Friday, December 02, 2005
The Psychology of Home Buying
In Real Estate price is not everything. It is important, of course, but not everything. Were price to be everything, then only low-priced products would sell and there would be no reasonable explanation as to why all those multi-million dollar mansions sell as well. When it comes to purchasing a house, other factors must be taken into consideration to understand the rationality – or lack thereof – of the Buyer’s decision-making process. Buyers are typically a nervous bunch, and understandably so. It is not easy to consider an investment that runs into the thousands of dollars, and any time you commit yourself to sixty months of $2,000 or so monthly payments your palms tend to perspire. Such factors as heritage, education level and risk-absorption and management play a pivotal role as well. More exotic relationships between money and nominal wealth in the minds of people – whether such relationships are clearly understood or merely hearsay - are even more important.
There is something impliedly strange in making decisions and humans, for a reason or another, tend to shy away from them. They like to stay in their comfort zones of blissful indecision. “Nothing ventured, nothing lost” is the way many people look at making any kind of move that might be to their benefit. And the purchase of a home or other real estate is one of the most beneficial decisions that can be made in our society, even at the wrong price. Making decisions is not easy, so people more often than not decide not to decide. This can be very frustrating, especially in retrospective. There is such a thing as Buyer’s remorse in reverse: how many times we real estate professionals hear comments the likes of ‘why didn’t I buy it myself’ or ‘why didn’t I think of it’ from prospective purchasers referring to properties that have already sold – and which they themselves could have bought instead of someone else.
I call it Buyer’s “alter ego”, which is a reflection proximately caused by the misinterpretation, whether effective or subjective, of what economists refer to as ‘the money illusion’. In Economics the term “money illusion” refers to a tendency to think in terms of nominal rather than real monetary values. Which tendency can be in part explained by the fact that the average consumer thinks and does things by reflection. A real estate purchaser will very well decide to buy a loft as opposed to an apartment not necessarily because he likes lofts more or because he thinks they are a better investment, but because his very close friend has just bought one or because his very dear girlfriend has stated that she likes them more, or merely because it is trendy to purchase lofts. And the fact that lofts are typically more expensive or that, ultimately, this particular consumer will end up living in a refurbished warehouse have little weight on his rationalization of the purchase.
Some colleagues in the industry are quick at resorting to statements the likes of “Buyers are Liars”. Personally I have never quite subscribed to such oversimplified, somewhat derogatory qualifications and, in fact, have found them to be untrue more often than not. Buyers are not liars to the extent that they normally tell up front which product they are looking for. Where, however, confusion lies is in the fact that economic transactions, particularly as large as real estate acquisitions, can be represented either in nominal or in real terms. The nominal representation is simpler, more salient, and often suffices for the short run, yet the representation in real terms is the one that captures the true value of the transaction. People are generally aware that there is a difference between real and nominal values, but because at a single point in time, or over a short period, money is a salient and natural unit of measurement, people often think of transactions in predominantly nominal terms. Consequently, the evaluation of transactions often represents a mixture of nominal and real assessments, which gives rise to money illusion.
As an example, consider a Buyer that purchases real estate in a downward market deflating at the rate of, say, five percent a year, and that he is able to purchase his real estate assets at a price eight percent off asking. This consumer will focus on the nominal discount of eight percent without, in fact, realizing that his real term savings consists only of three percent. Likewise a Seller, even if aware of the true value of comparable houses, may anchor on the historical price he paid for the house and will be reluctant to sell for a price less than the nominal anchor. Which, then, explains why so many listings are brandished as ‘overpriced’ in a downward trend: in times of shifting relative prices people’s reactions will be determined by the change between an item’s current price and its historical, nominal anchor. And which, in ultimate analysis, denotes a lack of experience and sophistication of many market participant and decision makers which affect their personal reactions to changes of price and market conditions.
Luigi Frascati
Real Estate Chronicle.
