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Real-Estate Investor's Psychology: Heuristics and Prospect Factors

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DOI: 10.24312/19142130101

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Paradigms
Print ISSN 1996-2800, Online ISSN 2410-0854
2019, Vol. 13, No. 1 Page 1-6
DOI: 10.24312/19142130101
Real-Estate Investor’s Psychology: Heuristics and Prospect Factors
Syed Zain-ul-Abdin1, Khurram Shahzad2, Muhammad Kaleemullah3, Mumtaz Ahmad4
Assistant Professor, Air University School of Management, Air University, Islamabad1, Lecturer, Lahore Business School, The
University of Lahore, Lahore Campus2, Lecturer, Lahore Business School, The University of Lahore, Lahore Campus 3, Assistant
Professor, Department of Commerce, The Islamia University of Bahawalpur, Bahawalpur 4*
*Corresponding author email: [email protected]
Cite this paper: Zain-ul-Abdin, S., Shahzad, K., Kaleemullah, M., & Ahmad, M. (2019). Real-estate investor’s psychology:
Heuristics and prospect factors. Paradigms, 13(1), 1-6.
This study contributes to the research related to investors’ behavior. Heuristics and prospect theories are
currently the most researched areas in the domain of behavioral finance. However, these theories have not been
thoroughly examined, tested or validated. This study aims to use heuristics and prospect theories to examine the
influences of behavioral constructs on real estate agents’ investment decision and performance in Pakistan.
Heuristics model consists of five constructs, and the prospect model consists of three constructs - both sets of
constructs are tested separately. The central theme of investment performance is to measure the level of
satisfaction toward investment decision. The research findings are based on data collected from 254 real estate
investors. Smart PLS 3.00 was used to apply SEM-PLS analysis to the collected data. The results show that
gambling and availability heuristics are the strongest positive predictors of the investment performance of real
estate investors. The prospect-based relationships show that loss and regret aversion are positive, statistically
supported, and substantial. Overall, the heuristics model has higher predictive power than prospect model in
explaining the investment performance of real estate investors in Pakistan.
Keywords: Behavioral Finance, Real Estate Investors, Regret Aversion, Gambling, Prospect Theory, Heuristics.
INTRODUCTION irrational behavior, there is a need to explore the factors,
According to traditional finance theories, individual which influence investment decisions of real estate investors
investors reach their investment decisions after considering (in Pakistan) and the effect of these factors on investment
the return and risk characteristics of the stocks. Traditional performance.
theories assume all individuals are normal and utility This paper investigates market inefficiency by measuring
maximizing. However, different research studies show that the heuristics and prospect components that influence the
this is not always the case. Furthermore, when individuals investment decisions of a real estate investor. However,
face uncertainty, they make irrational and inconsistent investors’ behavior in the real estate market has not been
decisions (Shefrin & Statman, 1994; Shleifer, 2000; extensively documented in the literature. Therefore,
Kahneman & Tversky, 1979). consensus has not been established in the context of
Malkiel and Fama (1970) stated that in an efficient behavioral finance. Gou (1984) investigated the efficient
market, all the investors make rational decisions and that market hypothesis in the context of the real estate market.
these decisions reflect all relevant information. The Capital Furthermore, Case and Shiller (1988) empirically examined
Asset Pricing Model (CAPM), the Arbitrage Pricing Theory the real estate market and concluded that the market is not
(APT) and the Modern Portfolio Theory (MPT) are perfectly efficient. A limited number of studies have been
quantitative models that are based on rational expectations conducted in the context of behavioral finance in the real
theories (Markowitz, 1952; Ross, 1976; Sharpe, 1964). estate market in developing country. Hence, the research
However, research suggests that it is not necessary that these examined the heuristics and Prospect Theories (PT) related
theories would always hold. Statman (1995) argued that the factors for Pakistani real estate market. Asian investors tend
Efficient Market Hypothesis is unable to explain the behavior to be more irrational than their western counterparts (Kim &
of the market. Nofsinger, 2008). Therefore, this paper aims to examine the
Problem Statement behavioral factors of real estate agents in Pakistan as a
It is believed that the real estate bubble caused the financial developing country.
market collapse in 2008, leading to extensive research on The research questions are:
volatility in the real estate market. Shiller (2003) explained  Do heuristic factors affect investment performance of
that the efficient market hypothesis is unable to explain the real estate investors’ in Pakistan?
level of volatility in the financial market. Barberis and Thaler  Do prospect factors affect investment performance of
(2003) showed that behavioral finance theories draw real estate investors’ in Pakistan?
evidence from cognitive psychology and the related Prior studies developed the effect of behavioral factors on the
behavioral factors through which people make preferences investment performance of the stock market’s investors.
and make irrational decisions. Investors in Pakistan’s Real However, many scholars paid less attention to the real estate
Estate market tend to exhibit irrational decision making. To market compared to the stock market. Therefore, the research
understand and provide a reasonable explanation of such establishes the influences of behavioral constructs on the

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investment decision and performance of real estate investors. explains how persons ponder, and the limits to arbitrage
By exploring different markets, researchers gain a better define whether the marketplace generates anomalies.
understanding that eventually helps the practitioner to Waweru et al., (2008) explains the limitations in traditional
understand the real estate investors, their behavior and financial models that focus on investors’ biases that bound
market conditions. the investors in terms of human behavioral characteristics.
Furthermore, there is less attention on behavioral finance These characteristics are grounded on mental psychology
in developing countries. This study tests the model in the and are affected via mental illusion. The cognitive illusion
context of Pakistani real estate market. The choice of the has two broad classifications, which are called prospect
study is made because of the lack of similar studies theory (PT) and heuristics decision process.
conducted in developing countries. Human beings like outcomes that are known to them as
This study does not consider any cultural aspect. The compared to those outcomes that involve probability
research model is strengthened by the structural model using (Kahneman & Tversky, 1979). They proposed the prospect
SmartPLS 3.0. In the final phase, this study revised the theory and argued that people value gains and losses
concept of heuristics and prospects in term of the real estate differently. They stated that it is difficult for people to adjust
market. themselves easily to losses. Wood (1996) finds that it is easy
This study sheds light on different behavioral components for investors to frame such situations that create a feeling of a
that influence investment performance as well. Therefore, sure gain or loss, which would result in pleasure or pain.
investors consider different behavioral factors in decision The most observed concepts of prospect theory are loss
making. aversion, mental accounting, and regret aversion. Kahneman
This study makes use of questionnaire data collected from and Tversky (1979) argue that loss aversion is the most
254 real estate investors in Pakistan. The collected data is crucial concept that works in behavioral finance. They stated
examined by applying the SEM-PLS using the SmartPLS that people give twice the weight to losses as much as a gain
3.00. of a similar magnitude. Investors like to sell stocks which are
Findings increased in price and avoid selling the stocks, which are
Investors’ behavioral factors play a crucial role to decreased in price (Shiller, 1999; Lebaron, 1999). The pain
influence the investment performance of real estate investors. of loss is much higher for people than the pleasure with an
Gambling and availability from heuristics, regret and loss equivalent gain. Thus, loss aversion influences the real estate
aversion from prospect are the most dominant factors that investor’s investment decision (Rabin, 1998; Shalev, 2002).
influence investment performance. The justifications of the Regret is described as the emotion that is caused by
supported hypotheses are discussed in the discussion section. comparing the state of events or a given outcome with the
LITERATURE REVIEW state of a particular event (Bell, 1985). Choosing between a
Traditional Finance Theory states that investors act familiar and an unfamiliar brand, a consumer might not select
rationally and correctly, bringing into consideration all the unfamiliar brand because he can consider the regret of
currently available information in the decision-making finding that the unfamiliar brand performs poorly compared
process (Kishore, 2004). Furthermore, Jim et al. (2007) to the familiar brand (Inman & McAlister, 1994). Investors
argued that traditional finance states that the price of assets want to enter into the asset market because they notice that
traded in the frictionless market reflects all available other people receive high returns on their investments. Regret
information, and there is no role for investors’ sentiment. plays an essential role in such markets which show high price
According to Malkiel and Fama (1970), an efficient market raises, recently. Investors ignore the increased risk of capital
can be defined as a market where asset prices always fully losses; they enter into such markets because they do not want
reflect all the available information. EMH assumes that all to have regret about not participating in the market (Farlow,
the investors make rational decisions, and their decisions 2004). Hence, regret aversion is considered a significant
reflect all available information (Malkiel & Fama, 1970). factor that influences the real estate investor’s investment
Statman (1995) EMH is unable to explain market behavior. decision.
Furthermore, French (2001) stated that the actual behavior of Mental accounting refers to how financial outcomes are
decision maker could deviate from the normative model of categorized and evaluated by people (Henderson & Peterson,
Markovitz, and this is due to the problem-solving behavior of 1992). People use heuristics to characterize the element of
individuals. Behavioral finance describes the actual behavior their expenditures in different mental accounts (Thaler,
of investors and the market. Therefore, behavioral economics 1985). Shiller (2000) stated that mental accounting is the
is a strong application to understand the actual behavior of tendency of individuals to make separate mental accounts of
investors and the market. Sewell (2007) explains that their world. In their investment portfolio, each element is
psychology’s influence on investors and in turn influences treated separately and as a result. It leads to an inefficient and
the market. Shiller (1999) documents that behavioral finance inconsistent investment decision by investors. Rockenbach
imports human behavior theories from social sciences to (2004) argued that between different investment possibilities,
explain human behaviors in markets. Statman (1999) states the investors seem unable to create a connection. For
that behavioral finance explains the cognitive and emotional arbitrage-free pricing, it is essential to make a connection
indicators that affect the investment performance of real between different investment possibilities. Therefore, mental
estate agents. Ritter (2003) explains that behavioral finance is accounting influences the real estate investor’s investment
the combination of two main elements: cognitive related decision.
psychology and limit to arbitrage. Cognitive psychology

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 To process significantly available information, individuals and Odean, 2001). They argued that these illusions drive
use cognitive heuristics to simplify the problem (Janis, 1989). investors to overconfidence. Therefore, investors use their
Heuristics are the rule of thumbs which are used by human talents, knowledge, and skills to select a particular asset from
beings to make decisions in the complex and uncertain the market.
environment (Waweru et al., 2008). Kahneman and Tversky, In availability, investors base their decisions on most
(1979) found that individuals do not behave reasonably available information. Investors make their decisions based
though doing stock choices. Investors do not follow the art of on readily available information (Waweru et al., 2008).
a collection of relevant information and evaluation of Investors like to prefer information that they know and are
information; instead, investors take mental shortcuts. familiar about. Adair et al. (1994) explained that investors
Waweru et al. (2008) cited that the heuristic decision process invest in assets for which information is easily available.
causes poor decisions. Waweru et al. (2008) mention that the Massimo and Simonov (2006) argued that availability is the
illusions that arise from heuristics are overconfidence, tendency of individuals to focus heavily on information that
gambler’s fallacy, availability anchoring, and is often mentioned. Warner et al. (2008) explain that
representativeness. investors rely on easily accessible information or information
In representativeness, the investors relate one event with that can be easily recalled from memory, or that corresponds
others to reach decisions (Waweru et al., 2014). De bondt to a future event that is easy to imagine. Thus, the investor
and Thaler (1994) argued that in markets, individuals relies on one piece of information for an investment decision.
purchase popular security and evade security that has Investment is under consideration in many ways, such as
accomplished badly in recent times. The representativeness investing in the stock market or real estate market.
heuristic makes investors buy such stocks that represent Nowadays, Pakistani real estate market is on an uptrend, and
desirable qualities (Shefrin, 2000). Solt and Statman, (1989) very few numbers of studies are conducted for the real estate
argue that good investment is those stocks which increase in market. Therefore, this study targets the real estate market.
price more than other stocks. Lakonishok et al. (1994) stated The above-postulated literature proposed the below
that investors like the stock of those companies which have mentioned conceptual framework and developed the
achieved growth in the past. Therefore, representativeness proposed hypotheses for the study.
effect real estate investor’s investment decision.
The gambler’s fallacy is a belief of people in the negative
autocorrelation of a non-auto correlated random sequence of Overconfidence
outcomes (Sundali & Croson, 2006). In Gambler’s fallacy,
the individual reacts to a situation reverse of a particular Representativenes
event. Thus, the investors choose the alternative investment
Anchoring
and do not bring in considering whether the decision is
optimal or not Availability Heuristic
Anchoring arises when an investor gives too much weight s
to recent performance. Kahneman and Riepe (1998) found Gambling
that people think that present prices are correct and the
purchase price is used as a reference point. According to Investment
Shiller (1999), investors try to fix prices concerning the last Regret Aversion
performance
price. Thaler (1995) argued that the reference point is the Prospect
Loss Aversion
stock price, and investors compare this reference point to the
current stock price. Therefore, investors select the asset with Mental accounting
the consideration of the initial point and forget whether their
decision is good or bad. Figure 1: Conceptual framework
Mahajan (1992) argued that overconfident individual Research Hypotheses
overestimates the probabilities for a set of events. H1: “Heuristic has an impact on the property’s investment
Overconfident investors believe that they can beat the market decision and performance in developing country
(Waweru et al., 2008). Investors are overconfident in (Pakistan)”.
particular areas where they have sufficient knowledge H1a: Overconfidence has an influence on a property’s
(Evans, 2006). Therefore, Investors are usually overconfident investment decision.
about their abilities in a complex task and consider that they H1b: representativeness has an influence on a property’s
are picking winning stocks. Trivers (1991) stated that investment decision and performance.
investors think that they are better than they are. Investors H1c: Anchoring has an influence on a property’s investment
believe that their knowledge is more accurate than it is. The decision and performance.
illusion of control (the beliefs of people that they would H1d: Availability has an influence on a property’s investment
affect the consequence of chance occasions), the illusion of decision and performance.
knowledge (the beliefs of people that they are more H1e: Gambling has an influence on a property’s investment
knowledgeable when they have more data) and the illusion of decision and performance.
self-attribution (when people get success they attribute this H2: “Prospect has an influence on a property’s investment
success to their abilities, and when they fail they attribute this decision and performance in developing country
failure to bad luck) are reasoned to be overconfident (Barber (Pakistan)”.

3
H2a: Loss aversion has an influence on a property’s are tested separately. The SEM was used to confirm
investment decision and performance. hypothesized models. Three steps were used to confirm the
H2b: Regret aversion has an influence on the property’s proposed models. The first step involves descriptive statistics
investment decision and performance. such as mean and standard deviation. The second step
H2c: Mental accounting has an influence on a property’s confirms reliability and validities. The final step shows the
investment decision and performance. path coefficient.
METHODOLOGY Data Analysis
Data Collection and Sample Procedure In PLS, three phases are considered to confirm the
This study focuses on the real estate agents as investors adequacy of the measurement model, first of which are the
because they show a vital part in the purchase and sale of item outer loading and the composite reliability of the
properties and because they have good know-how about the constructs. The composite reliability estimates the degree to
efficient functioning of the property market. Real Estate is a which a set of unobserved construct items follow the
rapidly growing business in Pakistan. Overall, it plays a measurement of a construct. The composite reliability of
crucial role in the economy of the country. For this research each construct achieves the minimum criteria of 0.7. Table 1
study, the sample of real estate agents includes Pakistani men shows the outer loadings for all the items ranged from 0.72 to
aged 25 years or more with a working experience of 3 years 1.00. Second is convergent and discriminant validity. After
or more. confirming the reliability, the validity is confirmed by
This research study makes use of primary data gathered convergent and discriminant validity. Convergent validity is
through survey questionnaires from real estate agents achieved if all the measurements items strongly correlated
operating in Lahore and Islamabad. The questionnaires were with its proposed theoretical constructs. Average Variance
covered with announcement letters to reduce social Extracted (AVE) is used to confirm the convergent validity;
desirability bias. Convenient sampling technique was used to it shows the ratio of the summation of its constructs items
target real estate agents. Most of the data was collected face variance as extracted by the construct relative to the
to face while the rest was gathered through email measurement error followed to its items (Gefen & Straub,
correspondence. Of the 400 targeted real estate agents, only 2005). The minimum threshold of AVE is 0.5; all constructs
254 are usable for further analysis. The response rate is of the study meet the minimum criteria. Table 1 shows that
reasonable (63.5%) for data analysis. The response rate is the AVE value for all variables lies between 0.66 and 1.00.
relatively high due to personal presence and assurances of Discriminant validity examines whether a construct shares
confidentiality. It took three months to administer the more variance with its measure than it shares with another
questionnaires. construct in the model (Hulland, 1999). Thus, the square root
Measurements of the AVE should be greater than the correlation with all
The questionnaire is taken from Waweru et al. (2008). It other constructs in the model (See: Table 2 and 3). Tenehaus
uses five points Likert scale for evaluating responses. One et al., (2005) introduce the global goodness fit formula to
represents ‘strongly disagree’ and five represents ‘strongly measure the model fit, i.e. the R2 value. The value of R2 is
agree’. The questionnaire has three parts. The first part considered substantial if it falls between 1 and 0.67,
includes information about demographics: age, income, and moderate if it lies between 0.67 and 0.33 and weak if it is less
experience. The second part comprises behavioral factors than 0.19 (Chin, 1998). Therefore, table 2 shows that the
related to heuristics and prospect. The heuristics part consists ability of heuristics to predict investment performance is
of five constructs with 08 items. Table 1 shows the number satisfactory (R2 is 0.294). Table 3 shows that the predictive
of items of the respective construct. The prospect part power of prospect toward investment performance is also
consists of three constructs, with each construct carrying two adequate (R2 is 0.290).
items, resulting in a total of 06 items. The investment Structural Model
performance is developed by the work of Le and Doan, To apply the structural model to measure the significance
(2011). Three items were used to measure investment of the hypothesized relationship, this study uses
performance. bootstrapping procedure with 500-resample (Tenehaus et al.,
This study utilizes PLS-SEM to investigate the influence 2005) to measure the t value of the proposed relationships
of behavioral constructs on real estate investors’ investment between the two models (See: Table 4). Table 4 shows the
decision and performance. PLS-SEM is quite suitable to path coefficient and significance of hypothesized
identify the postulates of the relationships because some of relationships. In the heuristics-based model, gambling
the constructs have only one item that is not tested by the (β=0.292, p-value < 0.000) and availability (β=0.212, p-value
AMOS. Before applying the analysis, more than four missing < 0.001) are the strongest predictors of investment
values were removed using hot dock method, typo error, and performance. The two facets of anchoring and
extreme value. overconfidence are statistically insignificant toward
DATA ANALYSIS AND RESULTS investment performance; they are not even significant at the
This section sheds light on the analysis, interpretation, and level of 90% confidence interval. The representativeness
presentation of the influence of behavioral factors on heuristics is significant and supports predictor ((β=0.212, p-
investment performance. The two extensive groupings of value < 0.05) of the investment performance. In the prospect-
mental illusion are the heuristic theory and the PT. The based model, regret aversion is the strongest predictor
heuristics theory is supported by five components, while the ((β=0.375, p-value < 0.000) of the real estate investors’
PT is reinforced through three components. The two models investment performance. The second facet loss aversion

4
((β=0.220, p-value < 0.000) is also significant and supported dominant factors that influence investment performance. The
predictor toward investment performance. Mental accounting investors set the property prices based on their knowledge
is supported, but it is not a statistically significant predictor and reaction against the real estate market due to gambling.
of the real estate investors’ investment performance in The other most important factors are the information about
Pakistan. the property market and the focus on trend property.
Table 1: Summary of Measurement Scales Furthermore, investors rely on the availability of
information and prefer to buy local property due to
IV DV Β P-Value Results
information available about the local property. Most of the
H1a OVC IDP 0.040 0.607 No
H1b REE IDP 0.192 0.010 Yes real estate agents use advertisement, newspaper, and web for
H1c ANC IDP 0.080 0.342 No collecting information about the property market. Moreover,
H1d AVA IDP 0.212 0.001 Yes mental accounting does not have a statistically significant
H1e GAM IDP 0.292 0.000 Yes impact on investment decisions in the prospect view.
H2a LOA IDP 0.220 0.000 Yes Investors do not manage their wealth into different accounts
H2b REA IDP 0.375 0.000 Yes because they are confident about their decisions.
H2c MEA IDP 0.108 0.130 No Thus, this research concludes that behavioral factors play a
IV=Independent variables, DV=Dependent Variables significant role in decision making. Hence, behavioral
finance provides a process to understand investor’s behavior
Table 2: Discriminant Validity to make real estate investments in Pakistan. Empirical results
Items Mea SD loading CR AVE
suggest that investors’ behavior influences their investment
Overconfidence 1.00 1.00
OVC1 3.37 1.09 1.00 performance.
Representativeness 0.91 0.84 Of the five components of heuristics, only availability and
REE1 3.57 1.13 0.93 gambling are the significant predictors that influence the
REE2 3.71 1.15 0.91 investment decision and performance. This implies that
Anchoring 0.80 0.67 investors use availability heuristic due to limited resources to
ANC1 3.41 1.03 0.90
ANC2 3.32 1.07 0.72 process efficient information. Pakistani investors do not want
Availability 0.90 0.80 to spend money to get valuable information to make an
AVA1 3.30 1.23 0.91 investment decision. Therefore, they use information that can
AVA2 3.36 1.08 0.90 be easily accessed in decision making. Furthermore,
Gambling 1.00 1.00
GAM1 3.56 1.05 1.00 investors use anchoring heuristic in the absence of reliable
Loss Aversion 0.85 0.74 information that influences their investment performance.
LOA1 3.52 1.02 0.89 From prospect factors, regret aversion is a significant
LOA2 3.48 1.00 0.82
Regret Aversion 0.79 0.66 predictor to influence real estate investors’ decisions in
REA1 3.54 1.08 0.80 Pakistan. This implies that investors feel regret to avoid
REA2 3.57 0.97 0.81 opportunities or they overvalue the gain in an investment.
Mental Accounting 0.91 0.84 Pakistani investors have different risk attitudes according to
MEA1 3.50 1.07 0.90
MEA2 3.48 1.08 0.93 the market situation. Research findings establish a broader
Investment 0.85 0.66 analysis of the real estate market that explains the
IDP1 3.63 1.08 0.86 phenomenon of heuristics and prospects concerning real
IDP2 3.40 1.26 0.85 estate investors.
IDP3 3.48 1`.15 0.72
SD=Standard Deviation; CR=Composite Reliability; CONCLUSION
Table 3: Discriminant Validity This study focuses on a set of behavioral factors that
R2 1 2 3 4 5 6 influence property agents’ investment performance. The
research confirms that psychological and behavioral
OVC 1.00
constructs act a vital part in the investment performance. Our
REE 0.29 0.92
ANC 0.58 0.32 0.81 results are consistent with existing literature. For instance,
AVA 0.28 0.29 0.25 0.91 Grinblatt and Han (2005) contends that stakeholders are risk
GAM 0.17 0.21 0.25 0.20 1.00 averse over gamble for some security and risk lover over
IDP 0.294 0.25 0.35 0.29 0.36 0.40 0.81 gambling in another security. Hence, behavioral finance
Table 4: Results of the Study provides a mechanism that helps the investors to use the
R2 1 2 3 4 behavioral factor rationally in their policymaking. The
LOA 0.86 findings of the research will support researchers and
REA 0.23 0.81 practitioners to understand the real estate markets in
MEA 0.1 0.58 0.91
IDP 0.290 0.32 0.49 0.35 0.81 developing countries. However, behavioral finance is widely
used in developed countries. This work is accomplished with
DISCUSSION the aim of establishing the suitability of applying behavioral
The objective of this study is to find the determinants of
finance for all types of markets.
real estate investors’ decisions in Pakistan by focusing on
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