Behavioral Aspects: Real Estate Investing

Investments are supposed to be financial decisions. When we take finance classes, we are taught models to evaluate investments and base our decisions on.

However, in real life, people take investment decisions emotionally. This is truer of real estate investments. Most people are emotionally attached to their homes or the idea of a home.

Hence they make decisions based on a lot of parameters which are not exactly financial or mathematical. In this article we will list down some of the behavioral motives behind real estate decision making.

Buying a Property as a Rite of Passage

A property is an emotional investment for most people. This is even more valid for young people. Individuals as well as couples in the late twenties and early thirties form one of the fastest growing segments of home buyers. These are people who are newly married or are about to be married.

The primary reason that they buy a house is because they believe that buying a house is a rite of passage on to adulthood. They have seen their parents and their grandparents buy a house the moment they were married and equate the act of buying a house with starting a family.

The act of buying a house therefore becomes a rite of passage to family life. Developers are fully aware of this tendency of the buyers and therefore design entire marketing campaigns to stimulate these emotions. However, successful real estate investors know that investing is after all a monetary affair! Mixing family emotions in the process only complicates it and leads to bad investment decisions.

Buying a Property Because Everybody Else Does

For many people, buying a property is a symbol of economic prosperity. When they move out of college and have a relatively stable job, one of the first things that they do is get themselves a mortgage and buy a property. This is because once again emotions are at play in this investment decisions. They equate the decision of buying a house with the public declaration that they have succeeded in life!

The house is thus a symbol of success. Developers once again have realized this tendency. Therefore they have built many suburban homes for middle class families with opulent amenities! The idea is to give the middle class buyer an aspirational feel of success and validate their emotional decision that they have indeed become successful.

Buying a Property Because Someone Earned Millions in the Past

The past couple of decades have witnessed a real estate boom in most parts of the world barring a few. Therefore stories of people who had nothing and suddenly became millionaires because of the vast tracts of land that they owned suddenly became very valuable is common. As more and more urbanization has taken place, people who owned large tracts of farm land have suddenly become very wealthy.

This has given rise to another class of wannabe investors who want to repeat the process. There is one major difference. They expect the real estate price appreciation to continue at the same rate that it has done in the past! Anyone familiar with real estate or economics in general will tell you that exponential growth at high rates cannot continue for a very long time.

The general outlook towards the real estate sector world over is bearish. However, the emotion of greed in these investors makes them believe that the markets will continue to rise endlessly. Therefore, their decisions are not based on sound financial analysis. Rather they are based on emotions and the adrenaline rush that the idea of making a lot of money in a short time provides them.

Buying a Property Because of “Tax Advantages”

Another rationalization that a lot of middle class buyers use for buying homes is tax advantages. Governments all over the world offer tax breaks for buying a home. They allow the borrower to deduct a portion of the amount that they have paid as interest and capital towards their mortgage from the income thereby reducing the income and the tax owed!

This makes investing in real estate seem like a good idea. This is because it does provide some upside in the form of possible capital appreciation and cash flows. On top of that it allows investors to save money because of a reduced tax bill!

This is not the case in reality. The tax breaks offered by the government are minimal as compared to the interest that one ends up paying on a mortgage. Thus if we look at it financially, buying a home may not be a viable decision. However, emotionally the “perceived tax breaks” seem to make sense to a lot of investors!

Buying a Property Because Land is Scarce!

Lastly, developers monger on the fear of the common public that land is scarce and the population of the world is rapidly growing. Thus falling supply and rising demand ought to bring about an appreciation! This argument is flawed on several counts.

Firstly, even with the massive population growth there is enough land in the world to house all the people and this can be done several times over! So we are nowhere even close to a supply crisis. On top of that, the demand for real estate will not grow at the rate that it has because the population of the world has stabilized in the past few years. Therefore, buying land because there won’t be any left to buy in the future is an incorrect argument.