General consensus in the real estate industry may be that setting initial list price of a residential property for sale too high or too low may affects its marketability and essentially its time-on-market (TOM). With higher prices being correlated with longer TOM and lower prices with shorter TOM. While this may be common sense, such an argument may be a unidirectional positive correlation and does not answer the question of what initial list price is optimum to maximize sale price and minimize TOM. Neither does this answer the question of how to determine optimum initial list price.
The unidirectional argument of price versus TOM is adopted by Anglin, Rutherford, and Springer (2001) and fails to incorporate the psychological methodology of sales, negotiation and demand acquisition. Here we will argue that a unidirectional approach is, in fact, not always at work and that a negative correlation of price and TOM may eventuate when taking into account more complex market methodology, thus making the correlation two-directional.
To illustrate our argument of two-directional correlations between price and TOM we will critique the unidirectional perspective followed by the more complex two-directional perspective and finish with a pragmatic approach to identifying optimum initial list price.
A critique of the Common Unidirectional Correlation Approach
The unidirectional correlation argument is that the higher the initial list-price the longer the TOM, while the lower the list price the shorter the TOM. Both list price strategies come at a cost of either longer TOM or lower sale price. The argument is that the list price either attracts or detracts potential buyers thus affecting TOM.
This argument fails to incorporate market competition, in that a lower list price may attract a greater amount of interest and thus competition, which in turn may impact on the final sale price. Furthermore, houses that remain on the market for an overly long time period may suffer from a stigma, because current buyers may assume that there must be a non-trivial problem associated with the property (Taylor, 1999). The same stigma may also be assumed if a property is listed well bellow market price triggering suspicion from buyers and thus decrease competition for the property rather than increase it as would have been the objective.
From the seller’s perspective initial list price may not be the same as perceived reserve price. That is, the seller may have a higher initial list price but a lower psychological reserve price in that they have factored in strong bargaining attempts by potential buyers. This approach indicates that the seller is not confident that the property will generate enough interest from enough buyers to trigger competition and thus potential for a higher sale price. In reverse, a seller who’s initial list price is lower may have a set or higher psychological reserve price and is confident that there will be enough interest in the property to drive the sale price up (Yavas & Yang, 1995).
Therefore, it may be argued that the correlation between list price and TOM is not only two-directional but also not always linear, or at least not continuously linear as illustrated in figure one.
Figure 1. Continuous Unidirectional Correlation
A Complex Multidirectional Correlation Approach
Taking into account the two-directional correlation of list price and TOM it may be assumed that, at times and in certain conditions, a lower list price may also affect a higher TOM as illustrated in figure two.
Figure 2. Twodirectional Correlation
Taking into account both bellow and above TOM stigma as discussed previously we can see that there is a price range (within the red zone) prices should not be set at, as these are likely to extend TOM and ultimately affect sale price (Figure 3). There may, in fact, be an optimal initial price listing range falling outside the red zone.
Figure 3. Correlation including Stigma Red Zone
Therefore, initial list price should be set above ‘bellow market price stigma’ and bellow ‘above market price stigma’ to attract buyer competition and avoid extensive TOM. It should be noted that initial list price and reserve price may be separate issues as long as list price falls within the legal specifications.
The question then becomes: “how do we set optimum initial list price using this model”?
Setting an Initial Listing Price
In most cases real estate agents will use Comparative Market Analysis (CMA) to provide sellers of an approximate sale price or value of their property. Research indicates that this may, however, not always be the best way of setting price (Anglin, Rutherford & Springer, 2001).
Using a dataset from a real estate listings, similar to those in CMAs, to identify properties sold in a specified area including their listing price, TOM, and sale price; and a multivariate ‘logistic regression model’ to identify causative factors including initial list price and degree of over- and under-pricing as determined by the multidirectional correlation approach may be used to indicate optimum initial list price strategies; rather than an averaging approach as is used on CMAs.