Many buyers or sellers ask about the value of the property they are buying or selling, known as the subject property. How do real estate professionals evaluate the value of a property? In a competitive market, how do we know how much to bid?
Real estate professionals use a method called Comparative Market Analysis (CMA). This is also known as sales comparison analysis. The comparative market analysis is used to help us figure out a reasonable price range that a property of interest falls into. To provide a ballpark estimate, we pick out similar properties from the recent sales near the subject property.
We usually pick 2-3 similar properties sold within 0.5 miles of the subject properties in the past 6 months. These similar properties are known as comps. The more recent the sale, and the closer the property, the more relevant the comparable. Sometimes if the subject property is a unique property, or if there were very few sales in the area, we have to widen the search radius to 1 mile, or extend the time frame to 1 year or even longer if there is not enough data.
Typically, there are no two properties on the market that are exactly the same in every way and located at exactly the same location. So when we are doing the appraisal, we have to make some adjustments based on the features of the comparable properties. These adjustments could be based on square footage, distance to public transit, parking, private deck, private patio, renovation quality, projected appreciation, finished basement, etc. For example, if the subject property has 1 garage parking, but the comp has 2 garage parkings, then we could subtract 20k from the comp because 20k is the worth of garage parking in that area. This number could be higher or lower depending on how much garage parking is worth in that area. In prime locations in a major city, garage parking could be worth 100k. In the suburban areas where garage parking is commonplace, the worth of the garage parking could be less, or just based on the construction cost of a garage in that area. So the number could be 10k instead of 20k.
The idea is that because no two properties are exactly the same, by making adjustments to the comps based on various features, we come up with the value for these comps if they had the exact same features as the subject property. Then we take the average of the adjusted number to come up with the range of market value, typically with a 5% margin of error.
Also, the property type is relevant to the analysis as well. If we are looking at a condo in a 2/3 family building, the analysis is going to take into account other condos in a 2/3 family building, but not apartments in a large complex or townhouses. The nature of living in a 2/3 family building is very different from living in a large complex with 20-30 units. If we are evaluating a single family home, then we have to take into account the lot size as well and double check the public record for the square footage. Sometimes the square footage record in the listing information page could be inflated, because it adds the square footage of the attic space or finished basement. Typically for appraisals, we have to discount the space of attic square footage and finished basement because they are not considered the same as typical living space with normal ceiling height.
Besides making adjustments for features such as property type and sale date, we also make some adjustments based on the history of bidding wars. For example, in more competitive years, condos with loft-style high ceilings near MIT often got bid up 10% higher than the comps. Same thing with single family under 1 million in Arlington. These homes often got multiple offers and occasionally sold above the CMA range. Eventually these comps become the new norms in the area, which leads to more appreciation.
Some features are not necessarily quantifiable. It’s important to look at these features differently in a bidding war situation in order to predict consumer behaviors. Loft-style high ceilings in such locations are so rare (and the demand so high) it’s almost like bidding for a rare artwork in an auction.
This year it’s a lot easier for buyers than before and properties don’t get bid up as much, because we have a bit more inventory at this point in the market cycle.
Buyers often ask me this question: how much higher than the list price should I bid? I would say a property can sell above or below list price at any time of the market. So the best way to figure out the best price to offer, is to look at the CMA as an objective report that stands apart from the list price. The list price itself is meaningless from a sales comparison perspective. I always say just treat the list price as zero so you are not distracted by that number. Both consumers and some real estate agents can have anchoring bias.
For example, if a property is priced too high by an inexperienced seller’s agent, even if you get 20k below that price, it doesn't mean you are necessarily getting a good deal. Some seller’s agents just priced the home higher to leave some room for negotiation because they know the property is not going to get multiple offers due to certain defects or the location. If a property is intentionally priced low to create a bidding war, you can still get a fair deal even if you bid well above asking price.
So I would take asking price with a grain of salt and focus on the final sale price. Otherwise it can get too confusing. The best way to get an objective sense of what to bid, is to ignore the asking price of all the properties and just look at the final sale price. Asking price can vary greatly based on the particular strategies of the seller’s agent and the season of sale. The final sale price can be higher or lower than the asking price, but being higher or lower than the asking price doesn't necessarily mean you get a good or bad deal.
Keep in mind that in a seller’s market, buyers are often faced with multiple offers or bidding war situations. If the property type is rare and desirable, we often see sale prices that fall outside of the reasonable price range indicated by the sales comparison approach. In bidding war situations, it is best to talk to an experienced real estate agent who knows the market well and strategize with your agent together. No one wants to overpay for a property! As buyers, we want to bid just above our competitors, the same price, or even lower. The most interesting part of my job is helping my clients stand out even when they bid lower than other people. I have won bids when my clients bid lower than others, or have lower down payments than others. This is coming from a business background, I always look for ways to help my clients stand out using innovative approaches. Each situation is so different and it’s important to change your strategies based on how the negotiation pans out.
For seller clients, it’s important to understand the purpose of the CMA range and it’s relationship to pricing. Depending on the property type and price range of your home, the strategy of pricing lower than market value to attract bidding wars may or may not work. The market is in transition right now. We are at a point where some areas are no longer seller’s market but not necessarily buyer’s market, more of a neutral situation. This year, I have seen some seller’s agents failed to adapt to this market transition and still price the home too low. And when they didn’t get the price they wanted because buyers just came in at the low list price, they had trouble negotiating with the buyers to raise the price because they already priced the home too low. And so the property sat on the market for a long time and the sellers in those situation often had trouble getting the price they wanted. The longer the property sits on the market, the more likely the buyers will come in and negotiate hard, and the more leverage they have. That’s why pricing strategy is so important. It’s critical to analyze the nuances of what’s going on in the market and try to reach as many buyers as possible with your pricing strategy. Don’t get carried away with bidding war strategies because I’ve seen many situations where such strategies actually backfire when not done properly!
I often try to find out how much a home sells for before the data even becomes publicly available. I would try to find out the sale price of many pending homes, before I even advise my seller clients how to price their home. It takes 1-2 months for a home to close and for the sale data to become publicly available. So relying only on public data if sold properties is often not aggressive enough. I try to find out information that others don’t have access to. In this competitive day and age, information is key to success. If you are in an area where the market is transitioning to a buyer’s market, you need to work with an agent who is extremely aggressive and on top of things. I try to research all the competing properties and observe their pricing activities before I put my seller clients’ home on the market. There is no other ways to get the best price than watching the market closely. There are so many buyers and pricing is a important tool for sellers to get the best buyers.