McLaughlin: Dunning-Kruger runs rampant when it comes to real estate

If you’ve ever bought or sold a home, you likely left money on the table. And, I don’t mean the escrow company stuck you with the FedEx bill for the closing papers. In almost every real-estate sale, buyers and sellers leave behind thousands, hundreds of thousands, or even millions of dollars in the process, depending on the home values in a market.

Given that the typical American homeowner has 40% of their wealth tied up in their home, the financial consequences can reverberate for a long time.

The good news? You will never how much money you left on the table. If ignorance is bliss, American home buyers and sellers should be in a state of rapture.

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Every day, I watch buyers and sellers make well-intentioned but ill-informed decisions that undermine the monetization of their asset. Their decision-making processes are guided by a vague understanding of the real-estate business, gut instinct, and, to varying degrees, the advice of their representatives. They have little awareness that their seemingly-innocuous choices ripple out into all aspects of the sales process with extraordinary costs to them.

Why? Psychological research suggests that we are not great at evaluating ourselves accurately, and we frequently overestimate our own abilities. In 1999, two Cornell psychologists, David Dunning and Justin Kruger, coined the “Dunning-Kruger effect” to describe a cognitive bias, whereby people who are not competent at something fail to recognize their own incompetence.

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They don’t know enough to realize what they don’t know. Dunning’s later research showed that people who have just a little bit of knowledge or success in a field tend to massively overestimate their abilities and get trapped in a “beginner’s bubble” of inaccurate self-perception. Not only are they unable to see their incompetence, they’re also likely to feel confident that they are competent.

Perhaps no industry is more susceptible to the Dunning-Kruger effect than residential real estate. People routinely overestimate their own real-estate expertise when buying and selling a home. Homes are unusual assets because we live in them.

We fall in love with homes in ways that we never do with our securities portfolio. Home is where we eat, sleep, raise children, open Christmas gifts, celebrate Bar Mitzvahs, birthdays, rites of passage. It reflects our identity, our tastes, and serves as a veritable memory bank.

We think we know our homes inside and out, what they are worth, and how they would appeal to the marketplace. Home ownership, though, is different from the business of buying and selling homes. Most homeowners don’t know enough about transacting homes to recognize their own lack of objectivity and expertise. A little knowledge can be a dangerous thing.

A soaring real-estate market can further fuel people’s delusions about their real-estate savvy. Homeowners fail to recognize that the rising real-estate tide is often responsible for lifting all the boats, not their uncanny ability to time a market or create value in a home. Their passive success strengthens the belief that they are their own best guide in the real-estate world — and they tune out their agent’s counsel.

Information about homes and markets only scratches the surface of what buyers and sellers need to maximize the value of their investment. The sophisticated and nuanced sales process often gets buried beneath the popular perception that one can hang a sign, post a listing, negotiate a deal, and fill out the paperwork.

A wide range of overlapping skills are needed to successfully purchase or sell a home. You must be an expert at valuing properties. You must understand the psychology of pricing a home. You have to be attuned to the shifting design tastes of buyers and how the local demographic wants to live in their homes.

Ideally, you are a concierge, possessing an ecosystem of stagers, designers, builders, and subcontractors who can quickly get a home ready for the market. Using your design acumen and resources, you show prospective buyers how to live in a home. You are skilled at marketing and branding, capable of building a story around a home that buyers remember. You have the negotiating skills to close a deal on favorable terms.

Perhaps above all, you have to deliver the unvarnished truth, even if they are messages that buyers and sellers don’t want to hear.

Success in residential real estate is not about timing the market or outwitting the person on the other end of the negotiation; it’s about adhering to a set of reasoned precepts and practices that will guide you through each step of a process fraught with emotional and psychological traps.

Tracy McLaughlin is one of the top ranked Realtors in the United States (No. 24 ), author of Real Estate Rescue, and an Aspen resident. She can be reached at 415-699-6680.