How the Endowment Effect affects Real Estate

There is a tendency for people to demand considerably more for a product they own versus what they are willing to pay if they don’t yet own it.

This bias has been identified and researched by both economists and psychologists for years, and in 1980 the economist, R.H. Thaler, named it the Endowment Effect.

Real estate is no exception. A big hurtle many sellers face is the belief that their property is worth more than what buyers are willing to pay. We often hear things like:

--We see what other homes are listed for and ours is worth more. The seller is comparing his home to properties not yet sold. They are listings for sale and with some the days on the market can far exceed average market selling time.

--I don’t care what other homes sold for. Mine is better and at my price, it should sell fast. Even after a careful analysis of best market price--and depending on market conditions--about 40% to 60% or more of homes for sale can be overpriced. They linger, expire, go off the market and--in some cases--go back on the market at a reduced price--4, 5 and 6 months later—long after the homes they initially competed with sold.

Why do we attribute more value to what we own?

One reason given by psychologists Kahneman and Tversky is our aversion to loss. This characteristic in us is an anomaly and somewhat irrational. Loss aversion suggests that the prospect of loss hurts more than how good the equivalent gain will feel. This helps to explain, at least in part, why a seller might demand much more than a buyer is willing to pay. Selling his or her home means losing something and to reconcile the loss wants more than he/she would be willing to pay if buying.

Still there is more to the story

Some experts indicate loss aversion has less to do with the endowment effect than “a sense of possession, a feeling that the object is ‘mine’.” We tend to overvalue something just because we own it. What’s more, attachment to a home, or any item, even if the attachment is minimal, plus the subjective feelings that follow can be responsible for a person’s lack of motivation and reluctance to sell.

Of course when sellers have pressing reasons to sell, in spite of the disparity between their subjective idea of value and what buyers are willing to pay, they are much more agreeable to list at a price that will cause the home to sell.

In her book, Focus, author Heidi Grant Halverson suggests that “the endowment effect is most likely to happen when we engage in prevention-focused thinking about avoiding losses.” When our motivation is focused on prevention, we “prefer stability (nonloss) over change (potential loss)....” People are not always biased in this way.

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