You may be asking, “What is uncertainty in real estate investing, and how is it different from risk?” Knowing the difference is simple. Understanding it will change the way you invest.
Risk can be measured, uncertainty cannot.
For example, the probability of a fire is quantifiable. You can look it up in a table of statistics. You can insure for it. You can reduce it. If you make sure your smoke alarms have fresh batteries and you have the right insurance, then the risk of fire, along with the losses, can be managed.
We’re told that we can protect against the risks. And with a little research on Google, and a good property manager, we can. But that’s only half the story. Risk’s evil twin is left out. In fact, he’s never mentioned.
Uncertainty is that which cannot be accounted for. It includes the entirely new (where the past no longer applies), and the events that are rare, high impact, and hard to predict, like a black swan. Let’s say the city decides to improve the property standards for better fire prevention. Now your building is no longer to code and it`s going to cost you thousands. You couldn’t have known before you purchased your property.
So what can you do?
Realize that you don’t, and can’t, know everything. All the models and statistics in the world can’t save you from uncertainty. And thinking that the next great formula will is a mistake.
Some people are thrilled when they learn about Discounted Cash Flow Analysis. It seems to be a sure fire way to riches. But these models are simplistic reductions of complicated systems. They make assumptions, many of which are uncertain (future interest, reinvestment rates, cash flows). As an investor, you have to resist the ludic fallacy. The temptation to believe your representation is reality.
I think that Kenneth Griffin, founder of the Citadel Investment Group, put it best in The Ascent of Money documentary when he said “Nothing is constant. Nothing is the way it’s always been. So what I find is that people who are really good at this have great intuition. They have great instincts. Their gut actually tells them something. The mathematics are important because they demonstrate that you understand the problem. But ultimately, the decision about whether or not to take a given risk, I think, is really a human judgement call in every sense of the word.”
Understanding uncertainty will change the way you think about real estate investing. Instead of focusing solely on the numbers, you’ll begin to focus on your intuition.
Faced with uncertainty, your unconscious mind synthesizes knowledge and context to make a judgement call. It fills in the gaps that the models leave behind. The more experience and knowledge you have, the better your judgements will be.
So trust your intuition. Let it grow. And in time, you too will develop what all top investors have: Great Instincts.
Hamilton Property Management Company - Del Franco Inc.