Commercial Real Estate Investors – Could You Have Investing Biases, Too?
In a FlexShares Advisor Wellness Index Survey that was completed in December 2017, the survey results found certain biases with investors. If such biases are found with these investors perhaps similar biases could hold reasonably true for commercial real estate investors that we have worked with for decades. Let’s take a look and compare these same biases to a sampling of commercial real estate investors from our experience perspective.
BIAS FINDING #1 – RECENT EVENTS REMEMBERED
“People tend to overemphasize the importance of recent events and believe they are more likely to recur simply because they are readily remembered. This can cause investors to chase recent returns, rather than focusing on their long-term goals.”
Our Observation in Comparison – Different. Events do seem to factor in and of course not all investors are alike. Not unlike the concept of - is the glass half full or half empty – mindset. We do not so much see however that long-term goals are not focused on. But current pricing of an asset and what a buyer can make on it by acquiring it at ‘right price’ is terribly key as there are no guarantees as to the future for the real estate investor.
BIAS FINDING #2 – CONTROL BELIEF BY THE INVESTOR
“Investors might overestimate their ability to control or influence events or outcomes. For example, investors exhibit this bias when they believe they can consistently time markets or pick the best investment funds.”
Our Observation in Comparison – Different. Most buyers in commercial real estate that we have worked with over the decades tend to be more cautious and see the limitations or opportunities the real estate market affords them. The real estate cycle is seen by many in the business as having peaked as of this writing. We see sellers seeking to sell when for many assets in certain markets, type and lease-terms should have been ‘marketed’ before now. Depending upon the asset and the seller, a notable number of sellers do not see that their ‘ask price’ could potentially limit a buyer from making a gain upon the buyer’s exit. To borrow a favorite saying by Guterman Partners – “You make your money on the day you buy – never on the day you sell. You collect your money on the day you sell.” Buyer’s today need the value-add or upside pricing factor should they buy at the peak of the real estate cycle so that the buyer’s going in price has room to gain over the course of the buyer’s holding period. BIAS FINDING #3 - LOSS AVERSION vs GAIN POTENTIAL
“Investors tend to prefer avoiding losses more than acquiring gains. As a result, they often fear short-term negative returns caused by volatility even when, over the long term, the expected return is positive. This can cause a misalignment between the portfolio and an investor's true risk tolerance, or result in costly market timing.”
Our Observation in Comparison – Somewhat Different. The underwriting of an asset is the foundation of valuation for a buyer. For the developer, their risk can be seen differently than for one buying an office property with a diversified tenant mix. Thus real estate developers do tend to prefer avoiding losses especially at the front end of their project. If their ‘lift-off’ is weak with cost overruns or if they miss the ‘market’ it can represent extreme losses from which they may never regain.
BIAS FINDING #4 – COMFORT WITH THE FAMILIAR
“People tend to favor the familiar over the unfamiliar. They may prefer stock from companies they're familiar with, rather than those they haven't heard of, regardless of projected performance or value. Familiarity bias also can lead to a home bias, for example, when investors prefer to invest in companies domiciled in their home country, even though doing so may produce inferior results to those they might obtain by diversifying globally.”
Our Observation in Comparison – Same or Similar. The commercial real estate investor gets comfortable with certain geo locations not unlike an investor who is familiar with a certain ‘company’. We frequently see investors miss great opportunities in other geo locations. These investors whose ‘comfort’ is with for example - New York, Los Angeles, Chicago, and Seattle – miss better opportunities than may exist in these areas by staying out of secondary and in some cases tertiary markets which may have better demographics with economic supportive factors that can positively impact the valuation of an asset whereby affording better returns. We have however in the last 12 to 18 months witnessed an investor movement by those type primary market buyers into the other markets for better returns at higher cap rates. We are happy to say – “Well it’s about time.”
BIAS FINDING #5 – RISK JUSTIFICATION FOR INHERITED VS EARNED
“Mental accounting is the tendency to separate assets into “sub accounts” or groups. For instance, an investor may feel he or she can take more risk with inherited money than with earned money. This can interfere with optimal asset allocation and hurt performance.”
Our Observation in Comparison – Not Sure. We cannot say with certainty regarding this particular bias. Several years ago we recall a study that had been done by a family office group that family wealth declined the further the number of generations moved away from the generation that had originally accumulated the “great’ wealth. Unfortunately as of this writing were unable to locate this study to speak on it with confidence. In our business of commercial real estate investing we do not have a method in which to measure this information to know if the ‘risk justification on funds for inherited vs earned’ is a common denominator. We therefore will humbly pass on this bias.
After our Team reviewed and discussed these biases, we agreed that this was a valued exercise for us. Knowing these potential biases may exist and then some, perhaps we will serve our clients better next time around by asking the better qualifying questions.
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