Reference Points

valuefunIf you really want to get me worked up, start asking me about “comps” and how important they are to the market. (For those who don’t know, in my world, “comps” refers to the basic business points of a lease deal.)

Assuming for a moment that they are accurate (which is questionable) they don’t provide any real value beyond an interesting or gossipy talking point.

A few reasons comps are barely worth the paper they’re printed on:
  1. They are trailing indicators. They don’t do anything to predict what’s going to happen with the next lease deal.
  2. Every lease is different. Each building has it’s own pro-formas and deal limits.
  3. Motivation for each landlord changes based on where they are in the ownership cycle of the building.

What comps do offer is a reference point, which is a concept I stumbled over as I read “The Undoing Project.” People look for outcomes that they consider break-even and then start measuring losses and gains. What’s interesting is people’s concern about minimizing loss rather than maximizing gain. The reason that all comps tend to be close to each other isn’t market efficiency. It’s both tenant’s and landlord’s aversion to perceived loss and lack of incentive to maximize gain.

In reality, comps just provide a data point so you don’t feel like you’re getting screwed.

We coach all of our clients to make decisions based on what your business demands, not perceived market norms. If you need to do a 1 year deal, we’ll find a way to get it done. If you need a deal with no out-of-pocket expenses, we’ll find a way to do that too. The worst case scenario is defined so pushing for more upside actually comes at very little cost.

The law of small numbers

I was having a discussion with a colleague the other day an he was complaining about the quality of the research available to us. He felt the research did a poor job of representing the market and didn’t represent what he was experiencing on the street. While I listened patiently, my internal dialog was screaming “BULLSHIT!”

Here’s the thing about the real estate market. It’s huge. New Jersey alone has more than 500M square feet of office space. And while it’s not the most transparent marketplace, the data is generally accurate. There are databases that track lease and sale comps, leasing activity, sales activity, vacancies and availabilities. All of this data provides accurate trend lines and a clear picture of the market.

But the market moves slowly. Deals take time. And brokers tend to focus on the things that are directly impacting their clients. This leaves brokers particularly susceptible to The Law of Small Numbers. They want to believe that the handful of deals they’re working on are indicative of the entire market. They ignore broader trends, extenuating circumstances, and the fact that generally, numbers never lie (if the sample size is big enough.)

Why is this important? Well, if you’re taking counsel from a broker that is ignoring larger trends in the market, he’s not offering you the whole picture. It’s not his fault, it’s human nature. We all love to talk our position and seek data to support it. (Economists and psychologists have studied this too. It’s call confirmation bias.)

How do you combat this tendency? Start by insisting that you see the broader market. My partner and I have a standard practice of showing our clients everything that’s available, even if we think it’s outside their geographic search area or price range. This helps provide a very clear picture of the overall market. We welcome challenges from our clients, and we challenge our clients in return. Everyone involved sees the real estate landscape. Decisions get driven by business needs and market realities rather than a short term narrative based on a small sample size.