Why aren’t sellers’ list prices dropping, if inventory is going up, and sales volume is going down? I mean, don’t sellers want to sell?
Fortunately, smarter persons than I have studied this phenomenon, and published their results in a paper entitled, “Loss aversion and seller behavior: Evidence from the housing market“.
The authors of the study examined the Boston real estate market during the 1980s and 1990s. During the early-1990s, some sellers in Massachusetts were faced with real losses – a situation where they had to write their banks big fat checks, to cover the difference between what they sold their homes for, and what they owed on their mortgage loans.
Let me start by saying, this isn’t the situation we are facing, today. Almost all sellers are still able to sell their properties for more than they paid for them.
So, we can’t necessarily apply the conclusions of the study to today’s market.
Let’s do it, anyway.
What did the authors conclude?
Well, sellers facing real losses do strange things.
At the market trough in 1992, new properties for sale had listing prices that were 35 percent above their expected selling prices, while fewer than 30 percent of listed units sold within 180 days on the market. Despite inventory levels of around 1,500 available condominiums, fewer than 750 sales took place in that year.
In contrast, in 1997, new properties for sale had listing prices that were only 12 percent above their expected selling prices and more than 60 percent of these new listings sold within 180 days. Inventory levels varied between 500 to 850 properties and 1500 properties were sold.
Why did they do this? It’s called loss aversion. Yes, it’s irrational human behavior. And, yes, it happens, a lot (not just with home prices, of course).
When house prices fall after a boom, as in Boston, many units have a market value below what the current owner paid for them. Owners who are averse to (unhappy about) losses will have an incentive to attenuate (lessen) that loss by deciding upon a reservation price that exceeds the level they would set in the absence of a loss, and so set a higher asking price, spend a longer time on the market and receive a higher transaction price upon a sale
Said, more clearly: sellers set higher list prices, if they are facing losses, than they would if they were facing gains. The sellers facing losses, still lose money on their sales, however.
The downside is, they end up having to list their properties for twice as long, before they find buyers. The upside is, they actually end up making (a bit) more on their sales, than those sellers who weren’t facing losses on their sales.
The authors of the study also found that sellers facing a small loss, set a list price much higher than sellers facing a large loss. Meaning, those who were deeply in the red, seem to have been more likely to take a loss, than those who were just a bit under water.
Also, investors and owner-occupants acted similarly, although investors seemed much more willing (twice as willing) to take losses on the sales of their properties (or were willing to take twice as large a loss on a sale, I’m not sure which).
Complete study: “Loss aversion and seller behavior: Evidence from the housing market“
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Updated: January 2018