Your Investment Committee Might Suck At Making Good Decisions, And You Probably Don’t Even Realise It
The investment committee is a staple of the real estate world. A group of professionals, many with decades of experience, come together to debate and analyse what to buy or sell. It’s the perfect forum for making the best decisions for an investor, right?
Probably not, according to a research paper from the UK Investment Property Forum released last month. Groupthink, a lack of ability to raise a dissenting voice, everyone just agreeing with the boss, not looking at how things might go wrong and mistaking good luck for good decisions are all traps the average investment committee can fall into. The key is to examine the way decisions are taken, not just the decisions themselves.
The paper, Mitigating Behavioural Influences On Decision Making Within The Property Investment Process, takes as its basis the discipline of behavioural psychology, and the common mistakes people make when making decisions of all types, like overconfidence, an inability to accurately predict the probability that something will go well or badly, and looking for evidence that confirms what you already believe.
It then looked at how these might play out in the world of property investment. It said that real estate as a sector is particularly prone to these mistakes: Unlike financial sectors like bonds or equities, every commercial property is different, which makes it hard to create an algorithm to tell you which assets to buy. More people are making decisions in the real estate investment process, meaning there is more chance for psychological biases to come into play.
And the arena in which a lot of these mistakes can play out is the investment committee, the body set up to avoid making stupid mistakes. Here are some of the key things to look out for and mitigate against, according to the paper’s authors.
Which Deals Are You Examining?
The paper said how the deals being examined by an investment committee are screened, and who does the screening, can have a big impact, even before a single deal is discussed. Are you sure that you have done a thorough search of all the properties you might buy? If not, you might have the false assumption that potential deals are scarce, and so attribute a higher value to the deals you do examine. An extension of this is the fact that the more people are involved in the screening of potential deals, the more chance there is of someone in a wider group contributing a piece of knowledge that only they have.
Have You Got A Checklist?
Checklists are a big thing in behavioural psychology. Human beings tend to put way too much faith in gut instinct and the experience of senior professionals, which myriad studies show is not nearly as effective as having a checklist of everything you need to do before taking a decision or undertaking an action. The airline industry is great at this, and it has helped reduce accidents dramatically. The medical profession is just starting to do this, and where surgeons have started using checklists before operations, fatalities and accidents have dropped dramatically.
When it comes to the admittedly less life-or-death matter of property investment, having a checklist of what characteristics you need from an investment can avoid falling into the trap of going with something that feels like a good deal.
Who’s On The Committee?
The people who make up the investment committee might be experienced, intelligent real estate professionals, but are they good at making rational decisions? Intelligence and rationality are correlated, but they are not the same thing, the paper points out. Organisations can test whether committee members are good at making rational decisions and avoiding the pitfalls the paper outlines. Also, four to six people on the committee is optimum, according to the IPF — any more and people can zone out.
Dissent: It’s A Good Thing
A lot of the suggestions made by the paper centre around one thing: Committees of all kinds are pretty terrible at encouraging dissenting views, which means that groupthink and mistakes can become commonplace. This can take various forms, but the paper has advice on mitigating the effects.
Firstly, it is important to think about how the purpose of the investment committee is framed. Is it just to approve decisions that have essentially already been made, or is it to genuinely dissect and examine which investments should be made?
Have outside views been sought, from different divisions within the firm, such as a research department, or even from sources outside the firm? Outside views are vital to avoiding groupthink or to present alternative arguments so that every decision isn’t viewed through the lens of the past experience of those on the committee. It is very hard for humans to envisage things going differently in the future to how they have gone in the past.
The paper gives the example of the committees set up by the Kennedy administration during the Cuban missile crisis of the 1960s. Outsiders were constantly brought in to examine and critique the views of the committees advising the president, in order to properly challenge their conclusions.
Bringing outsiders into commercially sensitive discussions might not always be viable, in which case, it can help to appoint someone as a designated devil’s advocate ahead of a decision, with the specific role of challenging why an investment is being made and trying to come up with reasons not to do a deal. It is hard for individuals in a group scenario to stand up and air a dissenting view, so rotating who plays this role is important, to avoid one individual being marginalised and becoming unpopular. Allowing people to air their views in separate one-on-one sessions can also be useful, so that dissent can be expressed privately.
Who’s In Charge?
You may have a problem with the boss. In any committee situation there is always a senior executive, and if that senior executive takes too dominant a role, the entire committee can descend into simply ratifying the decision the leader has made. Chairs of committees or the most senior figure need to check themselves to make sure they are not dominating and must actively encourage everyone in a group to speak. Citing the way the Cuban missile crisis was handled, the IPF paper pointed out that Kennedy would often remove himself from meetings to ensure he was not unduly influencing the debate that was occurring.
Human beings have a proclivity to imagine the decisions they have taken going well, and when constructing an argument, look for evidence to support decisions they have already made. Conducting a premortem can mitigate against this. It involves envisaging a scenario where an investment hasn’t worked out and trying to understand why that might be. Key point: The premortem can’t be allowed to say that things went wrong because “the market moved against us.” When things go wrong people too often say it is bad luck, and when they go right it was a good decision.
Know When To Quit
One of the most well-known behavioural mistakes goes by the common name of the sunk cost fallacy. During the process of analysing and pursuing an investment, the individuals will have put a lot of time, energy, emotion and money into a deal, making it harder to walk away, and possibly leading to professionals putting a higher price on an asset than it deserves. A good way to avoid this is to decide ahead of time a point or a price at which you are going to quit, i.e. stop pursuing an investment. That takes the emotion out of the decision, although of course sticking to that decision to quit will involve in itself a lot of discipline.