Priceless: The Myth of Fair Value (and How to Take Advantage of It) (29 page)

Least impressed were real estate agents. When the researchers presented their results to a group of the agents who participated, “they absolutely rejected the findings,” Neale recalled. “Their counterpoint was, ‘You can do anything with statistics. It isn’t true.’ My mother wasn’t real impressed, either. Over the years, I finally convinced her—but this was not something she got right away.”

It would be wrong to go away with the idea that real estate agents are charlatans. The agents were indeed less susceptible to anchoring than students who lacked their expertise. This experiment was really about the way the human mind generates numbers from the world’s rich and
immersive data. It speaks not just of real estate agents but of all of us. (When I reminded Northcraft of some of the acerbic comments about agents in his 1987 article, he remarked, “I guess I would say there’s no shame in being human.”)

The Arizona experiment made the important claim that anchoring by listing price is powerful
even for something with a market value
. Northcraft concludes that the zone of credible prices is broader than most agents believe. Furthermore, there is no reason to think that 12 percent over appraisal was any sort of limit to strategic anchoring. It was simply the highest figure they dared to try in this experiment.

Neale jokes that her colleagues read the paper for advice on how to sell their own houses. It is not a complete blueprint. As everyone knows, there is a trade-off between asking price and the time on the market. The benefits of a higher listing price have to be weighed against the costs of taking a longer time to find a buyer. (Real estate agents are not shy about pointing out
that
fact of life.)

“One of the things we’ve worked on since is, ‘At what point does my offer become silly?’ ” Neale said. In the psych lab, silliness doesn’t necessarily matter. Anchoring works with numbers understood to be absurd. Home buyers, however, are unlikely to look at a home that’s priced outside their range. “The adage ‘You can always come down’ does not work in this market,” explained New York agent Diane Saatchi, speaking of the 2008 real estate slump. When reasonably priced homes sit for months without an offer, there is not much scope for pricing well above market value. Or is there?

In 2000, Paul Morrissey, the film director and business partner of Andy Warhol, listed his Montauk estate for sale. He and Warhol had bought a 22-acre property, called Eothen, for $225,000 in 1971. Warhol never spent much time there—the ocean breezes kept blowing his wig off. In its heyday, Eothen played host to everyone from Jackie Onassis to the Rolling Stones. After Warhol’s 1987 death, his foundation donated three-quarters of the open land to the Nature Conservancy as a preserve. Morrissey was selling the remainder, 5.6 acres occupied by five homes, a three-car garage, a stable, and 600 feet of Atlantic oceanfront.

By East End real estate standards, Eothen was the unique property from hell. Built in 1931 as a sportsmen’s lodge for an Arm & Hammer baking soda heir, Eothen had stuffed deer heads and mounted fish on its weathered wood walls. Warhol and Morrissey never changed the outré décor. The small, never-updated rooms—characterized as “hobbit huts”—were unlikely to appeal to anyone who could possibly afford to buy it.

There was another way of looking at things. Conceivably the Warhol provenance was the place’s greatest asset. Hamptons buyers were the same people paying record prices for Warhol paintings. Morrissey spoke wistfully of finding a buyer who would preserve the place.

The mix of positives and negatives made it incredibly difficult to gauge Eothen’s market value. Morrissey set an asking price of $50 million. The real estate community felt that was way out of the ballpark. The East End buyer wants “satin sheets and ice makers and Sub-Zero
refrigerators and flat-screen TV’s, built-in pools,” Realtor Paul Brennan told
The New York Times
. “If he would sell it for $25 million, I could sell it for him.”

Going by that, Morrissey was asking about twice a realistic asking price. That’s a much higher anchor than those used in Northcraft and Neale’s experiment. Morrissey wasn’t impatient. He kept Eothen on the market for seven long years—a time study no psychologist could afford. Morrissey wasn’t in a hurry because he had the use of Eothen each summer, renting out some of the houses to defray expenses. Over time, he cut the price to $45 million, and then to $40 million. It apparently wasn’t until the latter reduction, in the summer of 2006, that he started to get serious nibbles. The $40 million price was still outside any zone of credibility (being 60 percent over Brennan’s suggested listing price), but it was no longer such a deterrent to lookers. On January 9, 2007, Morrissey closed a deal with Mickey Drexler, CEO of J. Crew. The sale price was $27.5 million. “He seems to be a great guy who understood it immediately,” Morrissey said of Drexler. “His intention is to keep it exactly like it is.”

The real estate agent’s nightmare is the client who wants to keep a property on the market to get a good price. Agents are not paid by the hour, and they would rather sell sooner than later. They have evolved several scare stories to justify this predilection to buyers. One says that an overpriced property becomes damaged goods. When it does sell, it’s sure to sell for less, not more.

Some would say that Morrissey was foolish to set such a high price; that the all-powerful and wise market brought an unrealistic seller down to earth. The marketing of Eothen seems equally consistent with experiments like Northcraft and Neale’s, saying that a high listing price raises perceptions of value. Eothen’s sale price was 8 percent more than the agent Brennan’s suggested $25 million list price (quoted just four months before the sale). Figure that a $25 million asking price might signal a willingness to sell for, say, $23 million. Then Morrissey got about $4.5 million (20 percent) more by anchoring with a ridiculously high price.

Most sellers who set too-high prices do so in the hopes of getting
those prices. They are destined for disappointment. Anchoring does not mean “You get whatever you ask for.” It means “The more you ask for, the more you get.” To use anchoring successfully, a seller must set a high price and
not
expect to get it.

Not many home sellers are in a position to wait seven years—or to alienate their hard-working agents. There is a way to have your cake and eat it too. It’s to use the trick known in other contexts as
advertised reference pricing
(ARP).

Discount stores have long used ads and price tags comparing their store’s price to a higher “reference price” charged at another place or another time. The higher price acts as an anchor, increasing the product’s perceived value and presenting a favorable contrast. For the same reason, stores leave old price tags visible when they discount items for clearance sales.

“This past summer, I went out to purchase a tennis racket,” explained Donald Lichtenstein (no relation to Sarah), a University of Colorado marketing researcher specializing in psychological pricing. “I went to the sporting goods store and looked at the vast array of rackets they had, about half (thirty-five or so) of which were on sale. When comparing the prices, I paid as much attention to the ARP as the purchase price. I knew better, but I just couldn’t help myself.”

That’s why reference prices are so insidious. Everyone knows they can’t possibly work! As Lichtenstein remarked in a 2004 speech,

ARPs work, a lot of research shows they do, and retailer practice and returns show that they do. This is nothing new—it is widely known. If I advertise a sale price of, say, $29.95 and accompany it with an ARP of, say, $39.95, in most contexts, sales will increase relative to a no ARP present situation. Sales will likely increase as I increase my ARP to $49.95, to $59.95, and to $69.95. But what if the ARP is set at a level of $129.95? What about $329.95? And just to add some interest, what about $5,000?

Lichtenstein and others have done experiments on how far reference prices can be pushed. One 1988 study reported that the relationship between the reference price and perceived value for consumer goods is
almost linear, even when the reference price is as much as 2.86 times the usual market value. That would correspond to a $279 item being advertised as selling for $799 elsewhere. As Lichtenstein put it, “your idea of what an item should cost is influenced by advertised prices even when they are totally unbelievable.”

For seven years, Eothen was notorious. Montauk cocktail parties and open houses were abuzz with talk of the $50 million white elephant. When Morrissey cut the price to $40 million, the $50 million price did not vanish into thin air. You can bet that every buyer was told that the property had originally been listed for $50 million. Intentional or not, it was tantamount to an advertised reference price. That original price still pulled estimates of value upward. Buyer Mickey Drexler obviously knew the $50 million and $40 million prices were hot air. But if he’s anything like experimental subjects, he must have felt he was getting a good deal. In the real estate market, just as at J. Crew, it’s hard for anyone to ignore a 45 percent discount.

One gimmick of home flippers is to list a property for a short time at a very high price, then cut it to a more reasonable asking price, consistent with the seller’s and agent’s patience. Thereafter the listing can “honestly” mention the original price (
REDUCED FROM $X
). This tactic adds only a few days to the time the house is on the market, yet it likely gets most of the benefit of the anchor price.

I will leave it to you to decide the ethics of such things. A somewhat more devious trick is for seller A to put his house on the market and persuade neighbor B to post her house as an FSBO (for sale by owner) on some websites. B doesn’t really want to sell; she lists at an absurdly high price (which she’d be glad to accept!). The point is to make A’s house look like a deal.

The Zillow website has a “make me move” feature whereby homeowners can post fantasy prices for their property, even though it’s not for sale. Anyone who uses Zillow knows that these “make me move” prices are ridiculous. Yet the “make me move” prices show up on the same maps and lists that buyers see when they search for homes that are for sale. One has to wonder whether they have a contrast effect, helping sell the nearby properties.

Not many home sellers use anchoring or reference pricing because
they’re sure buyers are too smart to fall for it. Donald Lichtenstein compares the reference price effect to certain urban legends. A rumor once went around that McDonald’s used ground earthworms in its hamburgers. Sales plummeted as much as much as 30 percent in some areas. Practically nobody believed the rumor. Certainly 30 percent of the public did not believe that a big corporation would risk its billion-dollar brand in order to save a few dollars on beef. The point is, things no one believes still affect behavior.

“Anchoring is not a curiosity,” Daniel Kahneman said. It “works quite well in negotiations, where getting in your number first gives an advantage.” For bargainers, this simple rule may be the most important and easily applied finding of the psychology of price. The first figure named in a negotiation silently shifts the other side’s expectations of what it will have to pay or accept. The evidence for this claim includes both field studies and lab experiments. Decision psychologists seem to have little doubt of its real-world applicability. Yet this rule has been extraordinarily difficult to communicate to businesspeople. The problem, according to Margaret Neale, is that executives no more believe in anchoring than in the tooth fairy.

After all, business negotiators give more thought to prices than does the shopper buying peanut butter. Before they sit down to bargain, they think long and hard about what their reserve price is. They try to estimate the other side’s reserve price and the surplus that supposedly lies sandwiched between those two prices. This thinking promotes the idea that reserve prices are real and solid.

That’s not necessarily the case. A famous hard bargainer, Samuel Gompers, was once asked what the labor movement wanted. His reply was “More.” The one universal conviction of bargainers is that they want as much as they can possibly get. Prices are not a unilateral expression of what someone wants; they are about what someone thinks he can get. That’s necessarily a guesstimate. There is abundant evidence that such guesses can be manipulated.

Neale, now a professor at Stanford’s Graduate School of Business, consults with Fortune 500 companies and governments on negotiation techniques. “We spend a lot of time talking to real folks making real decisions about the power of these anchors,” Neale said. “People are resistant. They say, it’s not possible that I’m influenced by that; I’ve done a lot of things and I
know
. And I say, you don’t know. Look, what our research is capable of doing, which you are not, is that I can put Maggie in this situation without an anchor, and then I can put Maggie in that exact same situation with an anchor. And I can then compare the differences in her behavior. There are differences, and they are systematic, and they are powerful effects.”

The invention of the microscope provoked a strong emotional reaction. Anton van Leeuwenhoek revealed wriggling monstrosities within a drop of the pure lake water that would refresh a thirsty traveler. He discovered the corpuscles of blood, the tadpoles that are sperm cells, and a gruesome zoo within the human mouth. Everyone knew this couldn’t be true. Any Dutch burgher of good eyesight could hold his hand in front of his face and see all there was to see there. No one ever saw bacteria.