Chicago Booth Review Podcast How to Negotiate Home Prices

George Wu: The realtor is going to start beating on you to take that number. And the way they think of it is the following. 450,000, I'm going to get one and a half percent of 450 if I can make this deal right now. If you push me and say I'm not interested, then it goes back to the market. There's a chance I get nothing and maybe I get an extra 10,000.

Hal Weitzman: It said that moving homes is one of the most stressful things you'll do in your life, but negotiating to buy a home has to be up there as well. What can you do to help ensure that the price haggling is as pain-free as possible? Welcome to the Chicago Booth Review Podcast, where we bring you groundbreaking academic research in a clear and straightforward way. I'm Hal Weitzman. Today, how to put yourself in a stronger position when buying a home. Chicago Booth's George Wu teaches negotiation to MBAs. So what techniques does he recommend to reduce the stress and improve the success when it comes to getting a deal over the price of a home? George Wu, welcome back to the Chicago Booth Review Podcast.

George Wu: Thank you.

Hal Weitzman: We had to have you back because we had such a fun time talking about salary negotiations.

George Wu: It's lot of fun.

Hal Weitzman: I want to talk about more difficult, maybe negotiation, a home purchase.

George Wu: Oh, wow, okay.

Hal Weitzman: What makes... You knew we were talking about this, don't make a sound like a surprise. I did tell you. I did tell you.

George Wu: You've done some.

Hal Weitzman: Oh my goodness, I don't want to tell you about my experiences. What makes a home purchase such a difficult negotiation.

George Wu: Well, where to start? I think there... Let's just start at the obvious one. One is that most of us are buying a house with somebody else, a partner, and we may not necessarily agree on everything, including which house we want. We may be more or less enthusiastic about something. You may fall in love with the house. I may be okay with this, but if we don't get this one, some other one might be better. So anytime there is a joint decision that makes it difficult. Second is that it's emotion. And I think that's mean... I'm not saying something that is terribly surprising or terribly deep, but people fall in love with houses in ways that are very, very different than other kinds of things. As I suggested, it may be one of the two or decision makers that falls, but it's emotional and so on.

I think the other thing is that housing markets are... Let's just say not every housing market is the same. Maybe in California, they've been in the same for a long time because it's largely been a seller's market. But we've gone from times where it's a buyer's market to a seller's market to a thin market on both sides. And it's a weird market right now with interest rates being so high and the amount of both inventory that's on the market and the number of buyers who are willing to pay, and the fact that that's likely to be different at different price points and so on. It's a very odd market, let's just say.

Hal Weitzman: Okay, now, last time we had you on, we were talking, as I said about salaries and you talked about this emotional point there, but there seems to be a difference. If I'd become emotionally attached to a salary, it's not the number of dollars that I'm earning, it's what I'm going to do with that. There's something else.

George Wu: Well, you get emotionally tied to a job.

Hal Weitzman: The job as well. But I mean, we were specific-

George Wu: Like this job is great for you.

Hal Weitzman: Let's not psychoanalyze me. We haven't got long enough.

George Wu: I love my job.

Hal Weitzman: We haven't got long enough in this episode to start to scratch the surface there. But the home is really an emotional attachment. It's the biggest single purchase that you'll make in your lifetime. You're going to have so many happy memories in the thing itself.

George Wu: Completely.

Hal Weitzman: So that emotion changes negotiation, doesn't it?

George Wu: Yeah, yeah. No, it's absolutely true. I mean, I think one of the things I talked about in the last episode was about something that my colleague Richard Thaler studied, which is called the Endowment Effect. And the classic demonstration is with mugs. You have somebody's given a coffee mug and then somebody's not. And the people who are given a coffee mug insist on two times as much to sell their mug as the other people are willing to pay. And so that's a demonstration that's kind of obviously a little bit bizarre because why should the value of this mug be twice as high just because you put it in front of me instead of you. And what that is a demonstration is what we call loss aversion, is that giving up something is much more painful than getting something.

And I think the same thing applies in lots of situations where you literally don't have something, but you have it in your mind. So real estate agents spend a lot of time trying to essentially create this endowment in your head. So if I'm an agent and you're looking at a house and you seem to like that breakfast nook, you like breakfast nooks. So then what I would try to do is really try to essentially have you really create these vivid... This is my favorite room too. I could imagine waking up on a Sunday and drinking a cup of coffee and looking over that beautiful car. And my cows going... Yeah, that's absolutely how I was thinking about it too.

Hal Weitzman: Listening to the Chicago Booth podcast.

George Wu: They did that the previous night too.

Hal Weitzman: No, but we are creating this emotion attachment. So I understand people, the endowment effect, other agents, which is another thing that makes housing-

George Wu: Yeah. We haven't even talked about agents yet.

Hal Weitzman: We're going to come to that. Right, because it's not simple, but how does that emotion change the way that people behave, I guess is what I'm asking? I understand the endowment effect, people are prepared to pay more. Same kind of thing apply?

George Wu: Yeah, absolutely. I mean, certainly, let's just say they are far less willing to let that deal fall through. And that means oftentimes when the deal... If the negotiation gets testy, which of course sometimes it does, then what's an extra 10,000, 20,000, $50,000 if you have it? I mean, if you don't have that money, then that's a different thing. But if you do have that money and you prefer to keep it for going on vacation or your kid's college, then I guess your kid won't be going to college now.

Hal Weitzman: Right. And that's another complication too, right? Is that you say if you have the money, well, I mean, if you're borrowing the money, who cares? You're borrowing it, you'll pay it off over a very long period of time. It doesn't really matter.

George Wu: But if you're maxed out a loan.

Hal Weitzman: It's another $10 a month or whatever. It's completely-

George Wu: It's nothing. Yeah. So one of the things that I tell everybody is that when you have found a house that you like, that means that just that you're going to negotiate and that what you tell your realtor is keep on showing me houses, keep on showing me houses. And even if you have a contract, the idea is like keep on showing me houses. And they hate that. And they may not believe you. And they actually did I say they hate it. They really do hate it.

And if they don't show you houses, then you keep on looking at the listings. And I think that's the mentality that you should have until this thing is done and closed and so on, you don't actually have that house. And I think it's the negotiation itself is also not just the sales and purchase agreement, it's all the contingencies that happen afterwards. And well-

Hal Weitzman: We'll come to that, but I want to press you on this idea of the still let's keep looking because as you say, if you see your dream home, it's perfect. And all needs to happen now-

George Wu: You would be a good salesperson.

Hal Weitzman: Now all that needs to happen is for them to accept just the small matter of the price.

George Wu: Of course.

Hal Weitzman: And so you're saying don't get emotionally attached, and one way you can stop emotionally attached is, well, let's go and look at other stuff, which I think is, I remember hearing this. I think I sat in your classroom a decade ago and heard you say that. And it made me think differently about this whole idea of negotiation of a BATNA, best alternative to a negotiated agreement. Because I think in the past, I'd always thought of a BATNA as a static thing. Well, if I walk away, what happens? And I hadn't thought, well, the best thing you can do is make that best alternative look really good, so that either you won't be disappointed if it does fall through or you'll have a stronger hand in negotiations. So talk a bit about the BATNA and how you can develop a BATNA.

George Wu: Well, a BATNA is... The way I describe it is instead of something static, it's really an itinerary or a set of scenarios about what happens. And I think what makes stepping back is the idea is that if you are unable to successfully make a deal on this house or this job or whatever, then something will happen. Something will happen for sure. And your job here is to make sure that the deal you negotiate at the table is better than what you judge to be what happens. But of course, what happens is sometimes very tricky to understand. So if you are selling a house and the house has been on the market for a day, what happens if I don't sell it to you? Well, it goes back on the market and there could have been lots of people who are interested or we don't necessarily know.

Or it could be a housing market that is very favorable to the seller, very favorable to the buyer. Or it could be something in which, let's just say, I need to get out of here. I need to get my money in the next month or else something disastrous is going to happen. Or it could be that the kind of house that I am selling is very idiosyncratic. It's a contemporary house in a neighborhood that doesn't have very many of these, or it could be a very typical house in which there's lots of other substitutes.

All of those things are, I think, very different. And they're different if you're the buyer or the seller. And I think part of it is that what you need to do is to the best that you can do, imagine what will happen there. And again, the way to think about your BATNA is that what you are doing is you're setting a bottom line, a reservation price. And what the reservation price is really doing is something conceptually very easy. Something in practice hard to do is dividing the world of outcomes into things that are unacceptable and things that are acceptable. And it makes sense that depending on whether that future looks really favorable to you or not so favorable, that's going to determine whether you draw that line really high or really low.

Hal Weitzman: In practice, do you think... So I'm just thinking about the dating market, which is another market that economists loves.

George Wu: I'm not-

Hal Weitzman: Neither of us, thank God is on that market right now.

George Wu: And you're not inviting me to that podcast.

Hal Weitzman: But I'm just saying, thinking about the dating market, it will be obvious that if you would want to have lots of options, and so you think about what are my options and what's realistic, but do you think that housing is a much... Well, dating is a big lift, but-

George Wu: You should change the subject.

Hal Weitzman: Housing is a big lift. You really only do this very, very occasionally, and there's a lot of emotional investment and time investment. And so do you think that when people do see their dream house, they really do go and look for alternatives or they just kind of relieved by that point that they found-

George Wu: Oh, I think they're relieved. And I think part of also the process is, and some realtors are more strategic about this. I mean, they start you with a house that's way outside of your range. I said, oh, you said that you're only willing to pay this, but why don't you take a look at this? And you go like, my God, is that house amazing, but if only I had an extra 250,000. And then you see another house that's not quite as good, but it's also amazing. It's only $150,000.

And then so they are obviously pushing on your budget. But a lot of the times, especially when people really do have idiosyncratic taste, and as I said, is that you're trying to appeal to you and your partner who may not agree on everything, when you find something in that sweet spot after being in the market for so long, it's natural to be exhausted. And so of course, I think that's part of what they're doing, and they're taking advantage of that exhaustion. And you've been looking for houses for the last six months, and now all of a sudden you call your mom and dad say, I think we found our house. Our house. It's not your house yet. It's a house that you may have. But when you start telling your friends and posting it on-

Hal Weitzman: Don't talk like that.

George Wu: Don't post it on social media. I would think that it seems natural. I'm sure lots of people do that, but don't be posting it on social media and telling your friends. And if you do tell people, you tell them cautiously and you don't want them celebrating with you because then walking away becomes that much harder.

Hal Weitzman: If you're enjoying this podcast, there's another University of Chicago podcast network show that you should check out. It's called Not Another Politics Podcast. Not Another Politics podcast provides a fresh perspective on the biggest political stories, not through opinions and anecdotes, but through rigorous scholarship, massive data sets, and a deep knowledge of theory. If you want to understand the political science behind the political headlines, then listen to Not Another Politics Podcast, part of the University of Chicago podcast network.

Okay, George, we talked about BATNAs, we talked about the endowment effect. I want to ask you about agents. You got there a little bit. Now, I mean, there are a lot of great realtors, of course, and some of my best friends, as they say, are realtors. But this is a complicated negotiation because you have an agent. I mean, if you talk about game theory, it's complicated when there's another party involved with their own interest. The agent wants to spend presumably the least amount of time and get you to spend the most amount of money and quickly-

George Wu: Though they have a fiduciary responsibility to you.

Hal Weitzman: Of course, but they want to get the deal done. And you don't necessarily want to get the deal done. As you said in the first half, you want to make sure you have lots of options to choose from and to give you leverage. So just talk a little bit about the complications an agent can bring.

George Wu: Okay. I mean, the first thing is that agents get paid based on purchase price, which I think everybody knows. And typically this is approximate, but if the fee for a house is 6%, 3% goes to the seller's side, the house, call that Berkshire Hathaway, maybe Berkshire Hathaway is on the other side too. So 3% to both sides, the seller and the buyer, and then maybe half to the particular agent. So if it's a million-dollar house, that's 60,000 in commission, 30,000 and 30,000 and 15,000 to me as an agent. And if I can get an extra a hundred thousand, that's an extra 1,500. So first of all, in class I talk about the study that Chad Severson and Steve Levitt did.

Hal Weitzman: Those are your Booth and U Chicago colleagues.

George Wu: They are. And they have probably been on your podcast before.

Hal Weitzman: Chad has. Yeah.

George Wu: Okay. And the study goes like this, which is that they have an old database of Chicago real estate sales. And that it turns out that about, if I'm remembering correctly, about 3% are essentially agents selling for agents. So 97% are agents selling for us, and 3% are agents selling for agents. And what it turns out is that if you use regression analysis to do what is oftentimes called hedonic pricing based on attributes of the houses and so forth, you find that basically agents houses, I can't remember the exact number, but agents' houses sell for quite a lot more than the equally attractive house that you own. And one of the things that is also true is that those houses stay on the market longer. So they sell for more and they stay on the market longer. And the way I always describe it is that even though they have a fiduciary responsibility to you, let's suppose you have a house on the market for 500,000 and you are looking to get 480 and you have an offer of 450.

Okay, so not exactly the number that you would like, the realtor is going to start beating on you to take that number. And the way they think of it is the following is 450,000. I'm going to get one and a half percent of 450 if I can make this deal right now. So one and a half on 450, if I can make that deal right now. If you push me and say, I'm not interested, then it goes back to the market. There's a chance I get nothing, and maybe I get an extra 10,000. So there's a probability that I get an extra 10,000, an extra 20,000, actually one and a half percent of that, $150, $300. Completely not worth it.

And if you just look at that calculus, whether they think about that calculus exactly that way, you don't have to be a mathematician to understand that having that deal right now for sure, and also having all that time that you would be spending on putting this back in the market and showing other people and so on, that is by far better than taking your chances of putting this back on the market. But if it's the agent selling it for themselves, that $10,000 is almost all of it goes to me. Of course, I'm going to spend that. Of course, I'm going to spend an extra... If there's a lousy offer, I'll take it if I have to. But if I think that there's any chance that I can get a better offer, I'm going to put it back on the market.

Hal Weitzman: Okay. So sellers, does that mean we can conclude that sellers who are not agents tend to sell too soon?

George Wu: Seller, yeah. Sellers who are not agents. That's right. Probably. Probably. And it's also almost surely true that a lot of ordinary people are risk averse for lots of reasons. And I mean, realtors are going to prey on your risk aversion. So if there's 450,000, how you can have that money today, we can have this deal done by the end of the month, or if we put it back in the market, I don't know when it would go happen. Who knows when. I think we'll probably be able to get another offer, but who knows? You Can take a chance if you want, but I wouldn't... Well, I actually would.

Hal Weitzman: You're so persuasive, George. Yeah, no, I'm happy to sell. You're so persuasive. That makes me think though, that there are, in a lot of negotiation analysis, you teach that people should set numbers before they start negotiating anything and stick to the plan that they've set, right? Red lines.

George Wu: Yeah. I mean, it's-

Hal Weitzman: In a whole price it seems, as you say, so obvious you're going to really ruin the whole deal for $10,000. It seems so obvious. They're easy to creep beyond those red lines, how do you get people to stick to those?

George Wu: Well, I mean, some of it is... I mean, I think that a lot of the times the red lines are not based on any real analysis. Again, I think ideally, and it's hard, it's easier said than done. The line is determined by really dividing the world into acceptable and unacceptable deals relative to what happens if you don't make a deal. But that really requires you to have thought about what will happen if you don't make a deal. And if you've really not thought about that, then you just pull the number out of thin air, which I think a lot of people end up doing.

500,000 sounds like a good number, nice round number. And people like round numbers. And I think what makes these things hard is that sometimes when people set a bottom line, it's really what we call an aspiration, not a real bottom line. So yeah, I'm hoping not to pay more than 600,000, but yeah.

Hal Weitzman: They can always extend the mortgage a little bit.

George Wu: A little bit. Or sometimes 75,000 or a hundred.

Hal Weitzman: Right, right, right.

George Wu: A little bit more than a little,

Hal Weitzman: Okay. We've been talking a lot about buyers. Well, still thinking about buyers, but thinking about the other side, because the other thing you do in negotiation analysis in class is you get people to think about what are they willing to sell? What would they like to achieve? Now, in a house negotiation, there's a lot of other stuff going on, the timing and whatever other conditions are affecting the seller, how can you find out about what's really going on and how does that affect negotiation?

George Wu: I mean, I think one of the things that is really interesting these days, especially with high interest rates and the fact that... Well, high interest rates, let's just say that. The people who so-called have cash. Some of those people are ones who are just sitting on lots of money for various reasons. And some of them are ones who essentially have just sold something and are the people who are sitting on cash are obviously in a very, very strong position. They're in a strong position in a couple ways. One is that the risk of actually getting loan approval and all that kind of stuff has gone down to zero or pretty close to zero. So that sometimes for people is a big thing. And everybody knows of somebody who's had a house fall apart because somebody was not able to get a mortgage. And sometimes, of course, that's critical because you have to sell your house in order to buy another house, and maybe you could take a short-term mortgage or something like that to bridge, but that's something that you want to do or something that you're able to do.

So I think that's one thing. And so I do think that it's one of these things that in this market, especially, people should think a little bit about what happens and how they should treat cash offers, so-called cash offers different than non-cash offers and has two obvious advantages of cash offers. One is that the chance that it will fall through goes down. But the second thing is that it's likely to close earlier. If the mortgage company has to get in involved and so on, that's going to be an extra 50 days, 30 days or whatever. If I have cash, sometimes the deal can close in 10, 15 days, and that's sometimes a big advantage. Now, is it worth 50,000? I don't know how much it's worth, but I think that sellers have to think a little bit about how much that's worth and why.

Hal Weitzman: But as the buyer, I know something, for example, that's done is bundling. I can either pay you this money now, but we have to close quickly, or I can pay you a longer timeframe, but there'll be less. Is that sort of approach sometimes relevant? Have you seen that?

George Wu: Oh, yeah. I think it's sometimes, for example, what we call joint gains in negotiation, which is that I'm looking for a house. I'm not going to move in until the summer because that's when the school year for my kids is. So why move my kids early? But it's a crazy housing market, so I'll basically get a house whenever I can. You don't want to be in the market just when everybody else is in the market, right around school time, because then that's a really tough market.

So some people in that situation, they actually don't want the house for May, June or whatever. And something that is beneficial sometimes for sellers is essentially to be able to rent back the house, maybe even rent back the house for nothing. That's especially the case in situations where people are doing renovations, which timeline on renovations is pretty uncertain.

And so you may be done in April, but you also may be done in June or July. And to have at least the flexibility, maybe you're renting or something like that, that's pretty good. And that oftentimes the way that's structured in a contract is so-called PMI or something like that, where essentially what you're doing is you're paying their costs, which is the mortgage and the interest and the taxes or whatever. And so they are not disadvantaged by that. But that's something that's certainly very attractive for some sellers. Not all, but completely costless for a lot of buyers.

Hal Weitzman: Right. Okay. George, how long have you been teaching negotiation?

George Wu: You're asking me to age myself. Since 30 plus years.

Hal Weitzman: 30 plus years. So in that timeframe, have you bought a house?

George Wu: I have.

Hal Weitzman: Yeah. Okay. So did you take your own advice?

George Wu: I have. It's actually funny. I will tell this. I should invite people to look up what I paid for property on the internet. But one of the funny stories is that when I was selling, I guess my previous place, the buyer, I don't even remember what the actual price was, but it was something like, if you look at our listing, or if you look at basically the public records, it'll say like our house, and it'll say some number like 917,787, and that's tied to my name forever, and I'm going to disabuse people with the fact that that's completely my doing. So people are going like, what a jerk as a negotiation professor ending up with a deal at 917,787. So the reason that came about was the guy who bought it Googled my name, and found out that I talked to negotiation, and then started looking around at all kinds of negotiation tips, and then found one article that said that when you make non-round number offers, they're more likely to be seen as non-negotiable. So his offer was this crazy non-round number.

Hal Weitzman: Okay. And you fell for the trick.

George Wu: Well, more complicated than that, I won't say everything.

Hal Weitzman: All right. We'll have to be back to talk about that. George, thanks again for coming back on the Chicago Booth Review Podcast.

George Wu: Thank you.

Hal Weitzman: That's it for this episode of the Chicago Booth Review Podcast, part of the University of Chicago Podcast Network. For more research, analysis, and insights, visit our website at chicagobooth.edu/review. When you're there, sign up for our weekly newsletter so you never miss the latest in business-focused academic research.

This episode was produced by Josh Stunkel. If you enjoyed it, please subscribe, and please do leave us a five-star review. Until next time, I'm Hal Weitzman. Thanks for listening.