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When Israeli-born, Princeton University professor, Dr. Daniel Kahneman was awarded the Nobel Memorial Prize in Economic Sciences in 2002, it set the field abuzz.  

Kahneman was not an economist, but an academic, working in the field of psychology, studying human behavior in his lab, with research partner Amos Tversky. Kahneman’s paper, How Investor Decision Making Effects Market Pricing, introduced the concept of Prospect Theory, and countered the accepted economic belief that investors – as human beings - made rational decisions, driven by self-interest.

Investors today face a rising tide of market data and information that threatens their capacity to make sound decisions. Even when presented with prudent investment options, the proper path can appear cluttered, but by applying the concept of behavioral economics, commercial real estate investors can make smarter choices.

The groundbreaking work by Kahneman applied psychological insights to economic theory, examining human judgement and decision-making under uncertainty.

Kahneman postulated that people made decisions influenced by anomalies, those experiences, aversions, and biases that can sway choice—depending upon how a situation is framed.  

Prospect Theory maintains that investors value gains versus perceived losses. The probability of gain is perceived as greater, given that both choices presented are equal.

Behavioral economics has informed investing strategy over the last two decades since Kahneman received his recognition. Financial professionals now consider human behavior in their approach to financial planning, portfolio allocation, and assessing a client’s risk aversion.

Prospect Theory maintains that investors value gains versus perceived losses. The probability of gain is perceived as greater, given that both choices presented are equal.

Relating Behavioral Economics to Real Estate Investing

How can the theory of behavioral economics translate from choosing stocks and bonds to something more concrete, like commercial real estate?

The real estate markets share many of the same psychological biases as the regular financial markets and have the potential to magnify the capability for suboptimal decisions. These irrational behaviors can be even more prevalent in decisions under stress, sometimes caused by inefficiencies in markets and less liquid investments.

Joe Hart, RealSource Properties’ Director of Capital Markets, an expert in the field, addresses that question. Hart uses behavioral economic modalities in his role at RealSource, which invests in multifamily properties across the United States, and has recently launched a multifamily REIT.  

He also used these principles to navigate his way through one of the most famous aviation accidents in the last quarter century.

Hart is a survivor of 2009’s “Miracle on the Hudson,” Captain Chesley “Sully” Sullenberger’s astounding river landing of US Airways flight 1549 that saved all on board and was splashed across front pages around the globe. 

A Lightbulb Moment Over 30 Years Ago on Asset Allocation

Hart explains that early in his career, decades before this watershed moment, he became intrigued by decision-making, and the effect of human behavior on investing performance.

The proverbial lightbulb lit when Hart came across an abstract for an updated analysis written in 1991 by Gary Brinson, Randolph Hood, and Gilbert Beebower (collectively known as BHB) to a study five years earlier, Determinants of Portfolio Performance II: An Update.

This seminal paper challenged the conventional wisdom that asset allocation accounts for 90% or more of investment performance. It flew in the face of the belief that security selection was both an art and science.

Many readers of BHB erroneously interpreted the study to say that “individual stock selection and market timing accounted for less than 7% of a diversified portfolio’s return.” (Brinson, 1991) The study went viral and was soon referenced in many sales decks and pitches across the industry.

“That was my wake-up moment, quite frankly,” Hart contends. “After reviewing the paper, I discovered flaws in the study’s interpretation, but still it resonated strongly.”

...every industry conference seemed to feature behavioral finance as a prominent topic, and it became the millennium “Talk On the Street.” Hart was hooked and has become a staunch advocate of the investment approach. He uses his knowledge to teach others about asset allocation and the motivation behind decision-making.

In the early 80s, after discovering and reading a copy of Psychology of Investment by John Nofsinger, another light bulb went off.” Hart explains, “This book answered all of my questions as to why the average investor doesn't outperform the markets.”

Hart also noticed that as time went on, every industry conference seemed to feature behavioral finance as a prominent topic, and it became the millennium “Talk On the Street.” Hart was hooked and has become a staunch advocate of the investment approach. He uses his knowledge to teach others about asset allocation and the motivation behind decision-making.

Hart maintains that the term behavioral finance, often interchangeable with behavioral economics, is just a particular handle ascribed to economic decisions, but it can translate to broader decision-making. “To understand why human beings, make decisions, you have to understand how the brain processes information,” he states.

Psychologists hold that decision-making is informed by a collection of synaptic tools that allow our brain to consider certain factors to make quick decisions.

We commonly draw on experience, subconsciously or consciously factor in our cognitive biases—where our brains form vivid scenarios—and assess probability weighting.

Our brains naturally use heuristics, which are mental short-cuts described as “Rule of Thumb” reasoning that can produce a “good enough calculation” to decide on the fly. By understanding how the brain thinks—whether fast, intuitive and emotional or deliberative, logical and slow, we can gain insight and make better decisions for our personal lives and financial portfolio.

Behavioral Economics And Commercial Real Estate Investing

How can behavioral economics help a commercial real estate investor choose assets and make decisions that aren’t influenced by cognitive biases or skewed decision-making that can possibly lead to bad choices? Hart explains that the human brain processes information in essentially the same manner for everyone. The brain absorbs data and renders with a bias toward either positivity or negativity.

Why does the brain behave in such a way? Certain researchers hypothesize that positivity bias is present in those able to shift mental effort toward goals and away from distractions. This tendency may also be referred to as the Pollyanna Principle. However, more often than not, our brains are wired to pick up existential threats and give weight to negative experiences or interactions. It is woven into our human survival defense mechanism.

Hart’s firm, RealSource Properties, understands that data and facts are essential to make decisions that are not influenced by assumption, bias or emotion. The firm relies on an econometrics-driven model that looks at over 160 due diligence points before acquiring a property.

The company evaluates 40 subcategories when making a purchasing decision, including a state’s GDP, migration, income, metropolitan statistics, and more. Significant development of this model over time allows for in-depth comparison over broad periods, markets, submarkets and regions.

RealSource Properties has turned its focus to secondary markets and seeks value-add assets that can create steady cash flow from rents and invests in regions that have demonstrated continued growth potential.

Hart confirms that to make impactful real estate investment decisions it is important to avoid heavy emotional attachment. These can cause an investor to price a property unrealistically and set an anchor that is not tied to market fundamentals.

Anchoring is one of four types of heuristics that are used when uncertainties arise. An example of anchoring effects can be seen at the auction house, where a work of art’s reserve price may be set at an unrealistic benchmark limit that skews decision-making.

Hart also points to overconfidence bias, which in simple terms is a tendency for a person to overestimate their abilities. This can lead to risky investment behavior, which can be detrimental. So how do these principles translate to real life where judgement and decision-making can impact your well-being and survival?


miracleonthehudsonCredit: - article January 15, 2009

Hart’s Personal Experience with The Miracle on the Hudson

Hart shares the harrowing tale of his experience on US Airways flight 1549, one basically sunny, raw day in mid-January 2009. The airplane, an Airbus A320 EOW, departed LaGuardia Airport in New York City at 3:25 in the afternoon destined for Charlotte, North Carolina, Hart’s hometown.  

Two minutes into the flight, the aircraft struck a flock of Canadian geese, severely damaging the engines, causing them to lose thrust. Hart was one of 150 passengers and five crew members who found themselves faced with a series of split-second decisions, as the plane quickly descended and improbably landed safely in the Hudson River.  

He recalls, “All I could think about was my kids and how frightened they were eight years prior during 9/11. Coincidentally, I was also on a plane during those terrorist attacks. My plane, departed from Charlotte that morning, ascended, then abruptly banked and was directed to land at the airport by traffic control. We were grounded as events unfolded in New York, Washington and Pennsylvania. I was not able to contact my kids right away, and their school called me on my cell later in the day to ensure I was safe. My kids thought I was somehow caught up in the attack and were badly scared.” 

Hart shares how that vivid scenario played in his mind on Sully’s flight. “I remember framing my current experience through that memory. I recall deliberately grabbing my cell phone wedged in my seat back pocket, and made my way out onto the bobbing wing of the plane. I witnessed passengers jumping into the water, and I thought to myself, ‘Oh no, that is not an option.’ I couldn’t risk getting my phone wet!”

Among other decision-making tools at his disposal, Hart’s understanding of bounded rationality, a behavioral economic principle, enabled him to take a complex situation, a plane crash, and simplify his decisions into manageable actions.

The Mysterious Human Mind and Evolving Behavioral Economics

Behavioral economics as a field continues to evolve, as more is comprehended about the brain, and includes nuanced factors not previously considered. 

Understanding behavioral economics basic framework can help investors make clear judgements and weigh meaningful information accurately to reduce uncertainty. Reframing techniques that shift a point of reference can help an investor think about things differently to make better decisions.

These techniques can extend to one’s personal and professional life and build a successful investment strategy for a more secure future.

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• There is no guarantee that any strategy will be successful or achieve investment objectives including, among other things, profits, distributions, tax benefits, exit strategy, etc.;
• Potential for property value loss – All real estate investments have the potential to lose value during the life of the investments;
• Change of tax status – The income stream and depreciation schedule for any investment property may affect the property owner’s income bracket and/or tax status. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities;
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• Illiquidity – These assets are commonly offered through private placement offerings and are illiquid securities. Because 1031 exchanges are commonly offered through private placement offerings and are illiquid securities. There is no secondary market for these investments.
•Reduction or Elimination of Monthly Cash Flow Distributions – Like any investment in real estate, if a property unexpectedly loses tenants or sustains substantial damage, there is potential for suspension of cash flow distributions;
• Impact of fees/expenses – Costs associated with the transaction may impact investors’ returns and may outweigh the tax benefits
• Stated tax benefits – Any stated tax benefits are not guaranteed and are subject to changes in the tax code. Speak to your tax professional prior to investing.

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