I think my becoming a plain old Philosopher – in addition to being The Real Estate Philosopher has resulted in a realization about long-term real estate outperformance that I wish I had figured out many years ago. Let me explain….
Generally – my biggest epiphany among many – is as Socrates said 2,500 years ago:
I am the wisest man in Athens (New York) since I know just one thing – which is that I don’t know anything.
This may sound like philosophical blather but it is not. It is the key to everything, as far as I can tell.
The reason is that my acknowledging that I know nothing is the first step towards realizing that my decision-making is a lot worse than I think. John Jennings refers to this as Knowledge Bias in his book, The Uncertainty Solution, which I recently touted in a prior article.
This bias occurs when you think you know much more than you really do about something, which can throw your decision-making off. Sorry, men, but we tend to suffer from this a lot more than women.
Brilliant and famous people like Kahneman and Twersky—in their book, Thinking Fast and Slow -- and Kahneman in his later book – Noise -- so cast dramatic doubt on our ability to make decisions and predictions with as much accuracy as we assume.
Now, you may have stopped reading by now – or maybe thinking that this doesn’t apply to you, but consider this:
- Did you predict that Detroit would be one of the hottest real estate markets in the U.S. this year?
- Did you predict the Austin Aura would turn into a bust this year?
- Did you predict that San Francisco – the coolest and hottest market in the US a few years ago – would descend into (almost) a Doom Loop?
- Or that steady-Eddie St. Louis would have its downtown descend into a disaster zone?.
- Or—for asset classes—that office would be left for dead now, industrial would stay hot and just get hotter for so long, retail formerly left for dead would be hot again, or multifamily would go from super hot to not hot at all with dramatic speed due to interest rates rising.
- Did you predict anything at all about interest rates? That they would rise when they fell and the converse. And what are you predicting now?
- Or did you think that today, many equity players would morph from equity players to a focus on high-yield debt?
I could go on and on and on and on but I assume you get my (simple) point, which is that Socrates was right – the only thing we can really be sure about is that we know nothing at all.
But this is hard to internalize as our brains lead us so far astray. This is because we also fall for what is known as confirmation bias. In a nutshell, this is that (old guy) who has done the exact same real estate investment forever and made a fortune. You might think he is a genius, but equally likely, he invested at the right time in history or in a market with demographics that went the right way for a long time. Note – as an aside – Warren Buffett’s reference to what he calls the “Ovarian Lottery.”
Okay – I have made my point. And let’s say you don’t think I am crazy. But what is the meaning of all of this? Is The Real Estate Philosopher saying just give up because it is all random?
Absolutely not!
What would a rational real estate player do if he knew the game was more random than he thought? I would suggest the following:
Diversify in every way possible, including: (i) geographically (including gateway cities, up-and-coming cities, shitty cities (sorry to say it that way), suburbs, and boondocks), (ii) where you are in the capital stack from super safe, to moderately safe, to high risk, (iii) across debt and equity, (iv) across asset classes, and (v) in whatever other way you can think of
Ignore macro concepts like elections, politics, wars, predicting interest rates, and things you simply cannot control or predict. Yes, you can predict that exogenous events will happen, but since you cannot predict when, where, or how, it is logical to ignore them. Also, everyone knows about the existing exogenous events—such as the upcoming election—so your assessment will not permit outperformance.
Stack the odds in your favor as logically as you can from a negative perspective; namely, instead of looking for how you could win, fortify against losses. This would include things like:
- Avoiding sleazy and dishonest players
- Avoiding deals where the sponsor has no skin in the game or no expertise
Make sure you never lose your stake by being too at-risk in one location, asset class, or with too much leverage, etc.
Gamble now and then. Yes – gamble – when the risk/reward is in your favor. For example, I don’t advocate a situation where you could double your money or lose half. But how about if you have a 50/50 chance of making 10X on the upside or losing it all on the downside? If the risk/reward is favorable, that might be advisable now and then as long as you don’t wager a significant portion of your stake. Nicholas Taleb (sort of) advocates this with his ‘barbell strategy.”.
Will doing the foregoing be cool and sexy? Absolutely not! You will be jealous of the guy who puts all his eggs into Atlanta before Atlanta booms and becomes a billionaire. But you also won’t be the guy who had all his eggs in office just before office crashed, either.
To conclude this article, I am becoming increasingly confident that the only sure way to outperform on a long-term basis is to diversify real estate investments along the lines I advocate.
I suspect there are holes in my analysis that I cannot see – and if I really espouse knowing anything, I am sure that Socrates will upbraid me. But I do entreat readers to let me know if I am missing something. If so, I will include those thoughts in my next article.
I wish everyone the best of success.
Bruce Stachenfeld aka The Real Estate Philosopher®