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Almost all human decisions are susceptible to behavioural biases, which include cognitive and emotional biases. The choices you make regarding real estate investments are no different. From confirmation bias and cognitive dissonance to risk aversion and overconfidence, each of these can impact our decision-making process, leading to real estate investment mistakes. While the influence of psychology on investments, especially the equity market, has been widely explored under behavioural finance, not much academic research has been done on real estate psychology. In this blog, we examine the main emotional and cognitive biases in property buying.
Cognitive Bias
Cognitive bias is an umbrella term that applies to decisions being based on established concepts, which may or may not be accurate. It happens when the brain, when attempting to simplify information processing, commits errors in memory, perception, and/or reasoning. Let’s look at how some of the cognitive biases affect the psychology of real estate decisions.
Types of cognitive biases
- Confirmation bias: Confirmation bias indicates a tendency to deliberately seek or interpret information that aligns with your pre-existing beliefs.
Example of investor behaviour: You have already formed a positive opinion about a particular township/locality based on something you have read or heard from a source you trust. Now, you look for people, write-ups, and data that support your viewpoint while disregarding everything contrary to it.
- Cognitive dissonance: This describes the uncomfortable feeling that sets in when you hold two conflicting beliefs, or when your actions contradict your thoughts.
Example of investor behaviour: One of the most common examples of cognitive dissonance is when you are excited about having bought a house, but also spend sleepless nights thinking about the long-term financial commitment (read EMIs) it involves. Two feelings that are equally strong but conflicting in nature.
- Scarcity bias: This cognitive bias in property buying is when you start attaching greater value to a property just because it is scarce, and lower value to a property only because it is more easily available.
Example of investor behaviour: Imagine you are scouting for an apartment in a particular township, and you are told that there are only two units left. If you are susceptible to scarcity bias, you will agree to pay more than the current market price for an apartment, just because you think it is scarce, and you need to buy it before someone else does.
- Sunk cost fallacy: You exhibit this bias when you decide to continue with a decision only because of the time, money or effort already invested. You carry on even if you know that opting out could be a better decision.
Example of investor behaviour: Consider this scenario — you have paid a non-refundable token amount of ₹1 lakh for an apartment. But later, you find out that the property faces a major water shortage in summer. However, you complete the deal because of the ₹1 lakh that you have paid, even if you know that you could still opt out.
- Anchoring effect: A typical real estate investment mistake, this bias affects both buyers and sellers. It happens when you ‘anchor’ all your decisions on the first piece of information that you received about a particular topic. Here, you don’t view a scenario objectively; instead, you always connect it to the anchor.
Example of investor behaviour: Imagine that the first property you visited in a particular township is priced at ₹1 crore. You store this as the ‘anchor’ information. Subsequently, you see another apartment in the same township where the asking price is ₹90 lakh. This property may be inferior on many counts (the extent of renovation work required, availability of sunlight, etc) and may have a lower market value. Still, because you have ‘anchored’ your decision on ₹1 crore, you may consider this property to be a wiser buy and go for it.
- Halo effect: This happens when your first impression of something is positive, and that opinion colours all your subsequent judgements about it. In such a scenario, you tend to overlook even obvious defects.
Example of investor behaviour: You visit the site office of a developer and are highly impressed with its posh settings. You are even more impressed when the staff speak impeccable English. Succumbing to the halo effect, you start assuming that the developer is trustworthy and offers high-quality services, though you have not objectively and independently verified any of these facts.
- Framing effect: When under the influence of this bias, you base your decision on how information is presented rather than focusing on the merit of the information itself.
Example of investor behaviour: You have shortlisted properties in two upcoming townships. One brochure states “only 20% downpayment required”, while the other claims “80% loan availability”. Though both mean the same, you might lean towards the latter because “80% loan availability” sounds more appealing and assuring.
- Recency bias: You exhibit this cognitive bias in property buying when you attach too much importance to a recent experience or the latest piece of information, rather than looking at the overall picture.
Example of investor behaviour: You have checked out at least 10 properties without being able to make a decision. When you reach the 11th property, you are told that, in the future, a Metro line could develop near the site, potentially increasing its value. Though you have visited better options that are more lucrative from an investment perspective, you choose the last property you saw because the information about the Metro line is fresh in your mind.
Emotional bias
Emotional biases are spontaneous errors based on an individual’s personal feelings at the time a decision is taken. They could be deeply rooted in personal experiences. Emotional biases in real estate buying are very common.
Types of emotional biases
- Emotional attachment: This can be described as ascribing more value to something than it’s worth purely because of sentimental reasons. It can affect both buyers and sellers.
Example of investor behaviour: You own a property that has a market value of ₹70 lakh. However, it’s worth much more than that in your eyes because it’s the first house you ever bought, and you fixed a price of ₹80 lakh.
- Herd mentality: This bias leads to Fear of Missing Out. It happens when you mindlessly follow the crowd without viewing a situation objectively.
Example of investor behaviour: A particular locality suddenly witnesses an investor rush. Though it’s inconvenient for you in terms of travel to work and school, you give in to the hype without analysing its suitability for you.
- Loss-aversion bias: If you have this type of bias, you will attach more importance to the pain caused by losses than the happiness profits bring.
Example of investor behaviour: Imagine that the value of your property is declining, while there’s an excellent property available nearby for a cheaper price. However, you’ll overlook the profitable option and hold on to your property to avoid the losses.
- Regret-aversion bias: Here, you play it safe by choosing an option with minimum scope for regret. In fact, to avoid future regret, you might even take a wrong decision that’s non-beneficial in the long term.
Example of investor behaviour: You have come across a good property at an upcoming locality with a lot of potential for future development. However, you are hounded by doubts — “What if there’s no development in the future?” and “What if this is just a fad and the locality loses its charm eventually?” — and decide against investing because you don’t want to regret the decision in the future.
- Overconfidence bias: As the name suggests, in this case, you tend to be extremely sure about your decision-making skills and knowledge, and do not listen to reason and logic.
Example of investor behaviour: You are all set to buy a property and soak in all the information available online. You are now sure that you are well-versed in the matter and don’t avail of expert advice — be it about legal compliances, price trends, construction quality, or the desirability of the location.
How to avoid biases when buying property
Cognitive and emotional biases in real estate can cloud your decision-making process. They often lead to grave errors, particularly when they involve a major life decision such as buying a property. You can tackle this by understanding your biases, utilising tools and apps, consulting experts, making unbiased, well-informed decisions, being flexible, training yourself to question and change your choices, and educating yourself. In short, before buying a property, ensure you have a thorough, objective understanding of it.
FAQ
- What is status quo bias, and how can it influence you as a property investor? A person with this type of bias finds a lot of comfort in the current situation. They will resist change even if it results in losses. For example, a person deciding against selling his property even if its price is declining.
- How can you overcome confirmation bias?
- What are the different types of overconfidence bias?
- How can one overcome loss aversion bias?
- What are some of the easiest ways to control herd mentality?
To begin with, it’s important to be aware of your personal biases. So, observe if they are influencing your decision-making. Another important step is to analyse multiple views, perspectives, and information, rather than focusing only on the evidence that supports your opinion. You should also be willing to change your decision if there’s merit in views opposing yours.
There are three types of overconfidence biases.
Overestimation: This is when you overestimate your ability to succeed and performance.
Overplacement: When you think you are better than average, even though that might not be the case.
Overprecision: When you truly believe that you know more than you actually do.
To begin with, make a conscious effort to change your mindset and focus on the profit. Secondly, be realistic about losses and accept the fact that they can happen in any investment. This will reduce your fear of facing losses. Also, when you invest, think about their long-term benefits.
Whenever you feel the need to follow the majority, encourage yourself to think and act independently. Recognise your feelings, pay attention to your thoughts and evaluate your options. Accept that the majority isn’t always right. Most importantly, take a pause and don’t act impulsively.
