Understanding Risk Versus Reward In Real Estate Today

Posted by Joe Manausa on Thursday, May 13th, 2010 at 11:05am.

If you have to sell a home, you need to understand that a fundamental change in the real estate market has occurred. With this change, the way that you address risk versus reward will need to be modified. No longer will you have the luxury of trying to get the top dollar for your home and suffer no negative consequence should you fail.

For most people in the real estate industry, prices have always been going up. Real estate appreciation was the rule, so pricing a home to sell, and all the various other elements in the home sales process, were based upon this important rule. So what I am trying to express is that

most real estate professionals do not know how to sell a home today!

Sadly, this is true. If you look at the home sales failure rate, it has hovered between 72% and 85% for the past two years. This means that most of the homes that came on the market during the past two years failed to sell before the end of their listing period! Does this sound like an industry that knows what it is doing?

Conventional Thinking Has To Be Thrown Out The Door

Historically, most home sellers would say "If I try to get top dollar for my home by pricing too high, I can always wait for the market to catch up to me. If I drop my price after a while, I will be dropping it to market value and it will sell." Today, they need to be thinking "If I try to get top dollar for my home by pricing too high, I risk losing a lot of money if I fail to sell it."

The consequence of failing to sell today is significantly less money for the home seller tomorrow! In the past, values were going up, so there was no negative consequence for "trying to get the top dollar." We have to know this today, and sellers need to calculate the risk versus reward benefit for trying to gain the top dollar for their home.

Risk Versus Reward In Real Estate

Imagine that you own a home that you purchased several years ago with the intent of living there for a long period of time. But life threw a curve ball at you and you now need to move. In fact, you are moving out of town and need to sell the home. Let's also add these two elements to the mix.

You owe $25K more on the home than what we think you will get at closing and your monthly expenses associated with the house is $2,500. You are moving out of the home in the new three weeks to start your new life in "Next City," so you are definitely motivated to sell.

Like most home sellers, you want to get "top dollar" for your home so you consider asking an amount that will net you zero at closing (meaning you are priced $25K higher than the market indicates your home is worth). You figure you will try it at that price for the next two months, then lower the price if it doesn't sell. After all, what harm could that cause?

Using the real estate graph above, I have plotted the risk versus reward scenario. If the graph seems confusing, please take the time to ask questions by commenting below, as this is a very realistic situation that many homeowners could find themselves dealing with if trying to sell a home this year or next.

In our graph above, we have plotted a scenario where the seller is going to "start high then reduce" the price if it doesn't sell. The red line in the graph is the seller's asking price. The blue line is the estimated current market value, and we can see that it is dropping. For the purpose of this example, we show values declining at the same rate as the market has experienced for the past two years with a turn in two more years.

As the graphic shows, a home sale will occur when the seller's asking price and the market are in agreement on price. Could it sell for more? Sure, but most likely it won't. This is where the risk versus reward comes into play. If the house sells for more than the estimated market value, in a short enough time frame, the risk was worth it. But if it doesn't .... Did I mention that 72% to 85% of homes failed to sell in the past two years?

There are three points illustrated in the graphic above:

Point A - The sale would have to occur before this breakeven point for the risk versus reward to work out for the seller. With a monthly investment of $2,500, the seller is "risking" this each month to get a higher price.

Point B - Even though the seller will sell the home a year from now for roughly $230K, the effective sales price is $200K because of the monthly investments made by the seller.

Point C - By the time a sale occurs, the seller would have invested another $30K in monthly payments.

how to find a real estate expert in local market areaIt is important that you have a full awareness of your situation if you plan to sell a home in the next few years. I cannot advise strongly enough to work with the absolute best real estate professional that you can hire in your market. If you are in Tallahassee, then drop us a line and let us know that you need to sell a home. If not, let us help you find the top real estate professional in your local market.

Joe Manausa, MBA is a 26 year veteran of real estate brokerage in Tallahassee, Florida and has owned and managed his own company since 1992. He is a daily blogger with content that focuses on real estate analytics and providing his clients with a tactical advantage in today's challenging market.

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