Two inconvenient truths are fundamental to the relationship between fund investors and asset/fund managers in real estate investing. They are straightforward and well-understood, but they are problematic.
When real estate investments are performing strongly, it is possible to let their significance and implications slip to the back of our minds.
But now that the long boom in real estate performance is over, we are relearning the importance of these two inconvenient truths.
- Past performance is not a good indicator of future performance
This must be one of the most written sentences in investment documents, but its meaning fails to penetrate our thinking.
We have an innate tendency to believe current trends will continue. Joe Wiggins describes extrapolation as “a convenient mental shortcut” and “psychologically comfortable”.
People do it in walks of life. In sports, for example, people often emphasise the importance of momentum.
In soccer, commentators and fans commonly describe teams that have recently won their games as “on a roll”. They assess their chances of winning their next match as higher. In contrast, they describe teams on a losing streak as “in a rut” and view them as more likely to continue losing.
However, a study of over 80,000 English league games found no evidence that sequences of consecutive wins generated a positive momentum effect. If anything, the effect was negative.
In sports, the apparent value of momentum is often a trick of the mind.
We imbue momentum with significance to impose cause and effect on a world where randomness plays a significant role. Humans are natural storytellers; developing narratives is easier for most of us than statistical reasoning.
But luck plays a significant role in determining the outcome of sports events and the same is true in investing.
