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Six Ways To Get Fleeced in the Housing Market

by Adam Juda on Tuesday, April 5, 2016

I recently read an article in The Christian Science Montior. It was entitled Housing market too hot? Six ways to win a bidding war.

As an economist with a particular interest in the housing market, I had no choice but to read the work in its entirety. I am now certain that its title should have been Six Ways To Get Fleeced in the Housing Market.

To demonstrate my point, I will dissect each of the author's six suggestions.

  1. Include a preapproval letter with your offer: A preapproval letter might be useful to you as a sanity check, but you should never show it to anyone else. Why? Once a seller understands the upper limit of your budget, he will be more likely to raise his price toward the top of your preapproval range. Who could blame him? No one wants to sell his house for significantly less than a buyer is willing to pay. That's like refusing a raise from your boss or tearing up a tax refund from the government. Not only that, but the process of buying such an expensive item with borrowed money will likely lead to shades of the effect I noted in The Big Secret: It Isn't Real Money. Unfortunately, the more you borrow, the more you'll have to pay back (barring bankruptcy).
  2. Use an escalation clause: Escalation clauses are a license to steal from you. Not only do they invite sellers to create shill buyers, but they also reduce your purchasing power. Sellers will become a lot less flexible, if they know that you're willing to spend more money than your current bid. No matter your approach to bargaining, expect to hear the following lines: "Look, you're getting this place for less than you're willing to pay. Use your leftover money to pay for whatever you're not happy about." The larger the escalation clause, the worse your position in negotiations.
  3. Limit the contingencies: Every time you wave a contingency, you strengthen the buyer's position. He'll believe that his pricing power is spectacularly high and charge accordingly. More importantly, you'll be opening yourself up to increasing levels of liability. The seller has far more information about the purchase than you do, so if he's asking you to wave liabilities, he probably has a reason. Some may argue this point, but I'll just direct them to the Nobel Prize winning article The Market for Lemons.
  4. Be flexible on the closing: The author came so close to making a good point, I wish I could let this one pass. I can't. She correctly points out that some sellers need to close the deal earlier or later than others. The author suggests that offering to be flexible with respect to your preferred closing date will lead to a more likely sale. The basic rule of negotiation is for each side to trade something valuable to the other party in exchange for something valuable to himself. If a seller needs to close immediately, the potential buyer should use this information to negotiate for a lower price or other concessions in his favor. Simply giving in to demands is not a form of negotiation so much as an act of cowardice. Buyers who give value freely will find themselves unable to demand anything in return. Note: my advice may not apply to interactions with Algonquian-speakers who were born prior to the year 1650.
  5. Write a "love letter" to the seller: This is just plain stupid. Not only does it take time to write a love letter, but it weakens your bargaining position to boot. It informs the seller about your desperation, and it allows sellers to use emotion against you. Suppose that I were accepting offers on my house and I received the following letter:
    This is the perfect house for my family, the one-storey layout is so rare and would be perfect for my elderly mother who will be living with us.
    What would I do? I'd respond with the following:
    I'm thrilled you love our home and that it's perfect for you. Your family, and especially your mother certainly deserve it! I can see why they'd be so happy to live here. Unfortunately, it's so wonderful that we're seeing more attention than I had first expected. Could you raise your bid a bit to ensure your family's happiness? I really want you to get this home! After all those years your mother spent caring for you, it's the least you could do to thank her. Plus, I know your children will have great memories playing in the backyard!
    Perhaps my response is a bit heavy-handed, but now I (the seller) am negotiating on two fronts: logic and emotion. The average buyer wouldn't stand a chance.
  6. Don't count yourself out after a bidding war: I'm an optimist at heart, and I really wanted to believe that the writer would list one good piece of advice. This one sounded innocuous. Don't count yourself out. If she had stopped there, I would have given her a pass. But she didn't stop there. She just had to press her luck. She went on to state that if higher offers fell through, it "could make your offer attractive again." While her statement makes sense, it should be noted that renewed interest in your bid should necessarily require a reevaluation of your offer (beware the winner's curse). If your offer is now considered to be the best, you might have more purchasing power to demand concessions or price reductions. Perhaps your original offer had limited the contingencies and another party had retracted his bid after discovering some serious problems (like a crack in the foundation or mold).

Anyone who follows the advice from the article will get fleeced. That's not what gets me upset. In fact, as more people get burned by poor economic decisions, both the relative value of my own expertise and the purchasing power of my savings will increase.

My biggest complaint is that no one taught the reporter to select interviewees properly. Take another look at the article - every single person that she quoted is either a broker, a real estate agent or a realtor. What do all of these folks have in common? Yes, they all work in the field of property sales. For the purposes of discussion, I'll even concede that they might be extremely knowledgeable about property sales.

Can you name something else that they have in common? How about every single one of them benefits when a person decides to spend more for housing? That's right, the more you're willing to pay, the bigger their commissions become.

Knowing this, the fact that the article provides harmful negotiating advice ceases to surprise me. Don't you think that real estate agents, realtors and brokers are incentivized to provide you with advice that works to their best interest rather than yours? You better believe it! There's even a term for this conflict of interest: the principal-agent problem.

I'm sure that some will take issue with what they would call my slanderous accusation that besmirches the unblemished reputation of those profiting from real estate transactions. In order to defend myself from such criticism, I found a couple of links to support my belief that not all realtors are trustworthy. Each post is from a website run by an organization that you might have heard of: The United States Department of Justice.

  1. Des Moines Area Attorney and Real Estate Agent Convicted of Bank Fraud
  2. Former Miami Mortgage Broker and Real Estate Agent Sentenced for Role in Multimillion-Dollar Mortgage Fraud Scheme
  3. Former Realtor Sentenced to 5 Years for Leading Decade-Long Mortgage Fraud Scheme
  4. Bowie Realtor And Leader Of $5.95 Million Mortgage Fraud Scheme Sentenced To Over 3 Years In Prison
  5. Real Estate Agent Sentenced To Prison For Fraudulent Short Sale Scheme
  6. Former Real Estate Developer and Two Virginia Recruiters Plead Guilty on Eve of Trial to Mortgage Fraud Scheme
  7. Bowie Realtor Sentenced To Over 4 Years In Prison In $2 Million Mortgage Fraud Scheme
  8. Florida Real Estate Professional Sentenced To 26 Years In Federal Prison For Mortgage Fraud
  9. Realtor Sentenced To 30 Months For Mortgage Fraud
  10. Milford Realtor Charged With Running $15 Million Investment Fraud Scheme

There's a lot of terrible monetization and pricing advice out there. Don't listen to just anybody. Listen to someone qualified. Listen to someone with interests aligned with your own. Listen to me.

I'm available for consultations, and (if you're in the software field) don't forget to grab a copy of my book on software pricing!