Underquoting - the auction system’s necessary evil: Mark Armstrong
Ever wondered why agents underquote? The simple answer is because it works. This may not be a popular view of underquoting and as frustrating as it may be, underquoting is a necessary evil in Melbourne’s auction system.
Growth in property prices this year has highlighted the widespread practice of underquoting and the frustration of buyers who miss out when properties sell for much more than the advertised estimate.
Ironically, the practice that frustrates buyers is the same one that enables the auction system to work in the first place.
When a real estate agent auctions a property, the vendor is paying them a fee to achieve the highest possible price in the prevailing market conditions. To achieve this, the agent must do their utmost to maximise the intensity of competition on auction day.
At any given auction the bidders will have a range of spending limits. Some limits may be close to the advertised sale price estimate, whilst others may be much higher. By competing in the auction up to their respective price limits, each underbidder plays a vital role by increasing the intensity of competition.
Although some buyers fall by the wayside when bidding goes beyond their limit, each one plays a part in pushing the bidding higher and, ultimately, determining the final sale price.
Even if the agent researches the sales results of comparable properties and advertises a price estimate that they genuinely believe is realistic, there’s no guarantee that the property at hand will sell within that range.
Therefore, in a free market economy, advertised price estimates and sales results for comparable properties should be taken as guides, not ironclad predictors, of the actual sale price a particular property will achieve. Ultimately, it’s the different spending limits of each bidder and the intensity of competition that count on auction day.
As I see it, the real problem isn’t underquoting per se, but the public’s (understandable) misconception that an advertised price estimate is the level at which the property is likely to sell. In fact, the advertised estimate is a marketing tool; a way of drumming up interest from a wide range of buyers to create competition on auction day and maximise the eventual sale price.
It’s the old adage: “Quote ‘em high, watch them die. Quote ‘em low, watch ‘em go.”
The rationale behind taking an asset to auction — whether it’s a property, a work of art or even a consumer item on humble old eBay — is to test the market. Unlike a private sale, where the vendor advertises a clear price at which they’re prepared to negotiate, auctions put the onus on the purchaser. They’re the vendor’s way of saying, “Sure, I know the price I’d like to achieve, but I want you to tell me what you think it is worth.”The public’s misconception about the purpose of advertised price estimates highlights another equally important issue — the shortage of supply relative to demand, particularly in the inner suburbs where most auctions take place. Buyers who bid there encounter the lowest ratio of supply relative to demand, and therefore the strongest competition from other bidders. In this situation, they must accept that a greater possibility of failure is a by-product of their participation.
In a perverse way, underquoting works because it brings in bidders who can’t afford the property — encouraging competition and driving up the eventual sale price. When transacting a privately owned asset in a free market economy, the highest bidder wins. The fact that some buyers will miss out is an unfortunate fact of life.
Mark Armstrong is a director of iProperty Plan, which provides independent analysis and tailored advice to investors and home buyers.
