,000 house, and the lender requires 20% down, they would be financing $240,000 and would need a $60,000 down payment (we’ll ignore closing costs for now to simplify the calculations). If the seller increased the price to $320,000 and gave the buyer a $20,000 bonus, the buyer would be able to finance 80% of the higher price, or $256,000. Although they would be required to put $64,000 down, they would be getting $20,000 back from the seller, so their net cash out of pocket ends up being $44,000, instead of the $60,000 required at the original price. The house then is recorded as a $320,000 sale, even though it was really only $300,000. Builders like to do this, because they usually have several houses they’re trying to sell, and if they drop the price on one house, it reduces the value of all of their houses in that development. Instead of lowering the price, they just offer a larger buyer’s bonus. However, lenders are starting to crack down on this practice and it assumes that the house can appraise for the higher amount, so we’ll probably see less of it in the future.
  

These are all examples of non-standard sale situations that can occur in any neighborhood, and the reason why you need to review multiple comparable properties when setting your selling price.

Setting your price based on other houses currently for sale: Being aware of other houses in your neighborhood that are for sale is important. After all, they’re your competition. Also, active listings in your neighborhood can indicate if prices are on a downward trend. However, don’t make the mistake of thinking that because someone is asking a particular price, that it must be the current market value. In my neighborhood, very few houses have sold in the last several months. I would see a real estate sign get taken down and would check to see what the house sold for, only to find out that the listing expired or was cancelled. After inquiring why the seller took the house off the market, they would mention something like “The market is too bad. There was no activity—There aren’t any buyers. We’re going to wait until the market improves.” The real problem is that the prices are all too high. They’re all setting their prices at the same level as all the other houses that aren’t selling. This has created a “dead zone” in an otherwise desirable neighborhood.

Keep in mind that overpricing occurs in all market conditions. However, it has the most negative effect in flat or declining markets. If a house is priced 5% above market value when the market is appreciating at 10% per year, the price would be at the approximate market value after six months and could sell at that price. However, if a house is priced at 5% above market value and the market declines 5% over the next six months, the house would now be priced 10% above market value, and the seller has lost 5% of their equity. They would have to drop the price by 10% to sell the house after six months, rather than setting the original price 5% lower and selling it sooner.

Check back soon, because I’ll be adding another post on the topic of pricing. In my next post, you’ll discover how to determine if the Comparative Market Analysis (CMA) that you receive from a real estate agent is accurate, or if it could cause you to misprice your house.

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Authored by David Monroe, Realtor and Pre-Foreclosure and Short Sale Specialist.
Access Seattle area short sale help and foreclosure resources including selling in foreclosure, and 8 Ways to Avoid or Stop Foreclosure.

Copyright (c) 2009 by David Monroe (Home4Investment Team at Keller Williams Seattle Metro West).
The Anatomy of Overpricing - Why Sellers Overprice Their Homes