By Kirstin Downey
Washington Post Staff Writer
Saturday, November 4, 2006
Sam LeBlanc tried to cushion the blow when he gave his wife, Karyn, the bad news. He told her to take a breath and think it over, because he knew that what he was telling her would hurt.
Her condominium isn't worth nearly as much as she thought.
"I was a little crushed," Karyn recalled.
People may think they make cold, hard decisions in financial transactions such as buying and selling a house. Increasingly, though, research shows that emotions play as big a role as intellect.
For Karyn, for example, the condo she bought in the District's Palisades neighborhood in 2002 was the first big, independent purchase she had ever made. She proudly added many special touches, including a closet organizing system she thought would be the envy of any woman. But she and Sam got married, had a baby and decided to sell the condo. Over the past few months, Sam did a lot of market research and decided they should ask $269,000.
The number came as a blow to Karyn, because she knew similar units, including some she thinks weren't as nice, sold last year for $280,000.
"You want to believe it's worth a lot more because you've invested your time and energy on it," Karyn said.
Evidence is mounting that people set prices, particularly for housing, as much on ego and self-image as on an objective review of the market. That's one reason for the phenomenon known as "sticky prices" -- home sellers who won't cut their demands enough to make a deal. It helps explain why the unsold inventory of homes has risen so high, and why, despite this rise, home prices in the Washington area have fallen only slightly. There were 24,741 homes for sale in September in Washington and the close-in suburbs, up from 13,950 a year earlier.
Economic researchers have found that emotions are a bigger influence than was previously believed in how people make financial decisions. For a long time, economists believed that human beings made decisions like robots, that people applied simple logic in making financial choices. But a body of research developed over the past two decades, known as neuroeconomics or behavioral economics, has shed light on how powerful a role the unconscious mind plays. New imaging technology, meanwhile, is allowing scientists to peer inside people's brains while they wrestle with financial decisions.
These studies have illuminated a few key concepts: Many people will pass up sure profits for illusory ones. Some will turn down profits if they believe someone else is unfairly profiting more. Some will even refuse to sell if they believe they may come to regret it, because fear of future regret can be as powerful a motivator as money in the pocket today.
In other words, people will cling to prices they recall from a brighter day, even when market conditions have changed; they will walk away from a sale if they feel the buyer is getting too good a deal at their expense; and they are terrified that [if they sell now] the market will rebound and they will feel like fools.
"There's a whole emotional processing system that goes on in the brain that's largely beyond our control," said Kevin McCabe, a professor of economics, law and neuroscience at George Mason University. "The general view is that our emotions control us, and not vice versa."
Little of this research has been applied directly to real estate, but neuroeconomists say the principles would logically apply to housing, too. For example, much work has been done on the concept of "loss aversion," which shows that people tend to deny reality when something they own, such as stock, declines in value. They will keep holding that stock, confident the price will rise again if they wait long enough.
They do the same with their homes, maintaining the asking price even at a level that makes no sense, economists said. Similarly, home sellers become attached to the prices their neighbors received at the top of the market rather than current prices, and they become reluctant to sell unless they get that higher price.
"It's classic loss aversion," said Christopher J. Mayer, director of the Paul Milstein Center for Real Estate at Columbia Business School in New York. "You could do it, but you don't want to. You don't want to realize the loss. It leads to housing markets that don't function very well. You've got a lot of houses on the market and they aren't selling."
Mayer said that people allow their wishful thinking to overcome realistic perceptions because they don't want to view themselves as having made a mistake.
"People should recognize that what they do won't change the housing market," he said. "They could wish their house could sell for more money but it doesn't mean it will do so."
David Laibson, who teaches psychology and economics at Harvard University, said a common error people make is believing that homes can't drop in value below what they paid for them, and, in particular, that they can't fall below their mortgage amounts.
"There seems to be a psychological resistance to taking losses on the sale of a house," Laibson said. "People think they'll make money on it. . . . That logic worked for a long time, and now anyone who bet on that logic is being burned."
Generally speaking, according to the evolving body of neuroeconomic research, people logically make rather simple dollars-and-cents analyses when they buy small items, but become more emotional around large decisions, particularly those that affect their futures.
"For decisions we make frequently, like buying eggs or which route to take driving to work, we're pretty rational," Laibson said. In areas that involve choices people make rarely, they have to extrapolate based on what they have heard or rely on limited previous experience. When people sell a house, they may have done so only once or twice before, he said. That means they may experience anguish similar to what people feel when they decide whom to marry or whether and when to retire.
Some sellers are able to be more dispassionate. Six months ago, mortgage broker Steven Waller of Stephens City, Va., bought three dilapidated townhouses in nearby Front Royal for about $100,000 each. They had been used as rentals; he spent about $20,000 refurbishing each. Other similar units are for sale by their owners, who live in them, for $165,000 to $200,000, but Waller is flipping his properties by pricing them at $149,000 each. He said they have been appraised at about $180,000.
"I'm making a profit, that's all that matters," Waller said. "I have no emotional attachment to it. You can stay ahead of the game if you price at where they will sell rather than sit on them for a year."
Fairfax resident Sharon Stapleton, in contrast, knew she had a "major ego involvement" when her family set out to sell their vacation home on Lake George in upstate New York. They held out for nine months, and three years ago, they finally got their price. Recently, however, she sought to do the same with the home she owns in Fairfax County. Stapleton has wondered if it is overpriced, but she believes the house, on a forested lot, is unique in a highly urbanized area, and so she has kept the price at $795,000. She's wondering now if she has been wise.
"I just need time to emotionally deal with the price drop," she wrote in an e-mail. "EGO. Not greed."
The difference in the ways that real estate investors vs. ordinary home sellers are reacting to the market can also be seen in national trends. Last week, the National Association of Realtors reported that nationwide, the median price of existing homes, sold mostly by people who live in them, fell 2.2 percent in September compared with September 2005, dropping to $220,000 from $225,000. The median is the point at which half the homes cost more and half cost less.
The next day, the Commerce Department reported that home builders -- in business to make a profit -- had more aggressively cut their prices. The price of new houses declined 9.7 percent in September, compared with the same month a year earlier. Analysts said that cutting prices helped boost sales after a slow summer.
Neuroeconomic research may provide buyers and sellers with some clues about how to psych out the market themselves.
Sellers, neuroeconomist McCabe suggests, might need to realize that no matter how passionately they wish things were different, prices have fallen and they need to accept that. They can hold on and wait, but may actually lose more money by making payments on a home in a place they no longer want to live -- in effect, throwing good money after bad.
Buyers, he said, need to be aware that they are dealing not just with a house but also with a seller wrestling with his ego. Sometimes it might be smarter to let the poor fellow keep his price, but ask for other concessions that might actually be more valuable. A new roof, new appliances or substantial assistance toward the closing costs all have material value, but they allow the seller the dignity of maintaining the price at a level that leaves him standing tall in his neighbors' eyes.
"Haggle less over price and more over other stuff," McCabe said the research indicates. "Change the bargaining so you still get the deal you want."
Of course, real estate agents say they haven't needed research laboratories to teach them about buyer and seller behavior.
"You always view your house as more valuable than the numbers will justify," said Owen Heine, a real estate with Sager Real Estate in Strasburg, Va. "Every person views his house as a castle. It's human nature to love what you have."