Chapter 30 : Real Estate Investment Decision-Making in Behavioral Finance

The real estate market displays many of the behavioral biases documented in the traditional financial markets. During bull markets, investor overconfidence, optimism, representativeness, and self-attribution bias among others drive prices far above their fundamental values. Conversely, during bear markets, loss aversion, false reference points and anchoring, and familiarity bias drive prices below their fair values. Combining these behavioral biases with severe limits to arbitrage including the illiquid nature of the market, high transaction costs, and short sale constraints can magnify the effect of psychological biases on real estate valuations. As a result, real estate prices in the short and medium time horizon often deviate from their fundamental values and price adjustments are slow. This chapter reviews common psychological biases in the context of real estate and the consequences of these biases to markets