The financial fallout from overbidding

Transcript:

Allie Barefoot: I'm Allie Barefoot with Cotality and this is Data and Context. Today we're going to be exploring a very crucial topic in the home buying journey: bidding wars. We're going to be breaking down new research from Steve Choi, an assistant professor of real estate finance from the Rochester Institute of Technology. His study dove deep into mortgage defaults and lower annualized returns using Cotality data to uncover what bidding wars mean for financial outcomes. And his findings are very relevant today as the housing market is actually shifting from a seller's market to a buyer's market for the first time in five years.

As we do head into that buyer's market, though, bidding wars may not be as important as they used to be. In fact, they may disappear overall as inventory increases and gives buyers the upper hand. But it does raise a really important question for those that have already purchased under pressure: how do bidding wars affect affordability and long-term financial security? So to get into it, let's go on ahead and jump into the questions with Steve. Steve, thank you so, so much for joining us here in Data and Context.

Steve Hyeok Choi: Thank you very much for the kind invitation. Really a pleasure to be here.

Allie Barefoot: Yeah, absolutely. You sent us a research paper that was brilliant. Honestly, it dealt with a lot on bidding wars and how that really shapes a home buyer's journey. And you and I can be honest, the home buyer journey over the last five, ten years, it's been a little up and down. There's a lot of things that go into it. And we know that the US housing markets have had a lot of highs and a lot of lows, especially over perhaps the last three years, as interest rates have really started to take over.

So, one way that people have been able to secure the homes they want is simply by overbidding that price that they see on the 'for sale' sign. But how common was this tactic of overbidding? And are bidding wars less common now than they were a few years ago?

Steve Hyeok Choi: Yes. So in our study we look at Cotality's data—over about 14 million single-family detached home transactions—and if you look at the time series of a bidding war (where a bidding war is defined in our study as a transaction that's sold above asking price), you see that actually reaching around 50% in 2021 or so. So I would say that immediately after the pandemic, on average, one in two or one in three homes was going through a bidding war. Recently that has cooled down. If you look at one of the Cotality reports ("10 things to know about the mortgage and housing markets") that came out in August, that number has gone down to about 34% in June of 2024. So things have been kind of easing recently.

Allie Barefoot: Right. And I know that the title of your research paper is "The Winner's Curse," but my main question here is: why is a bidding war considered a winner's curse and how is it affecting current and future home buyers?

Steve Hyeok Choi: Right. When you buy a house in a bidding war, I think there's a lot of heated emotion, a lot of attachment that goes into a transaction where you might have thought, "Well, I think this house is fairly priced at a certain price point," but then there is a lot of bidding going on. Perhaps you're tired of getting back to the search again, and also the inventories are just not that much. So you ultimately get into this overpayment—bidding up and saying, "Hey, I want that last final stretch to get the key."

Once that's done, unfortunately, I think there are potential consequences, which are adverse financial consequences of overpayment. When you overpay for something relative to a fair price, then you will ultimately get a lower return. So when you liquidate down the road, you'll realize a lower return on that house. But also, that means you're taking effectively a larger mortgage, and your loan-to-value ratio will be higher. So, you're more likely to default and not make full on the promises on the mortgage itself. Those are the two main winner's curse effects that we find in our study using the Cotality data.

Allie Barefoot: Right. And you mentioned that inventory was low. When buyers are looking for a home, and you finally find a home that you want and see a price that is affordable, you're obviously not the only people seeing that. So therefore, the bidding war does commence. You noted in your research that when buyers go into this bidding war, they're essentially paying 8.2% over price for a house. But now that we are shifting to a buyer's market, that inventory is increasing finally. Do you expect future home buyers will still face that same risk of overpaying, or will the competitive pressures begin to ease?

Steve Hyeok Choi: Yes. So, I think it's going to have more dichotomous results. Where it's a highly coveted neighborhood with great amenities and great school districts, I think there will still be a dormant group of home buyers who are looking cautiously at federal rates coming down by the Federal Reserve, but also looking at the 30-year fixed mortgage rate from Freddie Mac. There is a group of potential dormant home buyers who will jump in, sustaining that heightened competition.

But on the other hand, in many markets, I think we will see a lot of homes on the inventory, longer days on market, and a cooling down of prices generally. So you will see less of a bidding war, less people queuing at open houses, and so forth. I think it will be a bit polarized, a little bit stratified. You will see certain areas still maintaining some bidding wars, but generally, on average, you will see an ease of that.

Allie Barefoot: Right, and this buyer's market is going to be a little bit different. We know that Cotality data is showing us this is the first real buyer's market since 2008 to 2011. But there's still that struggle with affordability, and that has a lot to do with interest rates being so high. We know that a buyer's market means higher inventory and falling prices, like you just mentioned. But right now, is it truly beneficial for buyers to purchase that home? When do you expect interest rates to reach a level that is meaningful to buyers and actually affordable to make it really feel like we're in a buyer's market?

Steve Hyeok Choi: Yeah. So thanks for that question, Allie, because I think that is a nice follow-up building off our previous discussion. Affordability is not just a matter of heightened or cooling competition, but also closely related to the cost of financing. If you look as of the first week of October, the 30-year fixed mortgage rate averaged about 6.34% on Freddie Mac, which is nudging a little bit higher week over week. Mortgage Bankers Association's 2025 projections are about 6.5%. So, we're lingering around that lower 6% area.

To have a material impact for home buyers to say, "Hey, this is going to be moving the needle," I think we would have to look at somewhere like 100 basis points. Somewhere if the mortgage rates come down to 5.5%. If you do a back-of-the-envelope calculation on a $400,000 loan, going from 6.34% to 6% saves about $90 per month. As opposed to a hypothetical scenario of 6.34% down to 5.5%, which is about $215 per month. To move the needle, I think about 100 basis points should come down on the 30-year fixed.

When will that happen? At the current trajectory, many expect it maybe mid to late 2026. So for the current buyer, I think there's still room to refinance. If you already purchased and are looking to refinance, that might be a good time to consider. For future buyers, if you could stay a little bit tighter until 2026 ends, you might be in a better position to capitalize on a more favorable mortgage rate.

Allie Barefoot: Yeah, I'll definitely keep that in mind. I'm currently looking for a home right now and might have to wait until maybe next holiday season when we're moving out of that apartment. But you mentioned that there's...

Steve Hyeok Choi: Yeah.

Allie Barefoot: It comes down to just numbers in the sense of how much you're saving per month with these interest rates. But then, when you tack on top of that already overbidding for the house, that's got to add more money at the end of the day. Cotality data found that home buyers need an additional $200,000 compared to 10 years ago to close on a median-priced home. And when you add that bidding war equation into that, that's about another $33,000 on a median-priced home. So that's a big chunk of money just to secure the home. Did your research show how overpayment can affect homeownership long-term?

Steve Hyeok Choi: Yes. In our Cotality data that looks over about two decades (from 2000 to 2018), we found that the average holding period is about over six years. There's also a recent topic of "mortgage lock-in," where many are holding onto their lower mortgage rates locked in around when COVID started. If you think that that's going to make the average holding period longer for these folks, I think that if you overpaid, it might exacerbate the winner's curse effect—which is realizing lower annualized returns and higher defaults.

I think we need to take a look at this in the context of labor markets, job numbers, and interest rates. Interest rates respond to both inflation and job numbers. Recently there has been a softening job market. If you think about these general macroeconomic conditions that could bring an income shock—like unemployment or being laid off—that could exacerbate the long-term winner's curse effect.

Another component is climate risk. Cotality reports also cover rising insurance and taxes. If you overpaid, and your appraisal value anchors to that value, your property tax is going to increase over the years, putting a strain on your cash flow. Also, in certain coastal areas like California and Florida with disaster-prone risks, your insurance premium will go up. There are a lot of factors in the long run that could really squeeze your cash flow cushion, and we just need to be really careful regarding overpayment.

Allie Barefoot: Yeah. And you made a great point there about how it really depends on the location of the home as well. If you are in a natural disaster area, that may not attract as many buyers as a home that's not. You mentioned it earlier that data shows we saw the number of days of homes sitting on the market rise by double digits, which suggests that sellers are relisting homes at a high price to recoup those costs. Is that keeping affordability out of reach even as we move towards a buyer's market, if somebody is trying to raise their prices on a home if it necessarily isn't worth that price?

Steve Hyeok Choi: I believe that in the long run, the market will adjust to make that repricing adjust downward. In other words, if you relist at too high of a price as a seller, you really won't have that many people lining up at the open house or submitting a bid compared to the post-pandemic market. This means that many sellers will have to readjust, putting their prices down. That could elongate the days on market and send a very bad signal regarding the property. You just want to be really careful of relisting at a higher price.

In terms of affordability, I believe that even though relisting at a high price could squeeze affordability, if the market adjusts in the long run—basically making those home sellers ultimately adjust their prices downward—I think that could ease things a little bit. We already see that in being in a buyer's market where there are substantially more houses on the market, fewer sellers, and negotiation power changing the tide towards the buyers.

Allie Barefoot: Right. It's almost like using the best terminology to market your house to buyers who have a plethora of options to choose from, hopefully, as inventory continues to increase. But we also know that the purchase is one half seller, one half buyer. From the buyer's perspective, we actually have a survey here at Cotality, the "From House to Home" survey, where we found that nearly half of home buyers expected their real estate agent to guide them through the process to find the right home. With the upcoming buyer's market, how can real estate agents help the buyer make sure they're not overbidding? Just like you said how they can help sellers maximize terms and maybe not list their home too high in price, how can they help the buyer?

Steve Hyeok Choi: Yes. I think one of the ways is to show some of the anecdotal evidence of how many bids were coming in post-pandemic, as opposed to recent transactions the agent might have carried out, to show that the current market condition is not the same as the seller's market post-pandemic. Giving this guidance to the buyers and sellers makes the information and market conditions more realistic and pragmatic for both players. One way would be educational—providing a wake-up call that the buyer's market is becoming more average nowadays, and we need to be prepared.

I think the other thing is maximizing exposure. Post-pandemic, there were languages and strategies that instigated more competition and restricted the time to submit a bid. These strategies can be dangerous and risky in the current buyer's market. From the agent's perspective, walking through comparable sales in the neighborhood, looking at their time on the market, and providing realistic coaching and guidance to both sellers and buyers will be helpful to both market participants.

Allie Barefoot: Thank you again, Steve. This has been extremely insightful and thank you so much for joining us on Data and Context. You're actually the first expert outside of Cotality that has joined us, and hopefully not the last. This has been incredible.

Steve Hyeok Choi: Thank you very much, Allie, for the invitation, and it was a pleasure. Thank you.

Allie Barefoot: Thank you guys so much for listening and once again, thank you to Professor Steve Choi. If you haven't already, go on ahead, hit that subscribe button on Cotality's YouTube page, drop a comment, and hit that like button. And if you guys want to find out even more information, as always, head to Cotality.com.

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