Money illusions are alive and well. On average, homebuyers across the nation overvalue their properties by 8%, according to a report by the Journal of Housing Economics.

As of June 2015, a 1.15% gap between homeowners’ estimations and professional appraisals was recorded by Quicken Loans. May 2015 was the fourth consecutive month in which the gap between actual and perceived market value widened.

For reference, in May 2014 appraisers valued homes approximately 2.05% higher than owners expected. By May 2015, this number had dropped to 1.15% lower than owners anticipated.

This is the first time the gap has reached the -1% mark in nearly two years.

Accelerated pricing

Home prices in major metropolitan areas continue to rise, with most homes appraising at higher market values than owners expect.

Owners of properties in lower demand, the mid-tier price range properties, are using the same expectations to calculate their homes’ value. This fixation on an idealistic price, called a money illusion, creates accelerated prices driven by the fleeting momentum of a rising market.

With sticky pricing, prices stay elevated as a result of homeowners’ refusal to succumb to sinking prices in the market. With accelerated pricing, owners are clinging to increasing market prices to boost their own homes’ value.

The accelerated pricing phenomenon is caused by any of several false perceptions, including:
• unrealistic expectations for returns on property improvements;
• over-improvements relative to neighborhood standards;
• misattribution of mortgage debt to property values; and
• the erroneous assumption that a median of fair market value (FMV) exists for a particular property.

Calculating the proper FMV of a home requires assessment of two factors: comparable property and local market conditions. Market value varies by neighborhood, city and state; no national relationship exists. All real estate is local, and immoveable.

Owners under an accelerated price money illusion are also incorrectly equating their mortgage balances and improvement costs to the market value of their properties. They watch numbers fly through their bank accounts as they pay for improvements and mortgages, and believe their homes’ resale values should function as an investment return. Also, they are influenced by square foot averages as though that average somehow alone sets value.

Money illusions are nothing new

Money illusions have always affected the housing market following drastic changes like the Great Recession. Owners who bought their homes in or after 2007 reportedly overestimated their homes’ values by a national average of 14%.

Sellers seek to ride the momentum of the recovery upswing and “score” by selling at accelerated prices. Holdout sellers insist on waiting until they get that one special buyer whose emotional attachment to their home will blind them to the ludicrous price. If they don’t sell at the accelerated price, sellers believe they have somehow lost money they never had.

The elephant in the room is the agent who panders to the owner’s natural greed to get the listing for a property. The deceitful agent’s suggestion of a very high asking price as the listing price is what will turn the owner’s attention from all the logic and truths other agents present as realistic pricing. The seller will believe in a false premise, and feel justified – until the agent returns with a market price offer.

Homeowners’ overestimation creates more issues than just accelerated pricing. Given the heady rise of prices of low-tier properties in metropolitan areas, low- and moderate-income buyers are forced by what is being called gentrification to search elsewhere for housing within their financial grasp. If homeowners keep overestimating their properties, the rise in home prices based on deluded perception of market value outpaces the gradual inflation-related incline of wages.

Hasty accelerated pricing is also doomed to fail since drastic increases in price lead inevitably to decreases in sales volume – brought on in part by buyer shifts to increased construction starts. In turn, declining sales volume drives market prices back toward the historical mean price trendline, a price point buyers can qualify to borrow and buy.

Shattering the illusion

Agents and brokers need to lead their clients into reality by explaining a home’s true FMV in a way the client understands. Using a comparable market analysis (CMA) worksheet is a great way to objectively set value. Chances are, however, clients will just need to try to sell and fail before finally coming to this realization on their own. [See first tuesday Form 318]

To combat accelerated prices, inform your clients of acceptable valuation practices – appraisal. Explain how you arrive at the assessment of their home’s FMV.

If a difficult client refuses to be reasonable about their price expectations, you need to decide if pouring your talent and marketing efforts into a listing which will most likely sit on the market for 6-12 months is a valuable use of your time. It may just be better to walk away; let someone else educate this owner.

Re: “Why owners often overestimate their home’s market value,” from the Los Angeles Times