The Pitfalls of Outlier Sales in Pricing a Listing

Should Outlier Sales Be Used When Pricing a Listing?

Pricing a listing is both an art and a science. Real estate professionals use a mix of data analysis, market knowledge, and professional judgment to determine a property’s value or list price. However, in the quest for accuracy and reliability, one common mistake that real estate professionals need to avoid is the undue influence of outlier sales in pricing strategies.

Should Outlier Sales Be Used When Pricing a Listing

The topic of outlier sales came to mind recently when I noticed a sale in my market that was listed between two and three million dollars. The final sale price was around $6 million dollars!

I don’t know the details of the sale, however, it made me wonder about how good of a sales comparable this would be if it was used as a comp when pricing another home. Should it be used as a comp or should it be considered an outlier sale?

The market area that the property is located in can definitely support the price but does the price truely reflect the market value of that specific property or does it reflect what a super motivated buyer with available funds is willing to pay? There is a difference.

Some people will say that it is market value because you have a willing buyer and a willing seller. On the other hand, the value that is reflected in most appraisals is a value that reflects what the majority of other market participants are willing to pay. After all, that is why we use comps, to see what other similarly motivated buyers are paying for comparable properties not what one or two people will pay.

In this blog post, I’ll dive deep into what outlier sales are, why they should not be used in pricing other properties, and the potential consequences of relying on them. Whether you’re a seasoned real estate agent or a curious homeowner, understanding the dangers of outlier sales can help ensure a more accurate and fair representation of property values.

Defining Outlier Sales in Real Estate

Before we delve into the reasons why outlier sales should be treated with caution, it’s essential to understand what exactly an outlier sale is.

Outlier sales refer to property transactions that significantly deviate from the typical or median sales price within a particular market area. These transactions can be characterized by unusually high or low prices when compared to similar properties in the same locality. In essence, they are statistical anomalies that can distort the perceived value of properties in a given area.

Outlier sales can occur for various reasons, including distress sales, unique features of a property, bidding wars, or simply a buyer willing to pay well above or below the prevailing market rates. While these transactions are not inherently wrong or fraudulent, they can pose serious challenges when it comes to using them as comps when pricing a listing.

The Temptation of Outlier Sales in Pricing a Home

At first glance, outlier sales might seem like a goldmine of information for agents. They are, after all, real transactions that have taken place within the market. However, it’s crucial to remember that outlier sales are the exceptions, not the rule. Here are some reasons why agents might be tempted to include outlier sales in their pricing analysis:

1. Instant Value Impact
Outlier sales can have a dramatic effect on the perceived value of a property. If a property is priced based on a recent outlier sale, it can lead to a much higher or lower list price than what is typical for the area. For sellers, this can be appealing, as it may justify a higher asking price. For buyers, it could mean a potential bargain.

2. Pressure from Clients
Real estate professionals, including agents, often face pressure from clients to incorporate outlier sales into their Comparative Market Analysis (CMA). Clients may have a vested interest in inflating or deflating the value of a property to achieve their financial goals, and they see outlier sales as a way to achieve that.

3. Fear of Inaccuracy
Agents might fear that excluding outlier sales could result in an inaccurate list price. They may think that by including these outliers, they are providing a more comprehensive view of the market, even though it skews the data.

While these temptations are understandable, it’s essential to recognize the potential pitfalls and drawbacks associated with relying on outlier sales in pricing a home for sale.

The Pitfalls of Outlier Sales in Your Pricing Strategy

Now that we’ve explored why outlier sales might seem enticing, let’s dive into the substantial risks and drawbacks associated with their inclusion in the data used to price a listing.

1. Misrepresentation of Market Trends
One of the primary problems with using outlier sales in a CMA is that they can misrepresent the true market trends. Real estate markets are driven by the majority of transactions, not the outliers. Including an exceptionally high sale in an area with mainly moderate values can give a false impression of what typical buyers and sellers can expect.

2. Inconsistent Results
Outlier sales are, by definition, inconsistent with the majority of transactions in a market. As such, they can lead to inconsistent and unreliable results. A pricing strategy that relies heavily on outlier sales one year may yield vastly different results in subsequent years, making it challenging for buyers, sellers, and lenders to make informed decisions.

3. Lack of Comparables
The cornerstone of a reliable listing strategy is the use of comparable sales, also known as “comps.” Comps are properties similar to the subject property in terms of size, location, condition, and other relevant factors. Outlier sales often lack suitable comparables, making it challenging to apply the traditional valuation approach accurately.

4. Ethical Concerns
Using outlier sales to manipulate property values or cater to clients’ desires can raise ethical concerns within the real estate industry. There is a difference between trying to get the highest price for a client based on what the majority of other properties are selling for and pricing a home totally out of the market. Relying on outliers compromises this ethical obligation to accurately price a listing and sell it within a reasonable marketing period.

5. Legal Implications
If a buyer or seller relies on an inflated outlier-based list price to make a significant financial decision and later faces financial hardships as a result, they may pursue legal action.

The Agent’s Role in Pricing

Pricing a home accurately is a pivotal step in ensuring a successful sale. Real estate agents play a crucial role in this process, using their expertise to determine the right listing price. However, it’s imperative for agents to avoid relying on outlier sales when establishing the value of a property. Here are four key reasons why outlier sales should not be used in pricing a home for sale:

1. Distorted Property Values:
Outlier sales, by their nature, are properties that sold significantly above or below the typical market price. Using such sales as benchmarks can lead to distorted property values. Pricing a home based on an exceptionally high sale might result in an inflated listing price that discourages potential buyers. Conversely, relying on a very low outlier sale could lead to undervaluing the property, causing sellers to lose out on potential profit.

2. Unrealistic Buyer Expectations:
When real estate agents use outlier sales to set a listing price, they risk creating unrealistic expectations among potential buyers. Buyers who have seen news headlines about a record-breaking sale may believe that such prices are the new norm, leading to disappointment and resistance to making offers on reasonably priced properties. This can prolong the time a property spends on the market and potentially lead to price reductions.

3. Appraisal Challenges:
Listings that were priced using outlier sales can pose challenges during the appraisal process. Appraisers typically aim to find similar properties, or “comps,” that are close in location, size, and condition to the subject property. Overpriced listings may not accurately reflect the broader market, making it difficult for appraisers to justify the contract price. In turn, this can result in issues with financing, as lenders may be hesitant to approve loans based on a property that may not appraise for an over-inflated contract price.

4. Market Instability:
The real estate market is subject to fluctuations influenced by various economic and social factors. Outlier sales, driven by unique circumstances, do not necessarily reflect the broader market’s stability or trends. Relying on these outliers can lead to pricing strategies that are susceptible to market volatility. Agents should base their pricing decisions on a broader range of comparable properties that provide a more stable and accurate representation of the market’s current conditions.

Alternative Approaches to Handling Outlier Sales

While it’s clear that outlier sales should not be used as the primary basis for home pricing, there are situations where they can still provide some valuable insights, if handled cautiously:

1. Supplementary Information
Outlier sales can be included as supplementary information in a CMA. They should be clearly identified as outliers and explained within the context of the broader market. This approach allows agents to acknowledge their existence without allowing them to unduly influence the final list price.

2. Market Commentary
Incorporating outlier sales into a section of the market analysis can be helpful. Agents can discuss the outlier transactions, their impact on the market, and why they should be viewed with caution. This approach provides valuable context for clients

3. Market Analysis
A robust CMA report is the foundation of any pricing strategy. Agents can use this analysis to provide a broader context for outlier sales. By emphasizing the importance of typical sales data and illustrating the market’s overall behavior, agents can minimize the undue influence of outliers.

Conclusion
When developing a pricing strategy, the use of outlier sales should be approached with caution. While these transactions may be intriguing and can sometimes offer unique insights, they are, by their very nature, exceptions rather than the rule. Relying too heavily on outlier sales can distort market trends and compromise the integrity of the pricing process.

Agents have a critical role to play in providing data-driven pricing analysis that reflects the broader market. The inclusion of outlier sales should be a thoughtful and measured decision, with a clear understanding of their potential impact on the list price. Transparency is key, as clients and stakeholders should be informed about the presence of outlier sales and the reasons for their inclusion or exclusion.

Ultimately, the goal of a real estate agent is to provide an accurate and fair representation of a property’s value based on market realities. While outlier sales may capture headlines like the one I mentioned previously, it is the consistent and typical transactions that form the foundation of a reliable pricing strategy.

In conclusion, outlier sales may be outliers for a reason, and their influence on real estate prices should be approached with caution and restraint. To provide clients with reliable advice, agents should prioritize the use of typical market data and exercise their professional judgment wisely. In doing so, they can contribute to a more transparent and trustworthy real estate market for everyone involved.

If you have any questions regarding the appraisal process feel free to contact me and as always, thanks for reading.

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Comments

  1. I didn’t realize there are six million dollar sales in your area. Any idea what the highest sale is ever? In my market it’s $7M.

    • Yeah, a lot of people have a funny impression of Alabama that usually is pretty far off base. The highest price recorded in the MLS is around $6.5 million. That’s pretty close to what you guys have.

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