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

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.