Summary:
· Psychological biases can lead sellers to overprice their properties on the real estate market.
· « Classical » economic theory does not predict any impact of the asking price on the final sale price. More recent research may conclude either a positive or a negative effect on the final sale price;
· Real estate agents strongly advise against listing at too high a price, but their incentives are not necessarily aligned with their clients on this point.
· Empirical studies generally conclude that the asking price will have a positive impact on the final sale price. It will also increase the time it takes to sell;
· The choice of the initial selling price should therefore be based on a trade-off between selling time and selling price, rather than on fear of a « stigma effect. »
Selling a home is often a stressful experience for a household, as it often involves a large portion of its wealth. An important question for the seller is therefore how to determine the asking price for their home. This price is all the more important because it is relatively inflexible: sellers tend—as Merlo and Ortalo-Magné have observed—to make relatively few changes to this price once it has been set.
In fact, for 77% of the homes in their database (1), the initial asking price is never changed during the sale period. One explanation for this phenomenon is that such a change would send a negative signal about the quality of the property or, at the very least, reveal that the seller is in a hurry and therefore in a weak position to negotiate. Knight (2002), for example, shows that houses whose asking price has been lowered over time generally sell for lower prices than comparable houses.
The initial asking price can also influence the final price obtained more directly, without a price revision (usually downward) conveying any information. For example, Cardella and Seiler (2016) show, using an experimental framework, that the strategy chosen, between rounding the initial asking price (e.g., setting it at $100,000), setting a price just below a round number (€99,000), or, conversely, setting a precise price (€102,530) will impact the rest of the negotiation and its outcome.
The asking price may be overvalued
Several strategic mechanisms and psychological biases can lead sellers to set a high initial sale price. One such bias is « loss aversion »: the psychological tendency to value losses more highly than gains. Genesove and Mayer (2001) highlighted a widespread aversion to loss in the real estate market. Individuals who risk selling their homes at a loss—where the expected market value at the time of sale is lower than the purchase price of their property, for example because they bought during a boom and the market has since turned—put them up for sale at prices higher than those of comparable homes.
A second cognitive bias can reinforce and accentuate loss aversion: the anchoring-adjustment effect. As Tversky and Kaheman (1974) showed, to determine an unknown value, individuals will start from an initial value, an « anchor, » which may be completely arbitrary (note (2) illustrates the effects of anchoring with examples), and then adjust their assessments based on that value. However, these adjustments tend to be too small.
Homeowners may suffer from a similar bias. In the event of a market downturn, even if they would agree to sell for less than the purchase price, they may not adjust the price of their home sufficiently. In a study of the Hong Kong housing market, Leung and Tsang (2013) consider that these two effects, anchoring and loss aversion, are significant and could explain the correlation between price and volume in the real estate market.
Another study conducted by Benitez-Silva et al. (2015) also suggests that this failure to adjust prices could explain why homeowners overestimate the value of their homes by an average of 8%.
Loss aversion, sometimes combined with anchoring effects, can cause sellers to set their prices too high. Should sellers always be concerned about this?
What could be the effect of an overpriced property?
To better understand whether listing a home at too high a price is detrimental to the seller, it may be useful to examine the mechanisms at play. How could the listing price impact the final price?
As Bucchianeri and Minson (2013) point out, standard economic theory does not consider the asking price to be a factor influencing prices in the real estate market. Prices should depend only on « objective » factors such as the location of a house, its size, etc., and the market should correct the seller’s « strategic » choices or mistakes. However, this explanation does not take into account the fact that the asking price can also convey information, serving as a signal to guide buyers in selecting properties to consider among those available on the market (e.g., choosing which ones to visit).
A price that is too high could then deter potential buyers. It would lead to fewer visits and ultimately, perhaps, a lower price if the property develops a bad reputation after being on the market for too long (if buyers start to think that if it hasn’t been sold, there must be something wrong with it).
On the contrary, a low initial price would attract more buyers, put them in competition with each other, and ultimately allow for a better price to be obtained. This « war between buyers » effect is a phenomenon that is sometimes observed, at least in studies devoted to auctions.
Another area of literature also discusses anchoring effects. While anchoring can influence the seller, it can also impact the buyer. For the buyer, the asking price could serve as an anchor. In order to determine an estimate of the value of the house, the potential buyer would readjust their assessments based on the asking price. But once again, the adjustments may be insufficient. This would lead them to not negotiate the price sufficiently and therefore to pay a higher price for the property.
We can therefore find mechanisms that predict either no correlation between the asking price and the sale price, or a negative impact, or a positive impact. Which seems most likely?
What do real estate agents recommend? What do they do?
When selling a home, many sellers decide to use a real estate agent because they often have better information about the state of the market. It may therefore be interesting to study the advice and behavior of real estate agents.
Real estate agents are often the first to warn against setting prices too high. For example, Bucchianeri and Minson (2013) explain that when they searched Google for the strategy recommended by professionals in 297 pieces of advice, 46% seemed to recommend selling at a price below market value, while 96% of web pages warned against selling above market value. This strategy would deter buyers, reduce the number of visits, and, over time, « stigmatize » the house. According to real estate agents, prices that are too high should therefore be avoided.
However, it should not be forgotten that real estate agents, while they may be better informed than the seller about the state of the market and the value of their property, do not necessarily have interests that are perfectly aligned with those of the seller. Levitt and Syverson (2008 (2)) show that real estate agents sell their houses at higher prices than those of their clients and after having put them on the market for longer.
The article does not examine the strategy chosen for the « asking price, » but it would appear that real estate agents are not always concerned about the « stigma effect » since they keep their properties on the market longer than their clients. The interpretation favored by Levitt and Syverson (2008) is that agents’ incentives encourage them to sell their clients’ homes quickly because it is more profitable for them to pursue a volume strategy than a « best price » strategy. It is perhaps this phenomenon that leads them to advise against listing at a high price; on this point, agents may not necessarily be giving good advice. Bucchianeri and Minson (2013) confirm this idea by revealing that, when surveyed anonymously, real estate agents predict that higher listing prices lead to higher sale prices.
Of course, it is important not to go to the other extreme and refuse to listen to an agent, as they do have more information than the seller and have no interest in causing property prices to collapse. It is simply important to bear in mind that they may push you to slightly underestimate the value of a property.
What empirical studies say
Empirical studies face a major problem when studying the impact of the initial asking price on the final sale price: unobservable characteristics (for the econometrician). A higher asking price may either reflect a strategic decision (putting house A on the market at a higher price than house B when the two properties are identical) or reflect a difference in quality (house A is « better » than house B, but the researcher does not observe this difference in quality).
Several methods have been proposed to resolve this difficulty (using repeat sales, framing the estimated effect, etc.) and the results of recent studies generally indicate that the asking price has a positive impact on the time taken to sell (for two identical houses, if one is put up for sale at a high price, it will sell more slowly), but also that the sale price will also be positively impacted (the house put up for sale at the highest price will also be sold for more).
For example, the studies already cited, Genesove and Mayer (2001), find that sellers who fear a loss, in addition to listing their property at a higher price, will sell it at a higher price (but also take longer to sell). More directly interested in the asking price, Bucchianeri and Minson (2013) also find a positive effect (albeit relatively modest).
Cardella and Seiler (2016) find a similar result in their experimental study: a high and precise asking price leads to a higher selling price and a more profitable transaction for the seller than a precise but low figure. Thus, if a house is worth around €100,000, putting it on the market at €103,530 would be more profitable (for the seller) than €98,457 (these examples are arbitrary).
Conclusion
Contrary to the predictions of classical economic theory, which considers that the price of a home depends only on its « objective » characteristics, the asking price of a home will impact the price at which it is ultimately sold.
It is therefore crucial to choose this price carefully. While there are still relatively few studies on the impact of this price, it would appear that the pessimism of real estate agents, who predict a « stigma effect » (properties listed at too high a price are ultimately sold at a lower price), is not fully confirmed by recent research.
Notes:
(1) Their database is relatively small (780 observations), but extremely detailed.
(2) Tversky and Kaheman highlighted an anchoring effect with the following experiment. After dividing the participants in their experiments into two groups, they asked them to calculate a rounding of the following product in 5 seconds:
Group 1: 8 X 7 X 6 X 5 X 4 X 3 X 2 X 1
Group 2: 1 X 2 X 3 X 4 X 5 X 6 X 7 X 8
On average, group 1 came up with values that were significantly higher than those of group 2. The explanation given is as follows. Since it is difficult to give the exact answer in the time allowed, subjects round off using the first piece of information available: the first digit of the product. For group number 1, this is an « 8, » while group number 2 sees a « 1. » These two digits form anchors, and individuals adjust their estimates of the product’s value based on them, which is why the group seeing a higher first digit will come up with a higher result.
(3) The study is also mentioned in Freakeconomics by Steven Levitt.
Reference:
Hugo Benitez-Silva, Selcuk Eren, Frank Heiland, Sergi Jimenez-Martin, How well do individuals predict the selling prices of their homes, Journal of Housing Economics, vol. 29, 2015.
Grace W. Bucchianeri, Julia A. Minson, A homeowner’s dilemma: Anchoring in residential real estate transactions, Journal of Economic Behavior & Organization, Volume 89, May 2013, Pages 76–92
Eric Cardella and Michael J. Seiler, The effect of listing price strategy on real estate negotiations: An experimental study, Journal of Economic Psychology, Volume 52, February 2016, Pages 71–90.
Tin Cheuk Leung, Kwok Ping Tsang, Anchoring and loss aversion in the housing market: Implications on price dynamics, China Economic Review, Volume 24, March 2013, Pages 42–54
David Genesove and Christopher Mayer, Loss Aversion and Seller Behavior: Evidence from the Housing Market, The Quarterly Journal of Economics(2001) 116 (4): 1233-1260.
Daniel Kahneman and Amos Tversky, » Prospect Theory: An Analysis of Decision under Risk , » Econometrica, vol. 47,no. 2, March 1979, pp. 263-291
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Amos Tversky; Daniel Kahneman, Judgment under Uncertainty: Heuristics and Biases, Science, New Series, Vol. 185, No. 4157. (Sep. 27, 1974), pp. 1124-1131.
John R. Knight, Listing Price, Time on Market and Ultimate Selling Price: Cause and effect of Listing Price Change, Real Estate Economics, V30 , 2, pp213-237, 2002.
Steven D. Levitt, Chad Syverson, Market Distortions when Agents are Better Informed: The Value of Information in Real Estate Transactions, the Review of Economics and Statistics, November 2008 Vol XC, number 4
A.Merlo, F. Ortalo-Magné, J.Rust, The Home Selling Problem: Theory and Evidence, International Economic Review, Vol. 56, Issue 2, pp. 457-484, 2015
