Psychological pitfall in pricing properties - Why and how to avoid it
Getting the price right is probably the single most important consideration for many when it comes to buying, selling or renting property. But what is the right price and what makes it right? What goes into price and how is it related to value?
An experiment conducted by Gregory B Northcraft and Margaret A Neale from the University of Arizona in the US found that even expert real estate agents with nine years of experience on average can be influenced solely by listing prices when it comes to estimating the value of properties. A total of 54 undergraduate students and 47 real estate agents participated in the experiment. They were each given a package containing information on a selected property, including the listing price, floor area, characteristics of the property and a summary of sales transactions in the immediate neighbourhood for the past six months.
The only difference in the package they received was the listing price. Everything else was identical. Participants were also brought to the property for a physical inspection. Each participant received one of these four listing prices: a) US$119,900, b) US$129,900, c) US$139,900 and d) US$149,900. Participants were then asked to estimate the valuation of the property, an appropriate asking price and the lowest acceptable price if they were the seller, and the maximum price they would pay if they were the buyer.
The results show that the estimates by participants, including the expert agents, were heavily influenced by the listing price (see table). For example, agents who received the lowest listing price of $119,900 submitted conservative valuations of $114,204 on average. On the other hand, agents who were given the highest listing price of $149,900 submitted bullish valuations averaging $128,754.
In psychology, this cognitive bias or error in judgement is called “anchoring”. Anchoring occurs when humans rely too heavily on one particular piece of information (“the anchor” — in this case, the listing price) when making decisions. Once an anchor has been established, decisions taken typically revolve around it. In this experiment, the huge variation in property prices was caused solely by listing prices alone, as everything else provided were the same for all participants.
How to avoid this pitfall?
In actual real estate transactions, sellers usually decide on a listing price upon the advice of their agent, who will support their advice with data such as that from recent transactions or listing prices of comparable properties on the market. This listing price then becomes the first offer in the bargaining process when the prospective buyer or agent finds the listing that matches their requirements. The onus is on the buy-side to negotiate the price down to the level they are willing to pay or walk away from the deal. This can result in the buyer paying more if the listing price is inflated or the seller receiving less if he is not knowledgeable about the market and set a listing price that is too low.
Adam D Galinsky from the University of Utah and Thomas Mussweiler from Universität Würzburg conducted experiments that show the anchoring effect of a first offer can be eliminated when negotiators consider the opponent’s reservation price, the maximum a buyer is willing to pay or the minimum a seller would accept, or best alternative to a negotiated agreement. While there is no easy way to accurately determine these factors, an educated guess can be made if the fair value of the property is known. For instance, if the listing price of a house is $500,000 when the fair value is only $400,000, the buyer would be able to guess that the seller’s reservation price would likely be somewhere above $400,000 and, if he decides to walk away from the deal should the seller not budge on price, the seller would probably not find other ready buyers at the listing price point. Therefore, the buyer would be better equipped to negotiate for a more affordable price.
Can technology help improve decision-making?
The most accurate measure of fair value would be a recent valuation performed by a professional valuer. However, this is not always readily available as a valuation is performed for resale HDB flats only after the Option to Purchase (OTP) has been granted to the buyers. A valuation is not always performed for private property as it is only required by banks as part of the financing procedure or as part of the buyer’s due diligence.
TheEdgeProperty.com has collaborated with professional valuers to develop the “Edge Fair Value” — a proprietary valuation algorithm that employs many of the principles of an actual valuation and is endorsed by 3C Property Consultants Pte Ltd, a property valuation firm on the HDB panel with valuers who each have over 30 years’ experience. The methodology takes into account factors such as recent transactions of comparable properties, level, facing, size and outliers in formulating the values. For example, properties that are at higher levels will be priced at a higher $ psf. The same principle applies for smaller-sized units.
While it is not possible to account for every facet of the property such as the extent of renovation or the availability of appliances and furniture, we do allow real estate agents and professionals to provide their input within a given price band for the properties they represent. This enables the system to get smarter and more precise over time.
Our algorithm has been tested rigorously as well, and back-testing on about 260,000 data points shows that 90% of all actual residential transactions (HDB, condos, landed) in Singapore from 2009 to 2014 fell within +/- 10% of the Edge Fair Value.
Besides being a useful tool for establishing the fair value for negotiation purposes, the Edge Fair Value can also aid in screening property listings as any listing price that deviates significantly from this value should immediately set alarm bells ringing. Keeping in mind that the current sluggish market favours buyers, sellers should use the Edge Fair Value of their property to determine a suitable listing price. Motivated sellers can also use it as a yardstick to tailor their pricing and negotiation strategies to be more competitive if other sellers in their neighbourhood offer an alternative to their prospective buyer. This can help to prevent prolonged back and forth offers and counteroffers that are time and energy consuming, or a breakdown in negotiations.
This article appeared in The Edge Property Pullout of Issue 692 (August 31) of The Edge Singapore.