Overpaying for a Home in the Bay Area is an Everyday Thing

The Bay Area real estate market is renowned for its competitive nature, with prices often exceeding what anyone would consider to be fair market value. This article delves into the concept of overpaying for a home in the Bay Area and whether it can be a strategic move for potential homebuyers.

Introduction

In the fast-paced and competitive Bay Area real estate market, buyers often find themselves in a quandary – to overpay, be homeless, or worse – continue renting. The fear of overpaying is valid considering that purchasing a property is one of the most significant investments one makes in their lifetime, and even paying full list price on a Bay Area home, without overbidding, is a lot more than most people are ever comfortable paying. However, market conditions play a pivotal role in determining not what is fair, not what is reasonable, but what is necessary to pay if you want to buy into the Bay Area real estate market.

Understanding the Bay Area Real Estate Market

Despite economic uncertainties, regions like the Silicon Valley and surrounding areas continue to be a sellers’ market, year in and year out, for decades. True, there have been occasional slumps, like the Savings and Loan Crisis of the 1980s, the dot-com bust of 2000, the mortgage crisis of 2008, and the shock of the historic mortgage rate increases of 2022. Outside of these and a few other downturns, the Bay Area real estate market has been firmly on the seller’s side since the end of World War II. This means there are more buyers than sellers, leading to a relative lack of inventory or available homes for purchase. This imbalance typically results in buyers paying higher prices for properties, irrespective of the original listing price.

The Fallacy of Overpaying

In a market dominated by sellers, the concept of “overpaying” might be a misnomer. For instance, if a buyer plans to purchase a home listed for $1,000,000 and is ready to offer full price, even considering the fact that the property could “use a little work” or is somehow not ideal. In fact, the buyer may feel that by paying full price, they’re already overpaying, given their perception of value.

What happens when the buyer’s real estate agent advises that the house could sell for around $1,100,000 based on how competitive the market is? The buyer then faces a dilemma. Should they stick to their original offer, or heed their agent’s advice and offer more? This is a quandary almost every Bay Area homebuyer finds themselves in.

Pay More Now, or Much More Later?

In such a scenario, the buyer needs to consider two factors. First, the probability of winning the deal by “overpaying” by the 10% their agent recommends. Second, the significant potential that they would have to pay a lot more for the home they do end up buying, if they lose out on this one. That’s because the need to overbid on a home in the Bay Area typically happens when home values are appreciating – and homes are almost always appreciating in the Bay Area. That may not be true month-to-month or neighborhood-to-neighborhood, but when you see that many homes in neighborhoods of varying price points are all (or mostly) selling over list price, it is a strong indication that the market is presently going up, not down.

So buyers need to consider the very real cost not of overpaying, but of losing the property entirely. If you end up needing to spend an additional $50-$100K or more on the home that you are ultimately successful buying versus what you could have paid for the house you lost out on, it’s going to cost you a lot more than just the higher amount you’ll end up paying. Because you won’t just pay more than the purchase price – you’ll pay tens or even hundreds of thousands of dollars more in higher interest payments on a greater mortgage loan you’ll need to buy that still-more-expensive home.

The Overview: Analyzing the Risks

The dilemma boils down to a combination of data analytics and qualitative risk tolerance. If the buyer sticks to their original offer but loses the deal, they risk the possibility of paying still more later, which could inflate the total loan and repayment amount. And not only would the purchase price be higher in dollars – hot markets often experience rising mortgage interest rates, as the demand for money causes lenders to charge higher rates for their capital. Losing a deal and witnessing a 0.5% increase in interest rates could mean paying a fortune in additional interest charges over a 30-year loan term.

How to Know what a Bay Area Home is Worth

If there’s one question buyers ask me time and time again, it’s how much do I think a home is worth? Fair enough – I’m a real estate expert, and actually, I think I’m really good at doing a comparative market analysis (CMA) to come up with an opinion of value. So I can tell you what “the comps” (or recently sold comparable sales, that is, homes in the neighborhood or vicinity which are broadly similar and sold within the past 3-6 months) say what the home should sell for…but there’s a problem with that.

The problem with that is the using sold comparables would only tell you what homes like the one you want to buy were selling for…yesterday. Or 3-6 months ago. They will not tell you much about how much some other buyer, who you do not know, may pay for the home today. And it doesn’t help to look at asking prices either – asking prices can easily be very high, or very low, and are almost always misleading since only 5-10% of homes in the Bay Area sell exactly at list price.

Buyers will often look at online valuation systems such as Zillow, Redfin, Realtor.com, ComeHome.com, eppraisal.com among others to determine how much they should offer on a home. “But Zillow says it’s only worth $X!” is a common refrain from buyers when I tell them what I think the property is worth. The fact is, Zillow isn’t very accurate much of the time – none of those automated valuation models used in the Bay Area are.

Your REALTOR may tell you that you don’t need to worry about how much a home is worth. If you’re getting a mortgage loan, as 75-80% of buyers do in the Bay Area, your bank will in almost all likelihood require a formal appraisal of the home you want to buy. Or, perhaps the seller obtained an appraisal and included it in their disclosure package so buyers can feel comfortable about the price the seller is asking. But you should know that appraisals rarely come in low in the Bay Area, and that at the end of the day, an appraisal is just an “expert” opinion on what a home is worth…using comparable sales data from months ago.

Knowing How much to Offer on a Home in the Bay Area

It’s one thing to have a good idea how much a home is worth based on “the comps,” or an automated valuation model, or even an appraisal. But in a perpetually hot market like the greater Bay Area, the reality is, you’ll often end up having to pay more than what it seems the home is worth, according to the market data you can identify.

The vexing problem is, of course, that homes don’t always end up selling over list price, even when they are new on the market (“new” meaning 2 weeks on the market or less). In fact, they don’t always sell over list price even when there are multiple offers from competing buyers when the home is new on the market.

But the fact is, if you are competing against other buyers for a newly-listed home, the odds are very high that you will have to pay at least full asking price, and, quite possibly, much more than that. Unfortunately, I can’t give you a magic formula which always tells you how much you’ll need to offer on a home, relative to list price, to be sure you’ll be the winning bidder. And of course, there’s price, and there’s the terms as well: buyers often fail to appreciate that strong terms in an offer are at least equally as important as the price in most cases.

But I did write another article about knowing how much you should offer on a newly-listed home which you may find helpful, and another article about how to make a winning offer on a Bay Area home.

Overpaying for a Fixer-Upper in the Bay Area

Another factor to consider is the cost of necessary repairs or deferred maintenance on a house. In many other markets in California, and certainly in most of the United States, it is apparently fairly common for sellers to do repairs on their homes – either before they put them on the market, or after they have accepted an offer from a buyer.

In the greater Bay Area, we tend to do things a little differently, at least once the seller begins showing homes to prospective purchasers. What is common practice here is for sellers to prepare a complete disclosure package to the buyer before the buyer makes an offer on a home. The buyer is typically given all of the material facts relating to the property that the seller is aware of, and the buyer makes an as-is offer on the property, with a good idea of what work the property needs, or may need soon.

Buyers who are not versed in Bay Area real estate culture may think when seeing these reports and disclosures that it means the seller should then be open to doing some repairs, or being flexible on the price. What these buyers may not appreciate, however, is that most of the other homes they’re looking at, and which have recently sold and form “the comps” that the buyer is using to evaluate a fair offer on a property, also have most or all of these same issues. Even when a home is marketed as being in move-in ready condition, often times there are multiple old and outdated systems or components of the home which many reasonable buyers would deem necessary of refurbishment or replacement.

The reality is, most houses in the greater Bay Area are pretty old by now. Of course, that depends on what cities and neighborhoods you’re looking in, but as a region, I’d wager that the average age of a single-family home in the Bay Area is 60 years old, which means the home itself is more than half way through its 100-year life expectancy – to say nothing of the various components and systems like plumbing, electrical, roof, foundation, windows, heating, appliances, and the rest. The reality is, you are buying a used, “second hand” house and none of them are absolutely perfect in every way.

But here’s another way to look at it: if a home were perfect, if it was brand-new, built without a single flaw, you’d be paying more for it. A lot more. By buying an older home, you’re going to save money on the purchase, and much more over time with lower property taxes and interest payments versus paying significantly more for a new or “like new” home.

What Drives Value for Homes in the Bay Area

I feel that it’s important buyers understand what really drives value for homes in the Bay Area. While most people would prefer not to buy a fixer-upper, there are many good reasons to consider doing so – chief among them being that you’ll save some money and potentially build equity by making improvements that you want to see in your home (versus paying for something someone else thought was really great a few years ago).

If you ask me, these are the things that are most important when home shopping in the Bay Area. When it come to evaluating homes to buy, I firmly believe these are what matters most, and are worth paying the most for, in descending order:

Location
Lot Size / Utility
Square Footage
Floor Plan
Condition
Age

Notice those last two – age, and condition. Frequently, buyers put age and condition at the top of their list of preferences. I’m not saying buyers ought to ignore these factors completely, but buyers really need to understand what the market – that is, their competition for the home, whether seen or unseen – will view as truly valuable in the property, and be willing to pay for it.

The Change in Mindset: Overpaying as a Strategic Move

While overpaying for a house might seem like a financial misstep, it can potentially be a strategic move. If a buyer truly loves a home and doesn’t mind potentially higher-than-expected monthly payments, the perception of overpaying becomes less apparent over time. In fact, when I talk to long-time Bay Area homeowners, almost everyone says they thought they paid too much when they bought, but now, years later, the price seems almost ludicrously cheap.

Overpaying is subjective. Every buyer assigns their own value based on what they deem most important. If you find the perfect property and decide to pay over market value, you will usually find the investment worth it in the long run, so long as you hold onto the property for a while. After all, homeownership works best as a long-term investment.

The Home is Worth What You Pay for It

Many would-be Bay Area homebuyers are concerned with overpaying for a home here. Nobody wants to be made a fool of, suckered into paying way too much for a home. But the reality is, when you buy a home, you have just paid market price for it, even if you thought you’re over paying.

The reason for that is because you bought your home on the open market. While it’s possible you may have ended up paying considerably more than the next-highest offer (because you typically will not be told what the other bids are), the fact is, once you pay whatever you end up paying, you will have paid market price. Because what is the definition of fair market price?

Fair market price refers to the price at which a property would sell under normal market conditions. This implies a situation where both the buyer and the seller are reasonably informed about the property and its worth, neither is under any pressure to buy or sell, and both parties are willing to negotiate to reach an agreement. It’s essentially the price that a property should fetch in a competitive and open market, assuming all conditions are favorable and each party acts in their own best interest.

Assuming those are the conditions under which you buy, you will, by definition, be paying fair market price for the home. I can think of few instances where I looked back on a home sale and thought, “Wow, they paid way too much for that place.” Yes, it happens, but in my experience it’s pretty rare. What’s not so rare is this:

When I work with a seller, I often get them a really amazing price for their home – often setting a record. That price then becomes the new high water mark in the neighborhood. Soon, other homes will begin to sell around that price, and gradually, even higher. When a home sells for a high price, it is usually because prices in general are trending upward, and your home purchase is one data point in a much larger trend.

Final Thoughts

In the end, it is almost always more advantageous to enter the market sooner rather than later. You begin building wealth in the form of home equity as you start paying off the principal on your mortgage and as property values appreciate over time. The market (or the number of buyers offering to purchase a home at any given time) will determine the value of a home regardless of what you feel is a reasonable price. Ultimately, there is no ‘overpaying,’ only winning or losing a deal – and winning early is the best recipe for long-term wealth creation.

While the initial sticker shock of overpaying might feel disheartening, the investment in real estate is likely to show a positive return on investment (ROI) when it’s time to sell the home. Whether you’ve overpaid or not, the key is to hold onto the property, ride out any temporary market downturns, and wait for the inevitable market rebound. After all, real estate is a long-term investment, and patience is indeed a virtue in this market.