Sabermetrics used in Underwriting Commercial Investment Property: a Lesson from Bill James

Author

Ken Wimberly

On a plane back from Chicago this weekend, I found myself reading a book entitled The Mind of Bill James, by Scott Gray.  For those of you who don’t know, Bill James is known as “The Father of Sabermetrics”, the study of analyzing baseball statistics to evaluate players and teams with maximum efficiency.  James’ research was the foundation for Billy Beane’s management of the Oakland A’s during the “Moneyball” era, and I have become obsessed with him ever since.

There was a quote in the book that really stood out to me: “Misguided faith leads to stubborn repetition of foolish decisions.”

Let me start by saying that there are no religious undertones here.  The quote was used in the context of baseball’s best general managers having immense faith in a certain set of basic statistics (batting average, RBIs, stolen bases, etc.) that cause them to improperly evaluate a player.  However, this set of statistics is misleading and leads to “foolish decisions,” but because GMs rely so much on these stats they are bound to repeat the same mistakes over and over.

I spent some time reflecting on this quote and how it pertains to commercial real estate investment.  I have long felt that being an acquisitions or portfolio manager is a lot like being the general manager of a baseball team.  In each role, you are required to select from thousands of puzzle pieces available, and make those pieces fit so that they work well together as a cohesive unit.  In my opinion, some acquisition managers may be making some of the same mistakes that James referenced in his quote.  Investment properties and baseball players alike are best evaluated on a deal by deal, individual basis, but there is not enough time in the day to do so effectively.  Therefore, you have to maximize the efficiency of your process so that you can evaluate as many properties as you can without sacrificing quality analysis of each deal.  To handle this task efficiently most acquisition managers rely on a set of material facts or statistics to set their acquisition criteria; the most prevalent of these being cap rate.

In my opinion, acquisition managers put too much faith in cap rate.  Underwriting properties is not a science…there are both qualitative and quantitative aspects to evaluate.   If property evaluation relied completely on a single quantitative statistic then anyone could be an acquisitions manager; the job would simply require someone to look at a long list of numbers and pick the most attractive option.  That is not the case and there are a lot of qualitative facts to consider, such as market, lease term, tenant, etc.  This is where acquisition managers rely on the market to give enough comparable information for each deal to help them define a value range.  The problem with this approach is the reliance on the market and on other investors.  At this point investment firms let other firms have a hand in their decision making.  The spirit in the approach that Bill James took to baseball was to step outside of the lines and use inefficiencies in common practices to create a competitive advantage.

This has inspired me to spend some time to researching a new quantitative metric that accounts for qualitative factors.  One of the problems James found when evaluating hitters was that there were two basic types of hitters: hitting for average and hitting for power.  Hitters for average don’t get a lot of home runs, and power hitters don’t get on base a lot.  Therefore he created a stat that accounts for both, the OPS, which is widely used today as they a single metric that can compare any two hitters despite their tendency.  That is what I am after, an OPS for underwriting investment property.  Will it amount to anything determinable? I have no idea…but it’s worth a shot!

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