A growing body of literature has shown, again and again, that investors suffer from behavioural biases. They make cognitive errors by processing the available information in a selective and biased manner and rely on additional emotional heuristics to take mental shortcuts. Instead of making optimal decisions, they seek satisfactory solutions. Overall, they can muster bounded rationality only. Real estate investors are as human and biased as investors in other financial assets. Previous work has found that the intransparency of markets, low liquidity and the heterogeneity of assets paired with significant emotional involvement of buyers and sellers increase behavioural biases. That is why it is particularly important to understand the behavioural bias of real estate investors in general and owner-occupiers in particular.

In this dissertation, I study the bounded rationality of three different types of real estate investors and link these behavioural biases to real estate market dynamics and investment performances. The first two studies focus on the phenomenon of anchoring—a frequently-observed type of cognitive error where investors select reference prices and evaluate offers or market movements relative to existing price points (the anchors). In the first study, I reconfirm that prior purchase prices unduly influence sellers in the resale market: Sellers facing nominal losses try to sell at higher prices than those selling at a nominal gain. Evidence of anchoring bias in list and transaction prices has been found in the housing markets. I contribute to the prior literature by showing that the power of the anchors on transaction prices is a function of information availability and general market conditions. The effect is economically significant only when data from comparable transactions are scarce. Second, the effect is relatively weak in a bust period of the market cycle but it grows when markets recover.

The second study sheds light on the anchoring effect in the presale property market. Here, presale homebuyers only pay deposits when signing the purchase contracts and have the option to strategically default in case property values fall sufficiently before the delivery of their units. Effectively, the mental reference points are expected to differ from the anchors used in the resale market if contract holders rationally consider the deposits as option premiums (or sunk costs). I find that presale contract holders still anchor to the full contract prices rather than the outstanding payments. A presale contract is more likely to be rescinded if the property’s market price at settlement is lower than its contract price. In contrast, I do not find a sharp increase in the rescission rate when the market price drops further below the outstanding payment at settlement. Moreover, for those presale homebuyers who settle the out-of-money contracts, I find they are more likely to substantially increase their holding periods to recover from the implied losses.

One might think that institutional investors are less prone to suffer from bounded rationality than individual investors. After all, they are well-trained professionals with better access to market information. Nevertheless, earlier papers have shown that institutional investors are still subject to cognitive errors like price anchoring. The third segment of this dissertation studies how institutional investors rely on additional emotional heuristics in their decision-making, which are more challenging to correct than cognitive errors. I research investment decisions by local and out-of-town investors who have different access to local information and might be subject to familiarity bias—an emotional heuristic denoting that investors prefer to over-concentrate on familiar investments. I find that the familiarity bias can dominate the information advantage of local investors when adverse shocks depress the value of home-market assets. Using the public non-REIT firm acquisitions as geography-specific demand shocks, I find equity REITs perform worse if they hold more properties in counties where the acquired non-REIT firms are located. However, due to familiarity bias, institutional home investors are less likely to short the affected REITs than institutional non-home investors despite the continuous decrease in the REITs’ rental income up to at least one year after the shocks, which leads to implied investment losses.