by The Informed Appraiser
“Opinion has a significance proportioned to the sources that sustain it.” - Benjamin Cardozo (1870-1938)
From time to time I have the pleasure of perusing real estate investor survey reports. Several firms publish such reports regularly. They provide appraisers and other real estate professionals with useful information regarding market metrics such as occupancy levels, rents, cap rates, operating expenses, and the like.
These reports can offer an impressive array of figures and statistics. The sheer quantity of data as well as the precision of the numbers used can sometimes give a false sense of accuracy, so it is important to maintain a proper sense of context. Although these reports are certainly useful, they should be treated with care.
Investor surveys are based on the opinions of market participants. Opinions, by definition, are not facts. They represent the sentiments of human beings. People have emotions and moods. An investor’s outlook for the market can change from day to day, or even minute to minute. Furthermore, only a selection (or “sample”) of market participants is typically included. No survey can poll every investor in a market, let alone get responses from all of them. A gloomy outlook can change to an optimistic outlook based on just a positive news story or two. Also, talk is cheap. It’s one thing to give an opinion that the local apartment cap rate is 7%, but it’s quite another to put your money where your mouth is and actually buy or sell a property at that rate.
To be sure, the reports typically include full disclosures and disclaimers that explain the methodology and make it clear to the reader that a survey is just a survey. But not everyone bothers to read the fine print, and even after reading it, we may have a tendency to trust the numbers simply because they are “published information”. In addition, precise numbers often look more reliable than they may actually be.
For example, you might read that the average San Francisco office market cap rate for Q1 2011 was 7.42%. That’s a very precise number. If I see a 7% or 7.5% average cap rate, I know that it’s a rough, rounded figure. But if I see 7.42%….well, that sounds quite official. However, that can be misleading. Suppose that just three investors were polled, and they gave cap rate opinions of 6.75%, 7%, and 8.5%, respectively. Well, the average cap rate opinion is 7.42%. Is that a precise figure? Sure. Is that a reliable figure? Not so much.
While going through a recent report, I was struck by the figures in a cap rate forecast table. One column, under the header “Expectations”, provides information regarding the “shift” (up, down, or steady) expected over the next few months by the majority of investors polled. The table also indicates what percentage of investors formed this majority. These numbers drew my attention, as most of them were simple fractional percentages such as 50.0% (1/2), 83.3% (5/6), 60.0% (3/5), 66.7% (2/3), etc. The prevalence of such simple ratios gives me the sense that the cap rates and expectations were based on relatively small sample sizes of investors. Granted, this cannot be proven, as 66.7% could also mean 8 out of 12, or even 800 out of 1,200, etc., but I would guess that it points to 2 out of 3 investors, or perhaps 4 out of 6. Once you are dealing with larger groups, the probability of getting so many simple fractions is just too small.
In closing this post, I want to stress that my point is not to beat up on investor surveys. They serve an important purpose, and quite a bit of work goes into assembling this information and presenting it in a meaningful fashion. Appraisers certainly should refer to these surveys and use them to keep in touch with the pulse of the market. Investors’ sentiments can provide valuable insight into the state of the market, particularly in smaller markets or those experiencing a dearth of activity. However, when referring to these surveys, it is helpful to bear in mind the source of the information and keep it in proper context.
