Originally published May 2023.
Many use experience and expertise interchangeably, but they are different. While experience comes from exposure to a particular field, expertise develops when that experience is refined, codified, and transformed into a predictive model that works.
Real estate investment managers need to be mindful of this distinction. They need to be able to present themselves to fund investors as experts and must avoid intuition leading them astray when making investment decisions.
Intuition, often associated with expertise, is not a magical power. Instead, it is an ability people have to spot similarities in situations they have previously experienced. Daniel Kahneman, a Nobel Prize-winning economist, describes intuition as “nothing more and nothing less than pattern recognition.”
People build intuition through experience, but there are circumstances when it can be misleading. For intuition to be trusted, Kahneman suggests a stable environment, a large sample size, and immediate and accurate feedback.
None of these apply to real estate investing. Real estate markets are complex adaptive systems in constant flux, making them difficult to predict. Most real estate investors make occasional, lumpy acquisitions, limiting the sample size. And feedback on an investment’s success or failure is often only available after many years.
So investors should be wary of relying heavily on intuition when making investment decisions. Concerningly, people tend to have excessive conviction when guided by intuition, leading to overconfidence and incorrect decisions. Psychologists have conducted experiments that show intuition generated with high confidence is often wrong statistically.
What is expertise if it is different from experience? Drawing on the work of psychology professor Gregory Northcraft, Michael Mauboussin says, “The difference between experience and expertise is that expertise is having a predictive model that works.”
Experienced people can draw on their recognition skills to articulate their judgment and inform the building of a model. A model doesn’t need to be complex – it is just a system for decision-makers to follow. A checklist can be a model, for example.
Real estate investment managers should aim to capitalize on the experience in their teams by “opening the lid” on the heads of their most experienced investors and codifying their judgment process.
For example, an investor may have a long track record of investing in property in emerging neighbourhoods. They subconsciously recognize patterns and “sense good opportunities”. However, to demonstrate expertise, that pattern recognition must be taken out of an individual’s head and into some model.
The model could form a checklist that might include criteria such as whether the neighbourhood is part of a wider thriving urban area, offering a price advantage, attracting people to spend more time and money there, and experiencing increased business investment.
Somebody can test the checklist to see if all conditions hold in improving neighbourhoods. If not, they can refine it. When it reaches the stage where the model generally works, experience has helped generate expertise. Then investment managers confidently make investment decisions and promote their genuine expertise to fund investors.
