When I started in finance, behavioral finance was just coming into its own. Markets aren’t algorithms. They’re emotions - fear, greed, hope, and denial - all wrapped in spreadsheets. Understanding investor psychology isn’t a side note. It’s the whole game.
Behavioral finance helps us understand why markets move - and why individuals so often sabotage their own success. In the world of real estate investing, these lessons are more relevant than ever.
Why?
Because investor psychology shapes both markets and personal decisions, a lot of energy goes into helping stock investors avoid sabotaging themselves.
In 2006, as home prices soared, investors piled into subprime mortgages, convinced the boom was eternal. Herding - a classic behavioral bias - blinded them to the crash ahead. Fast-forward to April 2025, with 10-year Treasuries at or near 4.5% and multifamily values wobbling, emotions still drive deals. Behavioral finance, the science of why we make bad calls, holds the key to becoming a solid real estate investor. From anchoring to loss aversion, we’ll decode five biases that cost millions - and how to outsmart them in today’s volatile market.
Before we dive into the specific biases, it’s helpful to break behavioral finance into two lenses:
Internal discipline - How do you manage your own psychology, especially during euphoria or panic? Most of the real estate deals underwater today weren’t doomed by the downturn - they were overhyped and overleveraged during the boom.
Market psychology - How do you read the emotional state of the crowd? Herding into subprime in 2006. Buying at compressed cap rates in 2021. These are case studies in collective irrationality.
The two are intertwined - if you understand the market psychology but fail the internal test, you might still get carried away. If you only focus on yourself but don’t perceive what’s going on around you, you might still get blown up.
This series will explore one bias at a time to give it proper breathing space.
So let’s launch, without further ado, into the first and most pernicious of biases out there.
In short - you herd like a herd of cattle. Or a herd of lemmings marching right off the edge of a cliff. It’s not a great image - we like to view ourselves as being autonomous, highly intelligent, and controlled beings. The reality is rarely so, even for the best investors.
Herding most recently showed its head in market psychology in the mad rush to invest in Sunbelt real estate. I would call this “gold-rush” behavior. Suddenly, Arizona was the place to invest - and money poured into it like the Salmon of Capistrano (bonus points for you if you can name the movie reference).
Everybody was doing it. New syndicators were born daily, hawking deals in these markets. Investors got excited. Everybody was positive it was a good thing.
Just to be clear and fair to the Sunbelt, during the period of record low interest rates, all multifamily could potentially be viewed as herding bias. Everybody was doing it, everybody loved it, and money was pouring into the space.
Or how about the Dutch Tulip Bulb Mania? One of the great manias. It exemplified herding behavior - your neighbor had just acquired a tulip bulb for the price of his mansion. It must be good. Also, so did all the other guys at the club. So you go big.
I’d argue (vociferously) that the recent NFT craze really falls here, too. One notable piece (EVERYDAYS) traded for nearly the same price as Leonardo da Vinci’s Salvador Mundi piece. I mean c’mon.
For yourself (or myself), herding behavior can be identified (with difficulty) by assessing your decision-making framework. As I said, it’s quite nefarious.
Are you “comforted” by others also saying it’s a good idea?
Assess each deal using this framework. If you rely on the “positive” vibes of other investors or people who assure you your decision is sound, it’s time to check your assumptions at the altar of higher reasoning and dig in deeper.
It’s not to say that others saying it’s a “good idea” is bad. It’s that you can’t be reliant upon that as the metric.
Is your decision-making framework guided by “others”?
If you are assessing a deal and you’re highly reliant upon others' analysis, market rationales, and basically others, then you might be falling for herding behavior.
A good example of this is the aforementioned NFT purchases. If you think EVERYDAYS was worth $61.9 million, then you’re likely to make your purchase decision for other NFTs based on that. But that’s surrendering your common sense and logical mind to other market participants who paid exorbitant prices for things that had no actual value.
By the way - side note - this is investing in general. Everything is at least somewhat dictated by others. Gold, for instance, has no actual intrinsic value other than that which we ascribe to it. If the world suddenly decided that gold was nothing more than a pretty rock, its value would plummet. Or if we ever manage to tap that asteroid filled with gold - gold would plummet.
I told you behavioral finance is so important but quite tricky. As an active participant in the market, there are countless ways - both apparent and quite hidden - that its forces are weighing upon you.
How would you feel if your investment decision was “scorned by others”?
I like this test approach. What if you had an investment idea, and somebody wrote a post about your investment idea absolutely ripping it, and the post went viral? Pretty much everybody agrees. Your mother calls you and worries about you - everybody says this is a terrible idea.
How would your idea hold up? How would your investment conviction?
This isn’t to say that they’re wrong, by the way. You could be wrong!
But as a theoretical, I think it’s a great way to check it. You should be that solid on your fundamentals and your analysis to hold you through this period.
By the way - guess who went through this exact situation? Our famous Mr. Big Short, Michael Burry of SCION Capital, went through this. As some of you may recall from the movie, he had constant demands from investors who were furious with him. He had conviction in his trade, but nobody else did. People wrote him off. They said he was DOA in the business.
How would your investment idea hold up in this environment?
More difficult to assess - but uber important - to check your assumptions.
Herding bias can worm its way into your work in various pernicious, difficult-to-determine ways.
Here’s one.
The Denver Case Study
This is a real story. For a hot minute in 2022, I was very interested in investing in Denver. Everybody was investing in Denver. I literally could not compete for deals there because I was outbid, every single time, by San Francisco-based investors who were paying hundreds of thousands more than me and throwing earnest money out (direct pass-through to the seller) on every single deal.
Good times, right?
I never won a deal there, thank God. But it wasn’t for lack of trying.
But let’s move past the obvious (in hindsight) herding bias going on. When I was underwriting deals there, everything was transacting for 4-caps.
Brokers assured me that I was safe to underwrite to 4.25% cap rate exits on deals in Denver.
And you know what’s ironic? I utilized this “conservative” underwriting, so I lost out on deal after deal. It protected me. But it wasn’t conservative at all!
It was incredibly aggressive.
It just happened to be that everybody else was using even more aggressive underwriting.
But seriously - think about that. Herding behavior had driven cap rates and pricing in Denver to insane levels. Without even realizing it, I was operating within the framework of that insane market and underwriting conservatively within an insane framework. Herding had wormed its way into my analysis in a way I wasn’t even aware of.
What’s interesting about this story is that at the time, I had a good colleague and friend who had family from Denver. I was pitching him on a deal there, and he was like, "Well, I have extensive family in Denver who do real estate as their active job. If I do something there, I’m going to work with them.”
I asked a broker buddy about this. His response was - in short - that many of the long-term investors in Denver were not playing right now. "They’re too anchored on old-world pricing”.
And I totally bought into that. Except, as it turns out, they were right!
So check your assumptions and ensure you aren’t underwriting into an insane market.
Herding bias isn’t just something that happens to others. It’s the water we swim in. Next time, we’ll dive into anchoring - another subtle trap that can twist your underwriting without you even noticing.