Investor Behavior: The Psychology of Financial Planning and Investing

CHAPTER 30

Real Estate Investment Decision-Making in Behavioral Finance

Eli Beracha

Assistant Professor of Real Estate and Finance, University of Wyoming

Hilla Skiba

Assistant Professor of Finance, University of Wyoming

INTRODUCTION

The real estate market shares several psychological biases with traditional financial markets. Combining these behavioral biases with severe limits to arbitrage that include the illiquid aspects of the market, high transaction costs, and short sale restrictions often magnify the effect of cognitive and emotional issues on real estate valuations. As a result, real estate prices in the short and medium run often diverge from their fundamental values and market price adjustments are gradual. This is particularly noticeable in the residential real estate market where most participants are inexperienced, unsophisticated investors and driven by financial, emotional, and personal motives.

Irrational behavior of real estate market participants was partly a driving force behind the residential real estate boom and bust cycle that occurred during the first decade of this millennium. Because this cycle has had severe negative effects on both the United States and the global economy, it serves as a reminder of the widespread economic consequences that aggregated irrationality by real estate market participants can cause.

This chapter focuses on established psychological attributes in residential and commercial real estate and in real estate investment trusts (REITs) ...