28.05.2019Blog

On pricing real estate (and buying toilet paper)

Solita blog post on pricing of real estate

Yup.

This is 5-minute read, where I’ll shortly outline where we Finns nest our hard earned money (we suck at compounding interest), why buying and pricing toilet paper is easy compared to real estate, and how algorithms are changing the real estate market.

As Finns we like to own our homes. Compared to Sweden, our assets are lodged primarily in brick and mortar or suffer negative yield on our bank accounts. Those of us that own homes, have parents that most likely owned one. A home is also considered an investment. If you live in a growing urban area, there are good chances your home’s value will not depreciate during the next five to ten years.

Your home is something that the market – if it had a voice – would call a heterogeneous asset. In layman’s terms, your home has a lot of individual characteristics that make it your special place, and thus difficult to directly compare to similar listings that makes it illiquid. After all, your home is most likely sold and bought less than twice in a decade. It has on average a far longer sales time than say, publicly traded shares or even used cars.

Now, take yourself back to the last time you bought toilet paper. Bog roll, as our dentally challenged, quasi-European British friends call it.

It’s something you most likely picked into your shopping cart on your way to the cashier, as that’s how store layouts are planned. As you walked down the aisle of sanitary relief you were courted by promises of extra soft treatment for your derriere involving fluffy lambs – a very unsettling thought once you get into it – and the budget option that implies you might be a boss in the boardroom but still a scrooge in the bathroom.

You buy toilet paper because you must. Your pick of the day was out of habit, brand recognition, or because your spouse wrote down in intricate detail what is expected of you for getting s**t done.

Last year, you bought, on average, toilet paper at least once a quarter. If you have a large household and/or a propensity for dodgy late-night food, you’re a tier 1 customer for the tp-industry.

Toilet paper is a FMCG (Fast Moving Consumer Good) product. It is homogeneous and frequently sold. Volume of sold toilet paper has direct correlations to changes in unit price and marketing expenditure.

Both apartments and toilet paper are sold on a search market, but in a lot of different spectrums, such as liquidity and product comparison, they are more or less in the opposite ends.

Where pricing toilet paper is a straightforward operation, pricing apartments is a different beast altogether.

Apartment listing prices are a blend of comparable assets on the market (difficult), endowment effects, seller motivation (how fast do I need to sell this) and most commonly a real estate agent’s opinion.

One of the key value adds realtors claim to provide to the seller, is a fair and correct price for the apartment on sale. As we’ve learned, their intentions are not always fully aligned with the seller’s.

A carefully scoped listing price is super important, as it is the most important number that other characteristics of the apartment are valued against. It should also always rule out a large segment of potential buyers. If you get 30 full price purchase offers for your apartment in the first 24 hours, was it priced correctly?

For the seller, factoring into the listing price other attributes than square footage, future cost of ownership (renovations and repairs) and the location of the house is a mushy ordeal. The fact that you love your open kitchen design and windows facing the park does not automatically mean that potential buyers see that as a reason for a premium in the listing price.

Selling real estate boils down to Time on Market (TOM). Theoretically, every apartment or property is purchased eventually, with no changes in the listing price. The TOM might be a month or 20 years, but it gets sold. The seller seldom has this option, as there’s always direct and indirect costs associated to owning the property, that chip away the bottom line each day the asset sits on the market. Tolerable TOM’s are achieved by identifying what potential buyers value in the property and setting a price that reflects that perceived value.

Easy, right?

An effective algorithmic pricing model is a great tool for the seller.

It is a probabilistic program based on a large data set of Customer Value Factors (CVF), Time On Market (TOM) predictions and external data sources. It is used to give the apartment the best possible listing price with a TOM predetermined by the seller.

Unfortunately, these models are always proprietary and not available to the private seller. Algorithmic buying – also called iBuying – is also gaining real estate market share in the the US. Companies, such as Zillow are morphing from providing a marketplace for real estate to buying and flipping apartments and properties in large numbers according to their data model.

Algorithmic Pricing Model for Real Estate

Solita blog image Algorithmic Pricing Model for Real Estate

Real estate developers are racing to ramp up their own algorithmic capabilities in a similar fashion to the ongoing race to efficacy that started between investment banks a decade ago. When you sell in volume, a few percentages difference in the final sales price and a shorter TOM amounts to a lot of money. Algorithms are not only used to price the listings correctly, they’re used to search the right buyers according to the underlying CVF models.

What does all of this mean for us?

In Finland we’re about to face a huge redistribution of real estate assets in the next decades, as the baby boomers’ leave us. Simultaneously, growing urban areas will continue to expand outwards and to develop and repurpose existing properties and buildings.

Both real estate developers and private investors will face a market flush in supply, where achieving a decent bottom line with traditional pricing and search methods is difficult.

As a private homeowner, you’ll most likely have an iBuying option at your fingertips and algorithmic B2C products to help you price your property in the next few years. Real estate agents as a profession will all but disappear.

As I’ve written earlier, at Solita, we’re committed to solving complex problems.

Intelligent pricing models are among the most interesting things we’ve been helping our customers with.

If you need toilet paper, it’s the center aisle in your local supermarket. If you’re looking for an edge in the market using data and design, give us a call.

Topi Ahava is an Account Director at Solita, interested in developing learning organizations and driven by impactful innovation.

Photo by Brandon Griggs on Unsplash