May 26, 2025 • 21 mins
What’s the difference between conviction and certainty?
In this episode, Arie van Gemeren — fund manager, real estate investor, and author of Timeless Wealth — unpacks one of the most overlooked distinctions in investing and decision-making.
Certainty can blind you. It locks you into narratives, filters out risk, and creates fragility.
But conviction? Conviction is different. It’s not about being right — it’s about building a process you trust, having the courage to act, and the humility to adapt when the facts change.
Drawing on insights from Daniel Kahneman, Nassim Taleb, and Philip Tetlock — plus real-world investing stories from the 2020–2023 real estate cycle — Arie explores why the most successful investors aren’t the ones who are sure, but the ones who are prepared.
If you’re an operator, LP, capital allocator, or just someone trying to make smarter decisions under uncertainty — this is the episode for you.
Articles referenced in this podcast:
Alpha & Beta In Real Estate Investing
Subscribe to the Timeless Investor Newsletter for our long-form content.
Follow the Timeless Investor Show if you want to hear more of our podcast content.
Get your own copy of Timeless Wealth: Real Estate Through the Ages.
If you want to learn about new investment opportunities through Lombard Equities Group (accredited investors only), please reach out here.
Think Well. Act Wisely. Build Something Timeless.
Mark as Played
Transcript
Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
SPEAKER_00 (00:00):
Most people think conviction means you're sure.
But I think conviction means youact even when you're not sure.
And that difference is literallyeverything.
Because here's the truth.
The most dangerous kind ofinvestor isn't the reckless one.
Although let's be clear, being areckless investor is not a good
(00:23):
thing.
But I think the most dangerousinvestor is the one who thinks
they're right.
The one who believes their modelwholeheartedly believes the
story, believes the market willreward their vision because it
always has.
But here's the thing.
Markets do not reward certainty.
They reward adaptation.
(00:43):
Real estate fund manager.
(01:18):
So let's start with the basicpremise of this podcast show
(01:39):
today.
There is a false link betweenconviction and certainty.
And there's a reason thatthere's a false link.
investors of all stripes, peoplethat give you capital, people
that allocate capital, theythink conviction equals
certainty and that yourcertainty equals strength.
People are compelled.
(02:00):
They are driven by the visionsof the people that they invest
with.
And there's a lot of reasons forthis, right?
I mean, I'm going to riff for amoment here.
If any of you have read Sapiens,it's a fantastic book.
It's a little high level, butit's a really, really good book.
And one of the One of the corepremises early in the book is
that Holosapien outcompetedother versions of humans that
(02:24):
existed at the same timebecause, you know, Neanderthal
and human coexisted for tens ofthousands of years.
And at some point, Neanderthaldisappeared.
And one of the central premisesfor why this happened, because
Neanderthal, from what weunderstand of skeletal
structures and whatnot, wasbigger and stronger than
Holosapien.
But Homo sapiens are able tocooperate on a large scale in a
(02:50):
way that Neanderthal couldn't intheory, right?
We're talking about theory here.
But this is true of Homosapiens.
This is true of humans.
We have the ability to coalescearound vision.
We have the ability to coalescearound myth.
These things, the belief in thedivinity of the emperor, right?
The belief in the manifestdestiny of your nation, right?
(03:10):
is something that Homo sapien isuniquely situated to buy into
and to align behind.
So think about that in thecontext of investing with a
visionary investor or avisionary leader.
Their certainty, their story,the coherence of their story is
something that people get behindand buy into and it's something
(03:33):
that they're susceptible tobecause we as a species are
inspired by stories.
We are inspired by the epic heroof Saga that goes out and does
something great.
And think about that in terms ofwhen you make an investment
decision in an investor.
Are you going to put your moneybehind somebody that sounds
(03:57):
uncertain?
I doubt it.
You want that certainty.
We crave certainty.
And so investors that can showyou certainty seem strong, but I
actually think it's fragility.
Because the more certain you arein your outcome, the more
certain you are about yourbeliefs, the less likely you are
(04:19):
to adapt when reality shifts onyou.
And it will always shift on you.
That is the reality ofinvesting.
Investing is like riding a waveof chaos.
And your ability to manage thechaos inherent in investing is
critical.
And if you think about it, Like,if you're a...
Not to push my metaphor too farhere, but if you're like, you
(04:43):
know, a standing tower...
dealing with a tsunami wave, youmight buckle and break.
You're going to need to beflexible and dynamic in dealing
with it.
That is investing.
That is investing every singleday.
That is investing in the stockmarket.
That's what it's like investingin real estate.
Things change.
Things are constantly in flux.
(05:04):
And certainty can create a weakspot for you.
There's a quote I want to bringin from Daniel Kahneman from
Thinking Fast and Slow.
He said, confidence is afeeling, not a statistical
measure.
The confidence people express isoften unrelated to the actual
accuracy of their beliefs.
So Kahneman, who literally won aNobel Prize for this stuff, said
that confidence is just afeeling.
(05:25):
It doesn't actually track howright you are.
You can feel incredibly sure andbe totally wrong.
Because what we call certaintyis usually just a story that
feels tight.
The model works.
The narrative makes sense.
The spreadsheet checks out.
But the feeling of being rightis not the same as being right.
(05:45):
And that's why the bestinvestors do not rely on
certainty.
They rely on process, margin ofsafety, and humility.
And that is Kahneman's corewarning here.
We trust ourselves and we trustothers more when the story feels
tight, even when they're wrong.
And it goes back to the homosapien point.
(06:05):
We are you know, pre-programmedto like good stories, right?
So stories is a huge deal.
So let's pivot now and look atthis through a historical and
behavioral lens.
We wrote an article last week onthe Timeless Investor
Newsletter, which I will link inthe show notes, on the
(06:26):
overconfidence bias.
This is people's ability, or Ishould say people, investors,
who overrate their ability topredict or control outcomes.
There's many examples of this.
I think the last decade in realestate investing is a classic
example of rising overconfidencebias at work.
(06:47):
Okay, so conviction versuscertainty, right?
Overconfidence is in thecertainty bucket.
Here's what happened.
We had 10 to 12 years offantastic real estate markets
and returns.
And a lot of that is just marketbeta.
And I've described market betaversus alpha in real estate as
well on the Timeless Investornewsletter.
(07:09):
But just to clarify reallyquickly, market beta is what the
market gives you as an investorover time, not rewarding your
unique skill.
It's just that the market'sdoing well.
So if you're a stock marketinvestor and you invest in the
S&P 500, you're not doinganything special.
You're just investing in the S&P500.
You're just getting market beta.
(07:29):
So you can think of this in thestock market.
As in somebody started investingin the stock market in 2010 and
by 2020, they've made a killing.
But this person started to thinkthat they made a killing because
they were such a uniquelyempowered and incredible
investor, right?
Now, we think that soundsridiculous when I say it because
(07:52):
it's the stock market andanybody would say, well, you
didn't do anything wrong.
per se, you just invested inmarket beta.
But that's exactly what happenedin real estate.
So over the last 10 to 12 years,before interest rates rose and
inflation spiked post-COVID,people made a lot of money in
real estate.
And they made a killing.
(08:12):
And many of them started tobelieve that they made a killing
because they were a uniquelygood real estate investor.
not recognizing that they justrode the wave of market beta
that whole time.
So by the time we got to COVID,many of these operators, these
experienced operators, startedtaking on incredibly risky deals
(08:33):
because they'd been rewarded for10 years with really risky deals
that worked and overconfidencebias at work.
So Sunbelt Multifamily 2021,floating rate debt, thin
margins, an absolute confidenceand certainty that things were
going to work out the way theyexpected it to work out because
it had always been that way.
And boom, it blew up.
(08:55):
There's another quote I want topull in from Nassim Taleb in The
Black Swan.
The more you believe in your owncertainty, the more you are
setting yourself up for a blackswan event.
To say it differently, the moreconfident you are, the more
certain you are in the outcome,the more fragile you have
become.
That is a big problem.
And LPs who invest behindsponsors should try to figure
(09:18):
out how much of this isconviction in process versus
certainty in story andnarrative.
Because again, we are allinspired by stories.
I'm sorry to keep saying thesame thing, but I just think
it's a fascinating point.
That is a big thing.
It is a big behavioral issuethat all humans have to deal
(09:39):
with.
So let's talk about what realconviction actually looks like.
Conviction is not to say, I knowI'm right, right?
And I wanna come back to thiscentral premise here, which is,
it is systems and discipline andwell-managed processes that
(10:00):
produce good results over time.
It is not stories.
The problem in this industry isit's filled with storytellers
because we're all raising money,right?
And we all know good storiessell deals.
So everybody sells stories,visions, things they have in
mind that they wanna do.
But it's the underlyingconviction and process that
actually produces the greatresults in this business.
(10:22):
So I think I would put it almostlike I am prepared to act but I
am open to new information.
If you are certain in something,you might not be open to new
information because itchallenges previously held
beliefs that you have.
And it is very uncomfortable tohave your beliefs challenged.
(10:43):
Look at our political state inthis country today.
Look at religious wars acrossthe years.
Belief challenging is a massiveproblem for humanity and people
don't like it.
So you don't like it.
I don't like it.
So you have to let go of it.
You have to have conviction inyour process, but be open to
having your beliefs challengedbecause that's the way that good
(11:04):
results can actually happen.
And that's also the way you cannavigate really trying times
because there's good times andthere's bad times.
Both will happen to allinvestors over the course of our
lifetimes.
So separating these two isreally, really critical.
So I think conviction looks likehaving a margin of safety, space
for your certainty to be wrong,understanding that things will
(11:25):
not go according to plan.
you know, I find underwriting tobe a fascinating exercise and
that, you know, I'll probably doa long riff on this at some
point, but underwriting of anysort assumes a linear trend.
Think about that.
Any underwriting model assumes atrend and we assume the trend
will continue on a go-forwardbasis, right?
(11:46):
If you have too much certaintyin your model, you are setting
yourself up for problems becausethe reality is most deals, most
real estate investments, mostbig acquisitions by private
equity groups of companies areassuming a linear trend in their
model.
But life is not a linear trend.
Things are going to lookradically different over a three
(12:07):
to seven year hold than yourinitial underwriting did.
And you need to understand thatin any investment you make, that
the odds that your deal doeswhat you initially predicted
five years ago, it's pretty low.
You can do it.
It happens.
But I would almost say that'smore like a white noise, right?
(12:28):
Like when it happens, it'sgreat.
But like the reality is youcould do better than your model.
You could do worse than yourmodel.
Both outcomes are equally likelybecause there's so many
unforeseen variables that willhappen.
So having conviction in yourprocess but being willing to
change your perspective asthings come in is absolutely
critical.
(12:50):
We'll pull another quote.
Philip Tetlock, SuperForecasting.
This is a fantastic one.
The more famous an expert is,the worse their forecasting
record tends to be.
And why is that?
The loudest ones were usuallywrong, and the best ones were
always updating their view.
(13:12):
There's something to be saidabout that anecdote, by the way.
It's analogous, a superforecaster is analogous in many
ways to an investor that's had alot of success.
If you are considered a superforecaster, you've probably had
a long string of success, whichmeans that your certainty and
your own unique genius has risento a level that is problematic
for you and for your investors,right?
(13:34):
So we need to always be lookingat that and thinking about it.
So what are the tacticaltakeaways here?
Because This is all great intheory, but we have to figure
out how to manage our processesin a way to remove certainty and
improve conviction.
So you want to build convictionwithout rigidity.
So, I mean, these are prettystraightforward.
Shock your underwriting, likereally shock it.
(13:56):
So like, I'll give you someexamples from my own career.
So we bought a building inPortland in 2021 on a three-year
bridge loan.
And I did shock it.
I shocked it, right?
I put a high cap rate for exit.
We assumed relatively low rentson terms, but we did it with a
three-year bridge loan.
Bad idea.
We got out of it.
(14:16):
We did actually refinance thedeal and it's fine.
Everything's gone well.
Let me tell you what went right,what went wrong.
We underwrote to relatively lowpost-renovation rents.
And on average, we exceededthose post-renovation rents on
turn by over$100 per unit.
Good outcome.
Really good.
We underestimated The scale ofexpense increases over the same
(14:38):
period.
Insurance premiums were 2x inour case on this building.
Management companies startedexperiencing severe stress on
labor inflation, right?
Your best personnel were movingaround constantly to different
companies and they were gettinglike a 20% pay raise every time
they moved.
So really good property managersbecame a massively expensive
(15:00):
thing That's really, reallyvaluable because property
management and managingresidents and managing assets is
a people intensive business.
So having the right person atthe front is a really important
thing.
And we underestimated that.
We obviously underestimated thescale of rent increases.
Here's a really interestingpoint though.
So I said we underwrote to ahigh exit cap rate on our deal.
(15:23):
What is a high exit cap rate?
Well, there's the historicallyhigh exit cap rate and there's
the high exit cap rate in thecontext of sort of irrational
market.
So when we bought in 2021, thinkabout where the market was at
that point.
COVID had already hit, thingswere starting to look better,
(15:45):
rates were incredibly low, andthe Fed was pouring money into
society.
So cap rates were way down.
And this was a time where if youcould have a real estate deal
that produced a 3% to 4% cashyield, people were really,
really happy.
Because if you remember, moneymarket yields at the time were
like 20 basis points.
It was like nothing.
(16:06):
So this was a 4% to 4.5% capmarket.
Well, we underwrote to a 5.25%cap exit, which is conservative
at the time.
It's not conservative inhindsight.
In hindsight, we missed themark.
Like we...
Cap rates are in the high fivesto low sixes right now.
So we missed the mark, right?
So we did a bunch of differentthings on that deal that felt
(16:27):
conservative at the time.
I won't say that I had a ton ofcertainty in the model at the
time.
I felt pretty good about ourprocess that we went through to
try to hedge risks on that deal.
And we did shock theunderwriting.
In the context of the market atthe time, obviously, we could
have shocked it much more.
We might not have done the dealin hindsight if I'd shocked it
(16:48):
to the extent that the marketactually moved on us, which is a
whole different topic.
But we did our best in thatsituation to manage the process
and manage our expectations forthe deal.
And I do think those thingsended up protecting us.
Another thing you can do is...
to create downside narrativesalongside upside ones.
(17:10):
And this really leads into thisidea that one should be writing
investment memos for deals youdo, especially in real estate.
Why?
Because we deploy a lot ofcapital into real estate.
If you're a solo practitionerthat's buying your own
properties, it's really, really,really important for you to
hedge all possible risks.
There is a prevailing myth, or Idon't think it's a myth, I think
(17:33):
it's true, but there's aprevailing myth ethos in real
estate investing that timesolves all problems, which is
generally true.
The difficulty with real estateis that you have time sensitive
debt attached to it.
So if you're a commercial realestate investor, you can't get a
30 year fixed rate loan on a 10unit building or a 20 unit
building.
(17:53):
You are always constrained tofive to 10 years on the term of
your loan.
So you can't really solve allproblems by holding forever.
Now, if you take on a relativelyconservative amount of money on
debt and it's amortizing, Iwould argue that's a pretty safe
deal and you'll make that work.
But the main point is, I'm a bigproponent of writing investment
(18:16):
memos before you do a large realestate deal.
And the premise of it isbasically that you want to step
back and think about yourinvestment, pros and cons, as if
you're having to present this toan investment committee.
And the investment committee isgoing to sign off or not sign
off.
And they're going to pick holesin what you're doing.
And the beauty of the day andage that we live in right now is
(18:39):
you can put your investment memowith all of your counterpoints
and all of your arguing withyourself into your favorite AI
application right now.
And that AI and say to it, Iwant you to act like a very
difficult investment committeeand give me a really hard time
on this deal.
Let me defend it.
Let's see where we wind up atthe end of this.
That is an incredible,incredible tool for checking
(19:02):
yourself that has not existedhistorically.
It is unbelievable.
I can highly attest to the valueof it.
It is really powerful.
A solo operator buying afourplex can do this.
They can run an institutionalprocess on buying something and
check their assumptions at thedoor and make sure that their
process is sound.
This is not a tool that existedhistorically.
(19:24):
It is incredible.
That's what we wanted to talkabout today.
Conviction versus certainty.
Conviction is required.
You have to have it or you willnever act.
And that is the key toinvesting.
I cannot tell you how manypeople I have met that want to
be real estate investors andhave never done it for lack of
(19:45):
conviction.
They don't act.
But there's a fine line whereyour conviction turns into
certainty and you set yourselfup for serious problems.
Certainty is a liability.
It hardens you.
right before the system bends.
It's not good.
You have to avoid it.
So the best investors andleaders move forward.
(20:06):
They take action.
They are courageous, knowingthat they might be wrong.
That is strength.
It is not weakness.
And a business plan thataccounts for all the possible
upsides and downsides and ishonestly and transparently
presented to investors should befavored over one that you know,
hides the fragility of thebusiness plan behind a really
(20:29):
great narrative and a story.
Conviction is a discipline.
Certainty is a delusion.
You can act decisively withoutknowing the outcome.
In fact, you have to if you wantto do something in this life
that's great.
I'm gonna leave you with that.
Think well, act wisely, buildsomething timeless.
(20:51):
Thank you for joining us today.
If you've enjoyed this show, wewould greatly appreciate a
review.
Thank you so much.
I hope you have a wonderful weekand I look forward to hearing
(21:18):
from all of you.
Most people think conviction means you're sure.
But I think conviction means youact even when you're not sure.
And that difference is literallyeverything.
Because here's the truth.
The most dangerous kind ofinvestor isn't the reckless one.
Although let's be clear, being areckless investor is not a good
(00:23):
thing.
But I think the most dangerousinvestor is the one who thinks
they're right.
The one who believes their modelwholeheartedly believes the
story, believes the market willreward their vision because it
always has.
But here's the thing.
Markets do not reward certainty.
They reward adaptation.
(00:43):
Real estate fund manager.
(01:18):
So let's start with the basicpremise of this podcast show
(01:39):
today.
There is a false link betweenconviction and certainty.
And there's a reason thatthere's a false link.
investors of all stripes, peoplethat give you capital, people
that allocate capital, theythink conviction equals
certainty and that yourcertainty equals strength.
People are compelled.
(02:00):
They are driven by the visionsof the people that they invest
with.
And there's a lot of reasons forthis, right?
I mean, I'm going to riff for amoment here.
If any of you have read Sapiens,it's a fantastic book.
It's a little high level, butit's a really, really good book.
And one of the One of the corepremises early in the book is
that Holosapien outcompetedother versions of humans that
(02:24):
existed at the same timebecause, you know, Neanderthal
and human coexisted for tens ofthousands of years.
And at some point, Neanderthaldisappeared.
And one of the central premisesfor why this happened, because
Neanderthal, from what weunderstand of skeletal
structures and whatnot, wasbigger and stronger than
Holosapien.
But Homo sapiens are able tocooperate on a large scale in a
(02:50):
way that Neanderthal couldn't intheory, right?
We're talking about theory here.
But this is true of Homosapiens.
This is true of humans.
We have the ability to coalescearound vision.
We have the ability to coalescearound myth.
These things, the belief in thedivinity of the emperor, right?
The belief in the manifestdestiny of your nation, right?
(03:10):
is something that Homo sapien isuniquely situated to buy into
and to align behind.
So think about that in thecontext of investing with a
visionary investor or avisionary leader.
Their certainty, their story,the coherence of their story is
something that people get behindand buy into and it's something
(03:33):
that they're susceptible tobecause we as a species are
inspired by stories.
We are inspired by the epic heroof Saga that goes out and does
something great.
And think about that in terms ofwhen you make an investment
decision in an investor.
Are you going to put your moneybehind somebody that sounds
(03:57):
uncertain?
I doubt it.
You want that certainty.
We crave certainty.
And so investors that can showyou certainty seem strong, but I
actually think it's fragility.
Because the more certain you arein your outcome, the more
certain you are about yourbeliefs, the less likely you are
(04:19):
to adapt when reality shifts onyou.
And it will always shift on you.
That is the reality ofinvesting.
Investing is like riding a waveof chaos.
And your ability to manage thechaos inherent in investing is
critical.
And if you think about it, Like,if you're a...
Not to push my metaphor too farhere, but if you're like, you
(04:43):
know, a standing tower...
dealing with a tsunami wave, youmight buckle and break.
You're going to need to beflexible and dynamic in dealing
with it.
That is investing.
That is investing every singleday.
That is investing in the stockmarket.
That's what it's like investingin real estate.
Things change.
Things are constantly in flux.
(05:04):
And certainty can create a weakspot for you.
There's a quote I want to bringin from Daniel Kahneman from
Thinking Fast and Slow.
He said, confidence is afeeling, not a statistical
measure.
The confidence people express isoften unrelated to the actual
accuracy of their beliefs.
So Kahneman, who literally won aNobel Prize for this stuff, said
that confidence is just afeeling.
(05:25):
It doesn't actually track howright you are.
You can feel incredibly sure andbe totally wrong.
Because what we call certaintyis usually just a story that
feels tight.
The model works.
The narrative makes sense.
The spreadsheet checks out.
But the feeling of being rightis not the same as being right.
(05:45):
And that's why the bestinvestors do not rely on
certainty.
They rely on process, margin ofsafety, and humility.
And that is Kahneman's corewarning here.
We trust ourselves and we trustothers more when the story feels
tight, even when they're wrong.
And it goes back to the homosapien point.
(06:05):
We are you know, pre-programmedto like good stories, right?
So stories is a huge deal.
So let's pivot now and look atthis through a historical and
behavioral lens.
We wrote an article last week onthe Timeless Investor
Newsletter, which I will link inthe show notes, on the
(06:26):
overconfidence bias.
This is people's ability, or Ishould say people, investors,
who overrate their ability topredict or control outcomes.
There's many examples of this.
I think the last decade in realestate investing is a classic
example of rising overconfidencebias at work.
(06:47):
Okay, so conviction versuscertainty, right?
Overconfidence is in thecertainty bucket.
Here's what happened.
We had 10 to 12 years offantastic real estate markets
and returns.
And a lot of that is just marketbeta.
And I've described market betaversus alpha in real estate as
well on the Timeless Investornewsletter.
(07:09):
But just to clarify reallyquickly, market beta is what the
market gives you as an investorover time, not rewarding your
unique skill.
It's just that the market'sdoing well.
So if you're a stock marketinvestor and you invest in the
S&P 500, you're not doinganything special.
You're just investing in the S&P500.
You're just getting market beta.
(07:29):
So you can think of this in thestock market.
As in somebody started investingin the stock market in 2010 and
by 2020, they've made a killing.
But this person started to thinkthat they made a killing because
they were such a uniquelyempowered and incredible
investor, right?
Now, we think that soundsridiculous when I say it because
(07:52):
it's the stock market andanybody would say, well, you
didn't do anything wrong.
per se, you just invested inmarket beta.
But that's exactly what happenedin real estate.
So over the last 10 to 12 years,before interest rates rose and
inflation spiked post-COVID,people made a lot of money in
real estate.
And they made a killing.
(08:12):
And many of them started tobelieve that they made a killing
because they were a uniquelygood real estate investor.
not recognizing that they justrode the wave of market beta
that whole time.
So by the time we got to COVID,many of these operators, these
experienced operators, startedtaking on incredibly risky deals
(08:33):
because they'd been rewarded for10 years with really risky deals
that worked and overconfidencebias at work.
So Sunbelt Multifamily 2021,floating rate debt, thin
margins, an absolute confidenceand certainty that things were
going to work out the way theyexpected it to work out because
it had always been that way.
And boom, it blew up.
(08:55):
There's another quote I want topull in from Nassim Taleb in The
Black Swan.
The more you believe in your owncertainty, the more you are
setting yourself up for a blackswan event.
To say it differently, the moreconfident you are, the more
certain you are in the outcome,the more fragile you have
become.
That is a big problem.
And LPs who invest behindsponsors should try to figure
(09:18):
out how much of this isconviction in process versus
certainty in story andnarrative.
Because again, we are allinspired by stories.
I'm sorry to keep saying thesame thing, but I just think
it's a fascinating point.
That is a big thing.
It is a big behavioral issuethat all humans have to deal
(09:39):
with.
So let's talk about what realconviction actually looks like.
Conviction is not to say, I knowI'm right, right?
And I wanna come back to thiscentral premise here, which is,
it is systems and discipline andwell-managed processes that
(10:00):
produce good results over time.
It is not stories.
The problem in this industry isit's filled with storytellers
because we're all raising money,right?
And we all know good storiessell deals.
So everybody sells stories,visions, things they have in
mind that they wanna do.
But it's the underlyingconviction and process that
actually produces the greatresults in this business.
(10:22):
So I think I would put it almostlike I am prepared to act but I
am open to new information.
If you are certain in something,you might not be open to new
information because itchallenges previously held
beliefs that you have.
And it is very uncomfortable tohave your beliefs challenged.
(10:43):
Look at our political state inthis country today.
Look at religious wars acrossthe years.
Belief challenging is a massiveproblem for humanity and people
don't like it.
So you don't like it.
I don't like it.
So you have to let go of it.
You have to have conviction inyour process, but be open to
having your beliefs challengedbecause that's the way that good
(11:04):
results can actually happen.
And that's also the way you cannavigate really trying times
because there's good times andthere's bad times.
Both will happen to allinvestors over the course of our
lifetimes.
So separating these two isreally, really critical.
So I think conviction looks likehaving a margin of safety, space
for your certainty to be wrong,understanding that things will
(11:25):
not go according to plan.
you know, I find underwriting tobe a fascinating exercise and
that, you know, I'll probably doa long riff on this at some
point, but underwriting of anysort assumes a linear trend.
Think about that.
Any underwriting model assumes atrend and we assume the trend
will continue on a go-forwardbasis, right?
(11:46):
If you have too much certaintyin your model, you are setting
yourself up for problems becausethe reality is most deals, most
real estate investments, mostbig acquisitions by private
equity groups of companies areassuming a linear trend in their
model.
But life is not a linear trend.
Things are going to lookradically different over a three
(12:07):
to seven year hold than yourinitial underwriting did.
And you need to understand thatin any investment you make, that
the odds that your deal doeswhat you initially predicted
five years ago, it's pretty low.
You can do it.
It happens.
But I would almost say that'smore like a white noise, right?
(12:28):
Like when it happens, it'sgreat.
But like the reality is youcould do better than your model.
You could do worse than yourmodel.
Both outcomes are equally likelybecause there's so many
unforeseen variables that willhappen.
So having conviction in yourprocess but being willing to
change your perspective asthings come in is absolutely
critical.
(12:50):
We'll pull another quote.
Philip Tetlock, SuperForecasting.
This is a fantastic one.
The more famous an expert is,the worse their forecasting
record tends to be.
And why is that?
The loudest ones were usuallywrong, and the best ones were
always updating their view.
(13:12):
There's something to be saidabout that anecdote, by the way.
It's analogous, a superforecaster is analogous in many
ways to an investor that's had alot of success.
If you are considered a superforecaster, you've probably had
a long string of success, whichmeans that your certainty and
your own unique genius has risento a level that is problematic
for you and for your investors,right?
(13:34):
So we need to always be lookingat that and thinking about it.
So what are the tacticaltakeaways here?
Because This is all great intheory, but we have to figure
out how to manage our processesin a way to remove certainty and
improve conviction.
So you want to build convictionwithout rigidity.
So, I mean, these are prettystraightforward.
Shock your underwriting, likereally shock it.
(13:56):
So like, I'll give you someexamples from my own career.
So we bought a building inPortland in 2021 on a three-year
bridge loan.
And I did shock it.
I shocked it, right?
I put a high cap rate for exit.
We assumed relatively low rentson terms, but we did it with a
three-year bridge loan.
Bad idea.
We got out of it.
(14:16):
We did actually refinance thedeal and it's fine.
Everything's gone well.
Let me tell you what went right,what went wrong.
We underwrote to relatively lowpost-renovation rents.
And on average, we exceededthose post-renovation rents on
turn by over$100 per unit.
Good outcome.
Really good.
We underestimated The scale ofexpense increases over the same
(14:38):
period.
Insurance premiums were 2x inour case on this building.
Management companies startedexperiencing severe stress on
labor inflation, right?
Your best personnel were movingaround constantly to different
companies and they were gettinglike a 20% pay raise every time
they moved.
So really good property managersbecame a massively expensive
(15:00):
thing That's really, reallyvaluable because property
management and managingresidents and managing assets is
a people intensive business.
So having the right person atthe front is a really important
thing.
And we underestimated that.
We obviously underestimated thescale of rent increases.
Here's a really interestingpoint though.
So I said we underwrote to ahigh exit cap rate on our deal.
(15:23):
What is a high exit cap rate?
Well, there's the historicallyhigh exit cap rate and there's
the high exit cap rate in thecontext of sort of irrational
market.
So when we bought in 2021, thinkabout where the market was at
that point.
COVID had already hit, thingswere starting to look better,
(15:45):
rates were incredibly low, andthe Fed was pouring money into
society.
So cap rates were way down.
And this was a time where if youcould have a real estate deal
that produced a 3% to 4% cashyield, people were really,
really happy.
Because if you remember, moneymarket yields at the time were
like 20 basis points.
It was like nothing.
(16:06):
So this was a 4% to 4.5% capmarket.
Well, we underwrote to a 5.25%cap exit, which is conservative
at the time.
It's not conservative inhindsight.
In hindsight, we missed themark.
Like we...
Cap rates are in the high fivesto low sixes right now.
So we missed the mark, right?
So we did a bunch of differentthings on that deal that felt
(16:27):
conservative at the time.
I won't say that I had a ton ofcertainty in the model at the
time.
I felt pretty good about ourprocess that we went through to
try to hedge risks on that deal.
And we did shock theunderwriting.
In the context of the market atthe time, obviously, we could
have shocked it much more.
We might not have done the dealin hindsight if I'd shocked it
(16:48):
to the extent that the marketactually moved on us, which is a
whole different topic.
But we did our best in thatsituation to manage the process
and manage our expectations forthe deal.
And I do think those thingsended up protecting us.
Another thing you can do is...
to create downside narrativesalongside upside ones.
(17:10):
And this really leads into thisidea that one should be writing
investment memos for deals youdo, especially in real estate.
Why?
Because we deploy a lot ofcapital into real estate.
If you're a solo practitionerthat's buying your own
properties, it's really, really,really important for you to
hedge all possible risks.
There is a prevailing myth, or Idon't think it's a myth, I think
(17:33):
it's true, but there's aprevailing myth ethos in real
estate investing that timesolves all problems, which is
generally true.
The difficulty with real estateis that you have time sensitive
debt attached to it.
So if you're a commercial realestate investor, you can't get a
30 year fixed rate loan on a 10unit building or a 20 unit
building.
(17:53):
You are always constrained tofive to 10 years on the term of
your loan.
So you can't really solve allproblems by holding forever.
Now, if you take on a relativelyconservative amount of money on
debt and it's amortizing, Iwould argue that's a pretty safe
deal and you'll make that work.
But the main point is, I'm a bigproponent of writing investment
(18:16):
memos before you do a large realestate deal.
And the premise of it isbasically that you want to step
back and think about yourinvestment, pros and cons, as if
you're having to present this toan investment committee.
And the investment committee isgoing to sign off or not sign
off.
And they're going to pick holesin what you're doing.
And the beauty of the day andage that we live in right now is
(18:39):
you can put your investment memowith all of your counterpoints
and all of your arguing withyourself into your favorite AI
application right now.
And that AI and say to it, Iwant you to act like a very
difficult investment committeeand give me a really hard time
on this deal.
Let me defend it.
Let's see where we wind up atthe end of this.
That is an incredible,incredible tool for checking
(19:02):
yourself that has not existedhistorically.
It is unbelievable.
I can highly attest to the valueof it.
It is really powerful.
A solo operator buying afourplex can do this.
They can run an institutionalprocess on buying something and
check their assumptions at thedoor and make sure that their
process is sound.
This is not a tool that existedhistorically.
(19:24):
It is incredible.
That's what we wanted to talkabout today.
Conviction versus certainty.
Conviction is required.
You have to have it or you willnever act.
And that is the key toinvesting.
I cannot tell you how manypeople I have met that want to
be real estate investors andhave never done it for lack of
(19:45):
conviction.
They don't act.
But there's a fine line whereyour conviction turns into
certainty and you set yourselfup for serious problems.
Certainty is a liability.
It hardens you.
right before the system bends.
It's not good.
You have to avoid it.
So the best investors andleaders move forward.
(20:06):
They take action.
They are courageous, knowingthat they might be wrong.
That is strength.
It is not weakness.
And a business plan thataccounts for all the possible
upsides and downsides and ishonestly and transparently
presented to investors should befavored over one that you know,
hides the fragility of thebusiness plan behind a really
(20:29):
great narrative and a story.
Conviction is a discipline.
Certainty is a delusion.
You can act decisively withoutknowing the outcome.
In fact, you have to if you wantto do something in this life
that's great.
I'm gonna leave you with that.
Think well, act wisely, buildsomething timeless.
(20:51):
Thank you for joining us today.
If you've enjoyed this show, wewould greatly appreciate a
review.
Thank you so much.
I hope you have a wonderful weekand I look forward to hearing
(21:18):
from all of you.
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