Why Does The Under-Pricing Strategy Work?

Opinion | June 29, 2020


Years ago, I was seeing a specialist for a chronic back issue, and his methods, techniques, and philosophies were somewhere between new-age and old-world, if that makes sense.  He wasn’t working at one of the typical physiotherapy factories that were so prevalent in the 1990’s and 2000’s, but also wasn’t looking to cure what ailed me by smudging the room with sage and then spreading mud on my back either.

One of the first few times I was there, he said to me, “Can you try to wiggle your middle toe on your left foot?”

The concept was interesting.  Why?  Why that toe?  Who knows.  Regardless, I changed my focus from feeling what he was doing to trying to find that toe on my left foot and wiggle it, without moving the others, and then CRRRACK!

He cracked my neck.

A “manipulation,” for those in the know.

And the reason he did this successfully was because I didn’t expect it was coming.  I had no idea, and even if I did, I was busy trying to figure out how to wiggle my goddam middle toe.

You would think he could never catch me off guard like that again, but he did.  Over and over.

When the patient knows the manipulation is coming, they tense up, and it doesn’t work; at least not as well, if at all.

While he didn’t do this particular manipulation every time I visited, he did it very often.  And by the time I had been there a dozen times or so, I kind of knew when he was going to try it.  When he asked me to do something odd – akin to wiggling my middle to on my left foot, and along with the change in his tone, I just knew.

After that, it ceased to work.

There’s only so many times you can fool a patient with the same trick.

So why then, as we segue into a conversation about real estate, does the age-old “trick” of under-pricing a property, holding-back offers, and then selling for more than fair market value, continue to work, time and time again, after nearly two decades?

In late-March, after the Ontario government declared a state of emergency, the way real estate was being sold in Toronto drastically changed.  No longer was every property being priced-low with an offer date, as the buyer demand just wasn’t there.  Fast-forward to the end of June, and we are right back to where we started, and some segments of the single-family freehold market are hotter and more expensive than in February/March.

Last week, we talked a little bit about multiple offers and under-pricing, but after having a few conversations with agents, buyers, and a couple of readers who emailed me, I realized that even after having written dozens of blogs about this topic, I’ve never really dug down and started from the bottom.  Why under-pricing works, how the process takes place, but more importantly who are the players.

The “who” is key in this examination, because as a reader, you may identify yourself, or you may be completely obvlivious.  And that is exactly the problem.

Let me start with a recent example.

A house in Leslieville was listed for $1,329,000, and it attracted 18 offers.

A friend of mine from another brokerage, who we’ll call Ashley, told me she had an offer, and asked me what I thought it was worth.

“What’s it worth?” I asked.  “Or what’s it going to sell for?”

The house was gorgeous, but not without drawbacks, like every other house out there.

“Value-wise, it depends on the buyer,” I told Ashley.  “But regardless, this is going to $1.7M, no doubt.”

She said she figured as much, and her clients were mulling about an offer in the mid-to-high-$1.6M range.

“They love it, but not enough to pay anything,” she told me.

Ashley’s clients ended up offering $1,682,000, and after the top three offers, out of eighteen, were sent back to improve, they came up modestly but ended up losing to a bid of $1,711,600.

This house is worth $1,711,600, according to the saying, “A house is worth what somebody is willing to pay for it.”

But had these sellers listed at $1,711,600, with offers any time, I don’t believe for a second that they would have sold the house.

So why does this happen?

Why does this this hollow, obvious strategy always work?

You know how the process goes, and you know how it ends.  But let me identify the players involved and label them accordingly, so that you may finally see why we always finish up where we do.

Consider that, with respect to this house listed for $1,329,000, selling for $1,711,600, even a person in the 28th percentile of knowledge simply must know this is going to sell for, what, maybe $1,650,000, at a minimum?  To not know this is to be completely oblivious, in denial, irresponsible, and just downright stupid.  And I’m not trying to be mean here, but for the love of God, this isn’t rocket science here, folks.  Look at comparable sales, talk to the listing agent and ask about the action on the property, ask your colleagues at the office – this isn’t difficult.

Now in the context of “the players” involved in the offer process, I’m going to use these numbers for our example, as we move through the list of people making offers on offer night.

Here’s how I see them:

 

Novices.

As the defintion explains, these are people that are new to the process and inexperienced, but they are not to be confused with “beginners,” as I will explain in a moment.

Novices could be further divided into categories, since some of them are novices because they just started their search, and some of them are novices because they, or their agent, are standing in the way.

Novices aren’t always new to the game, but rather they’re often buyers who don’t learn, don’t gain experience, don’t evolve, never move forward, and continue to display all the traits of a person who just arrived in the city of Toronto for the first time, and has zero understanding of the market.

So while some novices are merely out-of-towners, and/or have the proverbial out-of-town agent with no clue what he or she is doing, and some novices are local buyers who are just starting out, some are long-time buyers who just can’t get past themselves.

A Novice offers the list price, with conditions, amid 18 offers.  Maybe more, who knows.  Maybe $1,345,000 on $1,329,000.  But that Novice never stops to ask him or herself, “Is there a chance that 17 offers are less than $1,345,000?”  Because the Novice lacks that logic and critical thinking.

Beginners.

Beginners are not Novices.  To be kind, Beginners are one step above.  However, Beginners also will never be successful, becasue they label themselves “beginners” and actually have zero expectation of being successful.  Why do they bother, you ask?  Good question.

The agent for the Beginner submits the offer and says, “This is my client’s first offer,” since he knows it’s a bust, and doesn’t want the listing agent to think he’s a bum.  I’ve written about this before as recently as last week.

The Beginner seems to think that this is a process.  That they should make a terrible offer on their first offer, then a less terrible offer on their second offer, and so forth, until they’ve worked their way through a process that they feel makes sense.

When I meet with a buyer for the first time, I am incredibly blunt about the Toronto real estate market; specifically the freehold market.  I will tell them, “It’s brutal.  It’s miserable.  You will feel every emotion out there.  But I’m going to educate you, guide you through the process and help you navigate this difficult market, and you’ll immediately avoid the trap that most buyers fall into – submitting loser-offer after loser-offer.”

In the context of that $1,329,000 house that’s going to sell for $1,700,000, I will tell my buyers as soon as I email them the listing, “This is a $1.7M house.”  If they want to offer $1.4M, I will tell them it’s a waste of time.  Rarely do my clients take this stance, but that’s because they know better.  But other agents string the buyers along, and that’s why, when you have 18 offers on a $1,329,000 listing that’s going to sell for $1,700,000, you end up with offers of $1,345,000, $1,360,000, $1,400,000, etc.

Deniers.

Deniers exhibit traits of the Novices and Beginners, but they’ve usually been at the search a lot longer.

Deniers may have started out with more enthusiasm, and eventually become disenfranchised.

Deniers seek out negative headlines, opinions from market bears, and love talking to the guy at work who has been predicting the real estate crash for a decade.

Deniers do make offers, but they’re always terrible offers.  Unlike the Novices, who lack experience and guidance, and unlike the Beginners, who “just want to submit the offer to see what the process is like,” the Denier has experience, but doesn’t want to believe that the current market conditions are real.

The denier says, “I don’t believe for a moment that this house will sell for TWO HUNDRED THOUSAND DOLLARS over the list price,” and thus submits an offer for $1,500,000, which isn’t exactly the list price, but also never had a chance.  The denier creates a world in which his or her vision of the market, and the offer process, is real.

The Denier is smart, well-educated, and with it.  But the Denier is putting frustration, anger, bitterness, jealousy, and resentment ahead of true desire – that of owning a home.  Many Deniers have been active for years, and have ridden the price curve upwards, but continue to make offers that will never be in the ballpark.  Of course, the Denier doesn’t see the irony in that, ie. the fact that had they made a ‘real’ offer two years ago, they’d have paid far less than the price of their dummy offer today.

In the context of this example, the Denier is the one offering $1,480,000 or $1,500,000, but will die shouting, “This house can NOT sell for more.  It just can’t.  It’s not worth it.”

Losers.

This is not intended to be used in the derogatory term, ie. you calling another kid at school a “loser” because you don’t like him.  This is simply meant to say that these buyers, for whatever reason, will always lose.  The prices they offer, the value they see, the leadership and guidance they do or don’t receive – it’s never going to work.  Ever.

Losers often do become Winners, but as with the Novices, they can also remain Losers for extended periods of time, through fault of their own.

Losers often start off as Deniers, and then take the next step toward buying a home, but can’t quite get to the level where they’ll need to go, in order to be successful.

In the context of this example, the Losers are offering in the mid-$1.5’s, which sounds like a lot, compared to the list price, but just never has a shot.  If they had stronger representation, who would either stand up to them and tell them their offer has no chance, or, would better educate them based on comparable sales, they would avoid months of heartache and disapointment.

Aggressors.

Aggressors are “Winners” when the market is warm, but not when the market is hot.  Aggressors put forth very good offers, but never great offers, which are needed to be successful in this market.

Aggressors often lack the confidence to put a winning price on paper, or, as I’ve described above, have representation that either lags the current market, or has a saviour complex.  Some agents “get in the boat” with the buyer, and feel that if they’re not getting the client a “deal,” then they’re not doing their job.  I respect that, in a different market.  But after six months and nine losing offers, in an ascending market, who is that agent really “saving” anyways?

In the context of this example, the Aggressors are offering $1.6M and up.  It’s a good offer, it really is.  But it lags current market value, and never had a shot.

Winners.

While there can only be one true winner, the category I call “Winners” are the buyers who put forth offers that will be in the top three.

I told my friend Ashley, “If your buyers want this house, then they need to offer $1.7M.  If they want to let price determine victory, then they can offer $1,671,000 and place in the top three.  It will just remain to be seen whether they improve enough after getting sent back, in order to win.”

There are often two winners, sometimes as many as four.

In the context of this example, a Winner is offering $1,650,000 or more, and either trying to get into the top-three, and take his or her chances when getting “sent back,” or submit an offer that he or she thinks is actually going to win outright.

Having read the preceeding, many of you are sickened.

You’re disgusted.

You can’t believe a real estate agent just wrote that.

Fucking real estate agents.  Driving up the price of real estate, playing pricing games, standing in the way of families and homes.  Right?

Well, I suppose I could simply do what most other agents do: say nothing.  But I’m trying to empower the consumers by explaining how things work, and putting names and faces to the types of buyers who make offers in these bidding-melee’s, while all the while, hopin you keep in mind that I didn’t invent this system.  It’s based on supply and demand.  Continue to sit around and hate on the market, and the process, and the market will pass you by.

The problem is not agents and under-pricing.

The problem is buyers submitting offers that have no business being submitted.

Let’s say there are 18 offers on a house, and it breaks down like this:

Novices – 3
Beginners – 3
Deniers – 2
Losers – 4
Aggressors – 3
Winners – 3

Out of 18 offers, only six really have any business being submitted.

A blog reader last week said that an offer “should be what the buyer is comfortable offering.”

I understand where that comes from, but don’t people realize that the Novices, Beginners, Deniers, and Losers are simply driving up the market?

Much of the public wants to blame agents for under-pricing, but where is the culpability for buyers who work to increase this false level of demand, thereby inflating eventual sale prices?

As I said, it’s not rocket science, folks.  That $1,329,000 list price may as well be $1.

Had there been 6 offers on this house instead of 18, the property would have sold for less.

So why does under-pricing work?

If you don’t know after reading this, then good luck in this market…

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24 Comments

  1. Munchen

    at 8:05 am

    The real winners are the ones that see value in properties that no one else does, pay under market for them, and then have the connection to quality trades that can make those properties shine.

    1. Thomas

      at 8:24 am

      100% true bit it will not fit the RE narative though.

    2. RPG

      at 9:06 am

      @ Munchen

      I’d love to see a list of all your wins in the Toronto market. Addresses and dates pls & thx. Otherwise your comment is fantasy.

      1. clifford

        at 9:42 am

        I mean there are people that make a living doing that. Also if you follow themash blog you’ll see plenty of homes that were sold for a song, renovated and sold for a nice profit.

        1. Jenn

          at 10:36 am

          “The real winners are the ones who see value in properties that no one else does, pay under market for them, and then have a connection to quality trades that can make those properties shine.”

          Sure if that’s what those people do for a living. Or if those people have an extra 15-20 hours per wk on their hands for a year.

          A professional couple in their early-30’s with a child and another on the way. They’re not winning anything by trying to do a full renovation over the course of six months. Risking something going wrong. Having to sue your contractor. Fighting with your partner.

          I think the real winners are the ones who buy a house and then live happily ever after while avoiding mumbo-jumbo about buying and renovating diamonds in the tough. Sounds like a radio advert.

          Speaking from experience here. Just my two cents.

          1. Professional Shanker

            at 12:28 pm

            Renovations are difficult and stressful for all those involved. Sounds like you had a tough one!

            Hiring a more reputable/expensive contractor can help alleviate some of the concerns you mentioned, but most don’t do that as they are trying to get “value” and have a budget to stick to. Nothing wrong with the latter but has risk associated with it.

    3. Geoff

      at 11:45 am

      Munchen – you forget the asterisk

      *and in Toronto have a time machine and can zip back to 2004 or so.

    4. Professional Shanker

      at 12:23 pm

      The “winners” flippers have had a tough last couple years often losing money on flips as competition in flipping increased.

      1. jeanmarc

        at 12:46 pm

        Buying a detached home now to renovate and flip is much tougher now than 10+ years ago. The law of diminishing returns comes into play here in the GTA. The margins are smaller now given the costs of paying for a detached property in a prime area (add LTT and closing costs), building permits, contractors, materials, etc. More homeowners are knocking down their homes (keeping the two sides up) and renovating. Much more cost effective.

        1. Professional Shanker

          at 2:46 pm

          Yup and if you break down the costs on moving vs. renovating, it is roughly 8% of the current home value to RE agents and gov’t – that can be put into a renovation if one chooses.

          More hassle and headaches but likely worth the investment if you make it through the other end still married 😉

    1. J G

      at 4:33 pm

      Lol, 416 condo sliding.

      Interim June median price was 677k a week ago, now it’s down to 670k. Feb peak was 727k.

      1. Appraiser

        at 5:57 pm

        Being obsessed with condo investors is a little odd. No?

  2. jeanmarc

    at 11:45 am

    David,

    Your article is right on! Every property that I have sold has always been priced low and sold much higher. My last property (in 2017) sold for over 20% higher than the list price. Comes down to location/supply/demand.

  3. Libertarian

    at 12:22 pm

    Hi David. How many of those would-be buyers are investors? As Munchen said, investors are always trying to get a house on the cheap. Maybe it’s the investors putting in the stupid offers.

    1. jeanmarc

      at 12:38 pm

      Imagine going through 28 offers and collecting stats on each who is an investor.

      Would be surprised if there are any stats of would-be buyers who are investors until the deal is firm. Then they go through fintrac, etc. and the seller agent may get more info about the buyer. Even at that, this information would be subjective to confidentially.

  4. JL

    at 4:24 pm

    “Had there been 6 offers on this house instead of 18, the property would have sold for less.”

    But if the point is to bid what it will sell for (market-wise) because otherwise it’s a waste of time, wouldn’t those top 6 or 3 bidders still bid the same amounts against each other? That is, if you’re a serious bidder, would you not bid the same amount that you think will be enough to win regardless of whether there are 5 others (that are all serious) or 17 others (of which you think/know that only 5 are legitimate)?

    Or yet another way: if the serious buyers know that a lot of bids are junk (and wont come into play on offer night), why would the number of these lowball bids affect their own pricing/bidding strategy?

    1. Professional Shanker

      at 4:54 pm

      In theory you are correct, in practice it works differently, we are willing to pay more if more people “perceived at least” want that thing.

      Why is a night club with a line outside more appealing to people even if you know it might be empty inside? We are all about FOMO.

    2. Shana

      at 6:16 pm

      I agree whole-heartedly. If the “problem” is “buyers submitting offers that have no business being submitted”, then sellers can thank these buyers for creating hype. Unfortunately it froths the market in a way that fatigues buyers, influences extended levels of household debt and has created the high-risk for great losses for the most vulnerable homeowners in a crisis like today’s high unemployment.

      My hometown in Australia made a law that requires sellers to increase their list price to be above that of any rejected offer. Because rejecting an offer confirms it’s not a price they’re willing to accept, this method was used to protect buyers from wasting needless time and energy. The market there was still frothy even with the measure, but I think it would be an ethical approach in Toronto to equalize access to the market despite the many buyer and agent personalities David describes.

      David can you one day talk about why agents will ask buyers if they’ll increase their bid on an offer night? How often does the top bidder outbid themselves (as opposed to the competition)? How often would a seller have been satisfied with the top bid before reaching for more just in case? How often do the top buyers change their offer?

  5. Joel

    at 11:00 am

    I really think buyer agents need to take on some responsibility. If you are doing what the client asks you, instead of educating them and letting them know that they shouldn’t be offering list, then the agents deserve to have their time wasted.

    As the listing agent they must lover having all of the stupid offers in from these agents. I do get some of them right now as the market has been hot, cold and hotter all within the last 2 months. You don’t always know how the market is going to react to the new listings and it has only been a couple of weeks.

  6. Appraiser

    at 2:46 pm

    Looks like the 416 market getting ever tighter as inventory continues to shrink. More upward pressure on prices is inevitable.

    “MOI continued to tighten – with freeholds dropping below 2. While active listings only grew a few percentage points in the week, the rolling 30 days of sales up 17% for freeholds and condos. At lowest marks in 12 weeks for freehold, 11 weeks for condos.”

    ~ Scott Ingram CPA, CA

    https://twitter.com/areacode416

    1. Chris

      at 5:18 pm

      “I must admit, people bidding up house prices amidst the deepest recession in living memory is something I definitely did not see coming. All signs point towards a second wave of COVID-19, job layoffs, and a solvency crisis so you really have to admire the courage here.“

      – Steve Saretsky

      https://twitter.com/stevesaretsky/status/1276536493557735425

      Have to admit, I’m in the same boat as Steve! But then again, the NASDAQ is up 25.1% compared to this time last year, while the S&P500 up 2.3%. Wouldn’t have guessed for those types of returns in the midst of a pandemic either!

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