When the Lake Wobegon Effect Extends to Our Homes

When we got the results back from our third quarter Homeowner Confidence Survey, in which half of homeowners said their own homes were increasing in value or staying the same, we were surprised. According to our Q3 Real Estate Market Reports (to be released on Nov. 12), 74 percent of homes in the country have lost value over the past 12 months.

Homeowners are becoming slightly more realistic about home values. Last quarter 62 percent thought their homes had either increased in value or stayed the same. Still, the fact that the gap existed after months of stock market crises and federal bailouts was fairly shocking.

To help break down this phenomenon we went to an expert: Dan Ariely, professor of behavioral economics at Duke University and author of Predictably Irrational, a book about why people make irrational decisions. Dan had an interesting take on the results.

“It’s the Lake Wobegon Effect, extended to homes,” he said. (The Lake Wobegon Effect is the tendency of humans to evaluate themselves as better than average).

“We tend to fall in love with what we have,” Dan said.

There are a number of reasons why some people still think their own homes are insulated from the woes of the housing market.

One is that when we invest in our homes, we invest so much of ourselves into them, Dan told me. We customize them to fit our specific tastes, and sometimes that backfires. Dan ran into this himself when he and his wife were moving from Cambridge, Mass., to North Carolina. They had invested in their Cambridge home and decorated it to modern tastes. But, when it came time to sell, they actually had tear down walls and undo a lot of the improvements they had made to sell the house.

“We customize something, and sometimes we make it less desirable for other people, but more expensive,” he said. “We don’t understand the perspective of other people. The fact that we fell in love with our house, and think everybody else will- it’s everywhere. Because we’re trapped in our perspective, we can’t be neutral.”

“The human irrationality in terms of pricing and valuing what is ours has always been a barrier to good decision making, and the housing market is no different.”

“It is slightly comforting to realize that people are getting a bit more realistic in terms of their housing value, but the gap between the market and the personal beliefs about the value of our own homes is still very substantial.”

“What worries me is that with the attachment we have to our own homes, home sellers will continue to hold onto unrealistic expectations and pay for it in the process.”

Thanks for your insight, Dan.