In real estate, the anchoring effect refers to subconsciously using irrelevant information or “anchor points” to make purchasing or investment decisions. In addition, the anchored meaning has to do with cognitive bias that occurs when making judgments about the quality, value, or worth of a specific property.
What is the anchoring effect?
When it comes to the anchoring effect in real estate, the asking price of a property serves as an initial anchor point. This anchor point provides buyers with assumptions about how much the property is worth.
However, these assumptions can end up being irrelevant due to such factors as commodity value, relative scarcity, or the general uniqueness of a property or situation. The first offer placed on a property can serve as an additional anchor point.
Overall, with the anchoring effect, negotiations often drift back and forth from the anchor point as new information is presented or more investors get involved in a property.
It’s important to keep in mind that most initial anchor points or initial price points are based on emotion. Therefore, it is essential to not get swept up in the anchoring effect as an investor and instead to do thorough research about any properties you may want to invest in.
Case study of the anchoring effect
The following example serves as a case study for the anchoring effect in action.
A seller lists their property for $350,000, setting the first anchor point on the property. However, similar properties in the area are listed for $450,000. This low initial anchor draws in a multitude of buyers. Buyers begin to put in various offers, each time setting a new anchor point based on emotion rather than the actual property. The buyer that wins the bidding war on this property makes a final offer of $550,000. In this case, the buyer could have purchased a similar property in the area for $450,000. However, through the anchoring effect, the investor was swept into putting more money into the property than it was actually worth.
The bottom line
In a nutshell, the anchored meaning in real estate centers around the notion that anchoring is a bias investors hold based on pre-existing information. As noted, this information is not always relevant or reliable and is often centered around emotions.
Therefore, it is essential that investors don’t get swept up by the anchoring effect. Instead, investors must do their own research to make fact-based decisions on when, where, and how they invest in real estate property. Using anchor points established by others can often lead to investors overpaying on real estate properties.