Simple, not easy: how real estate investors can avoid their own worst enemy

“The real secret to investing is that there is no secret to investing.”

So states Seth Klarman in his preface to the 7th Edition of Graham and Dodd’s Securities Analysis, the value investors’ bible.

And he is right.

The tools used to assess the intrinsic value of most conventional investments are known and well understood. Estimates of value can then be compared with the current price to find buying and selling opportunities.

Why do prices diverge from value?

Because investors are human. Human nature guarantees that from time to time, prices will deviate from value.

People react emotionally to market movements. We get greedy. We get fearful.

And people are susceptible to biases, such as confirmation, overconfidence, recency, and availability biases. We are swayed by stories, not data. In the human mind, strong narratives overpower robust statistics.

The tricky part is capitalizing on the consequences of human frailties rather than succumbing to them. This is not easy.

Successful value investors do this by building an investment process and culture that instills patience and discipline, nurtures healthy, informed debate among people with diverse perspectives, and lessens the influence of emotion in decision-making.

Importantly, as Seth Klarman writes, “The best investors focus on process rather than outcomes, because they know that good process eventually leads to better outcomes, while good outcomes are not necessarily reflective of good process and could reflect mere luck, not skill.”

So what does it take to build the right process in commercial real estate?

1. Embed data-driven guardrails

A data-centric approach promotes objectivity and provides guardrails against the pitfalls investors can make through the cycle.

Establish your investment criteria before you start looking at deals. Set explicit thresholds such as required risk-adjusted returns and maximum levels of downside risk exposure. Make them binding.

Why before? Because once you’re evaluating an attractive opportunity, rational analysis becomes much harder as momentum behind a deal builds. So get the statistics into the process first.

2. Give your research teams room to challenge

Who in your organization is asking the hard questions when deal enthusiasm runs high? Research and analysis teams play an essential role. These teams often bring an alternative perspective to investment decisions.

They have different compensation incentives and career goals than acquisition and fund management teams. They can afford to be skeptical. They can afford to provide thoughtful challenge.

This positioning allows them to keep a keen eye on long-term investment performance and help ensure discipline is maintained through the cycle.

3. Design for the long-term, even when markets reward the short-term

Market cycles create powerful pressures to react, to chase performance, to follow what’s working now. Without disciplined long-term thinking, investment portfolios tend to follow the whims of fashion.

The solution requires conscious organizational design. Set performance measurement horizons that match your actual investment time frames. Build processes that resist reactive decision-making based on quarterly noise. Create governance structures that give investment teams permission to underperform in the short run if the long-term thesis remains intact.

Few investors manage this well, which is precisely why it matters.

The discipline difference

The challenge—and the opportunity—lies in building processes and culture that allow you to use those tools consistently, even when human nature pulls you in the other direction.

The principles are simple. Executing them consistently through market cycles? Not easy.

A version of this article originally appeared in The Property Chronicle. To read other articles I have written for The Property Chronicle, please click here.