“Bargain” Houses That Aren’t Bargains in the Pacific Northwest

Why would someone sell a home deep under market prices per square foot in a city with a high momentum price index like Portland, Oregon? There may be some forced selling conditions involved such as an Estate/Inheritance/Tax fiasco. I suggest there is a more obvious and common reason for this, and it’s one that people who think about selling their homes consider often.

One reason folks sell these homes in the first place is that the cost of renovation is going to be as high or higher than the “forfeited” costs in a sale. That is, it might be more expensive to fix the home than just sell it for a price that is somewhat below market price. This is especially true if a seller happens to receive an offer that is somewhere between the difference between cost of renovation and forfeited cash.

As an example, “Jack” owns a house in Goose Hollow that needs easily $90,000- if not more- of renovations for it to be a decent place to live. He didn’t actually know what it would cost to renovate it before he bought it, and let’s say he started dating a certain “Jill” or “James” who finds this place presently unlivable. Maybe they have a mold allergy and an allergy to pea-green trim, to boot. There’s also the fact that the water heater doesn’t really work. It works well enough for Jack, but his partner needs something closer to a sauna than a cold shower. It all adds up very, very fast. We won’t even mention the overall “vibe.” Let’s also add back in that the house, when he bought it, would need a roof “in a few years.” After a couple of years, “a few years” is close to “now.”

If the place were highly renovated, it could probably get $425,000. The problem is, it isn’t close to highly renovated. He gets the idea to market it as “a little bit of a fixer upper- sold as is.” He floats $335,000 as the price- $90,000 below what would be optimal. Let’s say a buyer comes along and has heard they’ll need to bid $20,000 over ask to get any property in Portland these days. As soon as Jack gets a $355,000 offer, he’s more than happy with that price. That can get him and his partner into a new condo in the South Waterfront (albeit a 1 bedroom) that is not going to give them any of the same headaches anytime soon.

Things don’t always play out this way. There is a highly efficient market that digests information rapidly. The problem is, housing markets are not at all similar to other cash flowing, business model and balance sheet focused markets with liquidity players smoothing information gaps continuously. Jack doesn’t need 20 million investors to passively agree to his pricing after digesting all facts- he needs one person who is looking for a “reasonable” priced home to live in next month. That person may never have even seen the property in person and may need to move there from Cleveland for a new gig in town. Assuming no one did anything illegal in the transaction, the new buyers just made a terrible deal and Jack received an excellent deal.

The number one way to not buy poor value properties is to assume the market is broadly correct in its prevailing prices it puts on things. There are a certain number of properties with a certain number of buyers who happen to have a certain amount of cash they’re willing to pay for certain square footage and amenities.

The natural conclusion to draw from this assumption is that premiums or discounts come mostly from variance in quality. Let’s also set aside investing as a goal here and assume you’re mostly thinking about buying something to live in and perhaps sell or leave to an heir someday in the distant future. Quality is a major factor in home pricing, and what quality you’re looking to get should be a major factor in your decision making process.

The second step is to conservatively project hidden costs. Just like buying an individual stock sometimes involves looking for a margin of safety in the price you’re paying versus the value you’re buying, if the potential renovation costs put the home out of reach, it is not a great candidate for you. Unless you have very tight relationships with local contractors and/or suppliers for hardware, don’t assume you’ll get bargains on renovations. People tend to pay more than they expect to pay in practice, not less.

In general, as long as you’re doing a good job of identifying the sources of perceived underpricing and answering those questions honestly for yourself, you’re probably on the right track.

The Fear of Missing Out (FOMO) is a prevalent cognitive bias. A cognitive bias isn’t something to feel bad for having. But it is something to keep in check when possible.

If you find yourself telling a friend or family member “I’m nervous about this one but I’m afraid I might miss out if I don’t just buy it,” there is potential for this to be a problematic purchase. Especially if you’re worried about being “priced out,” and that’s what’s pushing you to buy something that looks cheap on the face of it. If you’re buying something because you can’t afford anything else, can you actually afford renovations that are likely needed? Have you assumed that there won’t be any renovations to make the math “work?” If you needed to borrow a large amount of money for renovations and repairs on short notice, do you have a source for that money that you can rely on and afford to pay?

FOMO may prompt you to take risks that do not make mathematical sense. This isn’t just a pitch to hire us to do the math for you- we can help with that, but it’s likely you also have friends and family that can help too if you ask around. One of my least favorite situations as an advisor is when someone has done something they now know they could not afford in hindsight.

I learned an exercise decades ago from my uncle who traded Foreign Currencies at a Wall St. brokerage: being a good buyer involves thinking like a seller. It’s served me well in life many times. If you’re getting a good price, why are you getting that price? What hidden costs or motivating factors are involved in the person selling you this property’s calculus? If you were the person sitting across the table from yourself trying to sell something, what would make you accept a lower price than appears reasonable?

To some, this might sound like very shallow, common-sense based reasoning. It’s important to reiterate at this time, however. There is a lot of hype about properties. There’s a lot of fear mongering about lack of supply, future prices that are absurdly higher than the current price, and misinformation about “deals” and “fixer-uppers.” Social Media sites have occasionally served as platforms for distorted perspectives on asset purchasing and prudent processes in recent years, to the point that restating the fundamentals is critical. Do not be scared to have a rational, reason and fundamentals based process for making the largest purchase of your life. It can save you a great deal of money in the long run to think critically.