Are Home Sellers' Price Expectations Really That Inflated?

There’s a general perception that sellers have unrealistic expectations when listing their properties for sale – that a seller’s listing price for his home (the ask price) is often far above the eventual closed price. At this year’s American Economic Association conference in San Francisco this week, Frank Heiland from Florida State University presented his paper, “How Well do Individuals Predict the Selling Prices of their Homes?,” which provides some evidence that sellers do indeed overshoot, but in aggregate may not be as far off from the final sales price as is generally thought. The positive implications of measuring this overshooting are significant when modeling the current real estate market.

The authors quantify this “seller vanity premium” (my choice of words) to a specific range. From the paper:

We find that homeowners, on average, overestimate the value of their properties by between 5% and 10%. More importantly, we are the first to establish a strong correlation between accuracy and the economic conditions at the time of the purchase of the property.

To restate the authors’ findings - sellers clearly have inflated price expectations in the estimated market values of their home, but those inflated expectations are 105-110% of the final sale price.

Real estate agents often come under fire for listing properties at the behest of sellers (i.e. “telling the sellers what they want to hear just to get the listing”), but even if agents opt to initially list a property at the sellers' perceived value, it is a simple process to discount aggregate listing price levels by 5-10% to estimate the final future sales price by using the given list price.

There may be a tendency to discount Heiland’s paper and its results under the simple intuition that it just “can’t be right.” An additional outcome to the paper that the authors uncovered further supports why the seller vanity premium is “only” 5-10%, which is alluded to in the quoted text above:

While most individuals overestimate the value of their properties, those who bought during more difficult economic times tend to be more accurate, and in some cases even underestimate the value of their house. We find a surprisingly strong, likely permanent, and in many cases long-lived, effect of the initial conditions surrounding the purchases of properties, on how individuals value them.

The market certainly displayed these characteristics more recently – as the market experienced a run-up in prices, seller expectations about home values reached an inflated level beyond their actual market value. On the flip side however, buyers that have bought in down cycles tend to take an overly pessimistic view of their homes’ value. This indicates a psychological effect, but one that the authors extrapolated from their study and helps to even out the extremely over-inflated perceptions that some sellers may have.

What makes this paper interesting and useful for financial market participants?

By identifying a relatively tight band in the owner valuation premium of 5-10%, it enables market traders to make more accurate predictions about final sold transaction prices by simply discounting the list price of on-market properties.

Sold data is well-known to have lag period. For example the Case-Shiller Home Price Index lags by more than two months in its reporting time periods. The most recent release earlier this month provided market data for October 2008. Given the number of financial market events since this Fall alone, solely utilizing sold price data from October 2008 to model the real estate market right now in January 2009 seems incongruous. Would you prefer to make a stock purchase decision based on bid prices from two months ago, ask prices today, or some combination of both?

For posterity, I compared listing prices compiled from the real estate market data available from Altos Research and the affiliated sold prices in the Case-Shiller 10-City National Composite index through November 2008 to see if listing price would serve as a viable proxy to final sold transactions. The results seemed to follow this 5-10% “seller vanity premium” described in the Heiland’s research paper:

A visual check shows that the listing price data in red is consistently in the 5-7% range when compared against the Case-Shiller final sold price across this 10-City National Composite.

While this quick analysis doesn’t constitute a strict econometric test, there’s a clear indication that a close (and leading) correlation exists between listing and sold prices, and that the listing price seems to follow along with the 5-10% “seller vanity premium” suggested from the research undertaken by Heiland and his coauthors.

Undoubtedly, sold price data will continue to be a vital component to real estate market analysis, but given that listing price information is readily available and is shown to closely correlate with final sold prices, it would appear that an opportunity now exists to augment real estate market modeling and provide visibility to what’s happening right now in the market with a fair degree of certainty.

Disclosure: No position.

Comments

[dick streich:]

If its over-priced, brokers will not show it. When there is no traffic, a seller
has too high a price

Jan 05 08:54 AM

[Malkiel:]

If its over-priced, brokers will not show it. When there is no traffic, a seller has too high a price"

Whoa Nelly, a lot of assumptions there. The evidence of the above discussion is that ALL HOMES ARE LISTED ABOVE FINAL SELLING PRICE, or that all brokers are accepting listings that are "over-priced" because setting a first listing price is a negotiation between the agent and owner over what value to set to get the top dollar for the property. It might be the case that agents in bubble markets like California or Nevada may refuse listings that are orders of magnitude out of proportion to market realities, but I wouldn't imagine there could be many such refusals--after all, the seller can't list too far below breakeven, and in some markets almost all sellers are way below water on their mortgages, so one can list and try or do nothing and die. These are extraordinary times with no obvious strategies for how to proceed.

As for traffic, in a credit squeeze even discounted houses may not be selling, so buyers and agents can only work on the fundamentals of showing the home's assets and hope they have a desirable package. It simply isn't valid in a credit squeeze to claim that no sale equals overpricing...

Jan 05 09:23 AM

[TomF75:]

Duhh!!! Hmmm, let me think for a minute...I know my house is worth $170,000. What should I do, list it a $170k so that every offer I get is below value...OR list it at $175 or $180 and hope to get offers around what I think is the true value of the home. Amazes me how much time academics waste trying to figure out what is obvious to even the meekest of sheoples!

Jan 05 11:20 AM

[The Hammer:]

Why realtors take on these listings only makes them look worse in the eyes of the buyer?
Realtors played a big role in pumping up house prices during the bubble and now their propaganda arm has finally admitted the housing market is in a depression....but before that this unethical organization continually has called a bottom since the peak prices. They have hurt many families who put their blind faith in these thugs.
House prices in many high markets are still not anywhere near affordable for the local median incomes. When prices drop down to fundamentally sound valuations based on median incomes in the local region then houses will start to sell, but some of the non-sense that is going on by sellers in this market is just silly.

Jan 05 11:23 AM

[The Hammer:]

To think one's house is worth what some homedebtor fool paid for it is plain non-sense. better measures would be imo replacement cost or based on a historical range of median income. say 2.5 - 4 times depending the quality of the employment opportunities in a region.

Jan 05 11:27 AM

[User 41893:]

This 'inflated' seller price as you say, is just part of the bargaining deal - do you find people really just take the list price of anything these days? It's a starting point where the potential buyer 'makes an offer' that is, offers something lower - how much lower is wiggle room, then the seller has room to come down in price, and still be satisfied with the end value on the transaction. This is a negotiation as old a dirt.. or sand as it may be. So duh, of course the 'asking' price is going to be 5-10% above the final bargaining out point. If you start low, the buyers will just try to screw you down lower than that. At least that's a pretty obvious scenario that's played out no matter what the market for houses, cars, you name it.

Jan 05 11:36 AM

[The Hammer:]

"the buyers will just try to screw you down lower than that."

Oh and all those fools with no money down using someone else's money was not royally screwed by realtwhores and sellers cheerleading the crooked ponzi scheme?

This exactly what housing became, but houses are an expensive item to maintain and carry people do not realize until they buy one for the first time.

Houses will continue to plunge until they are at affordable levels vs median incomes in a local region. If i was a buyer today asking would mean nothing. I would base it on the local incomes and in my area that would mean another 15-20% lower prices. Why people buy something that saddles themselves with debt and takes a huge chunk of take home pay is beyond me. It gets old after while since every year taxes go up and cost of living. So what you see this year is not next years or the year after bills.

Jan 05 12:06 PM

[Ms. Jupiter:]

homes are overpriced. and nobody want to talk about why.
the reason in my view, inflated prices caused by raucious borrowing,
HELOC,s abound, second mortgages all to support that big screen and hummer. The greed gremlin, when prices were escaling, it was a " sure" thing to borrow against because surely it would continue to increase.
thats why prices are inflated. check out the financial history of listed properties with county clerks, bet you will or wont be slurprised.
Sellers want you... to pay for their wild and uncontrolled spending.

Jan 06 08:39 AM

[D. McHattie:]

This is just an irrelevant distraction. Fundamentals? Heard of that?

The most accurate predictors of long-term house and condo prices are the ratios of home prices/incomes and home prices/rents.

Asking prices may indicate where prices are right now but, when using 80% leverage to make the largest purchase of their life, a person should be consider the future price of their house or condo, not just what other people are paying right now.

Jan 07 07:45 AM

[rocmon:]

I think it's ridiculous to make offers on properties... the seller should list the actual price they are willing to accept or throw it into auction! The whole mysterious guessing game of the north American real estate only serves to perpetuate the abstract and creates a market for the vulture agents (80% of them) to feed off the labors of others!

Whats my point? Please substantiate how selling my 1 million dollar house deserves $50,000 in commission? please... anyone!

Jan 12 08:19 AM