Real Estate Psychology

I am currently in India enjoying my vacation. Couple of weeks back I met my friend who lives in Keelkattalai, Chennai. Near his place there was a new apartment complex that was being constructed. When asked about the price I was told that it costs Rs 6,200 per sqft.

At this price if you want to buy an apartment with 1000 sqft of carpet area then you will pay around Rs 85+ lakhs. Well if you multiply 6200 * 1000 you should get only Rs 62 lakhs. How did I arrive at Rs 85+ lakhs? It turns out that if you want to buy an apartment with a carpet area of 1000 sqft then you will actually pay for 1250 sqft (1000 / 0.8). Why? Builders charge you for super built-up area and in general carpet area will be 80% of super built-up area. The definition for carpet area and super built-up area is given below. You can get more information about this here.

Carpet area is the actual usable area of an apartment minus wall thickness. Carpet area is the area enclosed within the walls, actual area to lay the carpet. This area does not include the thickness of the inner walls. Built-up area is the carpet area plus the thickness of outer walls. Super built-up area is the built up area plus proportionate area of common areas such as the lobby, lifts shaft, stairs, etc.

So 1250 * 6200 comes to Rs 77.50 lakhs. To this add car parking, electricity, and registration charges and you will get at least Rs 85+ lakhs. Many of the buyers do not know and nor care to know about the difference between carpet and super built-up area. Also builders do not call this out explicitly and exploit gullible buyers by using availability bias. Remember you do not see what is not there in front of you.

What do I get from this Rs 85+ lakhs apartment? Before we find out what we get let us see what we do not get. There are few issues (1) roads leading to this property is not great (2) lack of proper water supply (3) you will have frequent power cuts. Also there is an opportunity cost. You could have invested that Rs 85+ lakhs elsewhere to earn a decent return. As of today you can invest this in fixed deposit at 8.5% interest. This translates to an income stream of Rs 60,000 per month. With this amount you need not work for someone and instead work for yourself.

Now let us look at what we get from this apartment. You can live in this apartment and raise a family and enjoy your life. This is a life style decision with emotions attached and hence I do not want to quantify this. Let us now look at this from an investment angle. The natural question one should ask is what is the return on invested capital? I can rent out this apartment and earn Rs 10,000 per month. This translates to a return on invested capital of 1.4%. This is without considering any operating costs. This is an awful return. But real estate also appreciates in value. Let us assume that price and rent increase at 10% and see what we get. If this assumption has to materialize then in 10 years the property should sell for around Rs 2.2 crores and rent per month should be Rs 25,937. Is this possible?


For this to happen there should be buyers. Let us assume that there are buyers willing to take loan to buy the property. They need to make a down payment of Rs 44 lakhs (20% down payment on Rs 2.2 crores) and if we assume that they take a home loan at 8% for 20 years then they need to make a monthly mortgage payment of Rs 1.5 lakhs.

To afford that payment a family needs to earn at least Rs 3 lakhs. Why? Remember they need to eat, send their kids to school, and take care of medical and other expenses. How many families can earn this much amount of money in that area in the next 10 years. I seriously doubt if they can. Why?  Everyone cannot be above average. On top of this why would someone buy a 10 year old property at the market price. Apartment depreciates in value. So you should consider lucky if you get 75% of market price. Also you cannot increase the rent 10% every year. Why? The tenant loses money and he will operate under deprival super reaction syndrome.

In spite of so many challenges why do so many people commit huge sums of money in real estate? This question can be easily answered using models from psychology (1) Everyone is buying it and hence it has be correct [ social proof ] (2) The price is going up and let me buy before it is too late [ scarcity ] (3) Those who already bought made a lot of money [ envy and jealousy ] (4) Real estate  always went up in value [ not considering negative black swans ] (5) My boss is buying and celebrities are recommending it in advertisements and hence it has to be correct [ authority bias ] (6) There is no price transparency and  brokers are incentivized to increase the prices artificially [ incentive caused bias ]

Is there a way to overcome these biases? Evolution has programmed these biases as it helped our ancestors to survive in the savannah 100,000 years ago. Depending on these biases in today’s world for taking major financial decisions is dangerous. We should learn how to train our minds to fight our own biology. Charlie Munger in elementary worldly wisdom tells

By and large, as it works out, people can’t naturally and automatically do this. If you understand elementary psychology, the reason they can’t is really quite simple: The basic neural network of the brain is there through broad genetic and cultural evolution. And it’s not Fermat/Pascal. It uses a very crude, shortcut-type of approximation. It’s got elements of Fermat/Pascal in it. However, it’s not good. So you have to learn in a very usable way this very elementary math and use it routinely in life—just the way if you want to become a golfer, you can’t use the natural swing that broad evolution gave you. You have to learn—to have a certain grip and swing in a different way to realize your full potential as a golfer.

The best place to start training ourselves is to read Innumeracy and Munger’s psychology of human misjudgments.

23 thoughts on “Real Estate Psychology

  1. Great post about the real estate mirage that has been created by all thinking that it is going to fetch them huge returns which might not happen after all the recent over-the-sky price rise in real estate.

    • Thanks Siva.

      Only time will tell what is going to happen. As Keynes once said – “Markets can remain irrational longer than you can remain solvent.”


      • Hey hi I partly agree on ur views. But RE traditionally has made money & wealth because of two reasons.

        1) u can create an asset by leveraging. And if u consider tax benefits ur leverage is at ard 8 % or less. U wont think of purchasing equity or fd by leveraging while one can buy house of rs 50 lacs from 10.lacs capital.

        2) as it is illiquid it remains as holding mostly for long term. Equity do gives great return but only few can hold for long 10 yrs and more.

    • Prashanth,

      I was in Bangalore 9 days back and I stayed there for 4 days. I never knew that you are in Bangalore!


  2. Nobody is going to pay 85L, of course the go by Mortgage. so double / triple of present rental money will be my EMI. so it will be manageable and cut the other unnecessary cost ( as corporate will do 🙂 ).
    Still 85L is quite big chunk, 45-55L is manageable for Upper middle class.

  3. Nice Writeup.

    It would have been nice to capture the other side of the story as well.

    1) Tax play in the whole game. Example link.
    There there are REITs, HUFs, Trusts etc who further fuel it.

    2) TRUST FACTOR— HUGE, HUGE ,HUGE ..If only the pesky agents of mutual funds, speculative stock brokers and ULIP sales agents could help.

    3) Its all relative. Based on Demand and Supply. Now why that demand is supply is created is different thing.

    ++ Just look at the NRI population. Its apprx 20 million fixed + 20 million floating. Considering 10% decide to buy a flat every year ( very realistic or conservative) ..u have demand for 2 million units coming from that sector alone.
    ++ Look at the investor group. They alone are sitting on close to 10 billion USD across india funding and running Pre-Launch/Launch exit Cycle.

    ++ RE prices are largely controlled by builder-agents. There is no market reference available. So they keep increasing price, media houses keep publishing it and people get an idea ..its the way to go.

    4) There is absolutely no other asset class which can absorb this kind of money. Finish. RE is the only asset class which can absorb huge sums and calibrate bubble like scenarios over very long term. Try pumping in 1~2 billion in equities and you will see high waves.

    Historical stats always command premium ..and history sides with RE. I am not saying that future will be same ..!

    • Thanks KorAiran for your valuable comments.

      Yes historically real estate has done well. But now the same thing needs to happen on a higher base which is very hard.


    • ‘Historical stats always command premium ..and history sides with RE’
      i am doubtful. if you call history to a period of 40-45 yrs. , i have a case of a house on land in posh area of Ahmedabad . in 1960 , a 200 yard plot house was bought for more than Rs.10000/- , and after 54 yrs , now it may fetch Rs.3 Crores max. , which works out @16% cagr, which is not bad , but not that great for the posh locality. as such there was some long year slack periods in real estate.only since 2005 or so prices have soared. thus this you can say ‘recency bias’ or wrong perception., i think.

      • 16% CAGR over 40 year period .. I don’t know any public listed fund across the globe which has achieved it. ( I didnt verify the 16% calculation though)

        Its FANTASTIC ..!

  4. Some thoughts.

    1. What are the avenues (for investment) for all the black money generated in India? Four which come to mind are Gold, Real Estate (both can be purchased domestically), lending cash money domestically (but this entails significant credit risk and re-investment of cash interest still remains an issue) and lastly sending it abroad. Now interest rates, say in a swiss bank account, would be quite low (1% or 2%). So real estate doesn’t seem unattractive from this perspective. Also once a property is bought, the buyer has the security of legitimizing undeclared income.

    2. What alternate asset class can protect an average family from inflation for a period of say 20 or 30 years? Does the average family have faith in putting a large portion of their net worth in Mutual funds or Bank deposits, especially for such time horizons?

    3. How are builders managing to hold inventory despite being highly levered with high financing costs? In the West, the crisis began from highly levered consumers. If there is to be a correction in Real Estate in India, will it start from builders (primary or first sale market) or consumers (secondary or re-sale market)?

    • Thanks Yash for your comments.

      (1) Agreed. Historically there was a huge gap between the guideline value and purchase price. This gap is coming down in major cities. I hope this should dis-incentivise black money usage in real estate to a certain extent. May be I am dreaming.

      (2) An average family stays away from the capital markets. Also real estate always has gone up and which makes them believe that it will go up all the times. What if it crashes? How would they react? I do not know if it will crash but we cannot eliminate that possibility. As Mark Twain said – “The cat, having sat upon a hot stove lid, will not sit upon a hot stove lid again. But he won’t sit upon a cold stove lid, either.”

      (3) Money is like oxygen and you will notice it when there is a lack of it. Builders cannot be bailed out all the times and when things go wrong for a longer time they will face the heat.

      End of the day the value of an asset is a function of what it earns.


  5. Excellent. Well said Jana. I think like this foolish purchase of property happening only in chennai and may be 99% are emotional decision than the level headed. Besides your friend is ending up with local builders (guessing) who does not registered company nor expertise. He may be banker or school teacher. 🙂 Anyway, you should share this blog with PROPERTY PLUS ” THE HINDU” – saturday supplimentary to open the eyes of millions. Good luck and keep writing. After all it has a cause and social responsible one.

  6. You have failed to take into account the effect of black money. Real estate prices are already unaffordable. If not for black money they would have crashed a long time ago. As long as we have rampant black money in the system this thing can keep going for a lot longer. In the mean time people need places to stay.

    • Agreed about your point on black money. But now it needs to be operate on a bigger base which is going to be harder.


  7. Hey … Great analysis that too in very simple and undestandable manner. I like your thought process on analyzing from all angles … it’s nice one.

  8. Most people invest in real estate to hide their black money. someone who is investing without this reason is obviously making a bad choice


  10. Good Analysis Jana! I am not aware of Chennai RE. But in Bangalore, RE is driven buy NRIs(for investment\renting) and some private foreign institutional investors. Actual end customer buying has declined with over supply of flats. NRIs see investment in RE (flats) is safer than any other asset class due to easy availability and publicity of big builders. Don’t know how far this will go but current Indian per capita income does not support previous rally\demand in RE(from 2004-till date) in the future.

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