New Age Financial Securities – Mortgage Backed Securities & Credit Default Swaps
The new age mortgage market was extremely unlike the old one. The old one used to work based on a simple mortgage contract between the borrower and the lender. However, in the previous few articles, we read about how the system has completely changed. Instead of the bank holding the loan for its entire tenure, […]
How the Gig Economy is Growing in US/Canada and What Stakeholders Need to Do?
How the US and Canada Are In the “Pole” Position for the Gig Economy/Workers The rise of the Gig Economy worldwide is one of the more notable workforce trends over the last decade or so. More so, in the United States and Canada, which are regarded as pioneers in terms of categorizing and classifying the […]
The Growing Trend of Jobless Economic Growth
Economic growth has always been the focus of all governments. This is because it was believed that if economic growth is achieved, it will benefit the maximum number of people in the economy. Economic growth, i.e., GDP growth was closely linked to employment growth. As more people started working, the economic sentiment would become positive, […]
Economics of Human Resources: Productivity and Efficiency
How Productivity and Efficiency are the Root of HR Decision Making Who does not like productive employees who can get the work accomplished in less time than others and hence, be able to take on other tasks? Further, who does not like to be productive especially if they are on contract to a company and […]
The Case Of Freddie Mac, Fannie Mae and Ginnie Mae
The role that the government played in causing the subprime mortgage crisis is highly debatable. However, the same cannot be said regarding the role performed by the so called government sponsored entities. The Federal Home Loan Mortgage Corporation (Freddie Mac), Federal National Mortgage Association (Fannie Mae) and Government National Mortgage Association (Ginnie Mae) are three […]
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.
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.
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.
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.
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!
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.
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