Kevin Kleen has a great post up today that underlines the irrationality of real estate investors.  Kevin underlines the lack of reason that goes into a borrower’s perception of their equity in a deal.  From the post:

Here is when the disconnect occurs. When you talk to Bill Ant, he will refer to his $4,500,000 or $2,500,000 of equity in the property. Borrowers tend to anchor on their equity at peak value of the property, or on their cash investment in the property, instead of the equity based on the current value. Bill doesn’t have equity in the property any more – all he has is a sad story.

But, he does have $2,500,000 in sunk cost on the deal. Is that worth anything when it comes to his decision to continue to make the payments in a workout context?

That post got me thinking about the irrationality of real estate investors.  I can boil it down in simple terms in the matrix below:

In an up market, Buyers are driven by emotion and continue to chase prices higher on the euphoric expectation of profits.  In the down market, Buyers become hyper-rational.  Perhaps a funnier way to think about it is that when the market is going up, Buyers are Believers.  When the market is going down, Buyers are like atheists.  Their stance is “Prove it to me.”

On the flip side, in an up market, Sellers are the more rational market participants.  When we enter a down market, Sellers are the ones driven by emotion and have a difficult time making decisions that are rational.

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