In a world of multiple investment choices, ever wonder why the old asset class of property continues to be a popular choice globally? The answer may lie in the nature of property as an asset class and psychology of investors.
The problems in property assets are well known – illiquidity, lack of information, high transaction costs – to name a few. These may well be the reasons that make it a good choice in the eyes of many. Property is easier to hold over the long-term because of how the human mind works.
If you look at the key secret that successful investors such as Warren Buffet share, it is quite simple – do not be carried away by short term sentiments. One must keep their eye on the long-term intrinsic value and ignore the cyclical fluctuations that kindle fear or greed in our mind.
This overarchingly simple lesson is however difficult to follow. Humans are, by nature, short-term focused, possibly being trained from pre-historic times to worry about the next meal and not far beyond. The immediate pain also usually over-rides considerations of future benefits.
To illustrate, consider you have a corpus of Rs 50 lakh and you buy stocks for Rs 50,000 (1% of your funds). The stock loses 20% in a short period, setting you back by Rs 10,000. When the stock price rebounds and your portfolio is worth Rs 50,000, it is likely that you are tempted to close your position. The loss aversion feeling is more acute if the investment amount is a larger share of your total portfolio or the dip was higher than 20 per cent or the period of paper-loss was longer. Just seeing the portfolio in the red day after day makes you want to avoid this pain. And in the process we may forget the long-term value of holding-on.
Curse of liquidity
Liquidity is generally a benefit in investments as you can exit a position quickly. Investments such as stocks and mutual funds have their prices updated daily as it is traded actively in the market. This constant price movement can also be a source of discomfort due to information availability.
Seasoned investors are able to ignore the manic-depressive tendencies of the market and focus on long-term value. But many of us are not blessed with such intelligence-filters and hence worry about volatility.
Less is more
One way to avoid over-reactions is to not check portfolio value often. Property markets interestingly offer this filter automatically. Prices are not flashed across our screens all day long. Price data is available based on transactions and is made available maybe only every quarter or so. Also each property is unique and the quoted price may not be indicative of the price for your specific property. For example, the rate per sq ft in a locality would be different between projects based on amenities, in the same project depending on the size, location and customizations.
Selling a property is also not instantaneous. Finding the price, a buyer and going through the process involves time and some amount of effort. And if the market is soft, there may be even more delays and price discovery may be an iterative process.
While the lack of price discovery and possible illiquidity is a problem for efficient market operation in general, it has its benefits. One, owners do not panic as much and get in and out of investments. Two, property is out of sight and hence tends to be out of your mind. Three, even if a price is given, due to the uniqueness of each property, investors are able to filter out information as it may not be indicative of what they would get. These help them to hold on, while the same investor may have sold out of stocks or bonds.
To build wealth, investors have to create a portfolio with many asset classes. The assets must have different risk, return and time horizon characteristics. And property investments differ from stocks and bonds and other alternate assets such as gold, making it an important tool in diversification and long-term wealth creation.