What happens to values as the level of perceived risk increases?

As the level of perceived risk increases, values typically decrease and expected returns increase. This relationship can be understood through the lens of investor behavior and market dynamics. When investors perceive higher risks associated with an investment, they tend to demand a higher potential return to compensate for that risk.

A common principle in finance and real estate is that risk and return are directly related; the greater the risk faced by an investor, the higher the required return to incentivize them to take on that risk. Therefore, as perceived risk rises, property values often fall because buyers are less willing to pay high prices if they expect potential uncertainties or negative outcomes. Consequently, expected returns must rise to attract investors back into the market.

In contrast, values remaining stable would imply that investors are not reacting to perceived risk, which is unlikely in a dynamic market. If values were to increase while perceived risk rises, it would signify a disconnect from rational investment principles, as higher risk usually leads to lower demand at current price levels. Fluctuating unpredictably does not capture the systematic nature of market reactions to perceived risk. Thus, the relationship between decreasing values and increasing expected returns accurately reflects investor psychology and marketplace behavior in the face of heightened risk.