Should I make an offer below the asking price for a house?

Welcome to another Q&A session with the publisher of the Home Buying Institute. In this article, Brandon will be responding to a person who asked about making an offer on a house. So let's start with the question at hand.

Reader question: "When buying a house, I've been told I should make an offer that is below the asking price so the seller will negotiate somewhere in the middle. Is this a good strategy to use? This is my first time buying a home, so I want to make sure I handle the offer correctly."

I've actually received a similar version of this question from a different reader. But since it's such a common concern among first-time home buyers, I'd be happy to answer it again. Let me come at it from a different angle this time. I'll explain some of the basics of making an offer to buy a house, and then I'll take on the role of the seller. You are the buyer, and you're trying to make an offer below the asking price I have set. I'll explain how a seller might handle such an offer.

But first, let's talk about some of the basic concepts of purchase offers.

Every Pricing Scenario is Different

From what I've gathered, there is a rule of thumb floating around that you should always offer less than the asking price when buying a house. Some people have even assigned arbitrary percentages to this rule. For example, they might say you should offer 5% below the asking price for starters. These "rules" are not only misguided, they are downright risky for the buyer. The reason is that they don't take unique pricing scenarios into account.

You cannot apply some arbitrary rule to every home-buying situation. Consider the difference between these scenarios: Some sellers price their homes realistically, based on comparable sales. Some sellers tend to overprice their homes, based on what they need to pay off their mortgages. And some sellers will actually price their homes below market value, in order to sell as quickly as possible. Given these three different scenarios, how can you say that it always makes sense to offer below the asking price?

In addition to the differences in pricing strategies, you also have vast differences from one real estate market to the next. In a sellers' market, you would be foolish to offer less than the asking price (if that price reflects the current market value of the home). While in a buyers' market, you have less to lose by offering below asking price. Even if the seller rejects your initial offer, they will likely come back with a counteroffer.

Two Different Situations, Two Different Offers

We just talked about two of the most important factors to keep in mind when making an offer. You need to consider how the home is priced in relation to its potential market value. And you need to consider the amount of leverage you have, based on the strength of your local real estate market. Keep those two factors in mind for just a moment. Here are two scenarios where it may or may not make sense to offer below the asking price:

Scenario #1 - Give It a Shot

You're in a buyers market. There are plenty of homes for sale, but not enough buyers to absorb them all. As a result, many homes have been sitting on the market for months. Sellers are frustrated and desperate to sell. You find a house that is listed for $275,000. You pull up a handful of comparable sales from the last month or so, and you find that the average sale price was $255,000.

In this scenario, it would make sense to offer less than the asking price. If the comps were very similar to the target house, I would probably offer somewhere around $250,000. If the seller shot that down without so much as a counteroffer, they would be foolish. It's a buyers market after all, so the next offer might not come around for some time.

Scenario #2 - Tread Carefully

You're in a sellers market. (I know, it's 2011 and there really aren't any sellers markets right now. But use your imagination.) There are plenty of home buyers but not enough houses to go around. Most homes are going under contract within a week of being listed. Sellers are getting multiple offers from buyers trying to outbid each other. You find a house that's listed for $275,000. You do some research and find that the average sale price from a handful of comps is $273,000.

In this situation, it would be a bad idea to offer below the asking price. Recent sales data would suggest that the seller's asking price is realistic. Additionally, you're in the type of real estate market where people will try to outbid you. So if you don't make a full-price offer on that house, you can be fairly sure somebody else will. If you make an offer less than the asking price in this scenario, the seller will probably turn you down and take a more favorable offer. Somebody will snatch that house right out of your hands.

I speak from experience on this subject. When I bought my first house in Maryland, it was a total seller's market. We made the mistake of trying to negotiate a few times, and we had several homes slip right through our fingers. We quickly adjusted our strategy and made full-price offers, as long as the market supported the asking price. We were still up against multiple offers, but eventually we got ours accepted. We simply had to realize the bargaining power was in the seller's favor.

These two scenarios illustrate the flaws in the arbitrary "rules" that say you should offer below asking price for a house. In scenario #1 above, you could probably get away with it. In scenario #2, your offer would probably be shot down without so much as counteroffer. Arbitrary rules are worthless. Every home-buying situation is different. Every pricing scenario is different. You need to consider how the home is priced, based on current market values in the area. You need to consider the real estate market you are in, and how much bargaining power you have. This is how you make a smart offer on a house.

See also: How much should I offer for a house?

A Word About Comparable Sales

In the previous section, I talked a lot about comparable sales or comps. If you're working with a real estate agent, he or she should pull up a list of comps for the area where you want to buy. A comparable sale is simply a house that has sold recently in the area where you're searching. It should be similar in style and price to the type of house you are considering.

For example, if I'm looking for a two-story colonial-style home in Colombia, Maryland for about $375,000, I want to find recent sales data for two-story colonials in Colombia, Maryland. When I find homes that have sold in the $375,000 price range, I have a pretty good idea what kind of house I can get for the money. These comps are showing me what the market will support in terms of the asking price. I can also use them to determine when it makes sense to offer below the asking price, and when it makes sense to make a full-price offer.

The three most important aspects of the comparable sale are proximity, similarity and timeliness.

• Proximity refers to the distance between the comp and the target house you are considering. Home prices vary from one city to another, but they can also vary from one area to the next within the same city. So you want to find sales data for homes that are in the same area where you are trying to buy.
• Similarity doesn't need much explanation. You want to look at sales data from houses that are similar to the one you are considering. That's what the word "comparable" means.
• Timeliness simply means that you want to find the most recent data. Home sales from six months ago are not very useful when evaluating a seller's asking price.

When you're looking at previous home sales that have these three qualities, you've found your comps.

Role Playing: You Will Offer Below My Asking Price

You mentioned that you're a first-time home buyer. This means you have never sold a home before, so it may be hard for you to get inside the mind of a seller. So let's do some role-playing for a moment.

You're the home buyer, and I'm the seller who has the house you want. We are in a slow real estate market that favors the buyer, but there is still a good deal of real estate activity. So it's not totally a buyers market. As a seller, I know I have to play my cards right if I want to get an offer. But at the same time, I've seen homes selling in my neighborhood. So I know there are buyers out there. I've seen them come into the open houses over the last few months. This scenario probably reflects many of the real estate markets in the country right now, in 2011.

I realize I need to price my house realistically in order to get an offer. So I spend a lot of time reviewing comparable sales in the area. I look at the homes that are similar to mine, and then I factor in the unique features my house has. For example, I'm one of the only homes in the neighborhood with a custom pool in the backyard. I price my home based on recent sales data with a reasonable markup for the unique features of my house. Based on all of the homework I've done, I feel that I have a fairly reasonable asking price. I've even erred on the conservative side, because I want to sell the house quickly. Who wants to stay on the market for six months? Not me. My house is priced at $260,000.

And then you come along. You've been told by a "friend of a friend" that you should always offer below the asking price when buying a house. So after viewing my home a couple of times, you decide to make an offer for $245,000 -- $15,000 below asking. Your offer is good for 48 hours, so I have a couple of days to think about it. The next day, I get another offer from a potential buyer. This person offers $255,000 -- $5,000 below my asking price.

What do you think I'm going to do now? You guessed it. I will either (A) accept the second buyer's offer outright, or (B) try to negotiate with the second buyer. Your offer gets put on the side burner for now. I will tell your agent that we are in the process of accepting a higher offer. Translation: "no deal." I'll keep your agent's business card though, just in case the other buyers fall through at the last minute. But you can consider your offer rejected.