Beware Damsels in Distress

By Adrian McMaster

On Wednesday of this week, the Eureka Report ran an article by James Frost in which he discussed the fact that the number of homes being offered for sale has risen in Melbourne. The article then discussed the relative merits of buying distressed property. It prompted my own thoughts on the matter, which may well be run in the ER this week. Regardless, here they are:

James Frost’s recent article on distressed residential property sales was fascinating. I was particularly intrigued by the psychology that can come into play when a property is being sold under duress. James quotes buyer’s agent Peter Kelaher:

Peter Kelaher adds: “It’s not unlike a deceased sale. They tend to attract a lot of people. In the 17 years I’ve been in real estate I’ve never seen a deceased estate go for a song. They’re always sold above market value. You need to be completely across property values in the area.”

Deceased estates always selling above market? This seems counter-intuitive. Aren’t the survivors desperate to sell for whatever they can get? Didn’t the guy who wrote Rich Dad Poor Dad make all his money from distressed sales? Don’t you always get a bargain from a distressed sale? Apparently not: and psychology explains why.

Behavioural finance, where psychology meets economics, has long told us that the two main culprits in financial mistakes are greed and fear. In the case of increased demand for distressed sales, greed is your guy. Greed is a given for we humans. We’ve always had it: it is one of the original ‘deadly sins’ and they were first published in the 6th century, and it is a fair bet that Pope Gregory pinched the idea from someone else before then. In the case of the distressed sale, greed has a willing accomplice: a sense of urgency. Potential buyers see or hear that the property is a distressed sale. Thus, they conclude two things: that they can buy the property for less than it’s worth (greed) and that it must be sold quickly (urgency).

Urgency works hand in hand with greed because it discourages people from doing their due diligence. Concluding that there is little time to think, people don’t think at all. The logic that ‘he who hesitates is lost’ may be true on the battlefield. It is not true in investment markets.

Creating a false sense of urgency is an old trick for people who would like to part you from your money. In June 2007, one of the large fund managers sent all their sales representatives an offer: they would pay double the usual commission on undeducted contributions that these ‘advisers’ could convince their customers to make before the 30 June (they hid the purpose a little by extending the offer to the end of August). You might remember that 30 June 2007 was the supposed ‘deadline’ for people to be able to make up to $1 million of undeducted superannuation contributions.

As the huge volumes that rolled into superannuation in June 2007 showed, this kind of approach worked. The technique once again let greed play Bonnie to urgency’s Clyde. In this case, the greed was on the part of the ‘adviser,’ who could double their cut from the contribution. The customers succumbed to the urgency, which was in most cases false: the ‘deadline’ had actually been announced almost twelve months previously. What’s more, following the 30 June an individual could still make $450,000 of undeducted contributions. The 30 June was only a ‘deadline’ for all those people who came into possession of a spare $1 million on the 29th. That is, both of them.

And, of course, as of September 2007 people with large amounts outside of super who want to invest it in within super no longer need to make an undeducted contribution at all. They (or some related entity) can simply lend the money to their SMSF, with the added benefit that, unlike an undeducted contribution, the loan can be recalled prior to their reaching the preservation age. People who now have to wait until they turn 55 or 60 to regain access to their money, as has to be done in the case of those who made undeducted contributions prior to 30 June 2007, are actually worse off.

In June 2007 no-one knew that the rules regarding borrowing within a superannuation fund would change in September. People who made undeducted contributions did so in good faith. But this is just another case of a sense of urgency being misplaced: when it comes to money management, the opportunity of a lifetime comes around about once a week. Never rush and – even more importantly - never let yourself be rushed. People who try to rush you are basically calling you greedy. Take offence and take your leave.

And if you are about to sell a property, here’s an obvious tip: regardless of why you are selling, let it slip to the agent that you really love the property but the interest payments are killing you. After all, whoever heard of an agent keeping secrets? Unless the buyers are reading this, their greed will do the rest.

Posted by Adrian