8/11/2019 Asset price inflation in real estate a rational collective action problem?

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History tends to view a run up in assetprices as irrational bubbles, produced byillogical investors acting on psychologicalmotivations, named animal spirits byKeynes. In real estate a rapid rise in assetprices can be viewed as a rational

collective action problem, much like thetragedy of the commons or the paradox of thrift , and not the result of irrationalinvestments.

History

JLL Asset price inflation in real estate a

rational collective action problem?

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The question of asset pricing and whether bubbles which can be defined as irrational price changes can and do exist is at the forefront of public debatefollowing the unusual monetary conditions that haveoccurred since the global financial crisis. For realestate an irrational price change would be a capitalvalue rise in excess of the commensurate incomestream rise- in short excessive yieldcompression. Shifts in real estate asset prices arethe result of cumulative actions of rational investoractions, even if the final result may look irrational.

Irrational Price Changes

JLL Asset price inflation in real estate a rational collective action problem?

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Tuplipmania is usually cited as the classicbubble based on irrational behaviour. The Economist ran an excellent article inOctober 13 on the Dutch tulip bulb bubbleof 1637. This article which is based on aseries of academic papers suggests thatinvestors in the tulip bubble were actingrationally and that there was no mania causing investors to act irrationally.

Tuplipmania

JLL Asset price inflation in real estate a

rational collective action problem?

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This response can also be observed in the realestate market where shifts in rules or shifts indemand result in a sharp change in pricing.Real estate as an asset class comes in largelot sizes and is in general less liquid than, forexample equity, bond or foreign exchange

markets. This means that shifts in asset pricesare more likely to be based on rational criteriacompared frequently traded assets such asshares in a particular company.

Real Estate Market

JLL Asset price inflation in real estate a

rational collective action problem?

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The resolution of such a collective actionproblem is first to gain agreement from theparties that their individual maximisation of value does not produce the optimal outcomefor society, and second agree what measuresneed to be put in place to ensure

cooperation. In the tragedy of the commons,formal rules are put in place to conservestocks or to implement private propertyrights.

Resolution

JLL Asset price inflation in real estate a

rational collective action problem?

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Solving other collective action problems is not as easy.Following the GFC, to prevent a collapse of aggregatedemand the G 20 governments agreed to implementstimulus packages and ultra-low interest rates to keepdemand above a point where economies could spiraldownward into deflation. The steps taken were thesolution to a paradox of thrift problem and in turn havecreated another collective action problem. Monetaryconditions aimed at easing the paradox of thrift, havecreated conditions where real estate asset prices haveheld up; the result of a series of rational decisions- notirrational investment sentiment.

GFC

JLL Asset price inflation in real estate a rational collective action problem?

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