I just read a book yesterday, The Paradox of Choice by Barry Schwartz. Great read for anyone interested in the psychology of decision making and some insight into why alot of choices are not necessarily a good thing.
He brought up some great points that we can apply to sellers and the current market called loss aversion and the utility of losses/gains. Loss aversion means that people hate to lose. In fact, people hate to lose twice as much as they would enjoy a similar amount of gain! EG: I would love to win $100, but would really hate to lose $100. Utility of losses and gains shows that people are risk takers in the realm of potential losses. If you have $100 and I offer to flip a coin and give you $200 if you win, most people would keep the $100 and not flip. However, if they owed me $100, most people would risk being down $200 in order to eliminate the debt. That second $100 loss is easier to swallow than the first.
Let’s apply this to housing. John’s home was 200k, then 300k, then 400k and now 600k. Each additional amount of equity has psychologically not given him much additional pleasure. Hedonic adaptation dictates that humans adapt to virtually all situations, including pleasure. Having a 600k home and a Lexus is now the baseline for John, and he is just as happy as he was when he first purchased and drove a Chevy. Not only has his baseline for material goods changed, but also his baseline for pleasure.
As the market has changed, John figures it will level out and that his home will just stay at 600k, he is still happy. A year later, the home is now worth 500k and John is not happy – loss aversion has kicked in. He hates the idea of additional losses. Loss aversion causes him to think, “If I list now, I can avoid losses.” He lists. Four months later, no sale. The utility of losses, however, causes John to avoid lowering the price further and instead he stays firm. He figures that he has already lost 100k and he chooses to risk further losses for the chance that he will eliminate some of the 100k loss if he sells to a “greater fool”.
John’s neighbors, on the other hand, are not as loss averse, but the utility of losses affects them in the same manner. They figure, “Our home is down 100k, but let’s not sell. Let’s risk further losses, and also gains, because it will likely go back up and we will eliminate this loss.” They anchor themselves on the idea that it will eventually go up, and that they will eliminate the loss.
John continues to follow the market down, never taking the obvious step of reducing his price below the market. Also, along the way he adapts to the new sales price/expected equity, painfully, since his baseline was so much higher. He is now under water, his HELO that he used to fund his lifestyle is maxed out and he sells his car, furthering his misery. Hedonic adaptation works in the opposite direction, but it is very painful. The neighbors lower their opinion of him, he is living below the neighborhood ‘status level’ and he becomes depressed.
How many sellers out there right now are like John?
I think it proves how much of it has been a mindset of “you can’t go wrong with real estate.”
People were brainwashed to think their home would continue to double in value. So when they can’t afford the HELOC to buy their yellow H2 and exotic vacationss, they just sell and reap the profits from 3-5 more years of appreciation.
As a renter I look forward to the reversal where these same people start to believe you can’t make any money on their home and prices come back to earth.
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