Your brain may react to many things in a real-estate deal, including the attractiveness of the real-estate agent and a house’s wall color. Your brain may betray you.
By Ryan Sager of SmartMoney
If you have hunted for a house, you probably got a sense that real-estate purchases don’t represent consumers at their most rational. Did you like a house or apartment more or less depending on whether you saw it on a sunny day? Chances are, you did.
Buying a house isn’t the same as buying a stock, an air conditioner or even a car. It’s not just a product with pluses and minuses — good school system versus a small kitchen, a new roof versus a longer commute. A house represents the kind of life you want to live. And given its cost, a house and the value it gains or loses represent concretely the life you could live.
Thus, it can be disturbing — though perhaps not surprising — to realize that people’s judgment about real estate is susceptible to many of the foolish forces that affect so many other consumer decisions. In some ways, it may be affected even more.
Research by Michael Seiler, a professor at Old Dominion University in Norfolk, Va., has found that men and women — particularly men — are susceptible to the attractiveness of a female real-estate agent. The more attractive the agent, the more the buyer is willing to pay.
Superficial things such as a room painted an ugly color can make people less likely to buy a house, even though fixing that problem is as cheap as a couple of cans of paint.
What’s more troublesome, though, is how attached our minds get to the perceived value of our house. In one study, economists David Genesove and Christopher Mayer looked at the spectacular bust in condominium prices in the early 1990s in Boston. When a market goes south, as the housing market did recently, standard economics tell us that sellers should recalibrate their expectations and behavior, knowing they must sell for less.
Of course, this isn’t how our brains work. Instead, we’re susceptible to loss aversion, the mental quirk by which we feel losses much more sharply than we feel gains. Instead of setting the price of our property by what the market will bear, we set it by what we paid and what we think we "have to" get.
People who bought at or near the peak of the Boston condo boom listed their properties for around 35% more than others. Consequently, those overpriced properties sat on the market; fewer than 30% sold after 180 days. Another wrinkle: Owners who lived in the units showed about twice as much loss aversion as people who had bought them as investment properties. A home, it seems, makes us more irrational than a house.
It doesn’t take a boom or bust to trigger this phenomenon: A more recent study says that homeowners consistently overestimate the value of their homes by 5% to 10%. The only cure for this seems to be buying a home during a slump; these buyers may underestimate their home’s value.
Buyers getting in now, then, may be at a cognitive advantage for years to come. Boom buyers, meanwhile, must come to terms not only with economic losses but also psychological losses and regret.
