Risk v Reward

In much of our homebuying discussion, we often mention the supposed opposing forces of Risk v Reward.

We mention them because a lot of homebuyers don’t act with any level of risk v reward consciousness in the homebuying process – in other words, they often make decisions without considering that, for every action, there can be many reactions. In this changing market a number of sellers are now facing similar risk v reward scenarios.

There are four key risk v reward areas we would like to discuss today. Two directly relate to buyer actions and two are connected with the buyer but are more related to seller actions.

  1. Offering
  2. Process
  3. Counter Offering
  4. Agent Selection

Four financially powerful risk v reward firecrackers.

Offering. When many buyers make an offer, they place little thought on what happens next. Their main focus is to get the property for as little as you can. There’s nothing wrong with that approach but what happens if the seller says no? Do they have a back-up plan in place?

What position has your first offer placed the seller in?

Three of five key questions we ask before we make an offer are:

  1. Do you, the buyer, want to buy a price or a property first – in other words, what is most important to you?
  2. If your offer is refused, then what position may we be left in to go forward?
  3. What does the other side really want and can we accommodate?

Let’s look at a practical example. On Saturday, on behalf of an investor, we attended an auction in with Richard James, Richard Winneke and Adam Cashmore (has to be the best selling agent surname going round), all from . It was a good single-fronted period home and our client had decided to buy it if the price was right but, equally would move on and look for another property if it wasn’t.

riskvrewardThe property was quoted at $900,000-plus and we asked Richard James before auction if there was a reserve. He answered ethically and said that, at this stage, there was no reserve. Annoying but very common.

The auction had a buzz about it and we made an opening offer of more than a – and we did that to shake other buyers. This opening bid had two key risk v reward impacts.

In trying for a knockout bid, the reward is that you buy the home and the risk is that you bid above what is needed to buy the home – ie pay too much. Making a lower offer, the reward is that you may pay less but the risk is that you may bring other buyers into the frame, who may then push themselves further than your knockout bid.

As it turned out, the opening bid created a deafening silence and Richard James, being an experienced auctioneer, padded things out until ……

Until we asked the question was it on the market?

This question now brought in a risk v reward scenario for the seller: acceptance or counter offer. In 2007 and 2009/early 2010, the counter offer for a seller was a lot easier than it was in 2008 and is again in May/June 2010. If you are selling your home in a rising market, then a “no, we want more” response carries with it far less risks compared to the reward (more money) than a “no, we want more” in today’s market. There are many sellers out there in million-dollar-plus Melbourne who are still owners and are now getting significantly lower offers now than what they had previously refused.

Back to Saturday’s auction. After the half-time break, Richard said “Mal, the property is not on the market.” In many ways, this was not surprising but it was nonetheless disappointing when a prospective buyer had bid well above the quote.

Our response was to offer significantly less – yes, we went backwards. It’s not the first time we have done it and it won’t be the last in this market. Richard, to his great credit, accepted the bid in the spirit in which it had been given and asked the slightly stunned crowd if there was any more bidding.

Richard’s acceptance of our bid at least proved the seller had made a good risk v reward decision in auctioneer and agent selection. Many sellers don’t consider auctioneer selection as risk v reward, as they consider all agents the same – it’s just a matter of who offers the highest price estimation and the lowest commission.

In this market – in fact, in any market – such thoughts are well wide of the mark, in our opinion.

How would an inexperienced or old-school auctioneer have handled a reverse bid and the ensuing negotiations on Saturday? They could have refused our lower bid, refused to deal with us, or belittled our bid (the best one and well above the quote). Any of these tactics could have resulted in a situation that weakened the position of the seller even more. Yes we could see an argument that such actions could strengthen a position of the seller as well. That is another risk v reward.

We brief our clients on the reverse bid and, in this market of choice, many of our buyers have accepted that, like a seller in a rising market (where there will always be another buyer), in a falling market, there will always be another home.

Back to the auction. Richard passed the property into us and we offered lower again against the seller’s even higher reserve. Can I say this is where the seller wised up very quickly and, through steady and calm selling agent work, an agreement was reached satisfactory for both and it was not at a higher figure than the original bid.

Sure, the seller today, may now be dealing with an offer from another party above our auction offer but, hey, the stats show that very few homes are selling above what was offered at auction – in fact, many aren’t even selling – so if Richard had of mishandled us then they may be dealing at a lot lower level. Risk v Reward.

Of course, a buyer could have done all this themselves by turning up at auction and just buying without an advocate. Buyers can just buy the first home they see that has four bedrooms. The reward for them is that they get their weekends back. Right here and now, the risk is … well, the risk is they buy the wrong home and learn the true meaning of “happy house, happy spouse” or they pay a far larger than necessary learning fee (high price, poor capital growth etc) – see our “Learning Fee” article. Mistakes are common in homebuying when you don’t go through a process. There is another risk v reward set of actions process or luck.

In summary, there are many risk v reward scenarios; in fact, every action you take or is thrust upon you will have a number of risk v reward scenarios.

Next week’s James Market Opinion will focus on the backward bid – look out for it next Tuesday.

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