Game Theory and Home Bidding Strategy

Please read this post first before reading the content below.

The optimal bidding strategy will need to be optimal in two components: (1) how to determine the price for your bid; (2) when to submit your offer. This post will not even try to help you how to determine the price for your bid: actually you should always be confident and comfortable to determine that price on your own: if you are not comfortable, then don't submit the offer. Talk to your buyer agent or do some more research to get there. Alternatively, drop me a note here.

Once you have determined the price for your bid, now let's think about what's the optimal strategy in terms of when to submit the offer.

Let's use an example: let's say you are interested in a home listed at $500,000. The analysis you did tells you that the fair market value for the home is anywhere between $450,000 to $480,000.

1. if you decides that your starting bid is somewhere in the fair market value, such as $440,000 to $460,000, then your bidding strategy is regular strategy. In this case, you should submit the offer whenever you are ready, there is really not much to optimize under the regular bidding strategy.
 2. if you decides that your starting bid is around $400,000, which is significantly below the fair market value, then you need to think about this question: when should you submit the offer? You will need a little bit of game theory concept to decide when to submit the offer.

Based on Wikipedia, game theory is defined as "the study of mathematical models of conflict and cooperation between intelligent rational decision-makers." It sounds complicated but its core concepts is very simple. Let's dummy down that concept with a brain teaser, which I was given when I was interviewing with a wall street firm back in 2005.

Let's assume 3 cowboys decided to participate in a shootout competition. At the end of the competition, only one of them could survive. They already know each other pretty well on how accurate they could shoot: A is the perfect shooter and can kill people with 100% probability. B is not as good, only at 70%. C at 30%. They also agreed on the following: (1) they will take turns to shoot at each other, one shot at a time; (2) since C is the worst shooter, C will shoot first, then B, then A, then back to C, then B, then A, etc. (3) the competition will end when there is only one people survive.

Question: if you were C, what would you do to maximize the probability of survival?

This is a typical game theory question and the answer lies in analyzing your opponents, which in this case are A and B. Let's assume C shoots at either A or B and missed, what would they do after the shot if they are still alive? B obviously will shoot at A because A is the much bigger threat than C. B also knows that if A gets to shoot, A will shoot B because C is much worse than B. Now given the fact that both A and B perceives each other as the biggest threat, C could actually sit back and let them fight till one of them is dead. When C goes into the final duel with either A or B, the most important thing for C would be to shoot first, which will give C at least 30% chance in survial. Otherwise, if either A or B shoots first, C will have less than 30% chance in survival.

So the answer to the question is: C should actually intentionally miss his first shot, which means that he should shoot to the sky. (Yes, that's an option in case you are wondering).

Again, game theory basically says you should study your opponents and figure out what they would do and then decide your strategy accordingly. Now let's go back to the low balling strategy and look at what the seller should do when you submit a low ball offer.

Let's first assume the house you are bidding just came to the market and you are among the first few people to see it. You really have two options to submit your low ball offer: (1) submit right after you see the house (most people actually will do this); (2) wait for a period of time, such as 3 weeks and then submit your offer. Which one is better?

Let's again analyze what the seller would do under each of the options. Please remember the fact that the house just came to the market, which means not a lot of people have seen it. If you submit the offer immediately, the best strategy for the seller is to not counter your offer, but wait for other offers to come in and use your offer to pressure other buyers. The key word is potentially 'use your offer to pressure other buyers', which will really hurt you and is the worst thing you want to see as the buyer. This is the downside of submitting the offer immediately. What's making this option worse is that there is actually no upside at all because

o   no rational seller will give you a meaningful counter offer or go directly under contract. This is what most low ball buyers hope but the seller actually wants to wait for a few more weeks at least to see whether there are any buyers who are regular buyers or overbidding buyers. Like I mentioned earlier, the seller should just keep your offer in his pocket and potentially use it against you when there are other inquiries;

o   you are not missing out on any opportunity cost of waiting for a few extra weeks either because if the house is sold within the first few weeks, there is almost no chance that it would be sold under the low ball price.

o   Your overall goal is for the house to be sold at a lower price, either to you or to other buyers. Yes, even when the house is sold to other buyers not you, you also want it to be sold at lower price because chances are good that there will be other homes up for sale in the same neighborhood. The lower sold price on this unit will lower the 'listing price' for the future sales because the pricing for future sales would be based on this sale. if you submit the low ball offer and later, there is another buyer who are regular buyer. Once he learnt the fact from the seller that there is already one offer pending for this house (just in case you don't know this already, the other buyer would not know your bid price because the seller would only tell the fact that there is one offer pending but not the actual price), he would be pressured to bid up his price a little more, which is not to your benefit.

o   Your offer would not discourage any other low ball buyers. let's assume there is another potential 'low ball' buyers who are also interested in the house. You would hope that your low ball offer would discourage him from even submitting the offer and go to bidding war with you. I don't think that would work. Here are the reasons: (1) low ball offer will only come under contract after the house has been on the market for at least a few weeks; (2) by then, the other buyer should be able to figure out that the sold price should be much lower than the listing price and there is no cost of try to submit an offer regardless.

To sum it up, you should never submit any low ball offers when the house is on the market for less than 3 weeks. The actual 3 weeks number can still be debated but the idea is really to wait for the house to be market tested before you go for it. After 3 weeks, you can do whatever.

Regarding the overbidding strategy, your goal is really try to reach a deal with the seller as soon as possible to avoid potential bidding wars with other buyers. The key for success in this strategy is quick and convincing. Quick refers to the timing and you submit as soon as possible and follow up aggressively with the seller. Convincing refers to the price should be just enough to make seller accept it, which should be analyzed case by case. In essence, the overbidding strategy is to pay a premium on top of the asking price to avoid the possible bidding wars with others. You should only use this strategy when you absolutely love the house at your overbidding price.

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