In cities like Toronto and Vancouver, many homes continue to sell over asking prices. Kim Parlee speaks with Nico Lacetera, a professor at the University of Toronto’s Behavioural Economics in Action at Rotman (BEAR) institute, about some ways home buyers may be able to increase their odds of winning a bidding war.
- Despite the COVID-19 pandemic, many real estate markets are still hitting record sales. And that means if you live in a city, that means bidding wars. So how do you deal with them?
Nico Lacetera is a professor at the University of Toronto and the Behavioral Economics in Action Center at Rotman. He's here to answer today's Ask MoneyTalk question. Nico, the question is, "I'm trying to buy a home, and I keep getting outbid. What am I doing wrong?"
Well, there are, first of all, some characteristics of the way the market for houses is designed that inevitably leads a little bit to overbidding to try many times. The fact that there is a collection of many bids in a short amount of time generates competition by design. And inevitably, competition on the buyer's side brings people up. It's different from competition on the seller side, which brings the prices down. So we have to look at the other side of the market.
There are also, though, some psychological tendencies that, at least to some extent, we might want to try and control. But, of course, it's hard to do this. For example, what people call the fear of missing out. Here a scientist called, for example, the endowment effect.
So all of a sudden, you're bidding for a house. And in your mind, your default state is that you already got the house. You think, OK, that house is going to be mine. Therefore, it's mine. Now I lose the bid, and I feel like I lost my house. I'm in the middle of the street.
And so to avoid that, I overbid to minimize that risk, which, at the end of the day, in most cases, is not as high of a risk as you think, because you have your previous house, typically, or flat or whatever, where you can go back and sleep for a few more nights. So this could go on.
The presence of multiple bidders, even if you don't see them, typically generates also some sort of social pressure. You don't want to be the sucker, the one that lose the bid. Even if you have no idea who the others are, but at least there is some social component into it that you want to avoid.
And so these tendencies might lead to a little bit of overbidding on the one hand. But because everybody overbids, you might also be in the condition of losing and keep losing over time.
- That's fascinating. So you've already mentally committed to it. So when you don't get it, it's like you've lost it. But you never had it to begin with. OK, so that's the first thing-- keep in mind your mental state.
What about the bid itself? Is there something I can do in terms of how I bid that's going to make a difference?
- Well, think about some pricing strategies, some practices you see around. Very often, prices end with 99. It could be a small item, $1.99. It could be a bigger item, $99, $299. So when we, as buyer, see those prices, we see 299, and to us it looks more like 200 than 300. And so we feel it's a bargain, whereas it's not. It's just $1 short of $300.
Now, think of yourself on the other side, where you are trying to make a bargain for the seller so the seller chooses you. In that case, you might actually want to do the opposite and enter a new bracket. So rather than $249,000, you might want to be $251,000. It's $2,000 more. It's not nothing. It's not a lot, given the price of a house. And as such, you might signal to the seller that you're really interested in the house.
So you are making that extra step. You might even go over asking, not by much. Think the asking was 249. I say 251 to say, OK, I want to do more to the point of showing you that I'm willing to put a different 10-- rather than 40, 50-- in the figure. And this might lead the seller to actually believe you are really serious about it, and maybe even serious to keep negotiating, because you enter a new bracket, so sort of a new state. And in that sense, you might actually get a lot for a little, especially if you are the only one thinking that way.
- Financial symbolism. I like it how we move from 240 to 250.
OK, last question for you. So maybe think about the fact that it's not yours yet, so don't have FOMO. Think about where you want to put your bid in terms of the tens. It makes a difference. Anything else we need to think about in terms of just that I don't overpay for something?
Right, so there is one major thing, I think, that sometimes people overlook. And it's really to think about what we really value in a house. And each of us, each different family might have different preferences. I might care about a big basement. Someone might really love an en suite washroom or an attic and things like that.
But sometimes, there is sort of a social pressure to think that a house needs to have certain things. And so even if you don't need a fully finished basement, for example, but the pressure is you need a house with a fully finished basement, maybe because you're going to use it, maybe because the house is going to sell well in five years, and so you get convinced that that's what you need. And then you end up bidding too much, overvaluing something that actually has not much value for you.
There is also a tendency to say, oh, when we resell the house, it will pay for itself, as if you're selling the house the year after. If you live in the house 20 years, or you expect that, you might as well enjoy what you really like. So this is something maybe we should all be a little more aware about, what we really need.
And to sort of flip what we were saying earlier, sometimes you feel like you lose the bid and so you are the loser. What you really need to avoid is to be the loser when you win the bid. Economists call it the winner's curse.
So now, you got the house. What does it mean? That you bid more than everybody else. And so you should start thinking, oh wow, maybe I bid too much. If no one else really valued the house the way I bid, maybe I am the sucker now. So you might lose by winning. And so this is a way to sort of flip or turn over its head the way you think about the bidding process that might help you being a little more cautious.
- Great insight. People should watch this before they get into that bidding issue. Nico, thanks so much.
- OK, good luck.
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