Does My Husband Suffer from the Endowment Effect?
NEW YORK ( MainStreet) My husband, Ryan, tells me that we could get $200,000 if we put our home on the market. I try not to roll my eyes.
He's talking about the Miami condo he bought for $230,000 in 2005, just a year before the height of the housing bubble. Real estate values in the region have fallen 34% since then, giving the apartment a projected price of $150,170. Zillow estimates it's worth slightly more at $165,933.
Despite these grim figures, Ryan thinks it's worth $200,000. I think he's a Pollyanna, the Sponge Bob Square Pants of real estate. His rose-tinted glasses are practically magenta, shielding him from the reality of owning an overwhelmingly underwater home. I tell him that he, like all homeowners these days, is suffering from a bad case of the endowment effect, overvaluing the things that he owns simply because he owns them.
After all, study after study shows that the endowment effect is a real thing. And it appears to show up in housing data, too. People thought their home values rose an average of 200% from 2001 to 2007, according to the Survey of Consumer Finances, a whopping 30 percentage points less than a market transactions index shows that they increased. In the following three years, people thought their home values fell 17%, 3 percentage points less than the transactions data indicated, according to a recent Federal Reserve staff working paper .
But as it turns out, my case isn't as airtight as I thought it was. Recent research shows that Ryan's likely to be right and my armchair psychoanalysis likely to be wrong. People are actually pretty decent at estimating the value of their homes, at least in the short term, two studies found.
"Generally, owners are good at understanding how the value of their home has changed," Alice M. Henrique, an economist at the Federal Reserve, wrote in the working paper. She found that the difference between the data from the consumer finance survey and the transactions index was likely not the result of over-optimistic homeowners, but instead the result of distorted transactions data: homes experiencing greater than average price appreciation tended to sell more in the boom times, and homes experiencing greater than average price deterioration tended to sell less in the bust.
Economists Karl Case, Robert Shiller and Anne Thompson reach a similar conclusion about homeowner perceptions in a 2012 paper that analyzes consumer sentiment data collected for more than a decade. "Homebuyers were, if anything, out in front of the short-term changes that were occurring," the authors conclude in the paper published by Brookings.
In our case, Ryan has sound reasons for believing the house is worth more than the various estimates indicate. He remodeled the kitchen with high-end appliances and cabinets and opened up the floor plan. He also upgraded the plumbing and electrical system. In short, he made some real improvements to the apartment, which should increase its value beyond what would be measured automatically by an index or algorithm.