Don’t Just Lose the Gut, Don’t Trust It Either

“Khaneman and Tversky are more responsible than anybody for the

powerful trend to mistrust human intuition and defer to algorithms.”

The thought of distrusting ourselves at all costs is a very uneasy one for most of us, because so often we have been told by our parents, mentors, and partners to “trust our gut feeling.” However, time and time again, the research over the last few decades has illustrated that an algorithm, a well laid out set of rules for decision making, will beat an even an expert’s judgement over 80% percent of the time. What does that say for anyone’s “gut” level of discernment when it comes to financial investment decisions?

Recently one of my favorite authors, Michael Lewis, released The Undoing Project. Lewis is well known for colorfully telling great stories in books such as Money Ball, Liars Poker, and The Big Short which was recently made into a very successful movie. The Undoing Project is another fantastic story of two exceptional individuals, Danny Kahneman and Amos Tversky, who looked at the world a bit differently, and had the compulsion to question conventional psychology and economics, which led to the creation of the new field of behavioral economics and decision theory.

Given my chosen field is commercial real estate, I wanted to try and develop an algorithm, a set of rules, that would drive a successful investment philosophy and minimize loss of capital by identifying values that are important to maximizing long term capital growth and stability.

Below are 11 simple questions that when answered “YES” provide a path to minimizing capital loss and lead to capital growth and stability. While all the information to answer the questions below may not publically available, by working with a good local broker you can obtain the information necessary to answer each one truthfully and without interference from your “gut’s” biases.

1.     Is value greater than price?

2.     Is price less than 80% of replacement cost?

3.     Are actual occupancy costs less than market lease costs?

4.     Does new construction in the area exceed the absorption rate for vacant space?

5.     Are there affordable housing options available for all employees within a 1 hour commute at peak traffic times?

6.     Are there affordable dining and entertainment options for employees within a 10 minute commute?

7.     Is the maximum developable area greater than the actual developed building area?

8.     Is the actual vacancy greater than market vacancy?

9.     Will prevailing financing options would allow for at least 1.3 debt service ratio on existing income?

10.  Is the loan constant less than the CAP rate?

11.  If any one single tenant vacated, while the others remained, would the debt service ratio still be above 1.0 for the prevailing financing options?

A local broker will also be able to aid in the further investigation which is always required to properly assess an investment opportunity and verify there are no unforeseen or undisclosed issues due to zoning, functional obsolescence, contamination, or other more detailed issues that should influence the decision-making process.

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