The Psychology of Price Anchoring

Price anchoring is a concept that arises frequently in real estate investing whether the involved parties are aware of it or not. The anchor is a number, a starting place of sorts, commonly used in pricing that has a tendency to pull the negotiations toward it. The effects it has can be dramatic. One must be aware of when an anchor is in play and if it working positively or negatively.

Rolf Dobelli states in his book The Art of Thinking Clearly, “The more uncertain the value of something -such as real estate, company stock, or art- the more susceptible even experts are to anchors.”

Value can be difficult to clearly define when it comes to real estate. Comparable sales are the most commonly used data to assess value. But every property is unique and has advantages and disadvantages, so comps aren’t always accurate. Fair market value is when a property sells for what it is worth in the free market when neither the seller nor the buyer is under duress. If the property is priced “too high,” then it will stay for sale until the seller accepts less, or the value appreciates to the asking price. If it is priced “too low,” then market forces- in the way of multiple offers- will raise the price to the appropriate level. The final closing price can vary wildly above or below the asking price.

In April, 2014, I purchased an investment property in East Nashville where this exact scenario of multiple offers unfolded. The house was listed on the MLS on a Friday morning, priced at $90,000. I looked at it at noon, and the listing agent said that two offers were already in. I was ready to put in an offer, but I expected there would be even more. By Saturday evening, the agent purposefully stopped accepting offers, as she figured nine offers were enough to reveal the “fair market value” of this house. With all of that competition, how did I proceed with my offer?

-this is the belle of the ball, receiving nine offers in about 36 hours

First of all, I tried to take a step back and not be affected by the price anchor of $90k. Then I asked questions to determine what the house was worth to me. What if this house was for sale for $120k? What would my offer be then? What if this house was for sale at an absolute auction, where the highest bid wins? What would my highest bid be? Finding that magic number is the key to a successful offer. If my offer is accepted, but I am not happy with the purchase price, then I know it is too high. In contrast, if my offer is rejected, and I regret not making a higher bid, then I know that number is too low.

I ended up offering $105,000, with no contingencies and a quick closing. I waived the inspection, had no financial or appraisal contingencies, asked the sellers for no repairs, and included a very large earnest money check. In other words, if the seller accepted our offer, it was a done deal. Yes, I offered $15k (almost 17%) over the asking price, with the sweetest terms possible and guess what? It was not the best. The sellers agreed to a higher offer, but asked if I wanted to be a backup contract. At least there was a consolation prize of second place. Two days later, I got a call, and the other buyers bailed. Did I want to proceed and purchase the house? Of course! (Although a thought did cross my mind for a witty reply: “yes, but I now reduce my offer by $5,000.”)

I encountered another example of price anchoring a couple of months ago when getting a price quote for new carpet in a house I was renovating. The sales representative of the national company measured the rooms and did some figuring. He told me that the style of carpet I had selected was on sale, but proceeded to quote the “normal” price of over $7,000. Boom. The price anchor had entered the building. I raised my eyebrows in response, as I was reasonably hoping to spend about $2500 based on the square footage I had calculated. He crunched some numbers and told me that I would be getting an incredible deal at about $4,500, a savings of over $2,500 (!). If he would have initially said the price of the carpet was $4,500, there would be no psychological victory, no feeling of a win by getting a good deal. But this well-marketed company knew exactly what they were doing by introducing a ridiculously high anchor at the beginning of the sales process. We ended up settling on a price that was about $3,200, over 50% off the original number. The sales rep congratulated me, and said he could learn about negotiating from me. I wonder if he tells all of his customers that so they feel better about their decision. Who doesn’t want to feel like they “won” the negotiating process?

When trying to figure out the price of something in a potential deal, there is a saying that the first person to name a price loses. I do not always agree with that. I believe it depends on the people involved, and their tendency to be affected by a price anchor. The ultimate closing price has to be acceptable for the buyer and seller, or the agreement will not happen. I try to approach every deal with an analytical view that is unaffected by an anchor, and I’m willing to walk away if the other party is held down by it.