Cognitive Risk and Real Estate Portfolio Management

By Wofford, Larry E.; Troila, Michael L. et al. | Journal of Real Estate Portfolio Management, January-April 2011 | Go to article overview

Cognitive Risk and Real Estate Portfolio Management


Wofford, Larry E., Troila, Michael L., Dorchester, Andrew D., Journal of Real Estate Portfolio Management


Real estate portfolio management often appears to deal almost exclusively with the application of rigorous statistical and mathematical techniques to develop, revise, and optimize real estate portfolios. A cursory examination of almost any issue of the Journal of Real Estate Portfolio Management confirms this casual empiricism. Underlying the applications of these techniques is access to large quantities of data, some publicly available and some proprietary. Because of the focus on these quantitative approaches using readily available "hard" data, real estate portfolio management has the appearance of being essentially "objective" in nature.

Often overlooked is the notion that this "objective" analysis occurs within a broader context of overall portfolio management. Such overall management involves developing and communicating strategy, developing systems and networks to monitor portfolio performance, team development and interaction, and overall corporate culture, among other attributes. Many aspects of this broader picture of real estate portfolio management have significant elements that do not generally fall into the "objective" classification. These less objective elements include, but are not limited to:

* Internal and external communications systems.

* Portfolio monitoring, dashboard design, and implementation along with the detection of weak signals of change.

* Analysis and effective communication of economic, financial, social, cultural, technological, and other external factors.

* Information systems and accessibility.

* Group dynamics at all levels.

* Corporate culture.

Each of these elements is critical to the overall success of the real estate portfolio management enterprise. Further, each element involves extensive human cognition and human interaction embedded within complex, dynamic, uncertain, and, often, ambiguous networks and systems. Thus, at a macro level, real estate portfolio management is not the purely mechanistic, algorithmically driven objective enterprise that it may, at first glance, appear to be.

Critical statistical and mathematical portfolio analyses are components of an overarching framework developed and managed within strategies, tactics, processes, systems, networks, goals, and objectives that are the products of individual and collective human cognition and interaction. These more or less "subjective" cognitive artifacts create the instrumental environment in which the structured "objective" quantitative analysis is framed, directed, performed, and evaluated. The subjective elements can significantly enhance or reduce the real or perceived effectiveness of the quantitative analysis and overall portfolio performance. Even though the objective element of portfolio management performs well, given its instrumental mission, the real or perceived outcomes can vary significantly. The potential variation created by subjective cognitive processes produces added risk for the portfolio management effort. Given its source, this risk can be labeled "cognitive risk."1

Cognitive risk is particularly pernicious because it has not been explicitly identified as a risk factor and, therefore, it has not been considered as an important element of overall real estate portfolio risk management. Given its potential significance to real estate portfolio management, simply ignoring cognitive risk is not a viable option as its identification also raises the question: "To what extent can cognitive risk be managed?" The simple answer is that, like most explicit risks, cognitive risk can be managed to some degree, but not eliminated. However, a cognitive risk management framework provides the opportunity to develop a better understanding of human cognition. This understanding will come from research into human cognition using the broadest possible set of disciplines.

Research into Human Cognition

Prior the 1950s, behaviorism viewed the human mind as a black box and research concentrated on stimulus and response. …

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