November 21, 2007

Real estate valuation - Psychological biases

I think there are several psychological baises working in case of real estate. The first is incentive caused bais. Typically real estate is sold via brokers or by sales agents of the builder. They have an incentive to sell the property and typically earn a commision based on sale price. It is quite obvious that the broker or sales agent would be motivated to sell at as high price as possible. In addition it is likely that he will give you a bullish outlook for the property prices.

The second strong bias is social- proof and deprival super reaction tendency. You see you friend buy a property and make easy money. At the same if you have not invested money and feel deprival super reaction tendency as everyone one else is making easy money.

So these two tendencies work together and motivate us to look for a property. Combine this with the incentive caused bias where the broker is constantly trying to create a scarcity (he will tell you that he has a lot of buyers and even you don’t buy now then the price will go up), lack of information and overoptimism on our part and this creates a combined effect. All these factors add up and can cause the buyer to become irrational.

I personally think the risk of bubbles are higher in real estate for the following reasons
- the common notion that real estate cannot lose value and represent something limited which is land
- High amount of leverage. Typically loans on a property is around 20%
- Lack of transparency and information in this market.
- All the above psychological factors


Ranjit kumar said...

Hi Rohit,

The most important psychological factor for most people in making a big real estate decision is the constant pestering of relatives & friends to grab this indifferent guy into their crowd of real estate owners and make them feel comfortable.

Needless to say most of the people feel comfortable in a crowd and move along with the crowd.

I've heard people saying its not worth doing conventional business, go buy a property it will fetch you all the money you need in your life. You cannot say anything but accept such statements because they have an odd example.

Currently the crowd is entering the stock market, with real estate prices at very high levels which makes deal making very costly and is evident from the number of demat accounts doubling recently.

Ranjit kumar

Rajendran said...

The property prices for a .10 acre plot + 2000 sq ft home in Dallas,Texas is around $250,000 . It is $350,000 in Washington DC area. It looks like chennai and Bangalore are more expensive than Dallas and Wash.DC. Comparing Median income, unemloyment rate, transport and other housing facilities ,interest rates , the realty prices in India are crazy and is unsustainable. I could see the people all over are greedy and expecting the realty prices still go higher. For me it looks like it is irrational.


Rohit Chauhan said...

i think you have hit the nail on the head. i have felt the same for a long time.we seem to have developed country prices on an underdeveloped country income.

property prices in bangalore are around 70-80 lacs for a 2000 sqt apartment which is almost 200000 usd. In locations bangalore is far more expensive than US. this is after US real estate is considered over priced.
now india is doing well and all that, but incomes which support these prices are still not at that level.

this is not even surprising. it has happened with IPO's in 94, IT stocks in 2000. the unfortunate bit that these folks rushing into stock market may suffer losses if the market drops and may draw the wrong conclusion. they may end up blaming everyone else other than their own greed.
somehow for the last 3-4 years, there is almost a belief that everyone should be compounding money at 50% per annum.
lets see how it all plays out


Anonymous said...

I also have seen many people having the same psychological bias. But most of them seems to be right..

What do you think?