How to Make an Offer for a House
Making an offer on a house isn't a total roll of the dice. There are some basic steps you and your Realtor can take to arrive at a price range and other terms that make sense.
Formulating an offer is not a precision endeavor. Unless you are buying
a new home, or a home or unit in a development where identical units have
sold very recently, there is definitely an element of crystal ball-style prognostication
involved in trying to make an offer the seller is likely to accept without paying
more than you have to for your home.
Step 1: Comparative Market Analysis
A CMA is the most widely used, reliable, and mathematical method of estimating the true value of "your" property, and works just like comparison shopping. A CMA distills your property into its essential characteristics -- namely, bedrooms, bathrooms, home and lot square footage -- and compares it with nearby homes that have similar characteristics which are currently on the market or have recently sold. Specifically, your Realtor will get into MLS and search for properties:
- With a similar number of beds, baths and square feet (give or take a little);
- Which are currently on the market (status: active), currently in escrow (status: pending), or have closed escrow (status: sold) within about the last 6 months; and
- Which are located within a 1/2 to 1 mile radius around the property you're considering buying.
The CMA report your Realtor prepares will list the status and specs of each of the comparable properties (comps), the list price, the sales price, and the number of days the property was on the market (DOM), and will probably also provide some calculations such as high and low sales price, average sales price, and price per square foot ($/ft2).Look for:
1. Sold Price, Not List Price -- Pay special attention to the difference between the list prices and sold prices. Active and pending properties can provide interesting insights, but these properties' MLS entries will only contain their list price (the sales price of pending properties is not reported on MLS until the property actually closes escrow). Remember, the list price is merely an asking price, while the sold price is the price a buyer actually paid for a property that actually closed escrow. For that reason, the sold comparables have the most informational value and relevance of all the comps in your CMA.
2. Adjusted Average Sales Price -- The most basic way to use a CMA to gauge what you should offer on your house is a three-step process. First, you get the outer limits of a range of prices by throwing out any extreme comparables in each direction (e.g., the homes that are overly upgraded or waaaaaay nicer than your place and the total tear-downs) and taking the highest and lowest sales prices. (As an aside, that highest sales price is probably pretty close to the maximum value that your home will appraise for.) To narrow the range, your second step is to average the sales prices of the comparable properties -- add them all up, divide the sum by the number of comparables, and the result is the average.
Then, the average sales price needs to be adjusted upwards and/or downwards based on how the comparable properties compare with the property you want to buy on each of the following items:
- Are the units or lots smaller or larger?
- Same number of beds and baths?
- Are they similarly upgraded with similar features?
- Are they similarly located?
- Were the sales recent, or were they quite awhile ago?
In real life, your Realtor will conduct this analysis for you. And they will have the expertise to gauge how much -- and in which direction -- to adjust the average for square footage location, or the recency of the sale. But I want you to understand the rationale behind it, so you can walk through the numbers yourself and have some basis for that subconscious reality check we all like to do. If the numbers don't make sense to you, see if you can locate the logical problem in the CMA. If you don't find any inconsistencies or mistakes in the CMA, that's your clue that you're probably just freaking out because of the momentous purchase you're considering. This is normal, so sit with your freak out for a moment -- take a deep inhale and exhale, then keep on truckin'.
3. Degree of Similarity between Your House and the Comps -- All these averages don't matter much if the properties are not really that similar to yours. This is the biggest drawback to rough-and-dirty web CMA sites like Zillow -- they get their essential specs for your property and the comps from the public records, which are often incorrect, and so they can't adjust for a house that has a huge addition, or is in an inferior location (e.g., on top of the railroad tracks), or is simply very different from neighboring homes. Also, if your market took a major upswing or downturn three months ago, the six-month-old sales won't be nearly as strongly predictive of the value of "your" home. Your Realtor will have adjusted the averaged sales prices of less similar comps in order to approximate the value of your home and the purchase price you should offer to pay, and adjustments can be imprecise.
On the other hand, the sales price of even one recent very similar comparable property can be highly predictive of the market value of the home you're considering. A highly similar comparable is one which lines up closely with the home you're looking at on the following criteria:
- The Basics -- Beds, baths, square feet of living space and lot size;
- Features & Upgrades - Garages, gourmet kitchens, additions, backyards, etc.;
- Condition -- Total fixers aren't comps for homes in undisputed move-in condition;
- Location -- If one abuts a greenbelt and the other borders a 24-hour multi-cine-plex parking lot, they aren't that similar.
The outcome of your CMA should be to narrow the infinite world of potential prices to: (1) A definite range of prices, with clear upper and lower limits, which reflects the realm of realistic prices an average buyer would pay for the home and realistic appraisal values for the home; and (2) A tentative target price within that range, provided by your adjusted average sales price.