In a recent online conversation regarding the state of some localized Real Estate Markets, the terminology of ‘price anchoring’ was brought up. What follows below is the original question, and my responses to the note.
Original Post & Question Regarding Price Anchoring:
Hey Russell Westcott long time since we have talked. I hope all is well. As we all continue to learn and educate ourselves and share our knowledge; tonight we discussed price anchoring and from understanding this is a term you are you do not have all of knowledge of.
Hopefully I can clarify it for you. Everyone including investors compared today’s prices to past prices. In general prices increase over time. As the prices increase people do not want to buy at the present because we bought at a lower price before. We are suck on the past price and do not analyze the deal at the present price to determine if the current price makes sense.
Here is a Simplistic Example:
last year you could buy Johnny Walker Black for $100 per bottle. Today that same bottle is $125. You have a hard time justifying the higher price because you bought it last year for $25 cheaper. You only drink the Johnny Walker when discussing deals with JV partners or after a win. Today’s JV are worth 25%+ closer to 40%. Therefore, the Johnny Walker is worth the $125 today as you gaining more value from it and closing more profitable deals. In summary do not worry about what you purchased something for in the past. Run the numbers today to see if it meet your current expectations/ returns.
My Response:
Hey Tom, excellent conversation topic to dive into, and I’m going to break this into two separate posts. A quick word of caution, these will be long reads, but stick with them… these are meaningful conversations. The ‘lenses’ that I will be looking at this is from the perspective of Investment Real Estate; owning a property a personal residence is an entirely different set of lenses.
Yes, I can see what price anchoring is and how it is applied. However, we can agree that the price is almost meaningless when looked at in isolation.
I’m not concerned that prices are higher; as a Caring Capitalist, I want the prices to be higher in the future. Isn’t this is why we all take risks to create a profit and fund our financial futures?
I hope all the prices are over 1M+++++ to the moon, baby.
What I Focus on are the Following:
- Has the recent price growth outpaced the economic fundamentals (GDP growth, Population, Employment, wages, vacancies, affordability, etc.)
- Is the price growth speculative (the only way to make money is if the asset goes up in value)
- Are the recent gains based upon ‘Black Swan’ events
- What is the yield on the assets
- What are the rents, and can they support the operation costs of running the business/house with surplus cash flow?
Whenever I see an article about a new price record in a market, I always ask the question, “what are the rents for that property?”
To me, A $1.1M+ Ontario duplex that rents for $4,200 don’t make sense. Perhaps that is why I’m having 2-3 conversations a day about investing in Edmonton. You can get over $6,200 in rents for the same asset price (brand new construction property). An asset that generates $2K more/ month has a greater chance of cash flowing and performing for the long term.
To build on your analogy regarding the higher price of the same bottle of Johnny Walker Black.
I don’t have any issues that my Johnny Walker black now costs $125 ($25 more). Where I potentially have an issue is; If I run a business (own a bar), the same Johnny Walker Black now costs more and comes in a smaller bottle with less alcohol content. Per bottle, I now pour fewer drinks to my customers. Plus, if I can’t charge more per drink to my patrons, this is not a recipe for long-term business success.
Much more to follow on the note below…
Russell Westcott
#Inspire # Encourage #Love
