Human psychology can have a big impact on decision-making. We make cognitive errors on a routine basis by using rules of thumb and over-simplifications. We follow stories rather than facts. We are prone to social biases, such as groupthink and herding.
Warren Buffett once noted that the wild swings in share prices are driven by the “lemming-like” behaviour of institutional investors rather than the aggregate returns of the companies that they own. Could that be true for real estate too?
Institutional investors and real estate
The research indicates that institutional real estate investors are not immune to behavioural risks. In fact, they may be more exposed to behavioural risks than smaller investors. The MIT Center for Real Estate found that “more experienced investors, and larger more sophisticated investment institutions, exhibit at least as much loss aversion behaviour as less experienced or smaller firms”.
MIT’s research focused on anchoring and loss aversion. There are two other behavioural biases, groupthink and herding, that merit attention in this late-cycle environment.
Going with the flow
Avoiding disagreement and conflict is human. Sticking together is strongly associated with survival. Investors go mad in herds but recover one by one, according to one observer writing in 1841. Herding can infect individuals but what about organisations such as pension funds?
Herding among pension funds
The Bank of England sees some evidence that UK defined benefit pension funds engage in reputational herding. They are driven by fear of underperformance relative to their peers. This fear makes them follow rather than think.