In fact, a better question would be – why do so many get it wrong?
The simple answer is those market movements are far from an exact science.
The fundamentals are easy to monitor.
Things like population growth, supply and demand, employment levels, interest rates, affordability and inflationary pressures.
However, one overriding factor that the experts have difficulty quantifying is investor sentiment.
And that’s what’s really been behind market movements of late.
Last year when all the news was good and we were feeling confident that we had this coronavirus thingy licked, investor sentiment was positive and it led to strong economic growth and property a booming property market.
On the other hand, for much of this year they’ve been worried by the barrage of negative sentiment surrounding the uncertainties about rising inflation and interest rates and this negative sentiment has led both buyers to go on strike.
We’re not rational
I’ve found that investors often suffer lapses of logic when investing and many of their investment decisions are driven by emotion.
For example, we tend to extrapolate the present to the future.
When things are booming we tend to think the good times will never end and when the market mood is glum, we have difficulty seeing the light at the end of the tunnel.
Think about it…when the media is full of reports about property prices falling and an impending housing crash, many investors become scared and sit on the sidelines, believing the end of the property is nigh and things will never improve when in reality much of the risk has been removed from the market.
Conversely, when property markets are booming and stories of investors seemingly making large gains overnight abound, people, want to jump on the bandwagon and cash in, often at a time when the market is near its peak.
Other emotional traps include becoming overconfident, wishful thinking and ignoring information that conflicts with your current views.
In other words, many investors make their own “reality.”
Can you see how investor psychology, drives booms and busts?
Can you see how the dominant investor mentality of the time helps drive the property cycle?
Just to make things clear…home buyers, who make up around 70% of property transactions drive our property markets.
But investor activity creates our booms and busts.
Simply, over the last couple of years, investor frenzy driven by Fear Of Missing Out drove the property markets in Sydney and Melbourne to dizzy heights.
Go back a few years further in the period leading up to the federal election in 2019 (remember that? – it seems so long ago now) investors put on the brakes worried about tax changes that never eventuated, but the effect was that property values fell.
But then after the 2019 election results, in the second half of that year, investors and home buyers jumped back into the market, demand rose and so did property prices.
Then look what happened the next year in 2020…
Fear of Coronavirus once again put many people on the sidelines, but then in 2021 buyers and sellers once again returned to the market.
We follow the herd
Obviously, one or two misguided investors won’t be able to influence property prices, but investor psychology is infectious.
People tend to want to do what others are doing – they ‘follow the herd’ because going against popular opinion is perceived as risky.
What if you make a mistake?
What if “the crowd” is right and you are wrong?
This behaviour stems back to the days of our ancestors when it was safer to remain part of the herd rather than leave the security of the pack and be eaten by a Saber-toothed Tiger.
This “herd behaviour” is magnified by several things including;
- Mass communication enables the behaviour to become infectious. Now more than ever we are bombarded with messages from the media that influence how we think and feel about things. When we hear that real estate is doomed, all but a handful of sophisticated investors get scared out of the game. And when the media tells us housing markets are booming everyone wants a piece of the action.
- Pressure to conform. If your friends or family are doing it, it must be right. Right? Human nature makes us reluctant to do the opposite of what our peers are doing.
- A major precipitating event can give rise to a general belief that motivates investor behaviour. The Global Financial Crisis saw waves of investors scared out of the share and property markets. On the other hand, the resource boom enticed thousands of investors into mining town housing markets to cash in on the resulting property boom.
- A general belief that grows and spreads. When the belief that property values can only go one way, and that is up, spreads through an uneducated new generation of investors the enter the market pushing up prices, perpetuating the belief and helping make it a reality! Similarly, when the herd believes the market is going to crash, they steer clear, this gets reported in the media and the negative sentiment feeds on itself.
These “lapses in logic” by individual investors and the magnification of such lapses by crowd psychology feed property cycles and go a long way in explaining why we experienced a property slump over the last few years despite the strong underlying fundamentals.
When investor sentiment is positive, the crowd jumps in feet first, pushes up demand and places upward pressure on prices – causing boom conditions.
Conversely, when sentiment is negative, the crowd backs off and frequently sells out of the game due to concerns that they’re about to lose everything – causing market slumps.
What can an investor learn from this?
- Our property markets aren’t only driven by fundamentals, but also by the often irrational and erratic behaviour of unstable crowd investors.
- Booms never last forever, and neither do busts. Don’t be surprised when they come around and don’t overreact. This will stop you from getting sucked into the booms and spat out during the busts.
- Treat your property investments like a business and stick to a proven strategy to help take the emotion out of your decisions.
- Recognise that property is a long-term play and set up financial buffers to help you ride the property cycles.
World-renowned investor Warren Buffett’s once said: “We simply attempt to be fearful when others are greedy to be greedy only when others are fearful.”
This is also the investment strategy of many successful property investors
I’ve always been an advocate of counter-cyclical investing because moving against the crowd often produces the best results and can mean the difference between outstanding gains in the property market and average ones.
Sure, it takes some courage to do the opposite of what everyone else is doing, but the results of your contrary behaviour will ultimately speak for themselves.
Now seems the best time in almost a decade to invest counter-cyclically.