15.07.2015

The full-of-emotions formula in real estate

“You only find out who is swimming naked when the tide goes out”. Warren Buffet 2001.

“You only find out who is swimming naked when the tide goes out”. Warren Buffet 2001.

I was struck by a presentation I attended on how personal emotions were connected to a real estate investment. Here’s the explanation.

 

First, the preference among the investing public over the desire to accumulate capital was discussed.

 

There is no doubt that capital is an element that people always prefer to accumulate. In the real estate sector, we can translate this when we focus our efforts towards seeking higher income (or rent) and assuming lower costs, in order to achieve a favorable result in each period of the life cycle of our investment. Obviously, we must not neglect the principle of financial management, in which we must seek both a positive result in profits, as in the preservation of cash flow.

 

Secondly, we focused on the risk preference we assume in each investment. Without a doubt, and with the use of financial techniques and tools -such as the use of insurance, bonds and others-, we seek to reduce the risk of investments to a minimum in the face of the challenges we face during development.

 

Finally, as the phrase “time is money” says, we cannot neglect the time factor. According to our role as investors, we have a high preference for wanting returns to be made today and not necessarily in the future; this always brings uncertainty.

 

By connecting these three investment preferences with the value formula that an investment generates, according to the discounted cash flow method at present, we can clearly see that these preferences are integrated into the formula and, in turn, they are also linked to the following emotions:

 

Ambition: By preferring, at all times, a greater cash flow for each period, always looking for it to be greater and not less.

 

Fear: By seeking to eliminate this negative feeling, which causes us the uncertainty of an investment, which leads us to discharge the fear in the discount rate that we use in our projections.

 

Impatience: Investors want the results to come out as we project them and that we obtain the results “now”; we don’t like to wait to face unknown cycles.

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