Loss Aversion & the Real Estate Market

The market is super slow right now.  

I can understand why that is.

We all hate to lose. That, I believe, is what is called a universal truth.  

This can be explained by the phenomenon of loss aversion. Loss aversion is a cognitive bias that explains why the feeling of loss is two times as powerful as the pleasure we obtain from winning or gaining. People would rather choose a guaranteed option over taking a risk, even if the safe option doesn’t bring with it much reward. They fear change and risk, even if taking the risk will bring with it a great reward. Rather than focusing on the potential gains, we choose to focus on the potential loss.

We will go to great lengths to avoid a loss, particularly a financial loss. In this world, it’s better to not lose $100, than to gain $100.

This is so evident in our real estate market.  

The easy out is to blame the media.  After all, bad news sells. 

The truth of the matter is that the media bias towards negative news is a direct result of loss aversion. We react stronger and faster to negative news than we do from positive news. Yet if you conducted a poll and asked what people would prefer, good news vs bad news, the overwhelming answer would, of course, be good news.  We just wouldn’t react in a positive way to it.  

Loss aversion is the logical explanation for why our market is so slow right now.  

Yes, interest rates are rising.  

Yes, prices have decreased over the past 6 months.  

We’ve written about this extensively and demonstrated that homes are more affordable today despite higher interest rates.  Yet buyers and sellers continue to sit on the sidelines.  

People would rather not participate in the housing market for fear of making the wrong call and either losing money because house prices continue to slide, or the cost of ownership continues to rise, making buying a home seemingly unaffordable. 

There was an interesting report published by Zoocasa this past week.  

They analyzed 34 markets in Ontario to determine which markets were tops for buyers and sellers.  Surprisingly, 4 of the 34 were still seen as seller’s markets.  There were 2 markets that were ranked as buyers markets and the other 28 markets?  Balanced.  

How is a market defined as seller vs buyer vs balanced? 

It’s called the sales to new listings ratio (SNLR). It measures the number of sales in a given period (a month) divided by the number of new listings that came onto the market during the same time period.  The resulting ratio expressed as a percentage will indicate who has the advantage.  Over 60% creates a seller’s market because demand outstrips supply.  Under 40% and the buyers have an advantage because there are a lot more homes for sale. The mushy middle 20% is a balanced market.  

The Waterloo Region in October had a SNLR of 59% so just squeaking into a balanced market.  Dufferin region was 57% and Guelph (including Centre Wellington) always being the outlier was 71%. 

The really interesting part of this chart is that in May, June and July, in all 3 regions the SNLR was in the low to mid 40% range - the best buying conditions since January of 2019.  

For a lot of people, sitting on the sidelines in these local real estate markets, or submitting to loss aversion, means they’ve missed out on some great opportunities.  Because of the fear of making a mistake or losing, they did nothing and now with the threat of another rate hike, market conditions have started to tighten up again.  

The real estate market is not going to remain static.  It can’t and it won’t.  That is another universal truth.  

People will continue to buy and sell based upon personal needs, bigger family, job promotion/change, death, divorce etc.  We have a large cohort of new buyers hitting their peak homeownership years and sustained immigration growth. All will want/need housing of some sort.  

My question, and what I consider when making large decisions is to see if I’m letting loss aversion play too big of a role in my decision making process.  Analyze and understand the risk in your decision.  Can you handle a negative outcome?  You might not like it, but if you can accept the risk, the reward will more than outweigh the risk.  

Fortune favours the brave, or at least those that understand loss aversion.  

Enjoy the weekend.

Paul

 

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