Friday, October 05, 2007

Stuff is worth what it’s worth

I received a friendly email almost two weeks ago from a fellow who referred me to this interesting article in the NY Times.

“Economists tend to think people are crazy because they won’t sell their houses for less than they paid for them — and people think economists are crazy for thinking things exactly like that,” said Professor Christopher Mayer, director of the Paul Milstein Center for Real Estate at Columbia Business School and an authority on real estate economics.

It's a re-telling of loss aversion disguised as a discussion of people who refuse to lower the asking price for their home. As detailed at this wiser site:

In prospect theory, loss aversion refers to the tendency for people strongly to prefer avoiding losses than acquiring gains. Some studies suggest that losses are as much as twice as psychologically powerful as gains. Loss aversion was first convincingly demonstrated by Amos Tversky and Daniel Kahneman.

[SNIP]

Loss aversion may also explain sunk cost effects.

Loss aversion implies that one who loses $100 will lose more satisfaction than another person will gain satisfaction from a $100 windfall. In marketing, the use of trial periods and rebates try to take advantage of the buyer's tendency to value the good more after he incorporates it in the status quo.

[SNIP]

Loss aversion is a concept of Social Psychology as much as economics. It is not the reality of loss that matters but the perception. This is one place where being good at math doesn't give the answer. Nations have gone to war and "stayed the course" until their doom because of loss aversion. It simply means you refuse to admit you made a mistake.

Oh, I think we're all very familiar with that... Anyway, back to the NY Times.

There have been housing booms in the past and the fellows quoted in the article analyzed the after-effects of Boston's boom in the late 1980s.

From 1989 to 1992, prices in Boston fell sharply, with condominium prices dropping as much as 40 percent. For a great many of those who bought condominiums during that period, selling could be done only at a significant loss. And, basically, many people refused to sell.

Their study, “Loss Aversion and Seller Behavior: Evidence From the Housing Market,” appeared in The Quarterly Journal of Economics in November 2001. The professors [Mayer and David Genesove, a professor of economics at the Hebrew University in Jerusalem] gathered data on almost 6,000 Boston condominium listings from 1991 to 1997 and showed that for essentially identical condominiums, people who had bought at the peak and were facing a loss generally listed their properties for significantly more than those who had bought at a time when prices were lower.

Properties listed above the market price just sat there. In the Boston market over all, sellers listed their properties for an average of 35 percent above the expected sale price, and less than 30 percent of the properties sold in fewer than 180 days. In other words, much of the market went into a deep freeze as many people held out for market prices that no one would reasonably pay.

It'd be fascinating to see how pronounced this behavior is in DC today. OK, so what advice is offered?

... Well, if you are holding out for an above-market price to recoup your losses, perhaps you would do well to hear the advice that Professor Mayer gives his own family members.

“If you want to sell your house then you list it at the market price and you sell it,” he said. “If you don’t really want to sell then don’t put it on the market. But don’t say you want to sell and then set the price so high that you spend the year cleaning up every morning, having people walk through your living room and look in your medicine cabinets and reject you. That’s just painful — and expensive.”

His research offers a simple lesson for everyone out there waiting for a high price to push them back into the black: Get real.

Or, as my hard-charging, Mercedes-driving real estate agent told me when I was selling my house in Dallas: "You don't have a house problem, you have a price problem." Dropped the price and sold it in a month.

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