Winner’s curse is one of the most critical aspects of real estate investing. It is a situation where the winner of a bid pays more than the worth of the property. It is an unfortunate occurrence since no one wants their efforts to go into waste. Performing objective due diligence is the best way to dodge the curse or any other unforeseen circumstances. Additionally, it helps to overcome bias in decision making.
Although the winner’s curse is unfortunate to an investor, it is a benefit to real estate fund managers. This is because they can differentiate early enough whether a valuation is optimistic or conservative. The curse has also caught experienced investors. They tend to overlook certain property fundamentals or rely on unviable strategies.
Atlantic Richfield engineers noticed that sometimes aggressive bids might prove to be too optimistic. They discovered that in the oil and gas auctions, essential information might be hidden beneath the surface.
Although valuations may vary in different industries, in real estate, prices might not reflect the underlying value. This is maybe due to the risk in investment property of setting the wrong prices, false assumptions or business plans that are not feasible. Furthermore, in private equity real estate, there is the rush to close the deal instead of waiting for the right opportunity or time.
For most investors, sticking to conservative strategies seems the most rational thing to do. However, behavioral economics indicate that markets are not always rational. In most cases, sellers hold unrealistic prices while buyers concentrate on factors that do not add intrinsic value.
There are limitless deals in the real estate industry. However, it is advisable to carefully check the inefficiencies that prevent investment opportunities to achieve the expected value. In fact, nowadays there is growing data science that can help to evaluate properties before committing an investment.
Due diligence is the best way to control the risks involved in real estate investment. However, it may not provide the nature of the risks. There are two major lessons when investing in real estate. First, joint ventures do not always guarantee favorable returns. Although getting into partnerships might reduce structural risks, they also limit control of investment and ultimately lessen the proceeds. Second, making off-market deals does not always guarantee a better return on investment. Therefore as an investor, find a suitable data-driven procedure that will help evade the winner’s curse.
