Three Fallacies Which Make Us Ignore A Real Correction In Property Prices

In the last quarter of 2016-17, even as the negative impact of demonetisation was still to play itself out, India’s real estate sector saw a 21 per cent revival in sales over the previous quarter in the top eight cities, according to property firm Liases Foras. Even though January-March sales were 5 per cent below that of the same quarter in 2016, the revival over the demonetisation quarter is testimony to the fact that demand remains robust – but at the right price. When prices and interest rates start looking reasonable, sales bounce back. The revival in January-March this year was the result of a weakening in real property prices, the fall in interest rates, and builders’ shift to affordable housing, which is a potential boom sector.

The truth is that prices are already correcting, but this is not visible in the nominal prices of house properties in most cities. There are two ways prices correct to meet demand: one is through formal discounts, and the other is through time correction. The second form of correction is about allowing property prices to stay where they are and letting inflation to bring down the real price.

The Liases Foras report notes that prices in Pune, Kolkata, and Delhi (National Capital Region) fell three, two and one per cent, while in Mumbai they rose one per cent. If we assume average inflation at 4-5 per cent, it means prices have fallen in real terms for all these cities over the last one year.

When real estate prices correct only over time and not through sharp nominal price cuts, revival will also be slower.

Clearly, investors and owners are falling prey to three psychological and economic fallacies that are best explained through examples. These fallacies relate to the human tendency towards “loss aversion”, “the anchoring effect” and failure to understand the time value of money.

A neighbour of mine in Thane (a major city near Mumbai) wanted to sell his flat two years ago. He believed that the market price should be around Rs 1.1 crore, but even though 30-40 people came to see the flat no one bought it. And this happened even though new properties in the same area were being sold by builders for prices ranging from Rs 1.5-1-6 crore.

Another person I know did the opposite. He bought a one-bedroom flat in the same complex for Rs 67 lakh, and spent another Rs 4-5 lakh paying for stamp duty and registration charges, apart from repainting the house. Three years after purchase, he decided to sell and asked for a moderate price of Rs 70 lakh. He found one buyer ready to pay Rs 66 lakh almost immediately. Even though his broker advised him to wait and get a better price, he decided to sell at Rs 66 lakh – a loss of about Rs 5 lakh from his total cost of purchase.

The first neighbour found that there were no buyers at Rs 1.1 crore and lowered his price to Rs 1 crore after 18 months of wait. Meanwhile, two more flat owners in the same society also decided to sell, and suddenly the supply of flats went up. Today, even at Rs 1 crore there are no buyers.

Who is right? The one who decided not to sell and wait, or the one who sold at a loss? A lot depends on how prices behave in future, but there are two psychological fallacies and one economic reality that all buyers and sellers need to understand. The two psychological factors influencing our decisions, mentioned earlier in this article, are “the anchoring effect” and “loss aversion”. The economic factor is the “time value of money.”

The anchoring effect is simple to explain. We tend to be biased towards a figure we are first exposed to. Let’s say you heard that someone sold his flat for Rs 1.1 crore; this makes you believe that this is the lowest price you can accept, never mind market conditions. You may give a discount of Rs 1-2 lakh, but not 15-20 per cent even if there are no buyers. This is what explains our first seller’s decision to not sell for two years.

“Loss aversion” is the human tendency to try and avoid losses even though there may be more to gain from doing something else. Brain researchers Amos Tversky and Daniel Kahneman found that people who lose Rs 100 tended to feel the loss more than people who gained Rs 100 in terms of happiness. This means, you may not sell your house at a small loss even though the money earned from the sale may get you more than that loss. This is the exact pitfall the second person avoided by selling his house for a loss. By freeing up his money, he could have invested in stocks or even a bank deposit, which would have earned him more than what he lost by not waiting for another year.

The last point is the time value of money. If you can earn, say, a 10 per cent return without undertaking major risks, it means waiting one or two years to sell a house at the price you want will actually lose you money. For example, by waiting two years, our seller in the first example lost more than 20 per cent in terms of returns. Meanwhile, the house price itself has fallen, and so his loss is even greater.

This is because there is a time value to money. Money in hand today can earn you something in one or two years; a house in hand today, if prices are weak, will lose you more money than just the price fall.

These are three truths all realty buyers and sellers needs to internalise so that they do not make mistakes.

The reason why property sales are not booming despite a huge latent demand is because even builders and investors fall prey to these fallacies. Hence the preference for time correction over price cuts.

(A part of this article was first used in Dainik Bhaskar)