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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.

So to the bias of “mental accounting”: what do market participants—buyers, sellers, professionals—need to know?

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.)

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: 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?

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

PART SEVEN OF A SERIES

THE COMING REVOLUTION IN BEHAVIOURAL REAL ESTATE PART 2 : ‘This is your brain on real estate’

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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.

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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.

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.

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 info@expertease.ca 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

YOUR BRAIN ON REAL ESTATE | AUGUST 2015 31489E 08-15

PART SEVENOF A SERIES

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.”

uFCT.ca