The psychology of home prices

Darren Moffatt

There was a great article yesterday in Property Observer by Housenet member, Brad Caldwell-Eyles on why vendors often think their home is worth more than it really is. As Brad writes:

"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."

He also quotes some interesting studies that illuminate the psychology behind this and how it relates to real estate:

"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."

This is a very scientific explanation for the disconnect we have seen, until recently, in many parts of the Australian market. According to SQM Research, latest indications are that the vendors are now beginning to meet the market which is the first step towards a recovery.

Brad concludes with some good advice:

"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 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."