This is the last video in our focus on behavioral economics, those forces that drive us as syndicators, fund managers, and businesses raising capital. These forces determine whether our underwriting is good or not so good. They’re the forces underneath the surface that help us make decisions, sometimes for good, mostly for ill. We need to be aware of what they are, what they do, and how they work.
In this video, the last of our series, we’re going to focus on the last three emotional biases that take place in behavioral economics. There are six emotional biases in total. In the last video, we talked about loss aversion, endowment, and self-control. Today, we’re going to focus on the last three: status quo, overconfidence, and regret aversion.
These emotional biases are in us all, driving us to some extent. They help us make decisions and make us more efficient, but they often can change our analysis in a way that’s less beneficial. By focusing on them, thinking about them, and going through a list as you’re underwriting, asking yourself if you’re being moved by one of these is helpful. It makes our numbers more accurate, our analysis more precise, which helps our investors make more money. It helps us by helping them make more money too. The better our decision-making is, the better our analysis is, the better it is for them and for us. It really works across the board and it’s a useful exercise to think about as you go through your underwriting process.
Let’s talk about what these biases are. The status quo is really just resistance to change. I like to think of the status quo bias as saying, “Well, I’ve done this this way for a million years, so that’s what we’re going to stick with.” For example, always putting out offers under the same rule, always raising money with friends and family, always going to one investor who invests 50% of all the capital needed, or always buying multifamily properties.
This is extremely normal. We all have this tendency to want to stick to what’s known, rather than venturing forth into the unknown, which feels riskier. But sometimes status quo can also cause problems. What happens when that one key investor drops out? When that one asset type we’ve been focused on suddenly changes in the market’s view? How do we adapt to change when we’re stuck in status quo?
When you’re underwriting or picking new projects, think about why you’re stuck there. Maybe you should open up just a little bit or think about things differently. Test yourself to see if it makes sense. It may not, and if it doesn’t, that’s great, but at least you went through the thought process.
Number two is overconfidence. This is the belief in superior ability to profit from economic data. This one is certainly present, especially among those from sales or development backgrounds. These fields often require overconfidence to get the job done. It’s okay to a point, as long as you’re not understating or underestimating losses and risks, or overestimating profits and benefits. We need to make sure that our analysis is complete, accurate, and neutral.
The last one is regret aversion. This is similar to loss aversion, but it’s specifically seeking to avoid negative outcomes. This can manifest as holding onto a position too long or avoiding markets with sharp gains and losses. You might think, “Maybe investors will think I got in too late or exited too early.” That’s regret aversion.
My name is Tilden Moschetti. I am a syndication attorney with the Moschetti Syndication Law Group. I help real estate developers, syndicators, fund managers, private equity funds, and businesses raise capital and stay in compliance with SEC and state government rules. Under the SEC, we’re talking about Regulation D rule 506(b) and 506(c), and for the states, it’s making sure they are notified that we are doing offerings under Regulation D.
I also wear the hat of a syndicator and fund manager myself. This gives me a broad view of the industry. I’ve experienced the pressures you face and the behavioral economic forces at play. I’ve felt the pressure of raising funds, pitched to investors, looked for assets to buy, and made decisions on waiving contingencies and putting my own money at risk.
We help clients be successful with their capital raising offerings. Not only am I an excellent lawyer, but I’ve also been in your shoes doing exactly what you’re doing. We can offer advice and consultation to help make you successful. Give my office a call if we can help put your offering together under Regulation D rule 506(b) or 506(c). We’ll also help you work through the issues you experience as a syndicator, from someone who’s been there and done it themselves.