Identifying Behavioral Explanations for a Subset of the Real Estate Shadow Market
Lane, Mark A., Seiler, Michael J., Seiler, Vicky L., Journal of Housing Research
This study examines both financial and behavioral explanations for the existence of a residential real estate shadow market for underwater investment properties. The findings reveal that the affordability constraint explains only 44.4% of the reasons not to list a property for sale. Three documented behavioral reasons primarily drive the remaining decisions. While various investor demographic characteristics are at times significant, no distinct profile emerged to identify those most likely to reside in this portion of the shadow market.
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The economy recently went through a major recession, the unemployment rate is near double digits, housing prices have dropped precipitously, and residential real estate inventory levels are near the 9-month mark (Freddie Mac, 2010). But this housing inventory number reflects only those properties that are currently listed on multiple listing service (MLS) inventory lists. The reality is that many more owners would like to sell their properties. However, there are a number of reasons why people who want to sell their investment do not currently have their properties listed for sale. This group of investment properties is referred to as the "real estate shadow market." The shadow market is problematic for policymakers because by its very nature, no one knows how large it is. This paper investigates some of the economic as well as behavioral reasons why underwater real estate investment properties exist within the overall shadow market. The economic reasons represent only a fraction of investor rationale for not listing properties for sale.
During the real estate boom of the mid-2000s, quickly rising real estate prices, no document loans,1 and a lack of regulatory oversight came together to create the perfect storm for individual risk-taking. The lure of easy access to perceived easy money was too much for individuals to resist. The result was a massive over commitment to residential real estate investments by non-traditional real estate investors (Bureau of Economic Analysis, 2010). All this came to a head when the real estate market pulled back and demand dried up. Currently, many people owe more on their mortgages than they could yield from the sale of their property. Without sufficient cash reserves, the simple economics of the situation is they cannot afford to sell their property. Instead of listing the property for sale, they hope to be able to continue to make the mortgage payment until prices rise.
A financial, or affordability, constraint is not the only reason investors in the real estate market do not have their properties listed for sale. This paper documents that familiarity bias and false reference points are also partially responsible for the underwater investor's hesitancy to list a property. As a secondary contribution, this paper explores the demographic characteristics of investors who reside in the shadow market to determine if demographics are responsible for the decision not to list underwater investment properties for sale. While there is statistical significance within the various tests, no specific investor profile emerges as one who is more likely to exist in the underwater shadow market.
The irrational exuberance observed in the financial markets over the last decade is becoming more commonly documented in the field of real estate as well. Behavioral studies in real estate are burgeoning and are geared toward providing explanations for investor behavior where traditional economic theory has fallen short. Behavioral real estate research began to sporadically appear in the literature during the 1990s. Gallimore (1994, 1996), for example, examined confirmation bias in the context of real estate appraisals-the tendency of people to seek out or at least pay additional attention to opinions that support the beliefs they already hold as opposed to giving all new and relevant information equal weight. …