Successful investing in private real estate takes more than deep pockets. Market expertise to underwrite properties and management experience to execute profitable business plans are critical too. Yet human traits can lead even the best private investors astray. Behavioral economics, the study of financial decision-making psychology, bares the subconscious biases that trigger real estate investment mistakes.
I studied behavioral economics as a graduate student at the University of Chicago under Nobel prize-winning economist Richard Thaler, whose central insight is that even a small intervention can lead to better outcomes. When applied to private equity real estate investing, Thaler’s research suggests investors should have a strict, methodical assessment process in place — an evidence-based framework to evaluate investments and control for hidden biases. That is how we work as private equity real estate managers at Origin Investments.
Seven steps, inspired by my knowledge of behavioral economics, can help a private investor avoid common real estate investment mistakes:
1. Manage your portfolio before it manages you.
Studies show humans are wired to be lazy. So don’t underestimate the desire to skip the due diligence process. Follow a plan to avoid bad property purchasing decisions and a schedule for reviewing your holdings. Hold assets for the long term, but don’t neglect them due to inertia. Also, don’t let adverse events prompt you to act rashly. When markets turn volatile, you should be comfortable enough with your decisions to not to follow the crowd and sell.
2. Choose a broad mix of real estate investments.
People are comfortable with things they know, a behavior that is known as familiarity bias. Choosing investments is similar to gambling in that it is decision making in the face of risk, and experiments show that people make gambling decisions based on the familiar — even when they have lower odds of winning.
Don’t let familiarity limit your private equity real estate choices, or increase your risk of pouring too many resources into too few deals. Instead, consider taking on partners to invest smaller amounts in more deals. Or include different types of properties in the mix, based in different geographic locations. Real estate funds can also deliver a diverse portfolio of assets with different risk profiles, while minimizing the overall risk posed by…