3 Ways Real Estate Messes With Your Head

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It was a beautiful apartment, no question. Arches, hardwood floors, and impossibly high ceilings. But the price was $30,000 beyond our absolute max. Besides, no other apartment in that line in that building had sold close to the asking price.

My husband and I were tempted. (Did we mention built-in bookcases?) But in the end, we walked away. Plenty don’t. According to the real-estate database Streeteasy.com, 27.4 percent of properties sold in Manhattan in the first eight months of this year went for above asking, a nearly 7 percent jump from the same period last year. (Brooklyn’s numbers went up 4.5 percent.)

There’s the buyer who, in love with a Clinton Hill loft and sure that many others would be gunning for the same space, put in a winning offer that was $71,000 higher (or 11 percent over) the asking price. Others have been known to include “escalation” clauses in their offers, which essentially state they’ll beat any other offers by a specific price. In San Francisco, one buyer paid $605,000 more for a two-bedroom house asking $1.496 million in Glen Park last spring.

Obviously, these approaches worked. The buyers got the properties they coveted. So strategically, they make sense. But in other ways, these behaviors are a departure from what common sense — and economic theory — tell us. As our broker often reminds us, there’s always another apartment, even in these inventory-challenged times. But the heart wants what it wants, and sometimes it’s a goner for a park view and inlaid floors.

So why not retreat instead? Researchers have some interesting answers. 

We’re bad at ignoring sunk costs — particularly when the search is getting tiresome.
“If you’ve been looking for six to nine months” — NYC buyers should be familiar with this timeline — “or you’ve lost out in the past, that puts [you] even more in this winning mindset,” explains Ravi Dhar, professor of marketing and psychology at Yale University and director of the Yale Center for Customer Insights.

Dhar says sometimes buyers fail to recognize that money (or, as with real-estate hunts, time and effort) are sunk costs that may not be recoverable but shouldn’t be reflected in future decisions. In other words, just because you’ve lost countless Sundays looking at apartments doesn’t mean you need to pay $100,000 more for one. “Once you’re emotionally attached to the product, you’re less likely to deliberate the pros and cons and compare what else I could do with that money,” Dhar says. That extra $605,000 the San Francisco buyer paid for his house could have landed another two-bedroom apartment in nearby Diamond Heights or a Tahoe ski condo.

Related perhaps is Harvard professor Max Bazerman’s examination in his 1992 book, Negotiating Rationally, of overheated bidding in a merger acquisition, describing it as an “irrational escalation of commitment” that continues “a previous course of action beyond what rational analysis would recommend.” Sunk costs, Bazerman wrote, “cannot be recovered and should not be considered when selecting future courses of action.”

When sellers price their property a little too high, we fall for “anchoring effects.”
Sure, setting a list price just under market rate has been known to incite bidding wars — everyone likes a deal, so they compete with each other, nudging the numbers upward. But researchers at the University of Pennsylvania’s Wharton School found that slightly overpricing works, too. In a May 2013 issue of the Journal of Economic Behavior & Organization, they explain that “higher starting prices” — about 10 to 20 percent more than other homeowners in the area — “are indeed associated with higher selling prices.” (Only by a small percentage, but still.) Their findings echo the anchoring effect that Daniel Kahneman and Amos Tversky explored in their 1974 study, which concluded that people are “biased toward the initial values.” Essentially, they attach themselves to earlier information — in real estate, the asking price — and make adjustments based on it.

Brokers told The Wall Street Journal that this pricing strategy works especially well when inventory is low (cough, NYC, cough). Given that properties are rarely identical, study author Grace Bucchianeri told the paper, “qualitative things really matter. Buyers will turn to the good attributes that justify the high price.” And absent a surfeit of recent sales that prove the price should be vastly lower, what’s a buyer to do but use the initial price as a goalpost and adjust from there?

People will pay a premium just to finally wrap up the search.
Dhar points to another possible explanation for irrational bidding wars: the need-for-closure (NFC) variable, which social psychologist Arie Kruglanski defined as, per its name, “a desire for definite knowledge on some issue.” Dhar explains the “need for closure” principle kicks in when “people who are looking to buy but don’t have the patience to wait for a good price want to ‘get it over with’ and that mindset makes you overbid … People want to wrap it up.”

Not everyone is equally susceptible to this influence, but it can greatly affect those who sit at the more NFC-influenced end of the spectrum. “Some people want to keep looking, while for other people that drives them crazy,” says Dhar. “They just want to get this done. The ‘need for closure’ buyers are more vulnerable to overbidding because they want to see their goal met. It doesn’t mean they’ll overbid for sure, but “it means you’re more susceptible to the fact that you want to overbid.” 

Those more comfortable with uncertainty, Dhar says, “will be willing to say, ‘Oh, I didn’t get the house, I didn’t get the right price. So let me wait another year or two and just rent.’” They’re also likely more flexible about switching neighborhoods, where they’d probably find something sooner, maybe even better.

There’s something else at play: a form of loss aversion regret avoidance. Once a buyer is in the mix and bidding for a property, they may end up ignoring information that signals they’re in over their heads — the maximum budget they’d set, for instance, one carefully honed after poring over their financials — because they don’t want to regret walking away if they don’t find anything else they like as much or if prices go higher. “This is especially true if they’ve missed out a few times,” Dhar explains. “When you anticipate the alternative — ‘I may not get it [if I don’t bid]’ — that makes the need to avoid regret more salient. And that makes you bid more.”

Then again, with real-estate prices escalating the way they are, the “need for closure” buyers and regret avoiders may just be the ones who win in the end.