What Happens When A Buyer Overpays for a Property?

What happens when a buyer overpays for a property?

As I mentioned in my earlier article "How to Use Comparative Analysis," real estate professionals use recent sales of nearby properties of the subject property to help consumers estimate the market value of the property. Often, however, buyers in some areas in Somerville, Cambridge, Arlington, downtown Boston, South Boston and Brookline have to pay way above the market value to win a bid, and often they are not the only ones who pay above market value (there are great regional differences within Somerville and South Boston). In many of my recent transactions of properties near the Red Line and Green Line, the winning bids offered the same price as a few other buyers, who all paid above "market value." In other words, those winners couldn't have won with a lower price because there were other people offering the same high price. There was no way they could have negotiated the price down given the other equally competitive offers.

Didn't all these buyers "over pay?" Why did everyone "over pay?" Is this practice fair to the buyers?

Let's examine the concept of market value. The market value is based on publicly available data of the sale price of the properties nearby. However, it could take 2-3 months for a property that goes under contract to complete the whole transaction and for the sale price data to go public. From the moment an offer is accepted, to the moment the contract is signed, until finally the property is delivered to the buyer, the realtors on both sides are not allowed to reveal the sale price of the property for the protection of both the seller and the buyer. This privacy ensures the best interests of both parties. And this means that for 2-3 months, no one (except the buyer, the seller, the realtors and the attorneys involved in the transaction) knows the sale price of the property.

However, during this 2-3 months many properties in the same area still go on the market and get bid on. The same buyers who bid and lost on the property could go on bidding for other properties that go on the market in that area. Often these buyers exhibit similar behaviors, bidding similarly (or more aggressively) as the recent bidding wars in that area. Only the realtors who do a lot of business in that area recently know what's going on.

This means that the so called "market value" as determined by the publicly available data, which is behind by 2-3 months, may not best predict the final sales price. Such data are not necessarily the best indicator of how much the property would sell for because it fails to take into account the consumer behaviors that occurred in the past 2-3 months. In a fast paced market like Boston real estate, where most good properties go under contract in a week after they go on the market, being 2-3 months behind is a big deal! In fact, during the peak season, 2-3 months could translate into a certain level of home price appreciation. The hotter the market, the more rapidly home prices appreciate and the more outdated the available data could become. This is why many recently sold properties looked like they got sold at a seemingly too high a price, but only 3 months later it looked like it got sold at a reasonable price or became a really good deal. Hind sight is always 20-20. Such rapid appreciation is also one of the reasons why some buyers are confident bidding very aggressively at the moment, believing that they will reap the benefit of appreciation later.

Here is how a rapidly appreciating market in Boston works:

Because Boston is a fundamentally low inventory market due to the scarcity of land, very few properties go under contract in a given time period. In fact between 2012 and 2017 the number of condos that went under contract has been dwindling. Because so few properties go under contract, any single property that gets sold can become a new benchmark. Because realtors use the sales comparison approach to calculate market value, taking into account all nearby properties that go under contract in recent months, any properties that fit this criteria will affect the market value. Therefore, when not just one property but multiple properties in a rapidly appreciating neighborhood get bid up to way above market value, they actually become the true "market value" because they become part of the important data for analysis, using the sales comparison approach. In this sense, it is not hard to understand why the appreciation has been happening so rapidly. You can't have it both ways. One of the reasons why it's so hard to win a bid in that particular neighborhood is because it's very desirable. A desirable neighborhood is always going to have aggressive bidders. Some would argue that some neighborhoods are just worth paying for, no matter at what point in the market cycle.

Is it wise to pay a certain price for a property that you are looking at? An experienced realtor can advise you about the price and available data. There is only so far you should go as far as bidding competitively, and only an experienced realtor who has personally dealt with recent transactions in that market can best help you predict the best winning price. We try to save our clients money whenever we can, and there are some creative strategies that can help you win in the best way.