I recently showed you three ways emotions can cost you big in real estate investing.
To start off the new year… today, I’m revealing three more emotional responses to watch out for – and how to overcome them – when you invest in real estate…
1. Confirmation bias
Everyone likes being proven correct. Most people look for information and insight to confirm what they already believe – and avoid information that challenges their pre-existing beliefs. Often, even less-than-clear evidence is used to support what people believe.
This is called confirmation bias (or “my-side bias,” or “verification bias”). It shows up in many ways, including how we research real estate investment opportunities.
For example, a real estate investor who enjoys the benefits of a housing boom is likely to attribute his or her success to personal acumen and skill. In contrast, investors who see the value of their real estate holdings plummet tend to blame the market, other investors, or just plain bad luck. Our brains look for ways to confirm our beliefs.
Confirmation bias is easily seen in politics. Those on one side of the political spectrum tend to look only at news and information that supports their pre-existing beliefs. Those on another side only consider news and insight that support their political positions. Both groups typically ignore evidence supporting the other side.
So how can you overcome it?
The first step is to recognise that your brain is programming you to confirm your own beliefs. Once you realise this, it’s a question of actively seeking out information that goes against what you believe and understand. Find a view that’s contrary to your own and think about it for a while.
You may – actually, you probably will – wind up believing the same thing. But your investment decisions may benefit from a conscious effort to deal with this bias.
2. The bandwagon effect
When it comes to investing in real estate (or any other asset, for that matter), your parents may have given you the best advice: “If everyone else decided to jump off a cliff, would you do the same?”
People tend to follow the herd. We think if everyone else is doing something, then it must be the right thing to do. But, there is often no good, rational reason for doing what everyone else is doing.
This bandwagon effect is what happens when you do what others do without making a reasoned, objective decision on your own.
Herd behaviour also drives real estate bubbles around the world. From Thailand and Hong Kong to New York and London, buyers piling into the market have caused real estate prices to skyrocket.
The bandwagon effect clouds our judgment about specific investments and prevents us from thinking clearly when analysing an investment. If you follow the herd into inflated real estate markets without forming your own informed opinion, you’re likely in for a rude surprise when the bubble bursts.
Some of the best investment decisions are those that go against the grain. This is called contrarian investing – you buy when the crowd is bearish and you sell when everyone else is bullish.
Buying when most people panic and selling when the bandwagon crowd is certain prices will increase is very difficult, but it can be remarkably rewarding over the long term.
Avoid being part of the herd. If everyone you know is talking real estate and newspapers are publishing overly optimistic news, it may be time to consider the contrarian view and be conservative.
As your parents said, just because everyone else is doing it does not mean it’s the smart thing to do.
3. The seersucker illusion
In the real estate world, as in every field, there are experts who can give you good advice and guidance. But relying too much on “experts” can sometimes be just as bad as investing blindly. That’s because no one, not even experts, is right all of the time, or even most of the time.
Over-reliance on experts is often called the seersucker illusion, from the expression “For every seer, there is a sucker.” In the realm of real estate, realtors and appraisers are some of the professionals you have the most interaction with.
Remember though, that appraisers can also fall victim to cognitive bias. And then there’s the issue of conflicting interests.
For example, your realtor may try and convince you to accept a low bid price because they benefit more from a quick transaction than a long negotiation.
It’s important to think for yourself and not put too much faith in experts, especially in an unpredictable field like real estate.
So don’t be a sucker. You may get excellent advice from people you trust and respect, but make sure you form your own opinions as well. If you are looking for expert advice, try consulting more than one expert, especially ones with different viewpoints.