THE COMING REVOLUTION IN BEHAVIOURAL REAL ESTATE
PART 2 : ‘This is your brain on real estate’
PART SEVEN
OF A SERIES
We’ve seen there are manifold biases which,
if the cards fall wrong, can cause us to
misprice a property, buy at a market peak or
otherwise fall prey to “irrational exuberance”
of an inflated market.
But that’s not all: biases have trailing effects,
too. Bias can cloud the most obvious of
calculations when we account for risk in a
housing decision. These are risks we hide from
ourselves; far better the devil we think we
know—that devil makes us feel we’re much
more less likely to leave money on the table.
Most of all, we’ll understand that while the real estate
market is far more “human” than most of us have been
aware, it’s also “knowable”: the goal here is a more
stable market because it’s a more nearly transparent
one. Human factors like mood, exposure to media and
market intelligence and lifestyle influencers will now
be factored in. We’ll know what we know, as the Zen
monks say.
“Location, location, location” in future is going to be
just as appealing—if the behavioural guys are right,
it’ll be an even more nearly transparent investment
bet too.
In reality, changing risk strategies in one element of our
portfolio has implications elsewhere. “Mental accounting” bias
in real estate decision-making is most often expressed in a
failure to refinance when the option’s there.
Point is, we behave so as to maximize our own satisfaction
with our present belief systems.
At the very least, that means we’re sometimes barely adequate
at assessing risk, never mind optimizing decisions in the face
of a market frenzy like the dot-com bubble or the sub-prime
market, when scant minorities made the rationally correct
market calls.
So to the bias of “mental accounting”: what do market
participants—buyers, sellers, professionals—need
to know?
So: in the past newsletter and July’s blogposts, we’ve
inventoried the ways our brains choose to succumb to bias in
assessing true risk in the chain of decisions and events that
comprise a real estate deal. Who’s done the leading research
on bias and true risk?
This bias has prospective buyers applying their own brand
of math to separate dependent calculations, rather than
assessing all the factors. It’s a “rule of thumb” bias, as in “my
stock portfolio has nothing to do with my mortgage—I’ll think
about that later.” (Ouch. Been there, done that.)
Funny you should ask, because “house purchasers (aren’t)
information-processing machines bounded by systematic
problem solving and calculative thinking.”1
1
Khoo, C., Thyne, M., & Harris, P. (2007). Making Cents: The Role of Consumers Emotion in
Property Valuation. International Journal of Business and Management, 2(5), 84-90
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Says Amos Tversky and Daniel Kahneman, who won the Nobel
Prize for economics in 2002 for the pair’s work in decision
theory: the human patterns of bias and choice.
Tversky and Kahneman (Tversky died in 1996; Kahneman’s
written several best-sellers since) invented two profound
contributions to understanding human markets: cognitive
bias (bias stemming from choices in how we think) and the
psychology of how we handle risk.
These two geniuses invented ‘behavioural economics’—
economics as if we actually accounted for how human beings
behave while participating in markets: Tversky and Kahneman
literally wrote the book. Cutting-edge real estate think-tanks
in North America and Europe are already modelling the
consequences of the Tversky-Kahneman innovations for 21st
Century real estate markets. (Silicon Valley is building real
estate apps by the dozen predicated on their thinking.)
It’s not just raw bias we’re contending with: it’s systems or
sets of decisions which overlap and influence each other, all
contending with each other in a bath of emotions and biases.
Real estate markets are rife with bias because biases interact.
This means that no chain of human decisions is stronger than
its weakest link—and real estate decision-making is interlinked
by human relationships, like appraiser/owner or realtor/banker.
Emotions rule, people: the purchase and mortgaging of a
family home is rich with emotional turmoil and satisfactions.
Real housing prices in Canada have increased well past values
we can rationally ascribe to market fundamentals; in the
Toronto and Vancouver condo markets, the combination of an
underlying psychology which says “my place is unique and is
therefore uniquely valuable.”
Add to the mix the fact that homebuyer behaviour, when
surveyed, admits only a one in five chance of taking into
account their own biases—and, as Nobel economics laureate
Robert Shiller (of the Case-Shiller home price index in the
US) emphasizes, an understanding of these biases are based
on vague life expectations themselves. As night follows
day—and as Tversky and Kahneman’s Nobel-winning work
demonstrates—these biases simply incite real estate buyers to
consume more today and therefore implicitly drive up prices
tomorrow.
In reality, changing risk strategies
in one element of our portfolio
has implications elsewhere.
“Mental accounting” bias in real
estate decision-making is most
often expressed in a failure to
refinance when the option’s there.
Point is, we behave so as to
maximize our own satisfaction
with our present belief systems.
At the very least, that means
we’re sometimes barely adequate
at assessing risk, never mind
optimizing decisions in the face
of a market frenzy like the
dot-com bubble or the sub-prime
market, when scant minorities
made the rationally correct
market calls.
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But there’s hope—and profits.
If we were more aware of our biases and the biases of those
involved in our purchase process, real estate markets would be
more efficient, they’d be more predictably profitable, risks would
be rationally hedged and—one infers—the coping mechanisms
of irrational biases would diminish.
We all just might be a little happier about our real estate
purchases and the lives we lead in living in them.
Emotions rule: the purchase and
mortgaging of a family home is
rich with emotional turmoil and
satisfactions.
Real housing prices in Canada
have increased well past values
we can rationally ascribe to
market fundamentals; in the
Toronto and Vancouver condo
markets, the combination of an
underlying psychology which
says “my place is unique and is
therefore uniquely valuable.”
Which is where we started in examining livability indexes back
in May’s EXPERT/ease: How do we measure those things that
really matter to us?
In the real estate marketplace, the evidence is clearly in: we’ve
been undervaluing—if not outright unconsciously ignoring—
the primacy of emotions and the behaviours those emotions so
profoundly influence.
That in mind, let’s conclude this two-month journey with a
little brain research—brain research of a special kind. Jill
Bolte Taylor, a brain researcher, suffered a stroke; she wrote
a stunning bestselling book, My Stroke of Insight, about her
recovery, which concludes this: “Although many of us may think
of ourselves as thinking creatures that feel, biologically we are
feeling creatures that think.”
Looking ahead, COMPASSpoint, the successor to EXPERT/
ease’s well-received year-end wrap on the 2014 mortgage and
real estate markets, is already in the making. We’re looking for
insights and contributions; if you’d like to participate in what’s
become a must-read, email us at [email protected] and we’ll
talk. p
Credit: with research files from Tinbergen Institute, Duisenberg School of
Finance, the Netherlands; https://www.academia.edu/5624353/Behavioural_
Aspects_of_Real_Estate_pricing_decisions_and_asset_allocation; http://www.
cdtl.nus.edu.sg/brief/v9n5/sec4.htm
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YOUR BRAIN ON REAL ESTATE | AUGUST 2015
PART SEVEN
OF A SERIES
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