How we think about the past influences how we think about the future, including what lies ahead for real estate. With many medium and long-term trends at play, not the least the curveballs thrown by the last pandemic, investors must be agile and responsive as views of the future change.
Traditional historians and deterministic views
Most traditional historians take a deterministic view of history. In their view, past events were governed by the forces of history, whether economic, psychological, or cultural.
From this perspective, the historian’s job is to understand those forces to explain how we got to where we are today. Meanwhile, they regard considering counterfactual eventualities as a frivolous activity.
As E.H. Carr, author of the 1961 book “What is History?” wrote, “Dragging into prominence the forces which have triumphed and thrusting into the background those which they have swallowed up is the essence of the historian’s job.”
A deterministic view of history is attractive. It makes the past more explicable and suggests a reason for how the past has played out. It offers the comfort of certainty. And comfort helps popularize historical books and TV shows.
Challenging determinism: acknowledging change and human agency
However, Niall Ferguson argues that, while seductive, the deterministic view of history is deeply flawed. He states in his book “Civilization,” “It ignores the role of contingency in human affairs, and it fails to appreciate the power of human agency.” A more accurate view of history acknowledges the role of both chance and human choice in shaping the course of events.
Ferguson argues, “The search for universal laws of history is futile.” Instead, we should see the present as one of many potential eventualities that various tipping points and competing factors could have shaped.
The power of contingency and unpredictability
Many find the idea that randomness played a significant role in shaping our past unnerving. To think that historical events could have played out very differently and that today’s world is a result of chance is disturbing.
Why does this matter? Because the tendency to seek comfort in a deterministic understanding of history leads us to underestimate the role of chance and the extent to which the future is unpredictable.
As Nassim Nicholas Taleb has argued, “Life is more, a lot more, labyrinthine than shown in our memory—our minds are in the business of turning history into something smooth and linear, which makes us underestimate randomness.”
And Daniel Kahneman has reasoned, “The idea that the future is unpredictable is undermined every day by the ease with which the past is explained.”
We can easily find rational narratives to illustrate why events unfolded as they did, but the outcome could have been more foreseeable. Something can seem obvious in hindsight but impossible to know ahead of time. “We always know better after the fact, but it’s too late then,” Mark Twain quipped.
Real estate investment and the uncertain future
Real estate investors cannot be deterred from thinking about the future by the role of chance. Typically the price investors are willing to pay for a property is their best estimation of the net present value of the future cash flows the asset is expected to generate. Today’s price embeds a view of the future.
Competing views of the future drive investing. To deliver superior investment performance, investors need a non-consensus view of the future that will likely be correct. Hence Howard Marks argues that for investors, “making intelligent decisions when future events are uncertain is one of the greatest forms of skill.”
Positioning for good decisions in an uncertain future
How can real estate investors best place themselves to make good decisions about the uncertain future?
Firstly, probabilistic thinking must be embedded into the investment process, with the required support from tools and platforms.
Intelligent investment decisions will come from knowing the range of potential outcomes and the shape of their distribution. Before investing, investors should underwrite deals under multiple different scenarios and probability-weight those scenarios. The mean and median returns, range of likely outcomes, and size of tail risks should inform the investment decision. Having a cone of uncertainty that is guided by current market data could be very informative.
Too often, investment decisions are informed by processes designed long ago when resource constraints were significant and the time and effort required to develop a single scenario was substantial. But technology, from a data platform and intelligent-inference perspective, has lifted those resource constraints, and investors should adapt.
Secondly, investors need to use resources appropriately. Fine-tuning single-point forecasts is unlikely to be productive, but assessing the reasonable probabilities to attach to different scenarios, each grounded in best-in-class market data, may well be. Expending resources to develop thematic views to inform sector allocation may have diminishing returns. Time may be better spent structuring decisions to mitigate bias and promote objectivity in asset selection.
Thirdly, and perhaps most importantly, humility about our ability to form judgements about the future should mean we should construct portfolios with sufficient diversification to deliver robust performance in various scenarios. Whereas running multiple scenarios for an extensive portfolio of assets once appeared to be a daunting, resource-intensive activity, advances in digital and AI infrastructure mean it is entirely practicable today.
Making peace with uncertainty
J.K. Galbraith said, “There are two kinds of forecasters: those who don’t know, and those who don’t know they don’t know.”
Like deterministic historians, the latter peddle a false but comforting sense of certainty. Real estate investors must act like the former.
As Annie Duke argues, good decision-makers “make peace with not knowing” and “embrace uncertainty.” “Instead of being focused on being sure, they try to figure out how unsure they are, making their best guess at the chances that different outcomes will occur,” she says.
We need to appreciate the randomness of the past to think intelligently about the many potential futures of real estate. Just as history teemed with potentialities, the future unfolds as a world of boundless possibilities. The critical takeaway is to have the technology platforms that allow investors to make the most-informed uncertainty-weighted decisions at every point in time and to re-visit decisions when market data start pointing in new directions.
