Real Estate Bidding Wars
In many populated regions, trends show growth in real estate bidding wars as the supply of homes decreases, and the pool of buyers continues to expand. This excess demand, coupled with the difficulty in obtaining financing for mortgages, has created a complicated situation for buyers, sellers, and agents. While many buyers are after their dream real estate purchase, it is the job of the agent to advise buyers to look below their price range instead of above. This is because buyers can be sucked into a bidding war very quickly and paying above their premium is unsafe without the backing of adequate, liquid assets. However, given the housing market today, it is more often than not that buyers are sucked into stipulations such as escalation clauses that force a buyer to increase their bid if a seller receives a higher offer. While these practices benefit the payoff to the seller, they can prove very dangerous to a buyer who is looking and willing to purchase quickly. Ultimately, it is the job of the agent to mediate with the seller from practices of collusion and to protect the buyer from paying above their financial means.
Real estate bidding wars represent a typical auction scenario where a seller has a single item to sell and every buyer in the specific market has a value for the desired item. In fact, these bidding wars are even more specifically indicative of a first price sealed auction where the buyers submit simultaneous sealed bids to the seller and the highest bidder wins the real estate and pays their price. However, in real estate bids there are also several areas for collusion. Escalation clauses often bring buyers away from and above their true value by automatically increasing their price if another buyer offers the seller a higher value. Practices such as these increase the payoff to the seller, but hurt the buyer. However, in a real estate market practices of collusion can’t be prevented especially given high demand.
The practice of shading bids downwards in these pricing wars represents the optimal strategy in a first price sealed bid auction. While intuitively it may seem natural to bid higher in an auction where demand is high and there are increasing bidders, the fact is that bidding too high will never result in an optimal payoff. However, shading down your bid is also difficult because if you bid too close to your value your payoff if you win will be relatively small, and if you bid too far below your true value then you weaken your chances of winning overall. In a a real estate where there are only so many unique items, it is hard to accept paying below your true value as an optimal, but to protect a buyer’s finances and receive optimal payoff it is best to keep with the winning strategy for first price auctions.
Source: http://www.nytimes.com/2014/06/15/realestate/winning-a-real-estate-bidding-war.html?module=Search&mabReward=relbias%3Ar%2C%7B%221%22%3A%22RI%3A10%22%7D&_r=0