Decision theory and real estate investment: an analysis of the decision‐making processes of real estate investment fund managers

Abstract

Decision theory is the study of models of judgement involved in, and leading to, deliberate and (usually) rational choice. In real estate investment, there are models for the pricing and allocation of assets. These asset allocation models suggest an optimum allocation between the respective asset classes based on retrospective judgements of performance and risk. The representation and role of real estate in a multi-asset portfolio has, historically, been viewed in the context of portfolio theory. Real estate is selected, as other assets, on the basis of some criteria, e.g. commonly, its marginal contribution to the production of a mean-variance efficient multi-asset portfolio, subject to the investor's objectives and capital rationing constraints. However, decisions are made relative to current expectations and current business constraints. Whilst a decision-maker may believe in the required optimum exposure levels, as dictated by an asset allocation model, the final decision may|will be influenced by factors outside the parameters of the mathematical model. The focus of decision theory is on the mathematical models. These may be probability based, loss functions, or other forms of statistical representations of judgements. Yet, much of decision theory does not lie entirely within any one discipline: it draws upon psychology, economics, mathematics, statistics, social sciences and many other areas of study. This paper discusses investors' perceptions and attitudes towards real estate, and highlights the important difference between theoretical exposure levels and pragmatic business considerations. The lynchpin in the decision-making process is how investors perceive risk. The concept of risk plays a central role in various kinds of decision problems under uncertainty. It is possible that the definition of risk within an asset allocation model, where risk is equated with the uncertainty of achieving a specific required return, sits uncomfortably with the definition of risk used by the decision-maker, where risk may equate to the consequence of not matching the performance of the competitors. In this paper, the author discusses the behavioural aspects of the decision-making process for UK pension funds in their asset allocation role, and relates the various decision-making models to the that process. Whilst the apparent question being asked is 'how much should they invest in real estate?', the answer achieved must be viewed in the context of what is pragmatically possible, or institutionally acceptable, with the constraints of business risk considerations. Copyright © 2001 John Wiley & Sons, Ltd.

An investigation of property-related decision practice of Australian fund managers

“…The key qualitative overlays identified by the Australian fund managers included judgement ("gut-feeling"), experience and understanding of investing in property assets, feedback from clients or shareholders, fund manager skills, asset quality assessment and peer comparison. The results are comparable to similar studies conducted overseas (French, 2001;Gallimore and Gray, 2002;Worzala and Bajtelsmit, 1997) that identified general experience/intuition, judgement and the use of personal feel of the market, as key qualitative factors that influence institutional property allocation decisions in the USA and the UK. Recent studies by Parker (2011Parker ( , 2013 also identified factors such as judgement, intuition and experience as key qualitative factors that affect property fund manager investment decisions.…”

“…However, in practice, asset allocation decisions must be made in an environment of incomplete information (particularly physical assets), changing estimates of return, and shifting definitions of the acceptable investment risk. According to French (2001), while definitive inputs to the asset allocation model (historic data or predictive forecasts) are important, fund managers are also influenced by many other non-financial considerations, such as behavioural factors, judgement, intuition and market sentiment (peer group allocation). There is a considerable diversity in the way asset allocations are made, in the use of consultants, in the discretion given to outside managers, and in the way that property investments are managed.…”

“…Therefore, to come to a rational decision, undertaking a decision analysis is paramount for both individual and institutional investors. French (2001) identified three distinct, yet interrelated, decision models:…”

A Fuzzy Decision‐making Approach for Portfolio Management With Direct Real Estate Investment

“…And asset allocation is a powerful tool for risk reduction (Kaplan, 1998). Yet, as the model relies greatly upon historical data as inputs to proffer recommendations on asset allocation and past performance of elements is an important infl uence on the decision (French, 2001), those inputs should be adjusted to refl ect the understanding of the market (Kaplan, 1998). Without such adjustments, the credibility of the analytical result is compromised.…”

A fuzzy compromise programming approach for the Black-Litterman portfolio selection model

“…According to Ko and Cheng (2003), fuzzy logic not only provides an approximate but also it is effective descriptions for ill-defined, or troublesome to cope with existing complex systems. The fuzzy approach can capture uncertainty in a realistic way (French, 2001). In order to overwhelm these problems, expert's knowledge is incorporated in modeling.…”