In the pandemic boom market, a lot of people did very well. Listing agents could sell a home for 10% over asking in a weekend; homeowners refinanced or cashed in on big equity jumps; middle-income families took advantage of low rates to snatch up their dream homes.
But there is one group that maybe didn’t do as well as you would expect. According to a new analysis by four housing economists, buyers who win bidding wars see much lower returns on their home and are more likely to default on their loans.
That “winner’s curse”—long observed in other auction-style scenarios where multiple buyers compete for one item, has not been tested in housing, according to the paper’s authors. But the researchers who conducted the analysis found that across 14 million transactions, bidding war winners see 1.3% lower annualized price appreciation and are 1.9% more likely to default than buyers who purchased in non-bidding war situations.
Although real estate professionals will be quick to point out that homeownership isn’t all about the money, it also isn’t clear that winning a bidding war is a bad financial outcome—especially recently.
Justin Farrell, broker at John Farrell Real Estate in Missouri, says that one thing that might offset the negative effects tracked in the paper is the factor of lower interest rates, which characterized the most recent period of high-stakes bidding wars.
“What (buyers) did get was a sub-3.5% interest rate,” he points out. “So while they may have paid what most people would assume was way overpriced, they got to take advantage of that low interest rate. And as such, they substantially beat out everybody that over the past 12 to 18 months has been looking and dealing with 6%-plus interest rates.”
Beth Sager, a top agent for Keller Williams in Boston, Massachusetts, agreed that timing and rates have made a big difference in whether bidding war winners are actually winners, and that advising clients in these situations is mostly about earning trust and having a plan from the beginning, rather than warning them of any danger.
“We absolutely do tell them at a certain point, you’re overpaying for the house,” she acknowledges.
But when it comes to the overall risk and complexity of a bidding war, Sager says her clients have never expressed regret after winning, and (eventually) appreciate the advice of an expert as they go through the process.
“The first offer out, they tend not to listen to you,” Sager says. “So by the third offer, they’re like, ‘Tell us what to do. We can’t go through this emotional up-and-down.’”
The long and the short
The fact remains that across the country and over multiple decades (going all the way back to 2000), this comprehensive analysis found that winners of bidding wars face more hardships in the long-term, with 10% lower equity over the average holding period for bidding war-winners and even more negative effects for lower-income and disadvantaged groups.
Does that mean that agents and brokers should advise clients to avoid these situations?
Sager said that isn’t realistic.
“I can’t think of one client that went in and bought a house without a bidding war,” she says.
But making sure clients have the most information and best advice to make their own decision is at the core of what a real estate professional is supposed to do. And the authors of the “winner’s curse” analysis claim that winning a bidding war might amount to more of a risk than many people are prepared for.
Buyers who won homes in bidding wars defaulted on their mortgages 11.42% of the time, compared to 8.28% for all other buyers, and suffered a “slightly” higher combined loan-to-value ratio, the researchers found.
In the large majority of the states examined by the researchers, bidding wars were associated with lower returns on equity—both in cash and financed transactions—meaning that while there was some regional variation, the negative economic effect of a bidding war was not restricted to specific regional dynamics. A few states, including Missouri, saw significantly higher impacts from this “winner’s curse.”
But buyers who are facing a bidding war are always making decisions based on factors outside of the economics, Farrell says, adding that while he always advises clients not to become “house poor” as they stretch to afford a new property, in the end, it is always their call.
“My job is not to protect you from yourself. I cannot make decisions for you,” he says. “I can give you all of my knowledge, expertise and experience, show you the comps, talk to you about market trends. But at the end of the day, this is your purchase, not mine. I will protect you every single way I can…you have to make your decision, and if this is your house, then let’s get it bought.”
Both Farrell and Sager tell clients that if you are staying in the home for at least five years, the economics are likely to be positive. But again, buyers are considering many other factors, and Sager claims she has never had a past buyer client come to her with regrets about winning a bidding war.
One common suggestion Sager says she offers to buyers is setting a hard limit on what they will pay, rather than just riding the bidding war out as far as they can stretch their budget.
That is especially important when decisions have to be made on short notice. Sager says often there are only minutes for clients to make a decision after they get a call from the listing agent, whether they want to move forward at a particular price.
“That’s why we prepped them ahead of time—like, look, you need to figure out at which number you’re going to say no to this house,” she says. “When I call you, we’re either good or we’re not, and we’re just out, which is fine.”
Farrell again points out that there are other factors at play, even though some of these bidding wars saw homeowners quickly end up underwater. He adds that the idea of buying a home as an asset instead of a living space is misguided, especially for people who finance.
Also, as people are stretching their budgets, Farrell says he makes sure to keep them aware of all the other costs that come along with the home-buying and homeowning adventure.
“When you buy a piece of real estate, you’re not just paying for that piece of real estate, you’re also paying for all the inspections that you’ve got to have done, plus the title insurance and everything else,” he says. “Then you’ve got to make repairs. I always tell buyers, ‘Don’t touch the house for a year.’ I know you want to go in and remodel the house, new flooring, new paint, (stuff) like that. But if you start shoving all your money towards all of that cosmetic stuff, the furnace is going to break, and that’s $12,000.”
In your feelings
Having that conversation before the high-stakes, tight-deadline rollercoaster of escalation clauses, love letters and back-and-forth is maybe most important because of the emotions and stress. Sager says that she does try to prep clients for the process before they get into it, but has generally found her buyers are making rational decisions and not throwing away their financial plan over a sentimental connection to a property.
“Even in the moment, I feel like our clients are a little more analytical and they are pretty careful about not getting too crazy for a house,” she says.
At the same time, she says she will often see “crazy” offers when she is on the listing side—buyers who “either have been in too many bidding or they just don’t care anymore.”
That would seem to support that conclusion of the researchers—that in bidding war situations, a certain number of buyers are apt to get into a situation they are going to regret.
How do you make sure those buyers are not your clients? Farrell says he approaches the emotional aspect of the process with a commitment to deep honesty, and tacitly affirming that buyers are going to make their own decisions—but not before he gives them the info they need.
“I’ll show you market trends, but you have to put on your big person pants, and you have to make the ultimate decision based on the information that is in front of you,” Farrell says.
That includes leaning into emotion sometimes. Asking clients to imagine themselves living every day in their home (good, bad and ugly parts of it) can help them make a better decision when they are struggling with all the financial uncertainty and back-and-forth of a bidding war. Farrell says that while some people “overpay” for the wrong reasons, many do so because they know what they are getting.
“If you love going home to your peace, tranquility, your roots, that is the greatest asset you can have for yourself,” he says. “This (house) is the one your heart is set on? What’s our price? Just don’t do something stupid.”
