written by John Wagner
Why are there so many bids on a house?
Recently, some buyers of mine and I went to a house asking $170,000. Despite it being a little small, not exactly the area they wanted, and knowing that they’d eventually want to tear out and replace the entire kitchen, they decided they wanted to bid $10,000 over the asking price. It turns out, that $10,000 over the asking price was just “par for the course” on that particular property. I do not know exactly how many bids it got, but we weren’t even part of the discussion at the offer table. I know for certain that the 2nd place offer was for $195,000 with no home inspection and THAT BIDDER DID NOT GET THE HOUSE EITHER, the seller’s accepted a $218,000 bid (with a home inspection).
How is that possible? What is driving that? What could the winning bidder possibly be thinking?
What you have there is a buyer that is knowingly overpaying for a house, and to understand what would drive someone to do that, one must look at the idea of homeownership and this market as a whole, which I’ve broken down into 3 categories: record-low mortgage interest rates, and record low down payment options and record low inventory.
Record low mortgage interest rates
I’ve talked at nauseam about this in the past, so I’ll keep it short, but you can watch my in-depth video here. When you borrow money from a bank, they charge interest. If you look at a house from the perspective of its monthly payment, this rapid increase in a house’s value starts to make sense. A $200,000 house at a 3% interest rate has a monthly loan principal payment of ~$844. If mortgage interest rates go up to 5%, to keep that payment the same, the purchase price of the house has to be $160,000 *I’m not a banker*. When you pay the principal payment, that money goes directly into the equity of the house. So while you are without the liquid cash, if you were to sell the house, you’d get that money back, plus its appreciation.
Bottom line: because buyers are able to retain the value of the house once they’ve got it, they’re willing to pay the seller lots of money for them to leave.
Record low down payment options
The 2 biggest obstacles one must overcome in order to purchase their home is having decent credit and having the cash on hand to close on the property. The credit is its own conversation, I’m focusing on the cash for our purposes here.
Traditionally, you had to have 20% of the purchase price in liquid cash just for the down payment of the loan, not to mention the closing costs, which stack up fast. Your whole first year’s property tax upfront, application fees, attorney fees, home inspection fees, the list goes on. Part of what keeps the balance between a buyers and sellers market is there just aren’t a whole ton of people that have that kind of cash, especially when you can get into an apartment for the equivalent of 2 months rent upfront.
So, what are the banks doing? They’re offering options of 3-5% down, a USDA program that offers 0% down (call me, I’ll tell you all about it), and a whole slew of creative down payment options in between. They also offer Seller’s Concessions which allow you to borrow more money that the seller receives to use towards your closing costs, minimizing your out of pocket cost in ways that we have never seen before. To put that into perspective, if you’re putting 5% down on the loan, you only need 12-15% of the total purchase price in cash, before we even start talking about Sellers Concessions.
When the requirements are that low, the amount of willing ready, and able home buyers is astounding.
The most effective way to bid on any house is with plenty of cash down, a 750+ credit score to get you into a Conventional loan program, and a good deposit down on the house. Those 3 things used to be an absolute requirement, but now just puts you ahead of the pack, regardless of if you’re going up against 2 or 10+ other bids.
If you are not in that position, it is still more than possible to accomplish, but you stand a bigger chance of losing some bids along the way. I work with lots of first-time buyers, and all of my clients buy houses. They do not give up. It’s war out there. Much like everything else in life, it’s much better to try and fail until you succeed, than it is to sit on the sidelines and wonder why the world isn’t working out for you.
Record low inventory
This market has been like this for a while. People are cashing in on their investments by selling their houses for lots of money even though they didn’t necessarily plan to. At the end of the day, only so many people are going to have that motivation, or any motivation at all, to sell. Add to that the total sh*tshow of a year 2020 was, lots of people have been hunkering down, working from home, and overall not wanting to make such large life changes in such a tumultuous time.
For those homeowners who have the motivation/need to sell, there is a LONG line of buyers who want to scoop it up, and they are paying a premium. That premium, in combination with the 2 items we discussed above, is the thesis of this blog.
But what is “overpaying”? How does one define that? Let’s dive into that a little.
Hypothetically; I’m looking at a house that is asking $90,000, and all of the comparable sales lead me to believe that by paying more than $90,000, I would be “overpaying”. I decide to knowingly overpay $15,000 for a total purchase price of $105,000, using extra cash out of my pocket to cover the appraisal difference, ensuring that I win the house because it’s reasonable to think that it will only appraise for the $90,000 and no other bidder will come up with the extra cash out of their pockets.
In 12 months, the need for me to sell said house arises. In theory, it has appreciated some, call it $5,000, but I still paid $105,000, leaving a $10,000 difference. If in that year I had been renting for $1,000/mo, that would be $12,000 just gone, which is more than the $10,000 I leave on the table by selling the house for a loss.
Further to that point, once I pay $105,000 for that house and it closes, it becomes a comparable sale for all other appraisals and bidding strategies in that area, directly impacting the appreciation of the house I just “overpaid” for. If the need to sell doesn’t arise for 36 months, the neighborhood will still be appreciating, I will have been paying down the principal of the loan, and suddenly, I’m flush again, or maybe even ahead. The odds are more in your favor the longer time goes on.
A rising tide raises all ships.
This may not be your thought process, but it is apparent today that the people you are bidding against, have this thought process.
In conclusion, as a prospective home buyer, you must look at a bigger picture than has ever been looked at. You must be working with a real estate agent that is able to help you see that bigger picture, and is hyper-in-tune with what the market is demanding. You must be willing to understand that the people you are bidding against are getting more and more creative, daily.