Animal Spirits in the Real Estate Market

My wife and I bought our first home in late-2007/early-2008. As real estate agents like to say, it was a buyer’s market. The real estate market had peaked a few years earlier. The worst was yet to come but people were already starting to feel the pinch.

It seemed the best way to get a better price on a house was to just wait a few weeks for the inevitable price reduction. No one wanted to list their home for sale because they were anchoring to home values at the peak of the bubble. They couldn’t accept the new reality. You began to hear stories about houses being on the market for well over a year and people completely giving up on the idea of selling their home in certain cases.

Even though we didn’t nail the bottom — something we weren’t remotely trying to do — we got a great deal on a home we have loved. We’re now looking to sell that house.

Things are completely different this time around. It’s now a seller’s market. You start to hear stories about people selling their house without ever having to put it on the market or houses that go up for sale and get 40 offers in a week. Now people are talking about holding off putting their house on the market because they’re worried it will sell before they can find a new one to move into.

It’s amazing to me how just a few short years ago people assumed the real estate market would never come back while now things are back to normal or even better than ever in many areas. The difference this time around from the real estate bubble is that many people now assume these latest gains are illusory. They’re just waiting for the next real estate crash to hit. People are under the assumption that any gains in real estate, the economy or the markets must be artificial.

To me the real estate market is a perfect example of how emotions can move prices and drive people’s actions. When we recently met with our realtor to discuss listing our house and start looking at new homes for sale the first thing he said to us was to try not to get too emotional about the whole process, something that’s easier said than done.

In their book, Animal SpiritsRobert Shiller & George Akerlof discussed the importance of understanding human emotions when trying to figure out how the economy functions:

To understand how economics work and how we can manage them and prosper, we must pay attention to the thought patterns that animate people’s ideas and feelings, their animal spirits. We will never really understand important economic events unless we confront the fact that their causes are largely mental in nature.

It is unfortunate that most economists and business writers apparently do not seem to appreciate this and thus often fall back on the most tortured and artificial interpretations of economic events. They assume that variations in individual feelings, impressions, and passions do not matter in the aggregate and that economic events are driven by inscrutable technical factors or erratic government action.

In many ways the real estate market is a perfect embodiment of this. People hear about others selling their homes at higher levels so they decide it makes sense to put theirs on the market too. After all, if prices are higher it obviously makes sense to sell, right? When you’re dealing with such large dollar amounts it’s easy to get swept up in the numbers and misinterpret their meaning.

Somehow people fail to realize that even though they can now sell their current residence for a higher price they will also be buying at a much higher price (assuming you’re not going to downsize or rent for a while) in this trade. Acting as both a buyer and a seller in this type of exchange means you’ll almost always be at a disadvantage on one side of the transaction.

This is why I feel so strongly that real estate should be looked at as an asset and not an investment. Unless you’re a professional real estate investor it’s mostly timing or luck that will determine how much money you’ll make over time.

Owning a home is also a form of consumption — you’re paying taxes, interest costs, insurance, upkeep and making improvements. And let’s not forget to state the obvious — it’s where you and your family live. It’s more than a mortgage or a sale price. It’s about your neighborhood, your school district and the surrounding community. There’s a certain amount of psychic income that people derive from owning a home that’s hard to put a financial price tag on.

I know firsthand that it’s nearly impossible to keep emotions out of the equation when making buy and sell decisions about your home. And that’s okay as long as those emotions don’t cloud your judgement. Problems arise when we forget that debt and personal feelings can be a  lethal combination when people start to simply see the dollars involved when buying or selling a home.

Wish me luck in this process — it’s hard to say when the animal spirits will take over or which way they will move the markets.

Animal Spirits: How Human Psychology Drives The Economy, and Why It Matters for Global Capitalism

Further Reading:
Point/Counterpoint on Real Estate as an Investment Option


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