The Shitbox Premium

I bought a house late last year. The whole process was horrible. I don't know why Melbourne became so enamoured with auctions as a means of selling houses, but it seems that now that everyone is doing it, everyone must continue. I experienced a few occasions where an owner was going to sell on the private market, but as soon as anyone made an offer near the asking price they panicked and switched to an auction.

Interestingly, after months of observation and trying to make sense of the bullshit prices that real estate agents quote on properties (add 20% for most and 25%+ for Biggin&Scott or Hocking Stewart), I eventually came to the realisation that it was possible to apply the "preferred habitat" theory to the real estate market. Not only did I find this interesting, I also enjoyed the pun.

The "preferred habitat" theory is an explanation for the shape of the forward curve of interest rates. The idea is that some people want to invest their money for a short period of time and some people want to invest for a long time. However, if long term interest rates are high, people who prefer short term investments will invest for a long period, and vice versa. Basically, it says that people will shift from their preferred strategy, but require a premium payment to do so.

When we were looking at houses, we found that other prospective buyers had a "preferred habitat" that fell into one of two categories; they were either looking for a renovation project, or they were looking for a finished home.

This strategic disjoint led to an interesting outcome; those houses that were well finished and beautifully presented, unsurprisingly, appeared to sell for a premium. More surprisingly, at the other end of the spectrum, houses that were falling down and smelled like cat piss also seemed to sell for relatively high prices; a phenomenon I dubbed the "shitbox premium".

The shitbox premium seemed to rely on renovators underestimating the cost of renovations, and the expectations that whatever price they paid whould be a 'bargain' given the house was so delapidated. Meanwhile, tired looking houses with ugly 1980s facades seemed to sell at a relative discount. It seemed like many of the wide-eyed renovators had an optimistic view of how easy it would be to whack on a second story and move the downstairs toilet, but both the renovators and the 'perfect home' buyers struggled to see past terracota tiles and green marble in the bathroom.