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Everything you need to know about buying and selling real estate in Mexico, Puerto Vallarta, and the Banderas Bay region

When Pricing Moves Away From Fundamentals

Behavioral Biases in Real Estate Markets

Nick Armet, Investment writer for Fidelity in the UK has an interesting perspective on real estate:

One of the most interesting asset classes where we see the very pronounced influence of behavioral biases is in real estate.

Why is real estate such a ripe area for behavioral biases? Real estate is a highly emotive asset in most cultures. This can help explain phases of ‘irrational exuberance’ in property markets where prices move away from fundamentals.

Real estate markets suffer from a greater degree of information asymmetry than stock markets. This is because no two assets are the same, and there is no central exchange, so sellers tend to know more about assets than buyers, a fact that real estate intermediaries exist to exploit. This means the quality of, and access to, information is much poorer than in stock markets.

Related to this point, humans (and subjectivity) tend to play a much more influential role in the operation of the market than in other more information-efficient markets.

Other studies provide similar support for the idea that sharp appreciations in property prices are at least in part due to over-optimistic expectations. In fact, models of economic fundamentals explain only between 10% and 40% of changes in property prices.

Ultimately, it is clear that real estate prices are very volatile, but this volatility is not fully explained by fundamentals. The behavior of investors and real estate market participants themselves is the issue. In fact, research suggests real estate markets show a wide range of behavioral biases.

Herding and groupthink can both explain why pricing moves away from fundamentals, but there are other implications. Herding can encourage over-investment in certain markets and sectors. For example, the London prime property market was a significant beneficiary of real estate sentiment in recent years as investors strongly favored prime assets in the post-financial crisis environment.

Despite the fact that real estate is an asset class which demands a long-term perspective, investors show a repeated bias towards fast and short-term return.

When herding combines with loss aversion, we can see some of the most disastrous consequences in real estate due to the illiquid nature of the asset class. Real estate investors are highly sensitive to capital loss. We know that generally, losses are felt as least twice deeply as gains.

Food for thought, no?

 

 


This article is based upon Flex MLS reporting, legal opinions, current practices and my personal experiences in the Puerto Vallarta-Bahia de Banderas areas. I recommend that each potential buyer or seller of Mexican real estate conduct his own due diligence and review. If you have any other questions, contact me through my website.

Harriet Murray

harriet@casasandvillas.com

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