April 23, 2016

When Loss Aversion Kicks In

A weekend topic on psychology starting with CBC News in Canada. “What a fabulous buying opportunity. Or is it? After years of sharp price increases, the costs of Calgary houses are finally down nearly four per cent from where they were a year ago. While real estate company statistics show prices and sales continuing to climb across the country, a number of markets have turned, offering Canadians a useful experiment in the behavioural economics of the housing market.”

“About a year and a half ago, I wrote a piece saying that house prices could fall like oil. The point was not to predict a property market crash, it was merely to remind us that the smartest people in the oil industry failed to predict the current tumble in energy prices that now seems so obvious. At the time, the response from many was that a property market crash could not happen, simply because there were so many people waiting to get into the market. As soon as prices declined, those hungry house hunters would respond by snapping up anything that was offered.”

“Housing is considered to be what’s called a ‘lagging indicator,’ meaning that real estate markets only respond long after the economy has started to go sour. And according to Calgary-based behavioural economist Robert Oxoby, that’s at least partly due to something behavioural economists refer to as ‘loss aversion’ by current home owners.”

“Behavioural economists love to point out when conventional market rules are overturned by psychology. Especially when human behaviour makes us act contrary to our own interests. Normally, economic theory tells us that when things get cheaper, we buy more. When things become more expensive, we buy less. In the property market, that often turns upside down.”

“‘There’s a lot of herd behaviour here. We behave like cattle,’ said Oxoby, a professor at the University of Calgary. ‘People see the prices going up, and they go, ‘Oh, shit, I better buy a house now before it gets worse.’”

“It is on the way down when loss aversion kicks in, this time hurting people who want or need to get out of the market. ‘When the value of that house is high, they tend to view that as a gain,’ said Oxoby. Loss aversion makes sellers refuse to sell, preferring instead to wait until house prices bounce back again. The problem arises when that bounce-back fails to happen. And the people it hurts most are those who bought just before the downturn began, when the market was at a peak. ‘So, what happens is as prices start to fall even more, people get trapped with those big assets that they have a lot of debt on but aren’t worth as much anymore,’ said Oxoby.”

“For prospective buyers, suddenly, the challenge is exactly opposite from what it was a few years ago. Instead of being forced to buy before prices become unattainable, they wait, wondering when the market will hit bottom, fearful that further declines will wipe out their down payment and leave them owing more than they own.”

“There is only so much people in other parts of Canada can learn from housing markets devastated by falling energy prices. ‘One of the things that was supporting Alberta home prices was the fact that our incomes were 40 to 50 per cent higher than the rest of Canada, and that’s changing very rapidly,’ said long time investment adviser and real estate guru Hilliard MacBeth.”

“But property owners and prospective buyers elsewhere would be wise to watch and see if, indeed, the plunge is nipped in the bud by bargain hunters or whether prices continue to fall for a while yet.”

From Star News Online in North Carolina. “The Wilmington region was one of three markets in North Carolina and 19 nationwide that saw homes sell for less than owners paid for them, according to a RealtyTrac report. Wilmington owners sold their homes for an average of $10,250 less than what they purchased homes for. Wilmington’s average losses were the second worst in the state after Winston-Salem, which led the country in terms of dollar losses at $12,750, according to the report.”

“The Durham area saw the state’s highest average dollar gains, at $27,750, while San Jose, Calif., saw the highest average gains across the country, at $312,500, the report said. According to the Wilmington Regional Association of Realtors (WRAR), the average sale price in the Wilmington region in March was $246,665. March’s average price was still below pre-recession levels — the average sale price in March 2007 was $260,644.”

“Don Harris, a broker with Intracoastal Realty and president of WRAR, didn’t dispute the RealtyTrac report, but said he believed the report was more of a reflection on the inflated housing bubble market of a decade ago than it was a reflection of today’s housing market. He said that, in 2006 and 2007, housing prices were increasing by 15 or 20 percent annually.”

“‘The market in ‘07 was out of control,’ Harris said. ‘What we’re seeing now is housing prices trending up. We’re seeing locally that the market is robust’ but not out of control.”