Why your home is not worth as much as you think it is

Why your home is not worth as much as you think it is
Brad Caldwell-EylesOctober 17, 2012

When a home sells quickly and at a terrific price, everyone is delighted. In a bearish market this outcome remains the ideal target; however the wider the disparity between an asking price and the available offers, the more difficult the sale becomes.

The theory of "optimism bias" purports that individuals expect their own chances of receiving positive things in life to be greater than the average person and that their chances of incurring negative outcomes are less than average. The individual "optimism" outweighs the law of averages.

Thaler in 1980 postulated that “people often demand much more to give up an object than they would be willing to pay to acquire it”. Jeffrey Strain wrote “that people believe something they own is worth more than the exact same thing they don’t”. Thaler’s endowment effect (also known as ‘divestiture aversion’) has been described as one of the most important concepts in behavioural economics.

The connection to real estate is clear. It is common place that vendors of property perceive their own property’s value to be in excess of the buyer market’s perception of same. It is the single most significant impediment to the sale of real property. Essentially all property will sell “at a price” – it is the seller’s expectation that will hold up the process. Over time there usually becomes a meeting of the minds between buyer and seller and a deal is done; however very often there is a period of time and grief prior to achieving that consensus ad idem.

Richard L. Peterson (2008) proffered that in a normal housing market, sellers over-valued their own homes by around 12% more than is justified for the market to pay. In the US downturn, he further commented this to climb to an average of 33% above market value. Why? People are hardwired for “scarcity”, and we don’t want to let go of something we already own.

Peterson cited a study conducted at Stanford University (2008) that connects the endowment effect and the activation of the brain’s anterior insula. The intensity of activation of the anterior insula became a predictor in subjects for the strength of the endowment effect in a situation of value assignment. The interesting parallel is that the anterior insula also activates when someone is experiencing fear; pain or disgust.

The essence is that the prospect of a vendor selling their home below their own assessment of value will produce psychological responses akin to fear, pain or disgust. Given that the endowment effect has shown that the vendor’s notion of price will regularly be elevated beyond reasonable market perception, it is almost inevitable there will be some form of “pain” and that in an effort to avoid “pain”, the sale may be elongated in the pursuit of an unrealistic price.

 


 

In the absence of an ‘out of line’ price, it is the existence of a countering and stronger “pain” that can result in a sale. This may take many forms including but not limited to:

  1. Financial stress
  2. Illness/age
  3. Relationship breakup
  4. Undergoing the ‘schooling’ exercise of learning the reality of the market
  5. Sheer exhaustion/exasperation at prolonging the process

That is, that a price reduction to meet the market becomes the lesser of two “pains”.

While there are always anomalies, it appears that relinquishing our cherished home at a value we feel is appropriate is often destined for some form of disappointment with either the sale price or the period required to achieve it. Like most matters psychological,it is the very awareness of the endowment effect and its influences that may assist in combating its fallout.

For vendors and agents alike, understanding and empathy are key. The selling process is often a rollercoaster of emotions – high and lows of excitement; disappointment; stress and relief. A seller who is more aware of the reasons for his emotional response to his expectations will be able to take charge of his notions of price and be prepared to accept the reality of the market feedback.

Agents are often accused of "over pricing" a home to win the listing. It is a fine tightrope of dealing with this endowment effect while delivering genuine and considered advice.

One business coach puts the issue in terms of face cream. The coach describes the marketing of face cream as one of the greatest lies perpetrated upon the consumer market. The promise of eternal youth is readily clung to despite the buyers already being quite sure that a tub of cream is unlikely to actually turn the tide of age. The face cream companies are simply purveyors of hope. Optimism bias, the endowment effect, hope and the reality of market dynamics are all in play for owners presenting their home for sale.

The upshot of this is that the endowment effect predicts “unrealistic seller expectations” will in fact be the norm. It is a powerful emotional response to ownership and scarcity. Agents would be better served understanding the power of the endowment effect when dealing with clients and consider their approach taken.

It is those agents who can successfully navigate and negotiate these factors who ultimately are the most successful – those being able to represent with integrity and maintain their client’s emotions from start to completion.

Brad Caldwell-Eyles is a principal at 1st City - Hasemer+Caldwell-Eyles

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