Buying / selling?

email Kevin: Quick reply.

Why “Highest and Best” is Bad and The Auction Effect

Posted · Add Comment
Highest and Best Offers

When buyers make an offer on a property that already has multiple offers, the seller may decide to counter offer all of the buyers with the verbiage: Please submit your “highest and best” or “best and final” offer. Essentially, the seller is saying — “bring us the highest price you are willing to pay for a the property and whoever submits the highest offer with the strongest terms will be the winner.”

Here’s why that’s bad:

Buyers want to know what ballpark they should be in. Knowing that ballpark range, they can make the decision to either compete in that price range or not. Here’s an example:

An property is listed for an undervalued listing price of $500,000, has 4 offers, and a buyer wants to buy the property. The listing agent simply says: “We have offers over list price. Bring us your highest and best offer.” Now the buyer has to guess how high over list price will be necessary to compete for the property. A common buyer thought is: “If they came back to me and said, ‘The other offers are between $535,000 and $545,000,’ (see ethics concern below) then I’d be able to feel comfortable raising my price that much.” Think of it this way: on eBay, the software tells other buyers that — even though the start price was $0.99, you need to bid above $10.20 if you want to be in the running for the property. That creates the auction effect. “Highest and Best” actually reduces the auction effect because buyers don’t want to grossly over pay. For instance, a buyer may be able to pay $545,000 for the property and would pay $545,000 if the seller came back and said: “You need to be around $545,000.” However, if the buyers only guidance is “Bring your highest and best,” the buyer generally perceives that the seller is saying: “Raise your offer to where you think you’re a bit higher than the others.” As a result of the possibility that this buyer’s guess is grossly below what the other offers are, that offer essentially became a lost offer that could have lead to a higher, final-sales price for the seller.

Recommendations to Sellers:

  1. Be careful not to grossly underprice properties to procure multiple offers. Buyers like to know: “If I offer this price, I will likely get the property.” “Starting point” listing prices often frustrate and discourage buyers.
  2. Counter offer with an actual price that the buyer should come to. If a serious buyer thinks that price is too high, they will likely counter again. At least they were given something to reach for.

Recommendations to Buyers:

Highest and best situations can be frustrating. The best way to handle them is to think: “What is the highest price that I am willing to pay to the point where, if I don’t get the deal, I will know that I gave it my best.” I’ve been in this situation before. I offered 10% over the listing price to get the deal. Could I have gone higher? Absolutely, but I wasn’t going to unless the seller said: “You need to be 15% higher if you want the property.”

Ethics & Creating the Auction Effect

Agents need to be diligent in disclosing information related to other offers. A great way to handle this is to ask the seller to sign a form that explains the pros and cons of disclosing price-ranges of other offers. Second, the listing agent should disclosure to all other buyers that the ballpark range of offers (say, plus or minus 3-5%), will be disclosed to all offerers. If a higher offer comes in, the initial offerers should be made aware if this range changes. This creates the auction effect.