There is no clearer example of the difference between buyers and sellers in real estate than the hoped for level of competition for a property.
The buyer hopes they will be the only person interested in the property they like, so they can negotiate hard on the price and get a heck of a bargain.
The seller hopes that literally every person who is considering buying a home picks their home as the one they must have, so they compete against each other to drive up the price tremendously.
In our experience, we most often end up somewhere in the middle when we work with our clients.
We’ve helped buyers purchase homes where we were the only ones submitting an offer, and we’ve also helped buyers win out when we were competing against over a dozen other offers. The most common situation though, is where we’re one of two or three people who are interested in the home. There is competition, but not a tremendous amount.
On the sale side, we’ve listed homes for sale where we had high levels of showings and a number of people coming to the table to submit offers and we’ve had properties where we were negotiating with just one potential buyer. We work hard to make sure we have at least a couple of offers for our seller clients and the most common scenario for our listed properties is a few buyers interested in doing a deal.
Whenever there is competition, the eventual sale price of a property is almost always higher than the list price. In Toronto and the surrounding areas we often see sellers follow a marketing approach where they list below market value and hold back on reviewing offers for a marketing period of a week. The specific intent is to generate multiple offers in the hopes that in the competitive atmosphere a buyer pays a higher amount than they otherwise would for the home.
While some real estate agents say it is hard to know what will happen when there are multiple buyers competing for a home, we’ve been tracking what happens when we’re in competition. Our goal has been to validate a rule of thumb to use to give us a reasonably accurate ballpark estimate for where the sale price should land for a given level of competition. Here’s how it works.
First, here it is, the 2% Rule.
The rule itself is quite simple.
For every additional offer on a home after the first offer, multiply sequentially by two percent.
So, if you were competing against one other buyer for a home, expect that you’d have to pay 2% over the list price. If it was you versus two other buyers, it becomes a bit over 4% and so forth.
How does it work?
Here’s what the 2% Rule looks like for a specific example.
A condo is listed at $759,000 and they are reviewing offers on a certain date, a practice that is typically called “holding back (on reviewing) offers”.
On the offer day, as we approach the time the listing agent has requested the offers be submitted before, we can call the listing brokerage and get an update on registered offers.
An offer is registered when a purchasing agent submits Form 801, which is a document called an Offer Summary Document. This document gives the name of the purchasing agent and their brokerage, the name of the client who is going to submit an offer and the details of when that offer will be submitted and how long the seller has to consider it.
This form was created in response to concerns that unethical listing agents were pretending they had other offers, when in fact they did not. It was difficult to prove that was taking place, and since around July 2016, we’ve had this mandatory form to fill out for registering offers. That way, we have a record of what agents are submitting an offer and the name of the competing buyer.
Back to the 2% Rule and our $759,000 condo.
Suppose we discover that there are six offers registered on the property. Our client wants to submit their own offer, so we will become the seventh offer for the condo.
With a list price of $759,000 and six other interested buyers, our client looks to us for advice on how much they have to bid in order to be in competition.
Let’s be clear at this point that this is a separate conversation from how much the property is worth and what our client’s comfort level is in terms of price. Today, we are just talking about what we would likely have to pay in order to be successful in our attempt to buy the home.
When our client asked for advice on what they would likely have to bid in order to be the successful bidder, we didn’t suggest throwing all of their money at it. Instead, we said that a condo listed at $759,000 that has six offers in addition to our own, should sell for about $854,000.
Here’s the math.
Begin with the list price of $759,000.
If we were in competition with one other offer, the rule says it should sell for 2% more than list price. This is the premium we have to pay in order to beat the other offer.
$759,000 x 1.02 = Approximately $774,000
If it was us and two other offers, then we sequentially multiply that 2% to each offer, which looks like this.
$759,000 x 1.02 = Approximately $774,000
$774,000 x 1.02 = Approximately $789,000
We do the math sequentially rather than simply saying 2% for each competing offer (in this case, that would be 4%) based on the principle that each additional offer adds a bit more pressure. Buyers don’t tend to go crazy on their offer price when there are two or three people, but by the time it hits eight bidders, some buyers (and their agents) throw logic out the window.
In the example we are using, the condo listed at $759,000 should sell at around $854,000. Here’s the math.
$759,000 x 1.02 = Approximately $774,000 if we were competing against one other bidder
$774,000 x 1.02 = Approximately $789,000 if we were competing against two other bidders
$789,000 x 1.02 = Approximately $805,000 if we were competing against three other bidders
$805,000 x 1.02 = Approximately $821,000 if we were competing against four other bidders
$821,000 x 1.02 = Approximately $837,000 if we were competing against five other bidders
$837,000 x 1.02 = Approximately $854,000 if we were competing against six other bidders
The example above was a real deal for a condo in Toronto that we recently worked on with our buyer client. The 2% Rule said that the sale price for the $759,000 condo with 7 offers should be around $854,000. It sold for $850,000.
It didn’t sell to our client by the way, as they made the very reasonable decision that it wasn’t worth it at the price we projected it would take. We were right, they avoided an offer situation that would have ended up at a price they didn’t want to pay and we didn’t contribute to an inflated price by participating in the offer process.
Why does the 2% rule work?
Now that we’re clear on how the 2% Rule works, the question becomes why does it actually work that way?
First and foremost, let’s be clear that despite the math we go through for our predicted sale price, the offers that come are absolutely not following a logarithmic pattern up to the sale price. If we use the same example of seven competing bidders, here’s what we typically see when we review multiple offers for our seller clients.
- 2 offers at or even below the list price. Yes, despite the fact that five other buyers are interested in the property, there are always a few offers where the agent either failed to properly advise his clients, or they refused to listen, and submitted an offer price that has no chance of succeeding. We call this the “Well, you never know” type of buyer.
- 3 or 4 offers at a reasonable premium over the list price. These offers typically constitute the bulk of the offers regardless of how many offers are received. They range from a bit of a premium to a pretty good premium over the list price, but they often fall into a range that is pretty tight. It’s buyers who are afraid to “overpay” and who aren’t accurately judging the level of competition and likely result.
- 1 or 2 offers that are higher than the rest. This is where the 2% Rule tends to be proven as these offers are almost always close to the result given when we follow the 2% Rule.
While the offers range tremendously, the 2% Rule gives us a ballpark expectation as to what the eventual sale price will be for the home.
It is true that we can always see a situation where the 2% Rule doesn’t give us an accurate result. If there is a listing agent who massively underprices a property to get attention, the eventual sale price would be higher than the 2% Rule would predict. Similarly, if there is a buyer who has more money than sense, they can offer a price that was well over what they needed to bid in order to purchase the home.
In our opinion, the reason why the 2% Rule works is because it takes into account the emotional aspect of competing against other buyers, the impact of more and more people in competition and the most common level of discount that listing agents apply to a property they list below market.
We’ve spoken with other agents on how they handle a request for advice on offer amount and we weren’t thrilled with the most common answer, which was the client should bid as high as they are able in order to get the property.
That sort of thinking is in part responsible for some of the outrageous price increases we’ve seen over the last couple of years. When a buyer pays their maximum and it is well over what the seller would have taken based on the level of competition, it sets a new standard for sale price that the next listing uses as their comparable and tries to beat.
We like using data and logic when advising clients, so over the past 13 years, we’ve been tracking how competition impacts sale price. When we are representing buyers, we know how many competing offers are in play as listing agents are required to disclose that information. When we are on the listing side, we obviously know how many offers we’ve received, so in both cases, every deal gives us another chance to see how accurate the 2% Rule is in practice. It turns out, after reviewing hundreds of deals, it gives a very good ballpark idea of where the sale price will land based on varying levels of competition.
How accurate is it you ask? We’ve been tracking our experiences with real offers and currently the 2% rule is coming in at 98.9% accuracy. As far as a rule of thumb goes, that’s pretty good!