It’s the Endowment, Stupid!
I have been reading this afternoon (thanks to my wife) about the endowment effect, a behavioral economics term defined by Nofsinger as the fact that “people often demand much more to sell an object than they would be willing to pay to buy it” (it is also called the “status quo bias”), or by Goldberg and van Nitzsch as “the phenomenon in which most people would demand a considerably higher price for a product that they own than they would be prepared to pay for it.” This reading brought on an acute moment of clarity for me – here is much of my real estate career defined by a term I did not even know existed!
Most of us believe we are rational decision makers, and many of us (men in particular) believe strongly that those rational decisions are “data driven.” But data is only information. It is the interpretation of data which leads us to conclusions; and as the endowment effect research indicates, such interpretations are substantially subjective. Otherwise how could we explain the different conclusions economists (or for that matter appraisers) arrive at when analyzing our economy (or the value of our homes). Because of our own desires and beliefs, we skew data interpretation towards the conclusions we prefer.
Those of us who work in real estate have seen this phenomenon in action over and over. Most of us have even felt it ourselves when we were acting as principals; I know I have. The way you relate to buyers when you have your seller hat on and the way you relate to sellers when you have your buyer hat on are completely different. Warburg recently worked with a seller who sold with us first, in a complex transaction involving multiple bids, time pressure, and a lot of reactivity. We then moved on to find that seller a new home. They immediately began contemplating making offers at percentage levels (relative to reasonable asking prices) at or even below those which they had found so infuriating and insulting just weeks before, when they were sellers and not buyers. We found that our most effective antidote to this inclination was to invoke the buyer they had liked the least during their sales process (let’s call him “Dave”), and remind them that they didn’t want to “act like Dave.”
There are benefits for us all in awareness of the endowment effect. First, awareness of it should make it possible for sellers and agents alike to aim at more realistic value assessments. For buyers, forget that fantasy that this seller is “desperate” or that the estate HAS to settle by year’s end. Make a reasonable offer and that can probably lead to a reasonable deal. Overcoming the endowment effect is tougher for sellers. First, mint condition is, well, mint condition. The buyer won’t be wearing rose colored glasses or remembering the wonderful times you had there. And the market DOES speak when it comes to value. Enough time on the market, enough showings, and what the market will bear becomes apparent. The repute of your designer, the amazing hand painted murals, the heretofore undiscovered mine in Carrara whence came the marble for the master bath … in the end, all that matters is what a buyer is willing to pay. The endowment effect reminds us that we are all only rational and data driven within limits, and it is healthy to remember what those limits are.