Beware the Tricks: How Real Estate Agents Exploit Buyers' Cognitive Biases

Buying or selling a property is usually the most significant financial decision of one's lifetime. However, many buyers lack experience with auctions, bidding, and negotiation, putting them at a disadvantage against sellers who have experienced agents working with them. Also, due to lack of experience, buyers are vulnerable to various psychological biases that could negatively affect their decision-making process.

In Australia, there are three main sales method in the housing market: public auctions, silent auctions, or sale by negotiation. Public auctions are usually conducted in front of a property and bidders place their bids publicly. Silent auction is when buyers submit their bids privately to agents with a deadline. Finally sale by negotiation is when buyers submit offers at any time and negotiate with the seller to reach an agreement. Each method can yield different outcomes depending on the circumstances. In a recently published book chapter, I explained the behavioural aspects of the housing market and the cognitive biases that sellers and buyers face. In this article, I am going to discuss various tricks that agents use to exploit buyers’ cognitive biases and encourage them to pay more than they should.

Pricing tricks: One popular example is underquoting, where a property is advertised at a price significantly lower than its actual value. This strategy aims to attract more buyers to auctions and increase the intensity of bidding wars. However, underquoting can also mislead buyers and lead to disappointment when they discover the actual price. Tricks like underquoting work because of a cognitive bias known as herding behaviour. People tend to think and act like a group, and the fear of missing out (FOMO) on a good deal can push them to bid higher than they originally intended (Shiller, 1995).

Changing the selling method: Another strategy used by agents is changing the selling method, such as accepting offers before the auction. The reason behind this move is simple: agents expect the auction price to be lower than the offer. Overconfidence and overoptimism are two psychological biases that can lead buyers to place offers above the expected auction price. Buyers may fare poorly in such transactions as agents have access to superior information about market trends (Khezr, 2018).

Another example of a change in selling method occurs when the market trend shifts from a boom to a bust. When the market is booming, agents often use public auctions to encourage competition among buyers. However, when the market slows down, agents resort to using silent auctions or private negotiations while still relying on data from previous public auctions to stimulate competition. For instance, in a silent auction, a buyer may be the only one to submit an offer, but due to the lack of transparency, they may end up overbidding themselves. Buyers who are more confident and optimistic are more vulnerable in silent auctions, as in isolation, it is more difficult to determine how many other competitors they have.

Exposing Buyers to Nominal Data: Agents may expose buyers to nominal data to create a false sense of urgency. For example, they may present a property as having doubled in value over the past 10 years. While this may be true nominally, taking inflation into account reveals a much lower real return. Buyers who fall for this tactic may overestimate the property's potential value, leading to overpayment. This can also encourage FOMO as potential buyers believe they are missing a significant profit opportunity. A cognitive bias known as money illusion plays an important role here, where buyers rely solely on past nominal increases in house prices as a reference point for their value estimates (Raftery and Runeson, 1998).

Releasing Selective Data: Agents may only release the sold price for properties that were sold higher than expected and use the "price not disclosed" tactic for those properties that sold below expectations. This results in buyers having a biased estimate of the value of properties available for sale.

Educate, educate and educate

To avoid falling victim to these tricks, buyers need education. Most of the biases explain above are avoidable if one has enough knowledge about them. It worth even paying for professional help. Academics and researchers should also bear responsibility. At RMIT, we have a state-of-the-art Behavioural Lab (BBL) that aims to conduct experimental research and workshops not only to examine buyer behaviour but also to educate them on how to navigate a real estate transaction more effectively.

Call for better regulations

Data Transparency: There are currently limited laws that enforce data transparency by participants in the housing market. For instance, agents do not currently release the sold price of all properties. This gives them a clear incentive not to disclose prices that are below expectations, resulting in inaccurate value estimates by buyers. Governments can enforce agents to release all prices, or since the government itself has this information, they can make it publicly available.

More precise laws (rules) regarding underquoting can also help as currently underquoting laws do not accurately consider all the possible price manipulations.

Potentially new laws: Government and regulators can enforce laws that makes agents obligated to provide more transparency in private negotiations and silent auctions.

Most participants in other real-world, large-scale auctions invest considerable time and money in consultation and learning before the auction. Homebuyers should be doing exactly this as well. Additionally, there is a pressing need for clearer and more accurate regulations, and the responsibility falls not only on regulators but also on agents, buyers' advocates, buyers, and researchers.

Author:
Dr Peyman Khezr, Senior Lecturer, Economics

04 May 2023

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Beware the Tricks: How Real Estate Agents Exploit Buyers' Cognitive Biases