When calculating my net worth, I tend to take a conservative approach. Where certain balances are not exact, like the value of my car, I tend to assume the value is lower than what it might be. This way, there are no dangerous surprises if I needed to convert an asset like that into cash by selling.
Car owners expect this asset to depreciate. The older the car is, the lower its value will be, except in unique circumstances. If the supply of used cars were to dry up, the price could increase. In general, however, people expect the value of their cars to decline over time.
This isn’t true with houses, however. People expect their value to go up over time. Regardless of whether it’s an appropriate attitude, the history of real estate in the past century has shows that people will pay more money for the same property, over time, on average. The real estate boom fostered even higher expectations for value growth. When it comes time to sell, though, today’s real estate market is not only a difficult environment to make a deal, but psychology is making it worse.
According to Zillow, listings during the recession were priced higher than the estimated value of the properties by a greater degree than any other time in the preceding decade.
Obviously the idea that your largest asset has been devalued significantly is difficult to accept, however, people who bought in the run-up to the bubble are seemingly more willing to confront this reality than those who purchased after the peak. In fact, relative to sellers who purchased their home before 2002, those who bought while the bubble was expanding rapidly are comparatively underpriced. When first placed on the market, the typical house is priced at roughly 10 percent above its estimated market value, but sellers from 2006 touch as low as 6.4 percent. Looking at sellers who bought on either side of the market peak nationally reveals stark differences between these two groups. Sellers who bought in January 2006 overprice their home by only 8 percent, while those who bought in January 2009 overprice by 22 percent.
Reaching for a higher listing price is rooted in psychology, particularly loss aversion.
- Sellers don’t want to lose money. Even if they paid less for the house, but a later appraisal valued the house as having experienced a large gain, selling at a price somewhere in between the purchase price and the peak seems like a loss, even though it’s not. Some sellers did buy at the peak and would experience a loss, so there are some for which this concern is real, but for most sellers, there is no real loss.
- Sellers want to aim high. Possibly due to advice from real estate agents, sellers list their houses for a high price holding out hope that there, somewhere among the pool of potential buyers, is a greater fool. All it takes is one person willing to pay the asking price to turn the imagined, inflated value into the realized, official value. Depending on how motivated a seller is, they could sit on a high listing for a long time, possibly waiting for the industry to recover.
The biggest mistake has been convincing people that the house you live in is a good investment. When investing in stocks, you take costs into account, such as the transaction fees, account fees, expense ratios, taxes, etc. The equivalents when buying a house include maintenance, association fees, upkeep (like lawn care, painting), upgrades, closing costs, real estate agent fees, and more, but these are never figured into the “cost basis” of the house purchase. If they were, it would be clear that owning the house you live in may be a good option for your family’s needs, but it’s not a good investment. Without the overall assumption that owning a house should make money for the owner, people wouldn’t be so afraid of selling for a loss, the expectation when selling any other used, non-collectible asset like a car.
That being said, you wouldn’t be doing your own finances any favors by not aiming high when determining an asking price. If you need to sell, eventually you’ll accept the best offer you receive, and if you don’t and you don’t mind waiting indefinitely, you’ll perhaps find the right buyer in the future.
Updated July 20, 2011 and originally published July 19, 2011. If you enjoyed this article, subscribe to the RSS feed or receive daily emails. Follow @flexo on Twitter and visit our Facebook page for more updates.