When Money Doesn't Add Up
Home sellers, be warned—that attractive house price might be nothing more than an
(Mar 28, 2014) — Home sellers, be warned—that attractive house price might be nothing more than an
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Many home buyers and sellers fall prey to the phenomenon of "money illusion," says
Lucy Ackert, professor of finance at Kennesaw State University in Kennesaw, Ga., who
studied money illusion in residential real estate.
Money illusion occurs when people think in terms of nominal values rather than real
values—meaning, they consider the face value of money instead of its actual purchasing
In other words, homeowners who sell their home for a higher dollar amount than what
they bought it for see themselves as coming out ahead—even if inflation eats the gains.
"Homeowners don't think in real terms. They think in nominal terms. Many people would
prefer a situation where they have a real loss, than a real gain and nominal loss,"
Prof. Ackert says.
Prof. Ackert and co-authors Bryan Church and Narayanan Jayaraman of the Scheller College
of Business at Georgia Tech presented 141 homeowners in suburban Atlanta with four
scenarios in October 2005, near the height of the housing bubble. The researchers
then determined respondents' propensity to fall prey to money illusion. Their study,
"Is There a Link Between Money Illusion and Homeowners' Expectations of Housing Prices?"
was published in Real Estate Economics in May 2011.
Prof. Ackert noted that respondents weren't disillusioned about the price of their
house—77% had realistic expectations about their area's home values. Most respondents
also understood that a person is better off financially if real returns are higher.
But, in keeping with money illusion, people base happiness around nominal values—77%
of respondents believed that a person is happier if they are better off in nominal
terms, even if real returns decreased.
Why does nominal win out?
Simply put, it's easier to think that way, says Alan Cooke, a marketing professor
at the University of Florida, who studies consumer decision-making.
"People tend to expend as little mental effort as necessary to make a particular decision.
So, if you have the opportunity to consider things in nominal terms rather than real
terms, that's what people will focus on first," says Prof. Cooke, adding that people
will put more effort into making decisions that they see as more important.
Sarah Lanigan, 35 years old and a mother of two, recently moved from Davis, Calif.,
to Portland, Ore. Ms. Lanigan says she tends to think of house prices in face-value
terms while her husband, Ryan, who once worked as a mortgage banker, looks at them
in real terms. "I'm not oblivious to it, but it's not at the forefront of my mind,"
"Things like stickiness in prices, nominal versus real—that's not the average conversation
you have with a client who's about to buy a piece of real estate," says Maureen Mestas,
associate broker with Sotheby's International Realty in Santa Fe, N.M.
A housing bubble can be generated when people believe prices in the future will be
higher, and are thus not worried about overpaying today. Prof. Ackert says money illusion
alone won't cause a housing bubble, but when coupled with tight supply, "that's when
you really run into trouble. It's a perfect storm," she says.
A leader in innovative teaching and learning, Kennesaw State University offers undergraduate, graduate and doctoral degrees to its nearly 43,000 students. With 11 colleges on two metro Atlanta campuses, Kennesaw State is a member of the University System of Georgia. The university’s vibrant campus culture, diverse population, strong global ties and entrepreneurial spirit draw students from throughout the country and the world. Kennesaw State is a Carnegie-designated doctoral research institution (R2), placing it among an elite group of only 6 percent of U.S. colleges and universities with an R1 or R2 status. For more information, visit kennesaw.edu.