Mindblowing Mentality
The evidence for stockmarket investor bias is overwhelming. We are so not rational when it comes to our stocks that the thought that there are still researchers out there trying to develop theories based on the idea that we actually think through what we do is somewhat mindblowing. However, you’d expect that if we’re strangely biased when it comes to financial transactions involving the stockmarket that we might also be a bit slanty-brained when it comes to other asset classes as well. And as real-estate is probably the biggest single investment any of us will ever make it’s probably a prime candidate for a bit of behavioral analysis.
Sub-Prime Stretched
The interaction between real-estate and other asset classes was well exemplified by the most recent bust, as poorly managed sub-prime mortgages fed through into the wider markets and economy resulting in an economic convulsion we’re still feeling the effects of. In fact since 1970 there have been around 25 booms and subsequent busts in developed economies, as discussed by Luca Agnello and Ludger Schuknecht in Booms and Busts in Housing Markets, who find that these movements are related to short-term interest rates, the general availability of credit and mortgage market deregulation. Basically if you make it easier to borrow people will, and all too often they’ll borrow more than they’re able to repay when times get a bit tougher.
This behaviour immediately signals that there are some underlying biases here – the lack of foresight in taking on debt at a stretch which you can’t repay when things get harder is a typical failure to discount the future properly, a tendency we’ve seen in reverse in retirement investing where people also fail to prepare for the future. Given this you’d expect that the literature would be full of evidence about the behavioral ineptitude of property investors but, in fact, it’s rather limited in this regard.
Losses in Helsinki
A couple of years back we looked at the history of property rights and the likely behavioral implications in Property Rights and Wrongs, and the more recent research suggests that the indications there were correct. The same behavioral flaws that impair our judgement on the question of stocks are equally relevant to real-estate pricing.
Mikko Einiö and Markku Kaustia in Price Setting and the Reluctance to Realize Losses in Apartment Markets have…
