Step 1:  Estimate the home's market value
Step 2:  Find out if home prices in your area have been rising or falling
Step 3:  Estimate what you think the home's worth
Step 4:  Consider your bargaining position
 Step 5:  Decide on an offer price
 Step 6:  Decide how to make the offer
Step 7:  Make the offer
Step 8:  What to do if your offer isn't accepted
What to do when you want to come up with a fair price for both parties
Advanced negotiating tactics

You've found the perfect house, checked it out carefully, and slept on the decision to buy it.  Now it's time to make an offer. 

Step 1:  Estimate the home's market value

The asking price is typically set about 1-10% above the seller's estimate of its market value.  But sellers can get that wrong, and they're sometimes willing to accept offers that are well below the asking price.   To estimate the home's market value, I recommend that you collect data from various sources:

  • Get a $29.95 Complete Property Valuation from electronicappraiser.com.

  • Get free online appraisals of the property from Zillow.com, realestateabc.com, and Ditech.com.  (On the Ditech website, click on "Calculators," and then click on "Free eAppraisal.")   These websites don't reveal their appraisal methodology, but I think it's based on taking the last sales price for the property and scaling it upward or downward according to how average property prices in the neighborhood have changed.  If the owner has spent a lot of money remodeling the house, you should fudge the estimates up accordingly.  I found that Zillow gave fairly good estimates for houses in subdivisions but poor estimates for houses with unique attributes, like custom-built homes on scenic lots.  Zillow allows you to review the details they have about your home (Click on the "See home details" link) and edit them.  

  • Get information about "comparables"--houses that are similar to the one you want to buy that have sold recently.  Zillow.com and realestateabc.com are good sources.  (Click the "Map comparable homes" link.)  So is realestate.yahoo.com (Click on What's My Home Worth? in the Tools section on the left hand side.)  Create a separate fact sheet for each comparable, then drive (or better yet, walk) by all of the homes and compare them to the one you want.  Try to guess how much more or less your dream house is worth compared to each of them, then use these guesses to fudge the actual sales prices of the comparables into estimates of  your home's market value.  

Don't rely too much on online appraisals.  Here are the estimates I got from some online appraisal services for four different properties in California:  

A custom house in the city, last sold in 1998:

  • Zillow.com:  $990,120
  • RealestateABC.com:  $958,000
  • Ditech.com:  $793,000-$975,000

A custom house with scenic view on the coast, last sold in 2002:

  • Zillow.com:  $467,007
  • RealestateABC.com:  Insufficient data
  • Ditech.com:  $562,000 - $727,000

A tract home, last sold in 1983:

  • Zillow.com:  $492,520
  • RealestateABC.com:  $490,000
  • Ditech.com:  $515,000 - $595,000

A tract home, last sold in 2005:

  • Zillow.com:  $405,040
  • RealestateABC:  $432,000
  • Ditech.com:  $405,000 - $498,000

 

 

Other sources won't be of much help, either.  I examined three reports by certified appraisers that were based on adjusting the sales prices of comparables that had sold recently to account for differences between them and the subject property.  The adjusted sales prices often varied by quite a bit:

Property

Adjusted sales prices 
of comparables

Appraised value

#1

$717,500
$671,500
$720,000

$700,000

#2

$138,500
$148,175
$148,955

$148,000

#3

$476,180
$507,380
$541,150

$475,000*

*This property had just sold for $475,000 and the purpose of the appraisal was to reassure the lender that the price was reasonable.  

 

Step 2:  Find out if home prices in your area have been rising or falling

Go to the website of the National Association of Realtors and click on the Existing Home Sales link on the lower left hand side of the page.  Look at the Existing Home Sales and Pending Home Sales reports and see whether prices in your area have appreciated or depreciated.  Don't put too much stock in this information, though:     

  • The home prices reported by the NAR can rise not just because of supply and demand, but also because more expensive homes are being built in the area or because people are making improvements to their existing homes.  Ideally, we'd like to use a price index that shows how much a typical house in your price range would have appreciated or depreciated over time if no home improvements were made.

  • Home prices might be sticky downward.  If a market is falling, you might not be able to see how weak it is for several months.  That's because home sellers have trouble facing the fact that their homes have depreciated.  What you see instead is that homes stay on the market for longer periods of time.  

  • Many sellers (and builders) have been offering generous incentives and credits to sell their homes. So while the statistics are showing just modest drops in sales prices, the amounts sellers are actually netting have been dropping by quite a bit more.

  • The NAR and other reporting agencies use median rather than average prices.  These can understate the severity of the downtown if higher-end homes sell better than starter homes. Indeed, it's even possible for the median sales prices to rise in an area where all home prices are falling.

Here’s an extreme example that shows how it's possible for median prices to rise even as average prices are falling:

Suppose that there are just two kinds of properties in the town of Homesville: luxury homes and starter homes. In 2005, 200 luxury homes were sold for $800,000 each and 300 starter homes were sold for $400,000 each. In 2007, 150 luxury homes were sold for $600,000 each and 100 starter homes were sold for $300,000 each. Even though the prices of all homes in Homesville dropped by 25% between 2005 and 2007, the median sales price rose from $400,000 to $600,000.

Moral:  Don't rely too much on median price data.


Use this information to make adjustments to your market value estimates.  For example, if you based an estimate on sales data that were six months old and if you believe that prices have risen by 10% over the past six months, then adjust the market value estimate upward by 10%.

Step 3:  Estimate what you think the home's worth

This value may be more or less than the home's market value, but bear in mind that lenders sometimes won't approve loans if the sales price is much higher than the appraised market value.

A good way to figure out what the home is worth to you is to weigh your alternatives against one another.  Suppose you're interested in a house on South Street, but you also like a smaller one on Cable Road.  Write down the benefits of the two choices on a piece of paper.   Here's how your notes might look:

This diagram shows that, to you, the benefits of the South Street house outweigh those of  the Cable Road house. 

Now try to imagine how much money you would need to add to the Cable Road house in order to make the two properties equally appealing to you.  For example, if you added $100,000 to the Cable Road house, would that make it more appealing to you than the South Street house?  Keep testing different numbers until you come up with a number that exactly balances the two sides, like this:

Now guess the market value of the Cable Road house (say $870,000) and do some algebra.  Think of the balance's fulcrum as an equal sign and solve for the value of the South Street house.   In this case, the equation would read:  South Street house = Cable Road house + $60,000.  Substituting in your estimate of the price of the Cable Road house, you'll get a value for the South Street house of $870,000 + $60,000 = $930,000.  

The sum, $930,000, gives you an estimate of the maximum price you should pay for the South Street house, based on the assumption that you could buy the Cable Road house for $870,000.   

Now do the same exercise with one or two other options.  Perhaps one  would be to buy the Bond Street house, which you prefer by $40,000 to the South Street house:

Again, use algebra to solve for the value of the South Street house.  Here's the equation:  South Street house + $40,000 = Bond Street house.   If you estimate that the Bond Street house would go for $950,00, then the value to you of the South Street house is $950,000 - $40,000 = $910,000.  This means that the most you should pay for the South Street house is $910,000, assuming you could buy the Bond Street house for $950,000.  

When deciding how much a house is worth to you, consider renting as an option.  See The Buy vs. Rent Decision by Suze Orman for help in thinking this through.


Step 4:  Consider your bargaining position

My husband is a good negotiator, but it's agonizing to watch him in action.  He sometimes starts low--really low.   The buyer's agent (or car salesperson) invariably looks crestfallen.  I don't say anything during these negotiations, but I always feel faintly ashamed and embarrassed.  After wasting hours or even days of the salesperson's time, we're finally revealing ourselves to be flaky and unrealistic.

But we often end up getting terrific deals.  

Buyers' agents will often act disappointed or annoyed if you want to make a low offer.  Pay no attention.

Of course, we don't always make low offers.  Once, we even made a full-price offer with no contingencies on a lot that we absolutely had to have.   There were no other lots like it and we were afraid we'd lose it to another buyer.

Whether or not you can start low depends on the strength of your bargaining position.   Here are some factors that would give you a strong bargaining position:

  • If the house has been on the market for a long time. 

  • If there are other, similar houses in the neighborhood.

  • If you're likely to be able to close the deal in a timely manner.

  • If you're interested in more than one house.

  • If you're in no hurry to buy a house.

If your bargaining position is weak, it will be harder to get a good deal.  That's why it's a good idea to strengthen your position before you begin negotiations.  One way to do this is to sell your existing home before you begin searching for a replacement.  Another is to go a mortgage lender and get pre-approved for a loan so you can demonstrate your ability to buy the house.  Finally, you should look at lots of houses and try to find several that are acceptable to you. 

If you fall in love with a unique home that's fresh on the market, try to act relaxed and unrushed so the seller won't grasp the weakness of your position. 


Step 5:  Decide on an offer price

If your bargaining position is strong, try subtracting 10% from either your estimate of the market value or the asking price--whichever is lower.  Suppose, for example, the asking price was $950,000 and your estimate of the home's market value was $920,000.  I'd recommend that you consider a starting offer of $830,000 (which is roughly 90% of $920,000).  Before making this offer, verify that the offer falls below your lowest estimate of what the house is worth to you ($910,000 in our example).  If it doesn't, lower it. 

If your bargaining position is weak, or if the housing market is hot in your area, you'll probably want to make an offer that's much closer to the asking price.  And if the market is very hot, you may want to make an offer that's above the asking price. 


Step 6:  Decide how to make the offer

Here are your options for FSBO properties:

A buyer's agent showed you the house.

The agent is probably entitled to the commission.  Make the offer through him or her.

You visited an open house that was hosted by a real estate agent.

The agent hosting the open house may try to claim some or all of the buyer's agent's commission. 

No agent showed you the house.

You don't need to make an offer through a licensed agent.  You can make an offer directly, or (for a flat fee) through a discount agent or lawyer.  If the seller is offering a buyer's agent's commission, you can arrange to have it waived or to have most of it rebated back to you. 

To find a lawyer, go to Lawyers.com and look under REAL ESTATE>Buying or Selling a Home, or go to Findlaw.com and look for a real estate lawyer who specializes in transactions.  These lawyers will sometimes offer to represent you for a share of the buyer's agent's commission (say, 1%) or a flat fee, but you can usually do better if you pay the lawyer by the hour.  A typical fee in my area is $200 an hour. 

Since $200 an hour comes to over $3 a minute, I suggest you arrive at the lawyer's office well prepared.  Begin by getting a standard form Offer to Purchase Real Estate for your state (you can usually download these from Nupplegal.com), read it carefully, and fill it out to the best of your ability.  The lawyer's job should be to go over the contract with you and look for problems.  

If you're working with an agent, don't share your negotiating strategy.  As I've noted, "your" agent may actually be representing the seller.  If you share your strategy, the agent might have a fiduciary duty to share that information with the seller.  

Step 7:  Make the offer

 Here's what to expect when you make an offer:

  • You'll be asked to give an offer price for the property.

  • You'll be asked to explain how you plan to pay for the property.  (As I noted earlier, appending a pre-approval letter from a bank costs you little and sweetens your offer.)

  • You'll be asked to write a check payable to the seller as an earnest money deposit, usually for 3-5% of the offer price, and even more in a hot market.  The lawyer or agent will hold onto the check during the price negotiations.  If your offer is accepted and you later default on the contract, you'll forfeit the deposit.

  • Your broker or lawyer will probably add some contingencies to the contract so that will let you walk away from the deal if something goes wrong.  For example, you’ll want to get out of the deal if you can’t get financing, or if there’s something wrong with the house that wasn’t disclosed.  This article talks about the importance of these two contingencies.    

  • The contract will specify who pays for various closing costs.  These expenses are often allocated according to local customs.

  • The contract will establish a timetable for completing the deal.

  • The contract will set a date for when you can move in.

  • The contract will specify who is responsible for any repairs or improvements.

  • The contract will specify what stays and what goes (e.g., light fixtures, drapes, appliances)

Your offer's cover letter

Begin your offer with a cover letter that lists all of the documents you're including and gives the deadline for the response and your contact information.  You should also try to justify your offer price, perhaps by describing comparables nearby that sold for a low price.


Step 8:  What to do if your offer isn't accepted

If your offer is accepted, congratulations!  But it usually won't be if you've started with a low offer.  Here's how to interpret different reactions to an offer of, say, $830,000:

  • The seller counters with $930,000.  Sellers sometimes devise counteroffers with the hope you'll offer to "split the difference."  In this case, the seller may be hoping you'll bid $880,000.   I recommend countering with a lower value, say $860,000, and see what happens.

  • The seller counters with a firm price of $910,000.  A firm price means the seller isn't willing to entertain a counteroffer from you.  Since paying $910,000 for the South Street house would leave me as well off as I'd be if I paid $950,000 for the Bond Street house, I'd politely reject the counteroffer and urge the seller to contact me if he or she had a change of heart.  Meanwhile, I'd make an offer on the Bond Street house to see if I could get it for less than $950,000.  If that failed, I'd try to get the Cable Road house for less than $850,000.  (If I paid $850,000 for the Cable Road house, it would be equally appealing as paying $910,000 for the South Street house.)

  • The seller rejects the offer outright.  There are several possible reasons for this.  Sometimes it's because the seller is entertaining or expecting another, higher offer.  Sometimes it's because the seller hopes to press you into coming in with a much higher offer.  Sometimes it's because the seller is inexperienced, and is reacting emotionally to what he or she perceives as an insulting offer.  I recommend urging the seller to reconsider and make a counteroffer.  Send signals that you like the house and that you're a serious buyer.

Sometimes the seller is willing to bend on price, but not on something else.  Some friends of mine were involved in negotiations for a $700,000 that broke down over whether the drapes would stay or go.  If something (like drapes or the move-in date) matters more to the seller than it does to you, it's wise to bend.


What to do when you want to come up with a fair price for both parties

If the seller were willing to accept a minimum of, say, $860,000 for a house and you the buyer were willing to pay a maximum of $910,000, then any price within that $50,000 gap would make both of you better off.  When negotiating a price, each of you would normally use skill and cunning to capture as much of that $50,000 as possible.  But what if you and the seller aren't evenly matched?  What do you do if your opponent is elderly, sick, desperate, poorly educated -- or a friend or relative?

In these cases, I believe that you should abandon the game of negotiation and simply try to find a fair price.  Here's one way to do it:

  • With the seller, randomly select two appraisers and hire them to come up with independent estimates.

  • Agree to sell the house at the average price, assuming the price is below the maximum amount the buyer is willing to pay and above the minimum amount the seller is willing to accept.

Advanced negotiating tactics

  • Don't fall for statements like these:  "The price is $20,000 below market." or  "It's selling for less than the appraised value."  If the house can only sell for $600,000 in a market, than that's the market value.  If a house is priced below the appraised value, then the appraisal must be off.  

  • If you're working with a real estate agent, don't rely upon him or her for advice about how much to offer.  It's in the agent's interest for you to make as high an offer as possible so that the offer is more likely to be accepted and the commission to be paid.  Figure out how much to offer on your own.  

  • If you're working with an agent, try to convince him or her that your bargaining position is strong.  One way is to make a show of being interested in more than one house. 

  • If someone else is also looking at the property, give the sellers just a day to respond.  This can head off an alternative offer.

  • If things get bogged down, talk directly to the seller.  Agents won't like this, and some sellers won't want to talk with you.  But this might be an effective way of working out a deal.

  • If you can't break an impasse with a seller, consider making an appraisal offer, in which you offer to pay the average appraised value made by two randomly chosen appraisers.

Next topic:  Closing

ŠLori Alden, 2008.  All rights reserved.