There is another agent in my area that will list a property at about 50% of fair market value. He gets multiple offers and the property comes back on the market in about 2-3 months at a higher price normally 85-90% of fair market value. The lender has decided that they can get more that 50% if they forclose and sell the property as a REO. They want to see realistic offers not junk. If the offer has lots of contingencies the lender may also reject allowing the short sale on that contract as they also look at how likely the closing is going happen.
So, you want to be in the ball park. With another of my buyers we wrote an offer above listing price, as James explained, because we realized that property value was way above listing price and we want to tget our offer accepted. So in other words, it is about fair market value. Either you want to look like you are testing the market or you are a potential buyer.