The Thought Process Behind Making an Offer on a Home

The words will sound like they make perfect sense: "If we make an offer, we should make it to win."  Even though his eyes were scanning the path from the patio, through the living room into the kitchen, his expression was motionless as he finished his sentence.

It was coming towards the day when offers --- we anticipated several --- would be presented to the seller.  We'd already walked the home both during the work hours and at night, on a weekday and on a weekend, to see what the neighbors were like and experience what the character of this house was during different times. 

But that sentence was taken out of context.   During our search, we'd seen numerous homes throughout Silicon Valley's Peninsula and South Bay. 

One had a loft-style upstairs work area, where he began to rattle off everything from how he'd arrange his bookshelves to where his PC would go.  Another had a combined living and dining area, which he paced back-and-forth for about twenty minutes mentally replacing the staged furniture with his.

He liked this home enough to come back several few times, but he never talked about the inside, only the neighborhood (which we both knew he coveted).  And after a few questions, he realized the truth: he really didn't like the home itself all that much. 

If that's the case, should he make the offer to win, given multiple offers on this Silicon Valley home?  The real questions are: How much do you really want it and how much are you willing to pay for it --- especially when buying a home is inherently emotional?

Determining Revealed Preference and Reservation Price

Fancy economics terms for straightforward concepts, but they're also the keys to deciding whether to make an offer on a Silicon Valley house and how much you should pay for it.

When you go to Target, or Costco, or your favorite store to buy laundry detergent, you show your revealed preference every time.  Let's say you like Tide and always buy it for a conveniently round $10 per bottle even though the same-sized bottle of Wisk is the same price.  You have a revealed preference for Tide because it gives you greater "happiness" (economists call this "utility") at the same price.

Sunday comes, and with it, the coupon section of your favorite Silicon Valley paper, complete with a $1.00 off Wisk.  Meh.  You put the coupon away revealing a preference for Tide that can't be overcome by 10% off.  It's not looking good for the manufacturers of Wisk.

But laundry days have come and gone and that empty bottle of Tide isn't cleaning your clothes.  So you head over to the store only to discover that Tide is now 10% more at $11!  You close your eyes for a second hoping to divine the Wisk coupon into your hands from the kitchen table, but bite the bullet and reluctantly carry a $10 bottle of Wisk to the checkout line.  You've shown your reservation price for Tide and Wisk to be no more than $10.

What Your Reservation Price Tells You About Your Home Search

A few weeks before, we ran across an interesting townhome complex that had a slightly lower price than many of the others in its class.  It happened to be unseasonably warm that day when we pulled into one of the carport slots reserved for visitors.  Walking towards the townhome, with the sun beating down, we realized what the difference was: no garages.

This home met all his criteria, but that one point was a dealbreaker for him.  He elegantly quantified it by saying, "If they knocked $100,000 off the list price, I'd probably buy it."  His reservation price for this townhome was 12% lower than the asking price.

Not all cases are as extreme as dealbreakers.  Here are some tips I recommend to my clients for determining and using their reservation price:

1)  Separate the question, "How much SHOULD I pay?" from "How much WOULD I pay?"  The latter question quantifies your gut feelings and lets you compare how much you like one property compared to another (using revealed preference below).  This leads to answering the question, "Should I make an offer?"  The former is a technical question which leads to answering the question, "How much should I offer?"  (A very different question from "How much should I pay?")

2)  "You couldn't pay me to," is the sign of a dealbreaker.  Your Silicon Valley property search will be more expedient if it eliminates properties with features that lead to statements like, "They can't pay me enough..." or "I wouldn't buy it if they..." 

3)  Telling the owner, the selling agent, or an agent at an open house your reservation price is like showing another player your cards.  You can do it, but you know what the results are going to be.  When I'm representing you as a buyer, my responsibility is to you, not the other card players.

4)  A lot of buying Silicon Valley real estate is about going through the process of self-discovery.  Your reservation price might change because you get more information, you gain experience through looking at properties, you decide you want particular things more (or less), or you discover something you didn't know about yourself!

Deciding Whether to Make an Offer Using Revealed Preference

They bubbled up to the top of the list.  We stack-ranked his favorite homes, even the ones that had above-market asking prices and the ones that were spirited away by eager buyers.  The first pass didn't include the price, just the homes themselves.

He made that realization while he was walking that path from the patio to the kitchen he was eyeing.  It wasn't this home that was his favorite thus far.  His eyes lit up when he said, "You know, I actually like the one with the loft and the other with the big living room more, even if I had to pay more for them."  That sentence alone gave us clear directions to find the right set of homes at the right price for him. 

Revealed preference cues usually come up frequently during normal conversation, so I try to highlight them to my clients when they come up, not only to confirm that I'm listening and noting their requirements, but also to let them know what they're signaling.  A lot of times people learn something about themselves during this process.

Here are some ways revealed preference affects your decision making process:

1)  Revealed preference can change how you think about your reservation price.  I brought up an example previously where my clients decided they'd rather have a hot tub than a larger yard.  Not only that, they also decided that they didn't value a larger lot over a smaller lot if both had hot tubs.  They were able to save some money this way.

2)  One way to test how much you really like (i.e. value) a home is to hypothetically change its price and see what your new revealed preference is.  My client in this story made his discovery after thinking about whether he'd offer --- hypothetically --- $100,000 more for the home with the large living room than the one we were sitting in.

3)  Revealed preference ensures that you're consistent in your decision-making process because it turns your gut feel about a home into something you can compare with your gut feel about other Silicon Valley homes.  This refinement helps whittle down the list of homes you need to look at and gives you a clearer sense of "the right" home when it comes up.

Reservation price and revealed preference really are fancy words for concepts you and I use everyday. 

Next in the series: using these concepts to price an offer...

Previously: Reducing Your Stress When Searching for a Home