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Why Sellers Overestimate the Value of Their Houses

This article was written by in Real Estate and Home. 32 comments.

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.

HouseReaching 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.

Photo: karindalziel

Updated July 20, 2011 and originally published July 19, 2011.

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About the author

Luke Landes 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 Luke Landes and follow him on Twitter. View all articles by .

{ 32 comments… read them below or add one }

avatar 1 Anonymous

I think people get way too invested in a home where they’ve been living because they’ve made good memories there, and the value of those memories tends to inflate what they think the property should sell for. Of course, they also want to think that they may come out ahead, or at least not be underwater when they sell. The reality is that it just might not happen in this environment.

We’re starting to look for new homes now. i’ll be the first to admit that I mis-judged what our home is now worth. I knew that we would see a big drop in value, but the drop is even bigger than I thought it would be. In checking our area, there has been a lot of foreclosures, and builders selling homes at a steep discount. The result – huge price drops in the last 5 years. I guess we’ll need to take this all into account when we do sell.

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avatar 2 wylerassociate

good column and as someone who will be a first time homebuyer within the next year i’m doing my research and definitely looking at things like home maintenace, association fees, & upkeep.

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avatar 3 Ceecee

When I sold my house I picked the realtor that gave us the highest listing price. In the end, one of the other realtors we didn’t use hit the nail on the head. We wondered if our realtor inflated the asking price and then talked us into lowering it just to get the listing.

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avatar 4 Anonymous

I bought my home in 85 for 70k but I’ve always carried it on my books at the county’s assesement value rather than what some broker (or Zillow) might tell me its worth. This has proven “conservative” as the recent housing collapse did not bring the broker’s price down below the assessment or the purchase price. Peter makes a good point about being too invested in your home, but it is not just memories. The people that took their appreciated value in the form of Home Equity Loans and seconds are great examples to the folly of being too invested in your home.

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avatar 5 Anonymous

I guess the big difference in my outlook is that I don’t really see it as an appreciating asset.

First off, housing prices don’t really appreciate: This chart is exactly why:

If you look past the booms and busts, you see something very important, in the last 100 years, housing prices have only increased by about 10% after inflation, so less than 0.1% in real gains a year.

Second is that still doesn’t figure in the standard 1%-2% of the home’s value that’s typically spent on maintenance per year. So you are losing out money when you own a home. But even then it’s still not all doom and gloom. After all, unless you could live somewhere else for free, you’d still have to lose money by paying rent. So, as long as your repair costs + the mortgage interest + property taxes are less than what I’d pay otherwise in rent, then I figure I’m coming out ahead (but only slightly to tell the truth).

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avatar 6 Anonymous

I think you’re looking at “investment” the wrong way. Yes, it’s not an investment the way buying 300 shares of Microsoft is. But you have to live somewhere. Rent is money that you’ll pay and never get back; mortgage payments are payments towards principal and interest that’s usually tax deductible, at least for now. If you’re going to pay $3k a month in rent or $3k a month in P&I, the latter is almost certainly a better idea. Now, you can argue the down payment and closing costs tilt the rent/buy argument the other way, but I think that’s how most people view a house as an investment.

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avatar 7 Anonymous

That’s not really a fair comparison, because you’re leaving out all the extra expenses that come with homeownership. The rule-of-thumb is that insurance, taxes, maintenance, etc will come out to about 50% of the P&T, so you’re really looking at $3000 for rent and more like $4500 to own.

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avatar 8 Anonymous

Well you have to pay insurance no matter what, unless you’re crazy enough to not bother with renter’s insurance. And the taxes should be deductible as well. So even if you take your $4500 number, at least a 1/3 of that should be tax-deductible, meaning that it’s at worst, an even up proposition, and you at least own your home at the end of the day.

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avatar 9 Anonymous

Also don’t forget that principle usually isn’t lost, even assuming the house price remains flat, you’ll get back out what you’re putting in when it’s sold.

Plus think of it this way, if you’re renting, that means someone else owns the house. They probably have similar expenses you would’ve had if you owned it. Now unless they’re a charity or you have subsidized rent that means that the amount they charge you in rent must be enough to cover their expenses plus make a profit on top.

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avatar 10 Anonymous

Not really. Plenty of real estate investors are cash-flow negative for years after purchasing a property. Landlords charge what the market will allow. It has nothing to do with their expenses.

avatar 11 Anonymous

Huh well I admit I’m no landlord, merely a landowner. But the general advice I had read in passing, whether in blogs or books (Rich Dad, Poor Dad comes to mind) was that everyone always was advocating not to get into a negative cash flow rental. I guess I just hear this enough that I assume it’s common practice for most small time landlords.

avatar 12 Anonymous

Even if 1/3 is tax-deductible, you’d still be looking at $3k vs $4k. And you only get a benefit for deducting the amount ABOVE the standard deduction, which for most homeowners really minimizes the benefit of the real estate tax deduction. Single renters can deduct $5,800 and married renters $11,600 in 2011. You only get a benefit on interest and taxes OVER that amount. So if you’re married, you’d have to pay almost $1,000 per month in interest and taxes just to break even with renters.

Also renters insurance is so much less expensive than most homeowners policies that it’s not exactly a fair comparison, either.

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avatar 13 Anonymous

Rent vs. Buy is nowhere near this simple. You could fill pages and pages with the analysis (actually the NYT has what is regarded as one of the best calculators for this Case in point – your argument above is extremely simplistic. You are assuming that your fictional buyer has no other expenses that are deductible helping meet those minimums. realistically anyone spending 4500/month on housing costs, is already going to be paying state and local taxes in large enough quantities that those alone would push you into itemized deductions. So yes 100% of your mortgage expenses that are deductible would already be over that.

I was paynig 2400/month in rent. Now I pay 3600 for my total mortgage (including insurance and taxes). Interest and taxes come out to about 2900/month. Figuring on an effective 20% tax rate. That gives me about $580 difference bringing the comparison closer to 3000 vs 2400. Of course that’s going from a 575 sq foot studio in manhattan to a 3000 sq foot house in jersey…

But you could go on and on with this sort of stuff.

avatar 14 Anonymous

Perhaps my Northeast bias is showing. My property taxes alone are well above $11k, let alone interest on my mortgage. It’s not even close, and it’s not even close for anyone living in the Northeast, especially in a state with a state income tax.

avatar 15 Anonymous

Also, I meant 1/3 on the $4500, not your $1500 addition.

avatar 16 Cejay

I bought my house 18 years ago and I have seen the value go way up. But now I have seen the value go way down but it is still a little more that I paid for the house s many years ago. When we sold our first home, a little fixer upper that we had fixed up, I never thought that we would get what we were asking but we asked the price the real estate agent suggested. We not only got that price and they never blinked. I think that I would think my home is cheaper than it really is.

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avatar 17 shellye

I have a close friend who’s a realtor, and she kept my greed in check during my recent buying/selling transaction. We’re conditioned to believe that homes are an asset that will always appreciate, but this recent recession has opened most folks’ eyes to that misnomer. It’s all about location, location, location AND timing. The home I recently bought had been on the market for over a year, and I ultimately bought it for nearly $100k less than for what the original listing price was.

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avatar 18 Anonymous

If I were to sell now I’d probably lose about $35k on the deal. Even though I’m perfectly aware this irrational bias exists, it still affects me. I would rather live in another part of town but don’t want to lose $35k. And I’m not even underwater!

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avatar 19 Anonymous

Realtors are far more guilty of this than homeowners are. As a realtor…it is your *job* to know the market. I haven’t been involved in all that many RE transactions – but in every one, pre/during/post boom the realtor started high, sometimes ludicrously high.

On a side note, holy shit some markets are just so dead it’s unbelievable. I’ve been trying to sell a house in vermont to no avail. I bought this property in 2001 (clearly before any run up in housing prices) for 189K. So you’d think it’s reasonable to assume that the house could be sold for something around what i bought it for – hell it would be reasonable to assume it’s worth at least that + inflation. So right now it’s on the market for 149K and it’s barely even getting a passing glance. Been on the market a year – first realtor said to start at 225k (which for the uninformed might be reasonable given the year/purchase price). Second realtor came in when we had already lowered that to 159 – said it was reasonably priced…and here we are 10K less and still it sits there. It’s shocking cause I think you’d be hard pressed to buy a piece of land and *build* a new house for under 149k.

It sucks…luckily I can absorb the losses…but it really drives home just how bad things are in a way news stories don’t.

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avatar 20 Anonymous

Couldn’t agree more. We just sold our home (for less than we had hoped) because we were realistic and flexible. We lowered the price to what the market would bear and had a quick sale. Luckily we got a good price on the condo we are purchasing across the country.

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avatar 21 Donna Freedman

I hear this phrase sometimes: “The realtor said it would only sell for (X) but it’s WORTH MORE THAN THAT.”
Worth is determined by what people are willing to pay. The fact that you overpaid and now want some of that money back is not going to influence a buyer to accept your asking price. Neither are those granite countertops, by the way; remodels don’t necessarily pay for themselves.

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avatar 22 Bobka

A bit off the topic but still related to home values is the question of how much one’s house is worth for insurance purposes. My insurance company insists that I insure it to a value that covers the cost of rebuilding in case of catastrophe. That value is above the current market value of the noted by my property tax assessor. Does that infer the house is worth more destroyed than it is if in use?

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avatar 23 Anonymous

I’d be surprised if they require coverage at cost to rebuild. Usually they only require it cover the mortgage balance (which could easily, these days, be more than the value of the house).

and yes…find a way to torch it and get a better/newer house out of the deal;-) (just kidding!)

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avatar 24 Anonymous

Very true. It’s laughable what some people think their homes are worth these days. Still, when I look at an older relative’s home that was once purchased for $75K and now it’s worth $1M, even in a depressed market, it’s hard for me to believe a home can’t be a good investment in the long run. I haven’t completely given up hope…yet.

The rent vs. own debate is a very complex and personal thing. When times are good, everyone wants to own. Now that things suck, everyone wants to talk about how homes can’t be viewed as an investment and you should always rent. I personally would never own a house- too much work. However, I do love condos/apts, but I hate paying rent. I’d rather buy and take my chances in the long run.

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avatar 25 Anonymous

I think the appreciation in the value of a home is largely related to WHERE the home is. In our rural community in upstate NY, average home values haven’t changed much in 20 yrs. Sadly, the value range has condensed it seems. That is, lower end house prices have increased which makes it hard for first time buyers to get into a home and higher end houses have decreased lessening the appreciation for those homeowners. But, generally, you can expect your home value to increase moderately over time.

I still believe owning is better than renting financially as you can usually get your money (or most of it) back when you sell. When you rent, there is no chance of recouping any of it. Nonfinancial benefits – owning provides stability (not having to move when your lease runs out) and freedom (to renovate, redecorate, landscape, etc.).

You also have to consider the value of “the use” of the property. So, if you sell your home, deduct the rental value for the time you were there, and still come out ahead of what you originally paid, that’s a pretty good thing. You had years worth of housing and got your money back to boot.

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avatar 26 lynn

LR: I live in the same area you do. I can say this with confidence because I think it’s the only area in the country that prices are going up for smaller rural digs. This makes sense, but it will be a while before the locals realize most of the country would die for what we have.

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avatar 27 Anonymous

What a bunch of worthless crap!!! A house or a car is not an asset because it doesn’t generate income. So, take these 2 out of your net worth unless it generates income!

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avatar 28 Luke Landes

There’s nothing in the definition of “asset” that says it must generate income. An asset is ANYTHING you own. Your net worth isn’t complete without including major assets, but one could question how important it is to include a car on a net worth statement. Whether a particular asset is a “cash-flow positive asset” or a “cash-flow negative asset” is irrelevant for a net worth statement (but it is nonetheless important).

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avatar 29 Anonymous

Houses and cars are liabilities (not assets) because it generates expenses, not income! Take that to the bank and see how much they lend you based on houses and cars!

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avatar 30 Luke Landes

Flexman, sorry, the term “asset” has a specific definition in finance, and it has nothing to do with cash flow (income and expenses). Assets that generate income may be “good assets” and assets that generate expenses may be “bad assets” but they are all assets. Look it up or take a Finance 101 class. Considering you’ve commented “What a bunch of worthless crap” on several articles here, I’m not sure why you continue to read.

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avatar 31 Anonymous

I continue to read so that I can expose the truths about what is being written on financial literacy! Wake up, America!!! Do we want to continue increasing the population of financial illiterates? Finance 101 classes are also a bunch of worthless crap as well!!! That’s why foreclosures, short sales, and bankruptcies are fast becoming our common way of life!!!!

avatar 32 qixx

Sellers may also overprice their homes because they base their asking prices on the current sales in the area. This would make the problem cyclical. Basing what you should ask on inflated prices means your value will be inflates. The next home up for sale that bases numbers on your inflated price just keeps the problem rolling. People overprice a home because they don’t know better and get plenty of mis-information (other inflated prices) to convince them they are right.

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