The definition of a sellers’ market is pretty simple. When the number of potential buyers is 20% or more greater than the number of homes for sale, you have a sellers’ market. When this happens, it invites competition between buyers for every home that is for sale. Competition drives up prices and buyers can very easily let their enthusiasm push their offers above what the house is likely to appraise for putting them into a negative equity position right off the bat.
The issue is complicated because financial institutions usually only make conventional mortgage loans for 80%-97% of the appraised value of the home with the remainder being made up with your down payment.
However; if you have an accepted offer for a value greater than the appraised value, you will have to make up the difference by adding more money to your down payment. And, depending on how enthusiastic you got with your offer, this could amount to several thousand dollars more out of pocket.
This is where working with an experienced buyer’s agent/broker will pay off.
First you need to have your agent do a BPO (broker price opinion) which is a more sophisticated estimation of the potential appraised value than what an agent typically does. Not all agents or brokers know how to do a BPO so that should be part of your agent selection criteria.
Next you want your broker to do a special calculation called a sales to active listings ratio, which will characterize the intensity of the sellers’ market for the area you are looking at. As the ratio climbs above 20% the stronger the sellers’ market is and the more intense the competition is likely to be.
Finally, you and your agent need to establish what your ceiling is going to be on any given house and how much potential for negative equity you are willing to tolerate. Buying a house in a seller’s market is likely to turn into a “bidding war” and you will be competing with other buyers who are making offers above the list price.
Here’s your edge:
Having a better estimate of the potential appraised value will let you make an offer that stays within your acceptable risk tolerance for potential negative equity. Crafting an offer with a carefully calculated escalator clause can make your offer stand out from the crowd. You may not win the bid, but at least you will have a very attractive bid while being less likely to buy a house that will require several years of appreciation just to break even.
Jon Nelson of Nelson & Associates Realtors is an experienced Buyer’s Agent who does BPOs and can give you a competitive advantage while helping you to control the negative equity risk in buying a home in a sellers’ market.