A cognitive bias is a systematic error of thinking because our brain is always looking for shortcuts. Understanding these mental mistakes of memory, attention, and attribution can help you save a lot when making the biggest purchase of your life. Here are six prevalent biases in real estate that every home buyer and seller should be aware of.
- The Scarcity effect - is the cognitive bias that makes people place a higher value on an object that is scarce and a lower value on one that is abundant. In other words, homes in a hot market sell for more than a similar home in a cold market. The house remains unchanged, but the context changed. In the context of Covid-19, homes doubled up as home offices and school, and drove a structural increase in the demand for more space. Construction delays, labor, and material shortages have stymied the supply of new homes. A Covid spike in home prices is rooted in the reality of supply shortages and increasing demand. A Covid double whammy is different from scarcity caused due to yearly seasonality.
- The Anchoring effect - is a cognitive bias that over indexes the first piece of information offered (the “anchor”) when making decisions. During home price negotiations, buyers will use the initial list price of the home to make subsequent offers. Once an anchor is set, a lower price than asking seems more reasonable, even if it is objectively higher than the home is worth. The anchoring effect works both ways: if the seller truly believes in the unreasonably high price, a failure to reach that goal can affect satisfaction with the sale.
- The Endowment effect - represents the undue emotional value a seller ascribes to their own home due to memories created in it. The endowment effect is closely related to anchoring. Realtors play an essential role in reducing the anchoring and endowment effect by running “comps” or a comparative market analysis “CMA” to set a reasonable price that ensures a timely sale. If you are willing to be patient with the right house, anchoring and endowment can work in your favor.
- The Halo effect - is a perception distortion that influences how people interpret the information about someone, a product, or a home because they have formed a positive impression in the past. An example of the halo effect in real estate is the brand impression of a brokerage that does good marketing, e.g., Compass has made a name for itself with inexpensive and high-end homes. The halo effect in this case specifically refers to the price premium gathered by listing with a prime broker like Compass. Realtors will often try to convince you of “a higher price” they will secure on your behalf by listing with them. Buyers should focus on the house, not the listing broker. The apple iPod put a halo around all apple products, whether or not they are worth it. A $1000 iPhone, maybe, but a $549 Apple AirPods Max, maybe not!
- The Framing effect - is the cognitive bias where an individual’s choice from a set of options is influenced more by how the information is presented than by the information itself. Photography and staging are exhibits A and B or the framing effect in housing. Does your ability to imagine yourself in a well-lit and staged home with mid-century modern furniture deem $50,000 more in price. While sellers should make sure to hire a professional photographer and stager, buyers would benefit by imagining the art of the possible or hiring a virtual designer to use their imagination and save you top dollar.
- The Commitment bias - is our unwillingness to make decisions that contradict things we have done in the past. Realtors and mortgage loan officers sometimes make you sign superfluous paperwork. Don’t sign or disregard most of it unless it is your offer letter or closing day documents. Those are legally binding documents. Surreptitious initialing is a sales trick that commits a user to future action with meaningless signatures in the present. That is classical conditioning at its best. Ivan Pavlov, the famous psychologist who trained dogs to expect treats when a bell rang, would be proud.