Property sellers are influenced by endowment effect

Throughout the real estate agency world, agents are often asked to give price estimates for properties in their area. The thinking behind this is that, operating daily in their areas and sometimes also living there, they can be expected to know the value of properties in their precinct better than almost anyone else, says Nancy Todd, Western Cape regional sales manager for the Rawson Property Group.

31 Oct 2012

However, all too often estate agents' valuations are not accepted by potential sellers. "The client's valuation of his property will almost always be based on such flimsy evidence as the asking prices in the area, which, of course, are very seldom achieved. Alternatively they may reflect the values of properties which are different from theirs in many respects, even though in the same area and roughly the same size. In many cases clients' valuations will also be based on properties nearby but not actually in their own precinct."

Function of human nature

This phenomenon is so widespread that it can be regarded as a function of human nature - and there is evidence that this is the case. Richard Thaler, a professor of Behavioural Science and Economics at the University of Chicago Booth School of Business, has evolved a psychological theory which he has named 'The Endowment Effect'.

"Very simply, this means that humans tend to put a higher value on what they actually own, than they would if the same item was owned by someone else. Humans are by nature 'loss averse' and they tend to overvalue almost everything they have and feel deprived if they have to get rid of even one item," says Todd.

This means that when they sell something they are likely to feel deprived, even if they no longer enjoy or need the item. As a result of this feeling humans have an ingrained tendency to over-estimate the value of anything they are selling.

Selective of an agent

Because of this, sellers will endow even an ordinary, not particularly interesting home with deep-felt, desirable qualities, which they may be the only people to see. These qualities, they will feel, set their property apart and increase its value. They will therefore select an estate agent who is not only enthusiastic about their home but who is also prepared to over-value it.

"Home sellers have to recognise that none of us are immune from 'The Endowment Effect', and we have to realise that it can be very dangerous. If the price is too high, the house will stick on the market ad infinitum and they will eventually have to accept an offer that is below the home's market value,12 to 24 months down the line, because by then the property will probably have gained a certain stigma. Although it can be difficult, people must recognise the tendency to over-value and counter it with some fairly painful self-discipline," Todd says.