The endowment effect is a human tendency to value something more when we own it. Last year, economist Richard Thaler even won the Nobel Prize for his work regarding this behavior. But how does the endowment effect in real estate manifest itself?
First, let’s give a simple example of how the endowment effect works. Let’s say a group of people is asked how much a coffee mug is worth. They may respond with something like “around $2.” However, if they’re asked how much each member’s own coffee mug is worth, they will almost invariably respond with a higher value, like perhaps $8. It’s a striking phenomenon, and it’s observable in primates as well as humans. Simply put, there’s a strong tendency for us to overvalue things we already own. It could be something simple like a coffee mug, but it also applies to our real estate.
Homeowners often think their homes are worth more than they actually are. For a long time, I’d figured this was primarily because of a strong emotional attachment to the property. After all, it’s only natural: most homeowners have created lots of memories over many years in these homes, and so of course they value the property more highly than “the next guy.”
Sociologists, however, explain that this works on a much deeper level than simple emotional attachment: fear, or specifically, fear of loss (and no, fear is not an emotion). That fear of loss drives us to overvalue things we own, and according to the Endowment Effect, this is the primary reason we see so many homes that are overpriced.
When it comes to pricing strategy, I always suggest to people that they figure out how much their home is worth and price it a little below that value (2-5%, depending on how sure you are of “market value”). If the market perceives that price as a good bargain, you’ll see lots of offers and see your contract price will exceed listing price because of buyers outbidding one another.
This is a usually difficult concept for sellers to wrap their minds around, because the mind is fighting against that strategy with its fear of loss. Even when there are multiple and excellent examples of this pricing strategy working with spectacular results, few homeowners are willing to trust the invisible hand of the market, thanks to the Endowment Effect in real estate.
If you’d like to talk more about what we covered today, have any questions, or need more information, feel free to reach out to me. I look forward to speaking with you.