Why it May Cost You More to Turn Down an Offer

 

By Diane Saatchi

When a potential buyer offers considerably less than you’ve asked, it’s tempting to dismiss the offer out of hand.

What most sellers don’t take into account is that refusing an offer can mean many months or years of ownership. Time on the market can be costly.  

A listing price is an estimate of value at a moment in time. It is not gospel. In real estate, we often say sellers wish for a price, brokers guess a price, but ultimately it is the buyer who establishes the price. Listing prices do not exist in a vacuum, markets, economies, competition and other factors may influence value, rendering even yesterday’s price too high or too low.

As potential buyers are looking and deciding, an unsold home remains on the market while the seller is responsible for paying its upkeep: everything from landscaping to cleaning, to property taxes, insurance, and possibly mortgage payments and/or homeowners’ association fees. [Preparing to Sell Property & House

As an illustration, let’s look at a hypothetical home, and calculate the cost of turning down an offer and leaving it on the market for another year -- a distinct possibility, as homes can sometimes take years to sell. We won’t even get into the psychological cost of hanging onto a home you no longer want or use. [The Psychological Side of Preparing to Sell Your House]

Consider the house purchased about 20 years ago, for $400,000 with an 80% loan to value mortgage. Over time, the owner has kept up with regular maintenance, and made some improvements on the house. When the mortgage interest rates reached the current lows, she refinanced with an interest only loan for $1 million at 3%. Over the course of a year, she pays $30,000 in mortgage interest that is not applied to the principle. 

The annual carrying cost is $120,000 for taxes, insurance, utilities, pool and ground maintenance, and cleaning. 

Her cost basis, determined by the original purchase price and improvements -- how much the house is worth for tax purposes -- is $2 million.  

Before we get to the calculations, note that this is a rough estimate, not taking into account finer points like tax deductions on mortgage interest and property tax, or the tax levied on income or gains from investments.

The seller listed the house last year for $5.3 million and was soon offered $4.5 million, which she turned down since it was below her asking price. If she had sold last year at $4.5 million, she would have netted $2,023,250 after paying commissions, closing costs, capital gains tax, and repaying that remaining $1 million mortgage loan. 

If she were to invest that money and get a conservative 4% rate of return, it would have earned $80,930 by now, a year later. 

Still with me?  

If the seller had accepted the $4.5 million offer 12 months ago, she would now be ahead by about $230,930: $120,000 in carrying costs, $30,000 in mortgage interest, plus that $80,930 from having invested the balance after paying closing costs. 

In effect, $4.5 million paid last year is the same as $4,730,930 ($4.5 million plus the $230,930 lost over the course of the year) paid today. If the owner of this hypothetical house had a larger mortgage, an interest rate greater than 3%, or a more generous investment return higher than 4%, this number would be higher. 

Recall from above that sale prices, not listing prices, determine market value. If no other offer was made that year, it is safe to conclude the market value of that house is $4.5 million -- the price someone was willing to pay. How long and how much it cost to reach $5.3 million is anyone’s guess. The market would need to appreciate more than 5%/year to be even with a sale at $4,730,930 the next year. If the market is flat or worse, declines, it could take a few years to realize an offer as good as $4.5 million. 

There are a few caveats: We’re assuming here that she is not using the house. If she is, and would otherwise be spending $230,000 on a second home this year, she comes out much further ahead than we’ve calculated. 

This is not to say that a seller should necessarily jump at every offer that comes his or her way. Nor is it a belief that the first offer is necessarily the best offer. But our example makes an important point: In some cases, waiting for a better offer to come along can be an expensive mistake. 


© 2016 Diane Saatchi