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The Strategy of Underpricing Listings: The Price Is Right

Regardless if I'm working with sellers or buyers common questions circle around pricing. A continued pattern of homes being underpriced and selling for sometimes 150% of the asking price stirs up feelings in buyers and sellers alike. Still, given the economic model of supply and demand one must consider that the ultimate sales price for these homes is market value. Be that as it may, creating a feeding frenzy of buyers to seemingly boost a sales price up to market value tends to beg the question: Why not price at market value to begin with and take offers as written instead of the current auction-type environment?

Here's where psychology comes in to play. Back around 2010 in the doldrums of the recession someone got the great idea to generate interest and get buyers off the fence by listing properties for less than their value. And it worked! Buyers started buying again. Someone wanting something only when someone else wants it even has a name: mimetic desire. According to this article in Scientific American from 2012 (how timely!), "Mimetic desire is more than jealously wanting something because someone else has it. Rather, it's about valuing something because someone else values it." How better to demonstrate value than to offer to pay money for something -- at a time when people weren't typically throwing money at anything!

Flash forward to our current market and you might wonder why this strategy persists. I can see a couple reasons, one being that mimetic desire doesn't have anything to do with real estate or any other fluctuating market, it's psychological and carries its own baggage. In fact there have been local agents who have attempted to buck this trend (because believe it or not, some of us would also prefer a more measured market with realistic pricing). Multiple agents from a variety of firms (read: it wasn't a company practice) priced listings at market value and, knowing the trends, were vocal in their marketing to agents and buyers alike that the asking price was one the seller would accept. But no one wanted them. Those houses sat longer on the market and ultimately sold for less than the market would otherwise value them. Disappointed and with their proverbial tail between their legs, those agents fell back in line with the pricing strategy de jour.

So what else is happening besides the "I only want it if someone else thinks it's worth something" thinking? Well since the 2010-ish era buyers learned to tack on 20% or 30% to the list price when considering if they could afford the house. If a house is priced closer to market value and a buyer comes in and mentally increases the sales price by 25%, that home now feels overpriced -- even though it's really at market value already. It's a pattern that's ingrained in the minds of buyers who have been watching and participating in this market.

So, let's look at what tends to happen when you underprice a property and how it ends up with its ultimate sales price. When analyzing pricing for a property I base a home's potential sales price on recent sales of similar homes and the current market conditions. When looking to establish a listing price for that home I also consider the list prices of recent homes in the area because if buyers looking in that area are used to seeing houses priced under $800k, I could inadvertently reduce exposure by alienating potential buyers who now believe a house priced at $849k is out of their price range, or worse, overpriced. Still, my seller is hoping to get over $900k for their house, and I think it's possible. The seller agrees that pricing the property low to generate more interest is the route they want to go and sets an asking price of $789k. Skip ahead about 10 days to the date we're accepting any and all offers (come one, come all, come now, or not at all!). The strategy succeeds and we end up with 11 offers. What tends to happen is about half the offers will not be competitive in the least. In this scenario offers under $850k would be unlikely to receive any further play. Another 25% of the offers will be reasonable, possibly even strong offers, but they still end up knocked out of the game by the top 25% of offers. Typically there will be two or three very strong offers which are really the ones the whole game is geared toward; occasionally there will be one offer that is heads and shoulders above any other and ends the game entirely. All any property needs is that top 25%, those two or three offers that rose to the occasion, knew the market, bid accordingly, and possibly in accordance with an increasing market. The winning bid now sets a new value for the neighborhood and the next home listed will likely follow suit.

This way of pricing has resulted in benchmark sales which make sellers happy and is exhausting buyers (as an agent I can tell you that a price increase of $10,000 or $30,000 doesn't affect my commission in a way that has me planning any vacations -- even a weekend trip to Napa, but it is my job as a listing agent to get my seller the best and highest offer for their property). How do we get back to asking prices in greater accord with market value? At this point, your guess is as good as mine. It may take a psychological shift away from mimetic desires, and anyone who's spent any time in therapy can tell you those kinds of shifts take time.

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