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The Psychology of Selling a House for a Loss

This article was written by in Real Estate and Home. 17 comments.


There are two reasons a potential home seller might balk at selling his house in a down market. First, if the value of the house has decreased past the amount he owes on the mortgage, he’s underwater, and would owe money to the bank after he sells. But even if he has paid off the house, the fear of taking a loss might stop him in his tracks, even if it’s only a loss on paper.

For example, if he purchased the house for $200,000, at the peak of the market, he determined the house value was probably $800,000, and comparable homes are now selling for $400,000. Putting the costs of owning and living in a house aside, he would have a real gain of $200,000, but it feels like a loss of $400,000 from a theoretical peak.

The brain over-emphasizes the effect of a loss, and we are wired to avoid losses if possible. Many home sellers sell their current home at the same time they’re buying another. On average, the disadvantage one has as a seller is offset by the advantage one has as a buyer at roughly the same time. This is why the real estate market is slow to recover, however. People believe the myth about the great financial returns of real estate and rather than sell when they need to, they hold on until they can report that their home ownership was financially successful.

A recent article on NPR’s Planet Money illustrated loss aversion through a coin toss where the winning and losing scenarios were slightly different.

I recently visited Eric Johnson, a professor at Columbia’s Business School. He offered me a sweet bet on the flip of a coin. If the coin came up heads, I would win $6. If it came up tails, I would lose $1. I told him I’d take the bet. But then he changed the terms — if the coin came up heads, I would win $6. If it came up tails, I would lose $4. That bet I didn’t like.

Of course, this is irrational. The bet is still very much in my favor. If I took the bet 1,000 times, I’d almost certainly make a nice profit.

I think the key here is that over time, we know a coin toss will revert to positive performance 50% of the time. Although the overall probability remains the same when you look at one coin toss, there is no time for performance to even out. There is still the chance of losing $4, and it’s a good chance. It’s the same with selling a house. You don’t have the opportunity to sell houses over time so your performance reverts to average.

One problem with this analogy is that while the results of a coin toss are random, your selling price, while perhaps not exact, is relatively well-defined. You know going into the transaction whether you have a paper loss or a gain. While clinging to a house longer than necessary in a market that has fallen is avoiding a guaranteed loss (real or paper), choosing not to take a 50/50 bet when the losing outcome seems too painful is avoiding merely the chance of a loss.

There is also the assumption that the coin toss isn’t rigged. If I offered you the opportunity to win $5,000 if the coin I toss lands on heads or to pay me $4,000 if the coin I toss lands on tails, first you’d ask yourself why I would even offer such a bet. You would consider whether I knew something about the coin that you didn’t know.

I’m sure home sellers often think the real estate industry is rigged. In fact, it is — real estate brokers are the real winners, because they can take a piece of every sale regardless of whether the seller wins or loses. They also have a lobbying group that ensures a favorable environment for real estate transactions.

Would you wait to sell a house at a time when the market is more in your favor, even if it means buying a new house when you’d have to pay more than you would today?

NPR

Published or updated February 25, 2011. If you enjoyed this article, subscribe to the RSS feed or receive daily emails. Follow @ConsumerismComm on Twitter and visit our Facebook page for more updates.

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About the author

Luke Landes, also known as Flexo, is the founder of Consumerism Commentary. He has been blogging and writing for the internet since 1995 and has been building online communities since 1991. Find out more about him and follow Luke Landes on Twitter. View all articles by .

{ 17 comments… read them below or add one }

avatar Robert @ The College Investor

When it comes to selling and buying at the same time, it is hard to forget that “a rising tide raises all ships”. So, the danger of selling early to me is that if home prices rise, I may not have enough cash to buy the one I want. But, selling without buying can be advantageous if home prices continue to drop.

My boss actually just did a strategic short-sale to be able to buy again in a few years. He took advantage of the tax credit that lets you not pay on debt forgiveness, and he is renting for a few years to get his credit back on track. He is saving boatloads of money, and plans on buying a house soon.

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avatar retirebyforty

Your boss maybe saving boatloads of money, but his landlord is actually making boatloads of money.
If you focus on buying income properties, short term fluctuation doesn’t matter.

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avatar rewards ♦31 (Newbie)

“his landlord is actually making boatloads of money.”

Unless of course his landlord paid “too much” for the property and is barely able to pay for the mortgage/insurance/maintenance/taxes with the going rental rates.

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avatar rewards ♦31 (Newbie)

“Of course, this is irrational. The bet is still very much in my favor. If I took the bet 1,000 times, I’d almost certainly make a nice profit.”

This is not irrational. If I took the first bet 1 time, I’d stand to lose $1. If I took the second bet 1 time, I’d stand to lose $4. It’s the downside risk that makes people balk at the second bet. We don’t work in averages.

“I’m sure home sellers often think the real estate industry is rigged. In fact, it is — real estate brokers are the real winners, because they can take a piece of every sale regardless of whether the seller wins or loses.”

Home owners/home sellers are not necessarily losers when they use a real estate broker. Many people decide that they don’t have the time/experience/inclination to properly assess a homes market value. So they pay a real estate broker. Many people decide that they don’t have the time/experience/inclination to understand and jump through all the legal paperwork and regulations. So they pay a real estate broker. It’s simply a service that real estate brokers provide.

This statement is like saying mechanics are the real winners because oil needs to be changed on a depreciating asset; farmers are the real winners because they are making money off of the sun; etc.

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avatar Matt

My wife and I recently moved and sold our house at a loss. We knew right away that we were going to have to take a loss as there was a very similar house right down our street that had languished on the market for almost a year at a price near what we paid for ours.

So it became a question of whether or not we rented out and sold at a later date or took the loss. We talked about renting for a bit, but we were moving out of state, and decided it would be to much hassle to try and maintain the property from so far away.

We also remembered when we were first time buyers dealing with people who wanted way more than the house was currently worth (one home we put an offer on ende up going for $30k less than we offered months after the owners turned us down), and how frustrating that was to us.

Thankfully, the job that we were moving for gave us a generous moving allowance and we moved to a state with lover housing costs. So it wasn’t nearly as painful as it could have been.

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avatar twiggers

I wanted to lose money but no one would buy the darn thing. Now I’m an involuntary landlord and am losing money every month.

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avatar gotr31 ♦224 (Cent)

Sometimes you just don’t have a choice. But if I did I would certainly take into account the whole senario. Such as buying a house in a down market, the same time as selling one.

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avatar Darwin's Money

We went through this recently. In our area, home prices are off about 10-15% from the peak depending on the conditions. The first house we bought in 1999 appreciated over 100%. We scaled up in 2005 – at the peak. So on our current home, when we listed, we realized market pricing dictated we should take a loss of probably 30K or more if we’re realistic. We asked high, but eventually lowered our pricing to get real with the market and comps. It was amusing to hear friends and relatives gawking saying “I can’t believe you’d sell at a loss, we’d never do that”. Totally ignorant. Market pricing is market pricing. We made 6 figures on the way up and lost 5 figured on the way down, that’s how the cookie crumbles. Since we were looking to do new construction in the same area, we’re also getting a new lot and larger house for a steal as well so in the end, it’s a net gain for us when market pricing declines (where we would have paid much more back in 2005).

America needs to emphasis critical thinking and math skills more in schools I think.

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avatar Randy Barnett

In theory, I should be able to sell my house and buy an equivalent house somewhere else for the same money. In theory. But each time I move, I want to move up in the world, so I end up taking more out of pocket. It always seems realtors tell me it’s a buyers market when I want to sell and then explain why I can’t get the house I want at the price I want when I want to buy – even if it’s the same time.

I’ve never felt like I was on the good side of a sale/buy.

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avatar DonnaFreedman ♦80 (Newbie)

I’ve read articles about people stubbornly refusing to sell, even though they were already living elsewhere and losing money each month, solely because they decided the home was “worth more.” Not based on the market, or whether there was a surplus of homes or a deficit in loan availability — because they took the whole thing way too personally.
I’d rather lose money right away than over a period of months, myself. Right now I’m a renter so it’s a moot point.

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avatar skylog ♦368 (Nickel)

this is a very good point and gets to the psychology that flexo was talking about. i wonder how many people continue to lose, and end up losing more by holding on instead of letting go? the numbers are probably quite scary.

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avatar someguy

In a moving up scenario, and assuming no unusual shennanigans, the best time to sell and then buy is when the market is as low as possible. You get a lower percentage for your existing house, but you presumably pay the same lower percentage for your new, more expensive, house. Having worked in the industry, I know people typically do the opposite: move up when prices are bubbly because the higher equity in their current home makes them feel more comfortable.

Most of this works on a bigger underlying fallacy: that primary residences are good investment vehicles. Better to think of them as necessary expenses and perhaps somewhat as longterm hedges against inflation.

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avatar MC

I’d probably buy a new place if I wasn’t 30% underwater… so now for me the struggle is, what to do with the extra cash. Accelerate paying off the 20% that balloons in 4 yrs or stock pile cash because I can’t stomach paying the banks for an asset that may continue to depreciate. If I pay the 20% off and the market doesn’t change or goes down, I’m still stuck w/ a house that albeit affordable isn’t a place I want to probably be long term and don’t have any equity in it and spent a lot of my money just to get to a break-even point. The remaining 80% is adjustable so if the rates go up, it get’s even worse… Affordability isn’t the issue so much as my ability to leverage.

Considering buying another place and 1)letting the current one go 2)renting and a probable loss and that I may not be able to refinance because of the negative equity situation so even more expensive debt in 5 yrs…. I am consumed by thinking about this daily. It sucks.

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avatar skylog ♦368 (Nickel)

this hits on the point of “paper gain” and “paper losses.” to many people just get stuck or locked in on what something “was” worth or what something “is” worth. in the case you mentioned, to double one’s money is still, well, doubling one’s money. that should never be forgotten. sure, one “could” have sold and made much more, but that time is gone. too many people, myself included, get too emotionally attached to investments, be it a house, a stock, whatever. something is only worth what it can be sold for currently. just as much as it could go up in the future…it could just as easily do down.

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avatar moneymatters ♦357 (Nickel)

We bought our current house at the height of the market back in 2006. At the the time we paid what we thought was a pretty decent price for our house, around $273,000. In that market we felt it was a decent price. Fast forward to today – 5 years later – and our home has lost about $40,000 in value after we had an appraisal done for a refinance. Thankfully we aren’t depending upon our house as an investment, and we made a 20% down payment, so we’re not underwater – but it does hurt.

Until, that is, we consider that we also sold our townhouse back in 2006 at the height of the market. We sold it for $205,000, and it’s now worth closer to $150,000. So when we consider that fact, in the end we didn’t do so bad. We bought our house at a more expensive time, but we also had the good fortune to sell at that time, and make a nice profit.

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avatar belmontguy

We bought our house in 2006 and paid $800K as a first time homebuyer in California. Five years later it’s worth around $600K. So we’re now considering selling, which will pay off the loan, keep our nice credit score, but little equity. We’re then looking at buying another property for 900K in a nicer neighborhood. We can afford another 20% down on the new house, but it feels aweful to be selling the house we’re currently in and turning our paper loss into a real one.

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avatar DavidD

Seems completely reasonable to make the same mistake.

You already lost $200K and now you are going to buy a $900K house. What will the loss be on that one??? $300K?

People need to come to understand that real estate is dead… and will drift lower for another 5 to 10 years. Then it will find a bottom for 5 years and might start to appreciate. This is a decade away… maybe two.

Other factors: boomer down sizing, tighter lending, etc etc.

Yes, I know California is different. It is always different when people are trying to rationalize a foolish decision.

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