The “confirmation bias” of a real estate investor

Vivek Kaul

I have been writing quite a lot on real estate recently. Given that, I had thought that I will take a break from writing on real estate for some time. But that I guess is not going to happen. So here is one more column on real estate.

As I have pointed out in the past, every time I write a column on real estate, people write to me with reasons as to why real estate prices in India, can never fall. The reasons usually offered are population growth, not enough land, inflation and black money. I have debunked these theories at various points of time, so I won’t get into these reasons all over again.

But I would like to point out that real estate prices in India did crash between the mid 1990s and early 2000s. As an August 1997 newsreport in the India Today magazine points out: “Be it Mumbai’s ‘golden mile’, Nariman Point – the most expensive stretch of real estate in the world – or Somajiguda in Hyderabad; Delhi’s commercial hub Connaught Place or Koregaon Park in Pune; Bangalore’s pulsing heart M.G. Road or the sedate T. Nagar in Chennai. Each of these upmarket addresses, the most sought – after in their respective cities, are now dotted with unoccupied apartment blocks, unwanted commercial complexes and office space purchased at rates too hot to handle today.”

And this led to a huge real estate crash. “For the country’s over Rs 1,00,000 crore real estate business-one-twelfth the size of the GDP – it has been a crash without precedent. Between mid-1995, when the real estate boom peaked, and mid-1997, prices have fallen a bruising 40 per cent,” the India Today report newsreport further pointed out.”

The irony is that all the reasons that are offered now in favour of real estate prices not crashing, were as valid then, as they are now. But real estate prices did fall. So, real estate prices do fall, it’s just most people don’t remember about it, given that they haven’t fallen for a while now.

One of the newer reasons that has been offered in the recent past is that the government won’t allow the price of real estate to fall. This is because politicians have their ill-gotten wealth invested in real estate. Another corollary to this was offered to me by a friend yesterday who citing a discussion he had on a WhatsApp group said that the government will not allow the price of real estate to fall by more than 20%. If the government allows the real estate prices to fall more than 20%, the banks will end up with a huge amount of bad loans.

The problem with this argument is the assumption that the government can control these things. If it could, the banks would not be sitting on the massive amount of bad loans that they already are.

Let’s take the case of the Chinese stock market. On July 27, 2015, the Shanghai Composite Index fell by 8.5% during the course of a single day. It would have fallen more. But that did not happen given that the rules in China prevent share prices from moving freely once they have risen or fallen by 10% during the course of a single day.

This despite the Chinese government doing everything within its power to ensure that the stock market did not fall. It banned short selling. It banned initial public offerings, so that people buy shares already listed in the market. It banned investors with more than 5% of shares in any company, from selling those shares over the next six months.

Over and above this, the government got stock brokerages to buy shares. As Wei Yao of Societe Generale points out in a recent research note: “ The Ministry of Finance, one of the big shareholders of listed financial institutions, promised not to sell its holding and several central government SOEs[state owned enterprises]…started to buyback shares.” Despite all these measures the Chinese market fell by 8.5% in a single day, its biggest fall since 2007.

The Chinese government has way more control over the Chinese economy than the Indian government will ever have over the Indian economy. And if the Chinese government hasn’t been able to prevent the stock market from falling, what are the chances that the Indian government will be able to prevent the real estate market from falling?

The Shanghai Composite Index has fallen by close to 27% between June 12 and July 29, 2015. This, despite the government taking multiple measures to arrest the fall. The moral of the story is that the governments cannot prevent big market falls.

Another point that I want to make here is regarding the people who are going around saying that real estate prices will not fall and that real estate prices never fall. These are essentially individuals who make money through real estate. Either they own multiple homes and are sitting in the hope of prices continuing to go up or they work for the real estate industry.

Such individuals suffer from a confirmation bias. As John Allen Paulos writes in A Mathematician Plays the Stock Market: ““Confirmation bias” refers to the way we check a hypothesis by observing instances that confirm it and ignoring those that don’t. We notice more readily and even diligently search for whatever might confirm our beliefs, and we don’t notice as readily and certainly don’t look hard for what disconfirms them.”

Given that their incomes depend on real estate prices continuing to go up they refuse to look at even the most basic evidence. Real estate prices have gone way beyond from what most people can afford. At prices homes are currently selling at, even the Ritchie-Rich are having a difficult time buying.  As a research report brought out by real estate consultant Knight-Frank points out: “On the other hand, for end users, high property prices and low income growth continue to be the top concerns.”

And this explains why real estate builders have been unable to sell homes.  The Knight Frank report talks about the sad state of affairs in the Mumbai Metropolitan Region (MMR): “The MMR residential market contracted further in H1 2015 (January to June 2015). In comparison to the preceding half yearly period of H2 2014 (July to December 2014), absorption and new launches shrunk by 22% and 30%, respectively. Housing sales of 28,446 units and new launches of 18,887 units made H1 2015 the worst half-yearly period in the post global financial crisis era.”

So here is a real estate consultant telling us that the overall Mumbai real estate scene is in a mess. It’s never been so bad since 2008. And Mumbai is not even the worst performing real estate market in the country. That title goes to Delhi.

Despite all this, those whose incomes depend on real estate continuing to do well, are still telling us that prices won’t come down. I really don’t know what they are smoking but as the American journalist Upton Sinclair once said: “It is difficult to get a man to understand something, when his salary depends on his not understanding it.”

A few years back I had a similar experience when those associated with the insurance industry kept telling us that unit linked insurance plans (Ulips) are the best mode of investing. We all knew what happened to those who invested in Ulips.

The column originally appeared on The Daily Reckoning on July 30, 2015