The importance of having a realistic view
It is important for home owners to have a realistic view of the value of their property. Home ownership accounts for a major part of household wealth and plays a role in consumer spending, saving, and pension decisions. Misperception of the value of residential property may lead to less appropriate financial decisions.
Too rosy a picture of the value of residential property...
Recent DNB research has shown that Dutch home owners often overestimate the value of their property. Even now, some years after the residential property market turnaround in 2008, a major proportion of home owners still believes that their homes have kept their value. Three quarters of Dutch home owners overestimate the current value of their homes. Between 2003 and 2012, the median home owner stated a value that was 13% above the actual value of their property. The actual value is computed by combining the purchase value with regional price trends. In addition, a substantial proportion of home owners is more positive about the future price trend of their own homes than about the general trend of house prices.
This rosy view is also evident when owners compare their own homes with those of others. At end 2013, 29% of home owners were under the impression that the value of their own homes exceeded that of the average house in their street, whereas only 13% thought it was lower. In addition, 31% of home owners thought that their homes were in better condition (versus 5% worse), and 17% was under the impression that the time needed to sell their homes would be shorter (versus 8% longer).
...even after the property market turnaround
The value of residential property is overestimated more when the property market is doing well. Although optimism wanes when house prices take a turn for the worse, home owners take a long time to adapt to reality. Even now, years after the property market turnaround, a large proportion of home owners remains overoptimistic, whereas house prices have dropped by around 20% from their peak in the summer of 2008. This delayed and gradual price fall followed on the quick and sharp drop in the number of home transactions. The lower number of houses changing hands and the slow adjustment to a new market balance is associated with owners hanging on to their high asking prices for too long. The rosy picture that home owners have of the value of their property may explain their reluctance to lower their asking price.
Loss aversion and ownership effect as an explanation
Overestimation of the value of residential property correlates closely with two psychological processes that have also been found to occur in other areas. DNB research finds a duration-of-current-ownership effect; the value overestimation increases with the duration of ownership. The sense of ownership increases with the number of years that a home is owned and has become completely adapted to the preferences and needs of its owners.
Research has shown that loss aversion also plays an important role in the residential property market. Loss aversion means that a loss of a certain size has a bigger effect on people’s sense of well-being than a profit of the same size. This is not new: investors are known to be very reluctant to part with their shareholdings following a price fall, as they are forced to face the loss they have suffered when they do. In the residential property market, owners try to avoid losses relative to certain reference points, e.g. the purchasing price or the level of their mortgage. DNB research shows that particularly home owners facing high loan-to-value ratios have a too rosy picture of the value of their homes. A supplementary survey also shows that three-quarters of the Dutch population find it important to at least recover the original purchasing price when selling their homes. And an even larger proportion considers it essential not to be left with residual mortgage debt.