We like to think we are good at making financial decisions. Buying or selling a house is one of the largest financial decisions we will ever make. But do we make good decisions when buying or selling houses? The answer is not always. Psychologists have proven that we regularly make irrational decisions, particularly when they relate to our finances, and real estate is no exception.
Consider the following scenario: imagine you purchased a property for $250,000. Seven years later, a job offer comes up in another city. You decide to sell. Property values have doubled and your home sells for $500,000. You are ecstatic. You move and quickly purchase a new home for $500,000, effectively buying and selling in identical market conditions. Property prices across the country start falling. You decide you have had enough of the new job and you want to move back. You advertise your home extensively but the best offer you can get in the prevailing market is $450,000. Faced with “losing” $50,000, you sense how terrible you will ‘feel’ if you accept the offer. You decline the offer, putting the house back on the market in three years time when the market has improved. This time you get $500,000. This makes you ‘feel’ great. But have you actually gained anything? If the price of the next house you buy has moved in line with the market you are no better off at all. Not to mention that you have put your plans on hold for three years. These are your “opportunity costs”.
The historical price you paid is irrelevant. The current market price and your other opportunities are all that matter. When you decide to sell, it is implicit that you prefer your other options, so a decision to sell should be a decision to meet the market price. But experiencing a loss, even if it’s just a perception, is so powerful that we often find reasons to justify the choice that avoids it, while ignoring our opportunities. This is because losses ‘feel’ worse than the corresponding pleasure from gains. Psychologists call this “Loss Aversion”.
A compounding factor is that our minds assign a much higher value to things that we own. In other words, once we are in possession of an object we think it’s worth more than it is. Psychologists call this “The Endowment Effect” and it is one of the most widely studied phenomena in decision making. It explains why, typically, we think our home is worth more than it really is. In a related experiment, researchers had subjects make origami frogs and then guess what people would pay for them. Another group were just asked to assign a value to the frogs. The group that created the frogs valued them, on average, five hundred percent higher than the group that did not. This experiment suggests our expectations will be even higher when we have renovated our home and invested more of our creativity, time, and money into it. High expectations mean that we don’t even need a historical sale price as a reference point to experience Loss Aversion. Our expectations become the baseline from which, when the market price is lower, we ‘feel’ like we are losing, even though there is no real loss at all.
So how can we make better decisions? One way is to think about the decision differently. For instance, in the example above, inverting the decision is illuminating: imagine if you did not own the property already. Would you buy it now for $450,000? Of course not, since you really want to be in another city, if you did not own the property you would just buy a home in the new area you prefer. And yet, the decisions to decline the offer of $450,000 or to buy your current home if you didn’t already own it for $450,000, have identical outcomes. They just don’t ‘feel’ the same. By framing it differently it helps to highlight the opportunity costs involved and makes the right decision more obvious.
Conversely, you shouldn’t just accept any offer put forward. You should balance a rational consideration of value with a process that ensures a highly competitive result is achieved and a premium price is likely. The final decision to accept an offer will be easier when there is compelling evidence that you have achieved the highest the market will pay – such as great advertising, lots of buyer activity, and multiple offers. We believe our recent success rate of 86% through our competitive Tender process is industry leading. Call me anytime on 021-764-647 for a no obligation appraisal and a brief presentation on our sales strategy which I am confident will add significant value and help you make excellent financial decisions.