HOW MUCH PEOPLE THINK THEIR HOUSES ARE WORTH
Most people in the US overestimate the value of their homes, some by as much as 20%, according to research by Sergi Jiménez-Martín and colleagues, presented to the Royal Economic Society's 2009 annual conference at the University of Surrey. But individuals who acquire their properties during economic downturns tend to be more accurate, and in some cases even underestimate the value of their houses.
These results establish a surprisingly strong, permanent and long-lived effect of the conditions surrounding the purchases of properties on how individuals value them. For example, unless forced into it by circumstances, homeowners are unlikely to accept offers below the original price they paid.
For most Americans, in particular those with low and medium levels of income, their homes are their main asset (60% of the average net wealth of US households, according to the Federal Reserve's 2004 Survey of Consumer Finances), and many important decisions they make through their lives cannot be analysed without thoroughly understanding how to measure this source of wealth.
As real estate prices have become more volatile, it is imperative to look at the investment component of housing wealth. This is the first study to test the accuracy of self-reported house values using sales data from a rarely explored section on housing transactions from the US Health and Retirement Study.
The estimates suggest that homeowners on average overestimate the value of their properties by between 5% and 10%. The research also shows that the overestimation is primarily due to the large expected capital gains implicit in the self-reported home values, especially since the mid-1980s.
The effect of the capital gains variable is estimated to be around 0.91, indicating that homeowners may significantly overestimate the contribution of the capital gains on the sale price. On the contrary, the original purchase price is reflected almost one to one in the selling price. This result is consistent with the idea that homeowners are unlikely to accept offers below the original priced paid on the properties.
The result suggests a possible role for business cycle effects on the accuracy of the estimates through the characteristics of the period in which the household bought the property they eventually sell. The researchers document a strong correlation between the evolution of their accuracy estimates over time, and the business cycle.
In particular, they find a strong positive correlation between the evolution of their estimates and the interest rate; the correlation coefficient between the series of their estimates and the interest rate is 0.57.
A comparison of these coefficients with other market variables further support the evidence of the counter-cyclicality of the accuracy estimates: periods of declining median household income and active expanding monetary policy are associated with more accuracy in the estimation (and even underestimation) of the value of the properties.
One likely explanation for this evidence comes from the trends in the growth of housing prices over the last decades. Those who bought during a slowing housing market could have lower appreciation expectations, which could end up being more realistic at the time of the sale, or even pessimistic.
While most individuals overestimate the value of their homes (some by as much as 20%), individuals who acquire their properties during economic downturns tend to be more accurate, and in some cases even underestimate the value of their houses.
These results establish a surprisingly strong, likely permanent, and in many cases long-lived effect of the initial conditions surrounding the purchases of properties, on how individuals value them.
All this suggests that in good economic times, there are a larger number of buyers who are (eventually) overly optimistic regarding how much their properties are worth. This is precisely what is believed to have happened since the beginning of this decade and until 2005-06, when a wave of buyers (many of them first-time owners, which pushed the homeownership rates in the US to historical highs in the 2003-2006 period) responding to easy credit conditions, and with possibly overly optimistic expectations about the evolution of house prices, planted the seed of the current mortgage crisis in the US by accepting mortgage terms that were set to explode in the short to medium run.
ENDS
‘How Well Do Individuals Predict the Selling Prices of their Homes?’ by Hugo Benítez-Silva (SUNY-Stony Brook, and FEDEA), Selcuk Eren (Levy Economics Institute at Bard College), Frank Heiland (Florida State University)andSergi Jiménez-Martín (Universitat Pompeu Fabra, and FEDEA)