Q. How much is a house worth?
A. Whatever someone is willing to pay for it.
This is how valuations work. If I’m selling my house for $100k, and someone agrees to pay me that price, and then some while later after the transaction has had its diligence, the deal closes, then my house is demonstrably worth $100k. There’s little debate in this concept, except that I don’t really believe in it anymore.
I made a small-town, smaller-market name for myself in 2009-2012 when I dared to suggest that the market was worse than most market participants believed. I found great sport in writing offers well below the asking price, and did so time and time again, with frightening efficiency. The sellers were coming to grips with the market, and buyers were present, they just needed some motivation. At that time, the motivation came in the form of a discount. It’s that market that led me to believe that real estate cycles aren’t built solely around economic factors, they’re built mostly around the psychology of confidence and fear. What I didn’t understand then is what the current market is helping me to understand: Valuations can be wrong.
But how could that be? If someone offers a property for a certain price and a buyer pays it, then the market is functioning as markets always have, and any time a seller and buyer agree to terms then the market is made. This can be true, but so can my belief that markets can become disjointed and just as a market with no buyer interest and no volume is broken, the same could be said of a market with tremendous buyer interest and very little inventory. There’s no reason to think that the market is behaving normally today, and it’s causing a whole lot of confusion for both buyers and sellers.
Recently, I showed a new listing to a client of mine. I disliked this new listing, but he didn’t, and so we went for a tour. The house was, in my infallible opinion, worth at least 25% less than the asking price. Making matters worse, this was a home that I figured was worth around 50% of the current ask as little as two years ago. Making things downright disgusting was the fact that this home wasn’t part of our typical vacation home market, meaning the individual market segment is historically much weaker than it is at this very moment. All of this led me to believe that the house was something we should ignore, and so I presented the property to my buyer with that context. It’s just that my opinion of value was at odds with my client’s opinion of desirability, and so we bid on the house with the goal of purchasing it. The bid, I should note, was strong and clean, and in any normal market it would have been accepted in the blink of an eye. Ah, but this isn’t a normal market, and so the negotiation wasn’t a negotiation at all, and another buyer purchased the home. My buyer was momentarily upset, and I can only assume that he was left feeling less than confident in my opinion of value.
And I suppose that’s warranted, because as we know a property is worth exactly what someone is willing to pay for it. Or in this case, what at least two people were willing to pay for it. But is it? Is that home worth that grotesque valuation just because at this point in time someone says it’s worth it? If a house sells, is that justification of the pricing? In a normal market I would have told you that the answer is a resounding Yes. But in this market, I have to look deeper. I have to consider the market context of the specific market segment. I have to understand how that segment is preforming today relative to how it might normally perform. I have to think about the valuations down the road, and if a house like this is going to always have some sort of motivated buyer. If we’re talking lakefront homes, then yes, I can imagine a scenario where even outlier pricing becomes reality over some period of time. But can we take this same confident approach and apply it to all markets, just because we’re momentarily able to support the current, frothy valuations?
No, I don’t think we can. And that’s why today I no longer believe that a house is worth what someone is willing to pay for it. The real estate business today is built on the concept that every property is worthy of a bidding war, and because it’s a war, then there must be winners and losers. Historically, the winner is the person who buys the house, and the loser is the buyer who misses out. It’s just that today I think that the buyers who miss out are often the real winners.