Congrats, you found your dream home and you’re ready to make an offer. Only one problem… how much should you offer for the home?
Go too low in a seller’s market — where home prices are rising fast and inventory is lower than normal — you risk losing out on the home you want or, worse, find yourself knee-deep into a bidding war. If you go too high and you risk stretching your budget beyond your comfort zone.
Plus, if you offer more than the home is worth and you plan to get a loan from the bank, you will have cash issues. Banks only loan a certain amount of a home’s value (determined through an appraisal) or the agreed upon offer price, whichever is less. This could leave you responsible for covering the difference, getting the seller to come down, or having to walk away after a month-long process.
How do you find the right amount to offer on a home?
In this article, I will show you exactly how a home’s value is determined, and then how you can take your unique needs to make an offer that will win and that you can feel comfortable with.
But first, I want to dive into a few ways that you should NOT determine what price to offer.
Over the course of this article, we’re going to use a few real estate terms that you may or may not be familiar with. I have done my best to remove all jargon, but some is inevitable. I’ve gone ahead and listed some of these words. If you’re reading something below and don’t quite “get it,” visit this box to see if understanding a definition might help.
- List Price or Ask Price: The amount of money an agent and seller want for the home. It’s the amount you see on sites like Zillow or Realtor.
- Offer Price: This is the amount a buyer wants for the home and has an agent present to the seller. It could be less than asking price, higher or equal.
- Fair Market or Home’s Worth: This is the price of a home that a professional appraiser has determined through comparing it to similar homes in the area.
- Sale Price: This is the agreed amount between the buyer and seller. For the buyer, it’s the price in which they have agreed to purchase. For the seller, it’s the price in which they have agreed to sell.
- Comparable Market Analysis: The method which appraisers, banks, and realtors use to determine home much a home is worth.
- Absorption Rate: The number of months it would take for agents to sell all of the homes on the market at their current sales rate. A balanced market is usually 6.
- Days on Market: The number of days the home has been listed “for sale”.
- Value: An economic term to describe the usefulness of a product or service. It’s a subjective amount and differs from person to person. Said in a question, “How much is something worth to you?”
- Price: The amount money it would take to exchange value. In an ideal market, price and value are equal. Said in a question, “How much does this cost?”
How You Should NOT Pick Your Offer Price
I wish it weren’t so, but we’ve become obsessed with hacking life. That can be demonstrated by the proliferation of fitness articles that shout “You’ve Been Doing This Wrong All Along!” or the nutrition articles that scream, “What These World Travelers Discovered About a Tiny African Fruit During Their Time With Natives Will Shock You and Your Immune System.”
And we’re sucked into clicking because we want to know how to improve our lives. All of these hacks promise to make our life better with less effort. It’s an irresistible offer.
But they’re not limited to the fitness, productivity, or learning space. They exist in real estate too.
There are a lot of tools, tricks, and rules of thumb that try to simplify the process for determining an offer price, but all of them lead buyers down a dangerous slope.
Here are three ways you shouldn’t choose your offer price:
- A set percentage below the asking price, typically based on local market data.
- Using Zillow’s Zestimate.
- What you feel like paying or think a home is worth.
Offering a Percentage Below the Asking Price
Every so often I get a buyer who wants to know “what percentage below the asking price should we offer?”
Often, they’re hoping I would say something like, “three percent.” So if the asking price for a home is $200,000, they want to be able to offer $194,000 ($200,000 – [3% * $200,000] = $194,000). If the price is $250,000, then the offer price should be $242,500.
This method was birthed from someone making incorrect conclusions in an effort to make real estate simple for home buyers. Someone likely looked at data like the charts below:
The chart on the right shows the median list price and median sale price for homes sold, represented by the green line and black line respectively. For example, the average home that was sold in December of 2016 was listed (the amount the seller wanted) for $153,000 and sold for $147,000 (the amount to which the buyer and seller agreed).
When you divide the list price by the sold price, you get a list-to-sold ratio. If we take the December 2016 data, we get an average list-to-sold ratio of 96 percent ([$147,000/$153,000] X 100).
If you analyze the real estate data over the long-term (month-to-month over a few years), you will see that homes that sell tend to sell for around 96 percent of the list price.
This can be represented by the chart on the left. The lower black-line shows the sale-to-list ratio for the original list price. The goldish line shows the sale-to-list price for the list price before it sold.
The chart on the right is saying, if a home was originally listed at $225,000 and sold in October 2017, then it sold for $214,875 or 95.5 percent of the original list price. If, however, the list price was reduced to $225,000 and sold in October 2017, the sale price would be $221,625, or 98.5 percent of the list price.
It’s the data from charts on the right and left is where the rule of offering a fixed amount below asking has come from.
All of this data looks and sounds good, but there is one major issue. The data only looks at the median list-to-sold ratio for sold homes. The keyword is sold homes. If we try to apply the rule to all homes on the market, we’re ignoring the data from homes that don’t sell because they are priced too high.
This is referred to as survivorship bias. It’s a logical error of concentrating on only the home that made it past a selection process and overlooking those that did not. In this case, the selection process was whether or not the home sold.
The bias leads people to believe that we should offer a set percentage below list price. If we only look at homes that sold and use the fixed percentage rule, then we’re likely to overpay for a home.
Listen to this widow’s story:
The “mistake” she is referring to is making a fixed percentage offer. Her story highlights a critical assumption that buyers make when asking the question, “what percentage under asking should I offer?”
The widow assumed that the list price was right and decided to offer a fixed percentage. But a home’s asking price is influenced by more than market dynamics or what a bank determines a home is worth.
Sellers Have Their Own Motivation
I’ve had my fair share of clients who want to list their home for way more than the it’s worth. There are a dozen reasons they might want to do this.
For example, sometimes a seller believes that because they put money into repairing the home, decorating, and painting walls that they should be able to recoup all of their money. I hear statements like this all of the time, “we bought the home about two years ago for $175,000 and we did $30,000 worth of work — from landscaping, to painting, to removing all of the carpet so we think the home is worth $205,000.”
They believe that by putting $30,000 “into the home” they should get $30,000 back but not every repair or update adds value to a home. Convincing a seller of that can be a challenge and many don’t have the chops to tell a seller otherwise, so they list the home for more than it’s worth.
Second, sellers often have emotional ties to their home. This is an example of where value and price can differ. Some sellers believe their home is worth a lot because of the value the home has created in the life of the homeowner — from memories of raising the four kids to a place to live for 25 years.
Third, it’s possible the seller needs a certain amount of money to pay off their mortgage and other expenses. While the market has improved since the crash, there are still homeowners underwater. I run across some every so often.
Lastly, there is the homeowner who is convinced their home is worth a certain amount because a home down the street sold for “this much.” Every homeowner believes their home is worth more than their neighbors.
It’s important to understand that a list price is just an asking price. A large majority of the time the asking price is determined the the needs of a seller and offering a fixed percentage could lead you to grossly overpay for a home.
Real Estate Agents Have Their Own Motivations Too
Blame can fall on the agent too. A few agents overprice a home based on their own motivations. They do it so they can win a listing.
Shoot, I probably have about 10 percent of my potential clients hire another agent because the agent convinced the homeowner they can sell it for more. A homeowner wants to hear and believe the highest value for their home.
If I come in and say a home is worth $175,000 and another agent says it’s worth $190,000, then there is a good chance I’m going to lose the listing.
Some agents believe it’s better to win the listing and put a sign in the yard so they can free advertising than it is to sell a home. They tell themselves, “it’s fine if the house doesn’t sell because I will generate buyer leads from it.”
Even though I don’t play that game — I believe it’s better to get a sold home than a listing — a few agents do and that means there are plenty of overpriced homes on the market.
Second, there are some agents who have no clue about pricing. Either they’re new or never took the time to learn about how to price a home. Becoming a real estate agent in Michigan is easy. Take a 40 hour class and pass a test.
But becoming a good agent is much harder.
Inexperience and an agent’s motivation can cause a house to get listed for more than it’s worth; making a fixed percentage a bad way to determine a home’s offer price.
Using Zillow’s Zestimate
I have to make a disclaimer before I dive into this section. For some reason, there is a lot of animosity around agent, home buyers, and Zillow and I don’t get it. This section isn’t intended to point out all of the flaws of Zillow and make you feel dumb for using it — like many agents do.
I’m not the kind of realtor that feels threatened by Zillow, the giant technology and media company. Nah, I’m confident in my services and I understand where I (and Zillow) fit in the market.
In fact, I love Zillow for setting a new standard in the market; one that gives more power and information to buyers like yourself. The homes available for sale no longer need to hide behind the clutches of agents who are constantly trying to generate new business and sell. Now, you can search for homes in privacy and in a non-threatening environment.
Plus, it’s great working with more educated and informed buyers. Heck, it’s why I write content on this site and why I got my book published. I’m not going to try to desperately cling to the old way business was done — where I have all of the information and you have none.
As much as I love Zillow, it’s not perfect. Specifically, their Zestimates creates a lot of headache and false beliefs. And Zillow knows this, because unlike the proverbial man, at least they can admit when they’re wrong.
Here is some text pulled from Zillow’s website on their Zestimate:
Within 5% Of Sale Price:
This is the percentage of transactions in a location for which the Zestimate was within 5% of the transaction price. Nationwide, Zestimates are currently within 5% of the final sale price 54.4% of the time.
Within 10% Of Sale Price:
This is the percentage of transactions in a location for which the Zestimate was within 10% of the transaction price. In the U.S. as a whole, Zestimates are currently within 10% of the final sale price 74.5% of the time.
Within 20% Of Sale Price:
This is the percentage of transactions in a location for which the Zestimate was within 20% of the transaction price. Nationally, Zestimates are currently within 20% of the final sale price 86.9% of the time.
Let me break down what this saying. It’s saying that the Zestimate is within five percent for 54.4 percent of the homes that sell. Meaning, for every 100 homes that sell for $200,000, only 54 homes have a Zestimate between $190,000 and $210,000.
Another 20 homes fall within $180,000 and $220,000 (10 percent of sale price), 13 homes sell within $160,000 and $240,000. The remaining 13 homes have a Zestimate that is higher than $240,000 or lower than $160,000.
Meaning: Zillow’s Zestimate is highly inaccurate and should not be relied on for determining how much to offer.
Offering What You Feel Like
Just like sellers have their own motivations and set the price based on how they feel, it can be easy to do the same thing.
You walk into a home and see ugly wallpaper so you immediately take $10,000 away from what you’re willing to pay. Or you hate that they have rose bush in the front yard. This sort of stuff is usually accounted for when an agent lists the home for sale.
Offering what you feel like will either grossly undervalue the home, causing you to lose out on the home, or it will make you over pay.Even though the process to buy a home is very emotional, at the end of the day, this is a business deal. It’s transactional and what you pay is mostly based on market forces with a few emotional influences.
The right price to offer isn’t based on what you “feel” like a home is worth, how much you’ve been pre-approved for or feeling like you should leave room for negotiating.
So with that said, what is the best way to determine the offer price?
How A Home’s Value is Determined
A home’s value is determined by two economic principles: a determination of value — typically referred to as a comparative market analysis or home value analysis — and market dynamics. These two principles provide the foundation we need to understanding the value of a home and what we should ultimately offer.
We’re going to dive deep into how to perform a home value analysis (HVA) to determine the value of a home and then look at some of the market dynamics and forces that will help us shape our offer price.
Performing a Home Value Analysis
When a real estate transaction takes place, two things are revealed: what a buyer is willing to pay for a specific home and what a seller is willing to sell it for.
If we take a high number of completed transactions in a short period of time, then we can determine with a high level of accuracy what a buyer is willing to pay for a specific home and the amount for which a seller is willing to sell any home by comparing it to the past sales.
Said another way, the price of a home can determined by comparing similar homes — location, style, size, etc — that sold in the last three to six months to the home that you want to buy. In a homogeneous neighborhood with a high density of homes selling in a short period of time, determining the home’s value is relatively easy.
For example, if there is a 150-condo complex where four similar units — same bedrooms, baths, and square footage — sold in the last six months, we can determine the value of any other condo unit in the complex by averaging the sale price of three or more of the condo units.
Let’s say you want to buy Condo A and you’re wondering what to offer. Condo B, C, and D sold for $200,000, $205,000, and $204,000, respectively. We can get the average by taking the sum and dividing it by the number of units.
In our case, the total is $609,000. When divided by the number of units, three, we get an average price of $203,000. So when determining our offer price we should offer around $203,000.
The key to determining an offer price through a home value analysis is finding comparable homes. As long as we’re in areas that are densely populated and homogenous, we can price with confidence. The type of areas that tend to fit this description are condos and larger subdivisions like Mayberry communities.
Picking Your Comparables
In our condo example, finding the comparable homes was easy. We simply picked other units in the condo complex. No matter the home you want to buy, the principle is the same, start by finding very similar homes to yours that sold in the last three to six months. We will refer to these very similar homes as comparables moving forward.
Beth Graham, at BGAppraise had this to say about comparables:
When appraiser’s do their research for developing an appraisal of a property, we consider the market for that type of property. What is the typical buyer for this property looking for and what are the options for that buyer in this market area? Does the buyer want a water front home, a large home for many family members, acreage, etc.? Once I determine the market, I search for the comparables available in that market area with those features. I attempt to compare “apples to apples” i.e. water front with water front, acreage with acreage, pools with pools, etc. I use the MLS, Zillow and other available online tools to help me find available sales to analyze and develop a reliable opinion of value.
These are the three rules to we use to find good comparables.
Rule #1: Pick the same style. For example, if you’re looking to buy a condo, you should compare your home to other condos. If you’re looking to buy a cape-cod in downtown Lansing, you should find other cape-cods.
Rule #2: Location, location, location. Select homes that are as close to the address of the you’re considering buying. Try to use homes that are within a quarter- to a half-mile. In rural areas, you may have to expand this to a mile or two.
For example, if you’re thinking about buying a home in Allison Oaks in Lansing then you should use homes in Allison Oaks. You shouldn’t be looking at homes in Okemos to help or in Grand Ledge.
However, there are exceptions to the rule. For example, a home might be around the block but be in a different school district. This is common on the westside of Lansing and East Lansing.
For example, there are areas that reside in Delta Township but are annexed by the City of Lansing. Some of these neighborhoods are in the Grand Ledge school district and others in the Waverly School District. Below is an example in the Cambridge Manor, Walmar Estates, and GrandWoods Subdivision.
You have to have a good understanding of school district lines, taxable authority lines, and city lines. GreatSchools is a good tool to use for finding district lines. You can type in the address for the home you’re thinking about buying and see the district lines. You can also use the drop down menu to change school districts.
Use the map to make sure the homes you select are in the same school district of the home you want to buy.
Rule #3: Within 10 percent of square footage. For example, if you’re thinking about buying a home that is 2,000 square feet, all of the homes that you pick should be within 1,800 and 2,200 square feet (2,000 – [2,000 *10%]) or (2,000 + [2,000 *10%]).
If you follow this process, you will have a small number of homes to use as comparables. There is a high chance that you have more than three, so you will need to look through the homes to find the best three.
This is a subjective decision but they should be as close to the home you’re buying. Good ways to filter further are through bedroom count (make them the same), condition of the interior, and the number of bathrooms.
But what if you can’t find three exactly similar properties? Maybe it’s in a different school district, the square footage is off, it doesn’t have a garage, the basement is finished, or any number of things.
It’s rarely the case that we find homes that are exactly similar. Often homes have an extra bathroom, more or less square footage, finished basements or not, and other amenities, like a deck.
What do we do then? We still select these homes, but if we took the average there is likely to be a higher margin of error. Meaning, we won’t be able to rely on the value we determine. It’s no better than just picking a fixed percentage below asking.
To account for these differences, we make what we call “adjustments.”
Making Adjustments To a Home
Adjustments are made to properties to correct for minor differences in comparable homes. Most adjustments are considered “opinion.” This is the art part of finding how much a home is worth. It’s this subjective opinion that causes appraisers to come up with different values for your home.
For example, if the home we want to buy has 2,000 square feet and a comparable home has 2,100 square feet, we should consider making an adjustment to the comparable property. As a rule of thumb, adjustments should ONLY apply to our comparable properties NOT the home we’re considering buying.
Depending on the features — positive or negative — we may make a positive or negative adjustment. If a comparable lacks something that the home we want to buy has, then we will make a positive adjustment. The opposite is true for features our comparables have.
For example, if a $200,000 comparable lacks a deck but the home we want to buy has one, we would add $5,000 (chosen adjusted value for deck) to the comparable sale price. Giving us a new sale price of $205,000.
You can see an example below:
The more adjustments that are needed for our comparables, the less confident we can be in our pricing and the larger the variation. Meaning, if you hired 3 different appraisers and many adjustments are needed, you’re likely to see three very different results.
Want to try this on your own? I’ve created a spreadsheet to help you find an offer price on your own or to learn how adjustments can make a difference.
Determine an offer price with this spreadsheet.
The spreadsheet will help you find a ballpark price, but shouldn’t replace the use of an agent. It takes experience to make the right adjustments and comparables to produce an accurate price. If you’re looking for an agent, see if we might be a good fit.
The Effect of Market Dynamics
Once we’ve picked our comparables and made adjustments, we need to understand where the market is, where it’s heading, and how the home we want to buy is performing in the market.
Let’s say you calculate a fair market value of $218,000 for a home and the seller is asking for $221,000. What do you do? Do you offer your price? Meet at the middle? Or something else?
Well that depends on some of the market data and how the home is performing.
Every home on the market is communicating something. It’s communicating that it might be overpriced or that it’s underpriced. For example, a home that has been on the market for 180 days, and where all comparable homes are selling in 45 days, tells us the home is overpriced or has something wrong with it.
Here is a flowchart to help you make your decision. Answer the questions to determine what price to offer.
Considering More Than Price
You might think with all of that, we’re done. Almost.
We’ve calculated a “fair market value” but we haven’t taken into account your unique needs. For example, do you need the seller to pay for some of the closing costs? Will you be buying the home cash and closing in two weeks?
When you make an offer, price is only one component. We have to look at: (1) Contingencies or clauses that allow you to exit a contract without any financial obligation, (2) inspection costs — sometimes you can get a seller to pay for these — (3) the closing date, (4) how you will fund the purchase of your home, (5) if the seller will pay for closing costs (6) how much you will put down as an earnest money deposit, (7) and anything else that might come up.
For this reason, whenever I sit down with a buyer to write an offer, I talk about offer price last. Depending on what we’re asking for in our terms, we may need to increase our offer price if we want our offer to get accepted.
Let me give you an example: assume we’ve determined an offer price of $218,000 but you need the seller to pay $3,000 worth of the closing costs (called concessions).
We could try to offer $218,000 with concessions, but there is a small chance that the seller will accept it. That’s because you’re asking them to sell the house to you for $215,000 because the seller has to pay your $3,000 in closing costs.
Instead, we typically need to increase our offer price to $221,000. This would allow the seller to get the $218,000 out of their home. We add concessions to our offer price to put ourselves on a level playing field as someone who write an offer without concessions.
The more we ask in terms, the more we have to give in our price. The reverse is also true. The less we ask for the less we can give. For example, if we need seller’s concessions, a specific closing date, and add contingencies beyond the normal, the seller may want a price higher.
That’s not to say you can’t get everything you want and that you have to compromise, but economics tells us that we have to give in order to get. This is an exchange of value.
Our final offer price will be a reflection of the fair market value and then adjusted for your unique needs so that your offer is attractive and gets accepted by the seller.
How Much Should You Offer?
I wish I could give you a simple rule to follow, but the reality is that it’s much more complicated than a simple rule of thumb. I’ve done my best to break it down and explain the process to you so that you can come up with a number that you believe is right.
If you’re looking for a specific recommendation for YOUR situation, I’d contact your agent.
Alternatively, you could call an appraiser. An appraiser will cost you about $400 out of pocket. They will help you determine with a high-level accuracy what the fair market price for a home is.
However, they won’t be able to advise how much to offer if you want concessions, would like your offer to get accepted or need some other terms in your contract.
Every situation is different and that could influence the offer price beyond the fair market value.
Plus, you will have to pay the cost of two appraisals. One will help you make an offer and the other you will be required to pay for if you plan to get a mortgage. A lending company won’t accept the appraisal you paid for. They will need to use their own appraisers.
On the other hand, an agent is nearly free. They often only costs a minimal brokerage fee. Around Lansing, this might be nothing or as high as $400. The benefit of an agent is that they can help you determine the fair market value and advise on the terms of the offer. Plus, they will help you get all the paperwork together.
For the same price to hire an appraiser, you could hire an agent who will determine a fair price and help you make an offer that will get accepted and that you feel comfortable with.
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