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April 17, 2005

Are lizard brains driving "irrational exuberance" in real estate?

Godzilla_crowds1The brain is hardwired to expect patterns to repeat themselves, says Harvard Business School professor Terry Burnham author of Mean Markets & Lizard Brains:  How to Profit from the New Science of Irrationality, which may explain why many smart people still want to buy homes at irrationally high prices.  Publisher John Wiley & Sons writes: 

"In contrast to old-school assumptions of cool-headed rationality, the new behavioral school embraces hot-blooded human irrationality as a core feature of both individuals and financial markets. The 2002 Nobel Prize in Economics was awarded to scholars of this new scientific approach to irrationality. ...The human brain contains ancient structures that exert powerful and often unconscious influences on behavior. This "lizard brain" may have helped our ancestors eat and reproduce, but it wreaks havoc with our finances. Going far beyond cataloguing our financial foibles, Dr. Burnham applies this novel approach to all of today's most important financial topics: the stock market, the economy, real estate, bonds, mortgages, inflation, and savings. This broad and scholarly investigation provides an in-depth look at why manias, panics, and crashes happen, and why people are built to want to buy at irrationally high prices..."

How should smart home buyers protect themselves?  Make every single financial decision rationally, not emotionally, says Burnham.  Analyze your own behavior, find out where your emotional weaknesses are, and act in rational ways to counteract them.  Most economists believe that people are rational but over the past 20 years they have found that is not the case.  People make all kinds of mistakes, driven by emotional non-rational factors whether they are evaluating stocks, bonds, or housing.

When asked by The Motley Fool if he would buy, sell or hold real estate right now, Burnham said, "Real estate is not a bubble, but it is overpriced.  ...the reason it has gotten there is that people have been fooled by low interest rates."  Burnham's bottom line advice in the radio interview today:  "Don't buy, I say "hold" as I do in the book."  Chapter Nine, entitled "Live in Your Home; Make Your Money at Work" includes a seven page subchapter on the housing bubble.  You can view the table of contents, index, and reader reviews on Amazon.com.  I haven't read the book or the section on the housing bubble yet but am eager to do so. 

What's your take -- is the irrational exuberance in the housing market being driven by our lizard brains or something else? 

Bill Wendel | 07:41 PM in Book reviews, Real Estate Bubble | Permalink

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I'm a big believer in the irrationality of the residential real estate market, particularly at the entry level. I've trackbacked my website which has a full cashflow analysis of whether it makes financial sense to rent or buy.

Btw, I'm a former student and friend of Terry Burnham. The book is well worth a read.

Posted by: nestegg | May 1, 2005 11:41:07 AM

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