The anchoring and adjustment heuristic in real estate transactions.

The anchoring and adjustment heuristic in real estate transactions.

Jack and Sally were looking forward to buying their first house. Like many of us they browsed real estate websites and searched through the real estate agent shop windows looking for that ideal first home. As Jack and Sally browsed the potential properties they kept in mind their budget. Jack made note of a few potential properties with the correct number of bedrooms, bathrooms, reception rooms and garden size whilst noting the seller’s asking price. Eventually after visiting a few properties for viewings they decided to put an offer in for one of the properties. Jack noticed the asking price saying that it was above their budget and for a moment began to lose hope. After discussing with Sally as to how much to offer for the house Sally reminded Jack that although the house was on offer for £500,000 they could in fact put in an offer below the asking price. Jack and Sally went on to offer £450,000 and after some consideration the seller agreed to the price. Jack and Sally won the property that they wanted to buy and in the process demonstrated one of the most prevalent cognitive biases in human decision-making, namely the anchoring effect.


The anchoring effect (also called the anchoring and adjustment bias or anchoring and adjustment heuristic) is one of the cognitive biases that occurs most often when making a judgement about the quality, value or worth of an item. The effect works because when you are given a number (e.g., 1200 meters) that relates to a property of an item (the quality etc) with a question about that property you are likely to, whether knowingly or not, anchor your judgement by using the number as a reference point (i.e. the anchor). Imagine a boat tethered to a lowered anchor, the boat cannot move far from the anchor and remains within range of the length of the tether. We typically do not deviate a lot from the anchor. The anchoring effect has been observed to influence factors such as charitable giving, price valuations, fairness judgements, loyalty judgements, judgements of guilt, and prosocial motives among many other factors (Soule & Madrigal, 2015). The anchoring effect is just one of many cognitive biases that influences our judgements in a systematic and predictable fashion. It is simply easier to accept the anchor (e.g., the house seller’s asking price) and adjust closely to the anchor (e.g., £50,000 less rather than £150,000) than to make an entirely new judgement about something (e.g., the value of the house).

In the case of Jack and Sally there is a clear anchoring effect (albeit to no negative effect to the seller). Jack and Sally see the initial asking price (the anchor) and consider making offers that are close to this, they are anchored by the seller’s asking price. Of course, in the case of buying a house deviating from the asking price by too much (toward a lower price) will result in a rejected offer.

It is important to understand the anchoring effect because prices are by nature simple numeric information that can act as the anchor or reference point. Since the majority of the most agonising judgements that we must make in life revolve around pricing (e.g., buying that first house, holiday home, car or a big holiday) understanding the role of cognitive biases in decision-making is important. To avoid falling into the trap of the cognitive biases we should make ourselves aware of these biases. We are not the rational decision makers that we think we are.


One large study investigating the anchoring effect in residential home sales recorded data from 14,000 separate transactions (Bucchioneri & Minson, 2013). The researchers noted that the literature on housing economics, negotiations and auctions converge on the notion that home prices are an objective function of the property’s neighbourhood and characteristics (e.g., number of rooms, size of the house and characteristics). However, as we have seen above the judgement and decision-making literature on the anchoring effect suggest that there is a positive relationship between the listing price (asking price) and the sale price. The analysis of the 14,000 transactions found that higher asking prices are associated with higher sales prices independent of the property’s features, which is consistent with the anchoring effect. For the average property in the study overpricing by 10 to 20% lead to an increase in sales price because buyers were anchored by this higher sales price. So, whether a property has 5 large bedrooms in a desirable area of the countryside or 2 small bedrooms in a noisy part of a city asking for higher price for the 2-bedroom property (compared to the 5-bedroom property) could result in a higher sales price than the 5-bedroom property despite the larger property being initially more desirable than the smaller.

In the domain of property rentals the same study by Bucchianeri and Minson found that by adopting the same strategy of overpricing the asking rental price by 10 to 20% there was an increase in rental value of $117 to $163.

The data from transactions on house sales and rental pricing suggest that although we tend to believe that it is the characteristics of a property that determines the value of the property this is not the case. Pricing strategies are the major determiner of the value of the property. So, whether you are buying you first starter home, buying your dream family home, renting your house or looking to rent a house being aware of the anchoring effect will save you or make you more money. If you are selling your house to take full advantage of anchoring set your asking price 10-20% higher than the valuation, after all, if your property does not sell you can simply reduce the price at a later point. If like Jack and Sally you are buying your first home, to take advantage of the anchoring effect you can start by being aware that the asking price is not absolute, you can put in a lower offer if this is reject simply increase the offer by a small amount.

The finance room

First blog post

A brief introduction to heuristics and biases in the decision-making research.

John found himself standing at the station surrounded by the cosmopolitan rush. As the crowd ebbed and flowed around him he was struggling to remember. John had been to London some 30 years earlier but had visited so many places since, he had planned to visit before but never got around to it until today. He needed to get to his conference on time but couldn’t remember the route. John had to make a decision and risk being late by going the wrong way or staying at the station and guarantee being late. At that moment John thought to himself “Aren’t nice conference halls always in a nice part of town at an impressive hotel? Of course they are.” By remembering the numerous other conferences he had attended John headed towards the nicest hotel in this part of London. John got to his conference on time by going with his ‘gut-feeling’, a ‘hunch’ that he knew had worked many time before, he just did not know how.

Just like John many of us go with ‘gut-feeling’ about a situation every day, choosing to rely on our ‘hunches’ and ‘intuition’. We like to think of ourselves as logical thinkers who take our time when making an important decision. When asked “How did you make that decision?” or “Why did you choose that option?” most of us would reply that we weighed up the ‘pros and cons’, taking all of the facts into consideration. We are naturally inclined to think that decisions that are made with slow and careful consideration produce better answers than those that are not.

Many of us have grown up reading the books and watching films that portray famous double-acts that oppose each other in the way that they make decisions, take for consideration Dr Jekyll and Mr Hyde, Captain Kirk and Spock, or Sherlock Holmes and Dr Watson . The popular duo Sherlock Holmes and Dr Watson are a clear example of our natural inclination to believe that one decision-making strategy is superior to another. If you sit down and read the books (I’d recommend them) Holmes makes slow and calculated decisions, generating ingenious plans to whatever situation he finds himself in, whilst Watson on the few occasions when he does act, makes rapid decisions.

Holmes is of course famous for his deductive reasoning, a type of reasoning that is not always reliable outside of the idealistic word of the great works of Sir Arthur Conan Doyle. Below are two interesting examples where Holmes has failed to make reliable decisions. Firstly from the short-story “The adventure of the priory school” we encounter Holmes trying to deduce the direction that a bicycle had traveled by observing the tracks that had been left behind in the mud (The Strand Magazine, 1904).

Holmes: “This track, as you perceive, was made by a rider who was going from the direction of the school.”

Watson: “Or towards it?”

Holmes: “No, no, my dear Watson. The more deeply sunk impression is, or course, the hind wheel, upon which the weight rests. You perceive several places where it has passed across and obliterated the more shallow mark of the front one. It was undoubtedly heading away from the school.”

Here we see that Holmes’ deductive reasoning clearly fails. If you think about it, no matter what direction a bicycle is travelling the hind (back) wheel must always follow the front wheel. Bicycles cannot travel backwards, well, not very easily in any instance. Holmes opts to use the ‘confirmation bias’ heuristic here, where he takes notice of the information that confirms his idea (the heavier track cutting through the lighter track), whilst ignoring any contradictory information (this would happen no matter what direction the bicycle was travelling).


Secondly, in another of the great Sherlock Holmes stories (The Hound of the Baskervilles, 1902) we see Holmes and Watson picking up a walking stick with a small, silver band at one end. On the silver band we hear that the following is engraved “To James Mortimer, M.R.C.S. from his friends of the C.C.H. 1884.” Holmes and Watson spend some time trying to work out who it belongs to and what the initials stand for when Holmes makes the unusual ‘mistake’ in going with his intuition.

“…I would suggest, for example, that a presentation to a doctor is more likely to come from a hospital than from a hunt, and that when the initials ‘C.C.’ are placed before that hospital the words ‘Charing Cross’ very naturally suggest themselves.”

At first glance, Holmes’ deduction here seems logical, however, he is using what cognitive neuroscientists now call the ‘representativeness heuristic’. Holmes has no evidence that the walking stick belongs to a doctor he simply assumes that because doctors often frequent the place in which the stick was found and that it appears to belong to a wealthy man that it must therefore belong to a doctor. ‘C.C.H.’ could just as easily stand for the ‘Country Club of Honiton’ or a number of other things.

In recent years, since the Noble prize winning research of Daniel Kahneman (2002 prize in Economics) a substantial amount of work has been produced into how we make decisions. John’s ‘gut-feeling’ about which was way to go to get to his meeting in time and Holme’s diversion from his normal decision-making strategy fall into the realm of Kahneman’s short-cuts in thinking  (heuristics). Kahneman, although a psychologists by training won the Noble prize in economics because he demonstrated that in all walks of life we rely on these short-cuts to make decisions.

Intuition and heuristics can be used to both bad and good effects. Research in cognitive neuroscience and psychology since 2003 has shown the use of heuristics and intuition in most situations in which decisions are required. We use heuristics when in a hurry to make a decision or when we are distracted by something else. Experienced police officers (Brown & Daus, 2015), managers (Tversky & Kahneman, 1981), gamblers (Alberola et al., 2013), retail investors (Butler et al., 2014), forensic experts (Dror & Cole, 2010) and even the military (Keller et al., 2015) often use intuition and heuristics to make quick decisions.

Some professionals have even demonstrated that they have the ability to choose which type of decision-making style to use when in a hurry (intuition or slow and calculated). A piece of research published last year by Dr Volker Thoma and colleagues investigated decision-making in financial traders from the trading floors of London and non-experts when asked to make decisions regarding financial transactions (Thoma et al, 2015 – PlosOne). The study found that even when required to make cognitively taxing decisions the city traders ignored their intuition and made calculated decisions. The non-expert group as you can expect relied on intuition to make decisions regarding the financial transactions. This study shows that, although we like to think of ourselves as logical thinkers we often relying on intuition, heuristics and ‘gut-feeling’ to make decisions for us, particularly when we are confronted with a lot of facts to calculate.

Despite our intuition and heuristics being useful at times there is also a down-side to heuristic and intuitive-based reasoning. One case from 2004 demonstrates how heuristics can have negative consequences when we don’t understand how we have come to a particular conclusion (known as cognitive biases).

On the morning of Thursday the 11th of March 2004 a disaster struck Madrid at between 7:30 and 8:00, several simultaneous explosions occurred on the Madrid underground. In the following investigation the FBI offered to help the Spanish National Police find who was responsible. Fingerprints left at the scene were collected and the FBI linked these to an American attorney. Brandon Mayfield, a Muslim attorney from Oregon was arrested and held for two weeks on the basis of an erroneous match between these fingerprints. The fingerprints were not an exact match, but had some similarities with respect to the ridges in the prints. Not only did one FBI fingerprint examiner misinterpret these prints but a further two additional examiners corroborated with the original findings. After two weeks in jail Brandon Mayfield was released without any charges. Later in the investigation the Spanish National Police linked the fingerprints to an Algerian national called Ouhnane Dauod. The similarities in the ridges had made it easy for cognitive biases to take over and affect the identification of suspects. Once the FBI examiners found matches in some of the ridges ‘confirmation bias’ took control. The examiners paid explicit attention to the similarities whilst ignoring any differences. This case study goes to show that even in legal criminal cases of great importance decisions can by affected by differences in decision-making strategies, even when this is unknown to the decision maker.


These cases all go to show that the way in which we make decisions affects us in everything we do, nobody is immune to unknowingly making decisions based on cognitive biases. Since the growth in research after Kahneman won the Noble prize in 2002 a large number of heuristics and cognitive biases have been identified. We have seen previously clear examples of how we use the confirmation bias and representativeness heuristic. To name just a few of the other heuristics and biases there is the anchoring heuristic, availability heuristic, framing heuristic, hindsight bias, attribution bias and recognition heuristic. The positive and negative aspects of making decisions with the use of heuristics and biases are seen every day when they can either aid in making an accurate, correct decision or an incorrect decision.

Research by Professor Gerd Gigerenzer at the Max Planck Institute in Berlin in cognitive psychology has focused primarily on the use of cognitive biases and heuristics. In numerous pieces of research Gigerenzer’s lab has demonstrated that heuristics can often lead to more accurate decisions than taking the time to think about the alternatives. This research shows that the notion of taking the time to weigh up the ‘pros and cons’ when making a decision and thinking ‘logically’ as many of our popular literary duos do not always produce a superior solution to a problem, sometimes going with our intuition works (intuition as under-pinned by a set of basic heuristics).

Our decision-making strategies are complex things part of Gigerenzer’s work has focused on the recognition heuristic. The recognition heuristic suggests that when given two alternatives we often go with what we know. For instance, if you were asked to choose between two brands of clothing and there was no significant differences between the items of clothing other than the make you’d more than likely go with the brand that you are familiar with. Advertisers take advantage of the fact that we trust a brand that we know more than one that we don’t, this is in part why advertising has grown into a ‘big money industry’. When a company can advertise a car for example, on billboards around town, in advertisements on TV and in full-page spreads in magazines and newspapers their sales will go up. Put quite simply, we often go with what we know and trust. Seeing a brand on a daily basis reinforces our perceived knowledge about a brand which makes us more likely to trust it, associating it with good quality.

In research conducted some 30 years before winning his Noble prize Daniel Kahneman and his long running collaborator Amos Tversky identified another heuristic that is prevalent in everyday life, the availability heuristic. In the now classic study in cognitive psychology participants were asked to judge the frequency of which particular letter appeared in either the first place (e.g., right) or the third place in a word (e.g., work). Participants could think of more instances of particular letters appearing as the first letter in a word than the third, and therefore often judged falsely that the letters occurred more frequently at the beginning of a word. In terms of the speed of making a decision and the use of cognitive resources it was easier to think of letters occurring first. Participants therefore made the error in with this idea and succumbing to what Kahneman and Tversky called the ‘availability heuristic’.

For better or for worse intuition, heuristics and ‘gut-feelings’ are an important tool in our decision-making tool box this blog will explore these through the rooms.