Impact of Behavioral Biases on Real Estate Investment Decisions

Abstract

The concept of rationality, building block of standard finance, and its underlying assumptions are not applicable in the process of investment decision making generally and particularly in real estate investment decisions; at first, all the investor don’t have equal prudence and they don’t develop same logical approach in a given scenarios. Secondly, the level of information also varies at large degrees and information gathering in real estate industry is neither simple nor free of costs. Even decision making in other markets where information is easily available are subject to behavioral biases. Bashir et al (2013) investigated the behavior of investors at Islamabad stock exchange and concluded that behavioral heuristics have direct effect on the investment decision making. It is documented that investors with lower level of information are prone to higher level of overconfidence and vice versa (Bloomfield et al, 1999). The real estate investors show conservatism which leads them to biased decisions (Beracha, 2014). At third; the real estate investors don’t practice professional expertise and analytical skill to evaluate the alternative investment opportunities. Gervais and Odean (2001), reported that investors having more experience are less biased in their decision making. Fourthly, investment units are heterogeneous. It will be exceptional that given opportunities may resemble in all respect. Last but not the least, the investment units in real estate market are indivisible. Investment decision in housing and property are subject to many heuristic and cognitive errors, therefore it is proposed that Behavioral finance could better explain the decision making process in real estate market rather than standard finance which have more believe in fundamentals. Behavioral finance rest on two pillars namely: Cognitive psychology and limits to arbitrage and both will help in better understand different phenomenon’s of investment behaviors in real estate market.