Investment Forum - Real estate 

A behavioural perspective to property investment 

How rational can we really be? 

Photo credit: Sean Mallia

The determinants of property investment decisions are complex, to say the least. Standard economic theory would assume that investors act rationally, correctly considering all currently available information, benefits and costs in the decision-making process.

This is a rather presumptuous assumption, that presumes that all the required information is available, and that if it were, human decision makers are able to consistently evaluate a huge load of complex information and market factors (including interest rates, demographic factors, income, amongst others). 

Evidence from the behavioural economics field increasingly indicates that given these natural information processing and cognitive limitations, investment decisions may also be driven by psychological and sociological factors which are less easy to anticipate and predict.

Decision making would have to also revert to perceptions and mental shortcuts (heuristics) which in some cases may lead to biases in decision making that deviate behaviour from rationality expectations. All market participants are subject to these – it is not a question of recklessness but of natural tendencies and limitations. 


Forms of heuristics and biases

Some of the heuristics and psychological/ social biases which studies have found to influence property investment decisions include: 

  • Representative heuristic, where recently observed property price movements are used as a basis of future property price expectations. 
  • Availability bias, where decisions are based on information which is most readily available rather than that which is most relevant. 
  • Herd behaviour, where people do not always exercise independent judgment due to social pressure - when firms and households see others profiting from speculation they tend to follow.
  • Regret effects, where the fear of regret of missing an opportunity or making a bad investment decision impairs rational thinking. 
  • Overoptimism on the expected level of future returns and/ or overconfidence leading to the underestimation of risk.
  • Loss aversion, referring to the tendency for people to dislike incurring losses much more than they enjoy making gains.
  • Anchoring effects, where price evaluations tend to rely too heavily on (be anchored to) the first available piece of information, such as asking or past prices.    

Natural human cognitive limitations and the above-resulting tendencies may present an additional “cognitive risk” within a real estate investment decision. Awareness of these factors and inclinations can thus be of great value in the decision-making process.


Behavioural perspective of the market cycle

Looking at the nature of these heuristics and biases, one can see how they have the potential to amplify or alter (compared to rational market expectations) property market cycles.

One may also relate these to developments observed in local property market over the last years. These behavioural factors are one of the potential sources for property price misalignments to market fundamentals over the business cycle, as commonly indicated by indices that measure such misalignment. 

Studies have mostly linked these behavioural factors to booming (‘hot’) property markets. At this phase, the representative heuristic may kick-in following strong increases in property prices, where investors are prone to assume that prices will continue to rise at the same rates over the longer-term.

This, combined with a higher tendency for over-optimistic or over-confident risk-return assessments, has the potential to create and sustain a strong momentum effect in the market, amplifying the booming stage. 

With a tightening market, sellers also have a greater leeway to raise asking prices, which can in turn anchor buyers’ expectations and willingness to pay. Fear of regret is also likely to play a significant role in markets with strong price growth.

It has been found to have great motivational power - people are motivated to enter an asset market because they see other people ‘making a killing’ on their investments.

Whilst rapid price growth may warrant caution for increased risk of capital losses, people are psychologically driven to invest to avoid having regret about not participating in the market. Together with social herding behaviour tendencies, this may explain sudden surges in investment activities.

These tendencies can create ‘irrational exuberance’ in a heating property market. One may argue that resulting misalignments to market fundamentals can lead to market bubbles bust, as a triggering crisis event corrects expectations to fundamentals and these biases act in reverse.

However, one needs to also consider that certain behavioural factors can also control and prevent property price crashes. Loss aversion and anchoring effects can engage downward stickiness in prices, with participants’ resistance to realise losses. 

With sellers comparing their selling prices to available information on comparables past sales, current asking prices and aggregated price indices published with a lag (availability heuristic), coordinated price drops may not be observed if each seller does not want to be the first to cut. Asking prices may also be maintained to anchor price and negotiation expectations.

Besides market fundamentals such as limited supply, these factors may also explain why in a crisis stage property markets could experience only gradual price unwinding, or a stall in market activity with reduced transactions and investment appetite (whilst awaiting updated information), rather than price crashes.   

Behavioural aspects also emphasise the role of public policy in directing the market. Fiscal and monetary policy measures and incentives are prominent market information that influence general market optimism and confidence.

Time-delimited Government incentives, or ones which could be expected to be withdrawn, can be particularly impactful on market demand as participants are inclined to avoid the regret of missing these temporary measures.

These can be powerful tools in times of crisis/ recovery, but also present market overheating risks in a heated market stage. Easier access (availability heuristic) to granular public and private property market data will also assist investors in basing their decision making on specific data for market segments, rather than highly aggregated indices.  


Psychological and social factors are most likely to be active property investment decision determinants, acting alongside the more “traditional” financial and economic factors.

The market cannot be viewed as a fully rational mechanism. Participants naturally tend to overly extrapolate from past patterns, overweight convenient information, react emotionally, anchor to the opinions of others, engage in herding behaviour, be overly averse to loss and be influenced by frames of reference, amongst other tendencies. 

Awareness amongst market investors of these natural tendencies influencing decision-making processes (and their risks), can be an important tool towards ensuring optimal decision-making that controls for bias tendencies.

From a policy perspective, the ultimate purpose should not be to query whether the property market and its participants are driven by rational or irrational factors, but to arrive to a more holistic understanding of market behaviours and observations so as to better inform individual and policy decision making.

Qualitative analysis and research that takes us beyond traditional fundamentals and into social/ psychological perspectives can lead all market stakeholders to a better market understanding.    


property investment

Keith Tanti is an Economist and Manager at EY Malta as part of the Valuation, Modelling and Economics sub-service line. In his experience at EY he has contributed to the preparation of various economic and data analytics studies related to the property market. He’s very keen about bringing economic and inter-disciplinary perspectives to observed social behaviour. He also holds a MSc in Economics from the University of Malta.
DISCLAIMER: The content of this article does not necessarily reflect or represent the views and opinions of The Malta Chamber of Commerce, Enterprise and Industry. 
A behavioural perspective to property investment