What is the result of too many buyers and too few homes? Bidding wars. Bidding wars are financially advantageous to sellers and disadvantageous to buyers.

As you sense, it’s a seller’s market, and thus a seller’s game for the moment. Commonly, a seller’s agent will tell buyers’ agents they have offers that haven’t been presented yet – even when they don’t have an offer. Why do they do this?

To ignite a feeding frenzy.

When this occurs, buyers are forced to bid blindly, not only against phantom buyers and hypothetical prices, but against themselves. They are told to come back with a better offer, quickly escalating prices.

For example, a buyer initially bids $250,000 on a home. The seller’s agent then asks if that price is the buyer’s best offer, stating there are “other offers coming in.” Impulsively, the buyer bumps their bid up to $260,000. The buyer is then told they have won the bidding war.  Later the buyer discovers their initial bid of $250,000 was higher than all other offers. Thus, the buyer unnecessarily overpaid for the property by $10,000.

How are buyers to know that their agent is not colluding with the seller’s agent in order to hike up their commission? The payoff of a higher purchase price is small, especially compared to the referrals a satisfied buyer brings in. Ultimately, a $5,000 bump in price is unlikely to add more than $150 to the agent’s commission.

first tuesday insight

All this conduct is a nasty byproduct of the games lenders use in the disposition of their REO properties and treatment of offers.

Buyers in a bidding war easily become desperate, displaying knee-jerk reactions rooted in fight-or-flight, instincts. A buyer’s agent best fulfills their duty by protecting buyers from their animal instincts and reminding them the purchase of property is fundamentally a business decision, not an emotional one.

Nearly two thirds of potential buyers report they are willing to use aggressive tactics to attain their ideal property, per the Trulia Summer 2013 American Dream Survey.  41% fear mortgage interest rates will rise and 37% fear home prices will rise before they are able to buy. Sounds like business on Black Friday.

Related Article:

Summer 2013 American Dream Survey

What accounts for this frenzy? In large part, heavy real estate speculator activity has temporarily made inventory appear scarce.

All too frequently, speculators acquire properties with below market bids. Their successful low-priced acquisitions are due primarily to no-contingency offers, large cash reserves and collusion with seller’s agents.

The other side of this disequilibrium is a below normal level of end user buyers – some of whom are increasingly eager to beat the speculator to the inventory.

Together, speculators and agitated end users have driven the current rise in home prices. This crowding, paired with a near normal new monthly supply of available housing for sale, is forcing multiple bids to be submitted the instant a property hits the MLS, or when the for-sale sign goes up.

Mortgage interest rates are said to also be bottlenecking the marketplace, but history tells us that rising rates reduce competition, not the other way around. This translates to fewer buyers and a drop in mortgage originations in real time.

Fierce competition and bloated purchase prices await buyers unwilling to wait out the bidding war season. Bidding wars bloat purchase prices beyond initial asking prices, both figures exceeding fair market value (FMV) for a property. For an explanation, listing prices are set by seller’s agents at around 10% over market. Further, consider that nearly half of winning offers reviewed by Redfin nationally came in above asking price.  

The result of these bloated purchase price conditions is a larger down payment. Why a larger down payment?

Lenders considering an application for a purchase-assist mortgage not only need to qualify the buyer as creditworthy. Lenders also need to qualify the property as security for repayment of the loan – collateral.  As security, they rely solely on an appraisal to establish the property’s current value. Any difference between the buyer’s high price offer and the value of the property set by the appraiser is left to the buyer to handle (read: foot the bill).  Seller’s agents have learned not to budge once the price has been set by a binding purchase agreement.

But remember: a house is but a house. There are hundreds of thousands of them, and hundreds of neighborhoods for selection over the period of a year. The home sales market is very fluid and predictable over the long run. Around 0.4% to 0.5% of all homes come onto the market monthly, per the U.S. Census Bureau 2011 American Community Survey. Watch the new listings for several months and calculate for yourself.

When it’s time to buy, the trick for the buyer is to determine what their best reasonable offer is. Bid too high in a momentum market (read: today) and if the buyer wins, they suffer buyer’s remorse as the market settles down. Bid too low and the buyer is left to regret not making a higher bid when they had the means to do so. Sounds like 2005, from an observer’s position.

Agents need to help buyers zero in on the sweet spot — before a specific property is located, released into MLS and emotions run high. Remember — the buyer’s agent’s duty is to secure the lowest possible price for the property most suitable for their client’s needs.

Related Article:

A speculator by any other name

How do you best represent your buyer? Grab the seller’s attention. Establish a relationship with the seller and seller’s agent by:

  • calling, and if they do not respond, visiting the seller’s agent to question them about the terms most important to the seller;
  • delivering the buyer’s offer in person,  establishing rapport for the deal with the seller’s agent (or the seller) by going eye-to-eye when the deal is important;
  • providing a personal letter to the seller, written by the buyer, which accompanies the offer (more than a quarter of winning Redfin offers were accompanied by a cover letter); and
  • presenting documents on the buyer’s proof of funds and loan pre-approval, both current within 30 days.

Related Article:

Buyers get personal with a letter to the seller

Make a strong case for the buyer’s financial situation by:

  • requesting the buyer’s loan representative contact the seller’s agent to vouch for the strength of the buyer’s financing; or
  • offering for the buyer to be pre-approved by the preferred lender of the seller’s agent (then submit loan application(s) to the best lender(s) after the offer is accepted).

Related Article:

Advice for buyer’s agents

Refrain from dirtying up the offer by waiting until escrow is opened to make requests for:

  • little fixes; and
  • personal property  items the buyer wants to acquire with the home.

Cautioning buyers about the dangerous bidding war mentality helps to guard them against making impulsive financial decisions they will most likely come to regret – and potentially resent you as the agent for it.

Re: What’s your agent’s duty to you in a bidding war? from the Washington Post