Case Study: Should these MD buyers bid over the asking price?

Last summer, a buyer and their agent came to me with a property they really liked. Before they made an offer, though, they wanted to fully understand their options and the short- and long-term financial impact of each one.

What is the property's value?

We analyzed the automated value model (AVM) for this property. It was valued at $430,000 and rated a 4 out of 5 for value confidence.

Although the buyers really wanted the property, the value did not align when we looked at the comparables.

This property, although renovated, is smaller than the other properties listed. What matters is not how much the offers were for or how many offers came in, but rather what the actual data suggested the property was worth. The buyers ask, “What if this property doesn't appraise? How can I avoid overpaying?”

If you are willing to pay more to secure this property, the next thing you want to know is if the home will continue appreciating to recoup this investment when you sell it in the future. How do you determine if that will be the case?

Well, in this case, I walked the client through statistics on the macro level. National new household formation rates still outpace available inventory on the market, meaning residential real estate as a whole will continue to appreciate because there are just not enough homes for sale to meet the demand. But what about in Frederick County, Maryland, where this property is located? That’s when I dove into the micro level.

We looked at the Real Estate Report Card and saw that new household formations for this demographic are more than 3,100 while new homes being built are just above 2,000.

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So, in this location, the demand will continue to be higher than supply.

In the last 63 years, we saw a home appreciation rate of 4.48%. The following year’s projection was a 5.29% increase in appreciation. We know that homes have appreciated over the past six decades, and the data suggest that they will continue to appreciate. In this case, the target property is expected to increase its value by more than 20% in five years - mostly due to the steady demand for single-family homes in this area.

Knowing that they would see a return on this investment long-term was a huge lift off of the buyers' shoulders. But then they wanted to ensure they were not overpaying to secure the property. In other words, they wanted to know what their break-even point was on if they bid over the asking point.

At what price is it still worth buying this property?

Should you bid over asking?

Whenever you look at your financing options for a specific property, the question you're really asking is, “What is the break-even point for this investment?”

This is where I take the buyer through our Bid Over Asking tool. The current asking price for the home in this scenario is $429,000. If they overbid by $1,000 and the estimated value comes out to be $430,000, then they would break even immediately in terms of the sales price.

But what if we bid $430,000 and the property appraised at $400,000? If this property is only worth $400,000 and you bid $30k over its value, then your breakeven point is about 20 months.

Assuming you're going to be in this house for at least five years, you can see that the estimated increase in value would still make this a solid investment.

According to the Mortgage Bankers Association, owners will hold onto this mortgage for the next 5-8 years and they’ll be in the property for about 9-14 years. So when I use this Bid Over Asking tool with buyers, I recommend a break-even point of 24 months or less to allow for profit when they sell in the future.

In addition and to further plan out for a potential appraisal gap scenario, we built a total cost analysis. As you can see in the picture, we are comparing a buyer’s potential bid of $430,000 to the automated value (AV) and appraised value of $400,000. If this were to happen, we would have a delta or gap of $30,000.

We then took steps to validate that the appraisal gap was accurate (reconsideration of value and/or a second appraisal). If the appraisal gap still existed, then what are the buyers' options?

Here's how I explained the plan to my buyers:

• The traditional way to do this would be to add that $30,000 to closing, making the cash to close $133k instead of $103. But the reality is that most families don’t have that kind of cash to bring to the table, in addition to their down payment.

• We both know that the $30k is often better invested with an advisor like yourself as opposed to being invested in the actual mortgage. Why is this the case? Because properties appreciates but interest compounds. If the buyers have money invested and they are thinking of taking that money out of the market, it is something I like to work through with them and their advisor before they do it.

• A better option might be to adjust the loan amount. Rather than put 20% down, you incorporate the gap into your loan. Yes, this means they pay for mortgage insurance, but that is about $6 more each month.

Know Your Options

In this scenario, the buyer was delighted to have the options laid out in front of them. They were able to make an educated decision about their offer price, and ultimately, their offer was accepted and they got the house.

Buyers today are more educated than ever, and it is my job as the Lender to fill in their knowledge gaps and guide them through this large, long-term investment.

Who can benefit from the Bid Over Asking tool?

When you look at your database, I want you to identify clients who want to buy a new home but are nervous about jumping into the market. These tools are great for those types of buyers because it shows them with the numbers, arms them with information about the process and its possible deviations, and helps them plan for various situations.

All in all, this type of advice makes them feel more confident about their decisions, which makes the transaction smoother for everyone.

Once you have identified clients, feel free to send their scenarios to leo@anzoleaga.com so we can create their mortgage plan together.

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