Real estate is a slow moving industry. It can take many months or years for the effects of your decisions to become visible. Early activities like establishing an investment thesis, raising capital, asset selection, and acquisition alone may span several months to years. Once in your portfolio, it may take years still for a project to demonstrate a direction. Worse still, an exogenous shock may emerge and derail your objectives.
Collectively, these constraints affect how one thinks and makes decisions. This isn't a treatise on behavior or psychology in investment decisions. Rather, this is a discussion of anecdotes from past personal experiences.
Opportunity Cost
Of all the general partners I've met in my career, I've never encountered someone who has blown up a fund by sitting on the sidelines. While hesitation isn't a trait that's often rewarded, impulsivity is one that's certainly punished.
When we're on the up leg of a transaction, we have unlimited discretion. We can choose to buy; we can choose to wait. We can choose to buy this; we can choose to buy that. Once we're invested, our flexibility is constrained and our discretion in investment decisions is reduced to "hold" or "sell." A buyer can buy anything. A seller can only sell the asset under their control. This may sound obvious, but the implications are far reaching. Buyers and sellers are not equals.
Those on the sell side (brokers, etc.) may pass comments such as "it's a buyer's market" or "it's a seller's market." We're familiar with these cliches. And superficially, they don't seem askew. But the reality is that it's always a buyer's market due to the buyer's unlimited optionality.
Nowhere is this more visible than the financial markets where the option buyer pays a premium for the right (optionality) and the seller receives a premium for the conveyance of that right. This relationship is an economic identity and is always in all functional markets, real estate included.
It may feel at times that opportunity cost is sitting on the sidelines when assets soar. But this is just an emotional response. Being liquid is a strong position to be in. Conversely, a far steeper opportunity cost is entering an investment only to realize down the road we should be in a different investment or none at all.
That said, we make our money by transacting. Eventually you have to get in.
Transaction Cost
The transaction costs associated with buying and selling commercial real estate are quite large relative to more liquid investments. Brokers take a couple points up and down on the deal and there's often a point or more associated with your debt depending on how it was sourced.
Because of this friction, we're motivated to spread transaction costs over a period. Lockups and planned investment duration reflect this. However, holding out for a planned exit or minimum hold can be a trap. If an exit is warranted, then exit. Trying to avoid concentrating transaction costs can be akin to picking up pennies infant of a steamroller.
Then there are pre-payment penalties to the debt you've structured. When you have prepayment penalties, especially a sinking prepay, there's a motivation to anticipate transacting when the penalty is at its lowest. This structure, along with other transactions can have a very real influence over timing. Rather than have a sinking penalty, perhaps explore if your lender will take the average penalty as a constant for every year aside from maturity.
It's nice to think that fundamentals drive our investment decisions. But transactions costs can and will affect your timing if you're not careful. See how you can structure your investments or approach to minimize the psychological impact of these costs.
Reputational Cost
Not only are the emotional pressures intrinsic to the investments, but social pressure also plays a role. Remaining on the sidelines when assets are rapidly increasing in value can be a painful position to be in. Your investors want to know why their capital isn't being deployed. When your peers are allocated, you can experience a feeling of being left behind.
But remember, although you may appear to be a loser when assets are rising, you'll also be a hero when assets are falling, and you've managed to maintain the integrity of your decision making. Of course, that would necessitate that your assessment of market direction was correct to begin with. Which, it probably isn't. Be mindful of the randomness that exists in the world and never under appreciate the relative safety of the heard.
Final Thoughts
I've mentioned above just three different situations where emotional bias may creep into your decision making process. We're emotional creatures. Numerous vulnerabilities exist for emotions to hijack the rational mind.
First and foremost, be aware of where you as an individual are most vulnerable to being led astray by your emotions (fear, greed, aggression, passiveness, social pressure, etc.) Structure your investments where possible to accommodate your weaknesses. You can't eliminate the influence of emotions on decisions, but you can work to be more self-aware and manage biases when they appear.