Conjunction Fallacy and Real Estate

April 11th, 2016 by Potato

There’s a neat experiment in behavioural economics where people see a scenario that is more specific (and is actually less likely to happen) as being more likely to occur than a general case because it resonates better. The classic example (via Wikipedia):

Linda is 31 years old, single, outspoken, and very bright. She majored in philosophy. As a student, she was deeply concerned with issues of discrimination and social justice, and also participated in anti-nuclear demonstrations.
Which is more probable?
Linda is a bank teller.
Linda is a bank teller and is active in the feminist movement.

The first is more likely — it’s less restrictive and completely contains the second. Yet many people will choose the second option because it resonates better, or because it’s easier to visualize a representative example. Similarly people may pay more for insurance against a specific hazard they can visualize well (like dying in a terrorist attack) than more general insurance that also covers that specific case (dying from any cause).

So the watercooler gossip turned to the housing bubble today. I don’t usually say much when the conversation turns to real estate, as bearish views are not usually pontificated in polite company. I was especially restrained today, shocked into silence by the sudden agreement happening that all was not sunshine and roses — that in fact houses and condos were too expensive in the city.

For years I’ve been trying to say that the wise course is to rent because price-to-rent is out of kilter — but this has been a hard message to sell. Why is it cheaper to rent? Because of many factors, but the math says that’s what’s most likely the best course. When will it correct? Who knows but likely not tomorrow, a few years or so. You know nothing Jon Snow — I have an open house to hit. Those theoretical, general answers clearly didn’t cut it.

It seems that the meme unleashed by the Panama papers and stories of money laundering is one that resonates really well. Foreigners driving the cost beyond all reasonable affordability is a more salient reason for renting being a good move for now than a simple it’s too expensive for many possible reasons.

“We’re just Panama north!”
“There are so many empty condos in my building.”
“They’re not even playing the same game we are.”

I find it weird that a bubble described as high (and rapidly increasing) prices compared to moderate (and flat) rents was completely invisible — not even admitted as a low-probability possibility — but high prices plus alleged money laundering is immediately apparent as being an almost certain bubble, but that’s the conjunction fallacy for you.

There tend to be two camps on how to respond once people buy in to the predicate that hot money is behind prices increasing1:

  1. Greater fool/FOMO thinking, where the response is to buy now at any price while you still can, because you can sell later for even more because there’s no limit to the foreign money as long as we are cheaper than Tokyo/London/New York.
  2. Let the Grizzly have the fish thinking, where you stand clear of the explosive situation and see what shakes out — getting into a bidding war with a billionaire who’d be happy paying a 6-figure grease fee just to sneak money out is not a game you should be playing.

The conversation moved to the ironic feedback loop: foreign buyers buy for several reasons, but for capital flight it’s important that they can liquidate if needed. Even though they’re “clearly” responsible for driving prices up, they’re not the only market participants. Canadian buyers keep paying any price and are not suspicious of recent flips, reinforcing the idea that a GTA/GVA property can be liquidated at will.

Finally, another feature for the rental camp: price-to-rent is explained because hypothesized foreign capital is clearly not competing for rental space. They are not buying to have a pied-a-terre in Toronto or Vancouver — the prices paid are not for the usage of the property, as many are reportedly left empty.

Interesting changes in the small slice of the gestalt I can overhear.

1. Again for clarity: I don’t think hot money is the sole or even main reason, I’m more in the low rates/animal spirits/general cause camp. Prices are unsustainably high for many interacting reasons, and almost no matter what the underlying reason is the end conclusion is the same — managing your risk exposure and renting your shelter.

4 Responses to “Conjunction Fallacy and Real Estate”

  1. sherry @ save. spend. splurge. Says:


    Nothing is selling. I have a neighbour selling a large 2-floor condo for $300,000 in Montreal (albeit high, you can nab things for $200K here) and it is JUST NOT GOING.

    I’m sitting tight, parking my money & renting.

  2. Safety Says:

    Stuff is definitely selling in Toronto from my anecdotal evidence. I rent and agree entirely on a price/rent (cap rate) basis but have also been wrong for 9 years! I do have a real estate agent send me listings that might be of interest to me and they are usually sold before the week is up and usually at the ask.

  3. Jordann Says:

    Those markets definitely don’t exist everywhere, in fact, most areas in the country are in decline. It’s only Van and the GTA where people seem to have utterly lost their minds. I am genuinely sad for people buying at those super-inflated prices.

  4. BCGuy Says:

    Yeah BC is completely wacko right now. ALL OF BC! Even the Kootenays, the Interior, The Caribour, Nothern BC….just madness.

    I know hundreds of people who’ve lost jobs in Alberta who own homes in BC and are either not working or have taken a 50 percent+ pay cut. That has to start affecting things.

    Last year nationally we lost $50.5 Billion from the drop in oil, and this year will be even worse. Vancouver keeps soaring though….pushing up prices in the surrounding area and spreading across the province like a wave…

    Hopefully we see a 1-2 percent rise in interest rates so that we can really tell who can and cannot ACTUALLY afford their house.

    The madness continues..