Knowing The Ellsberg Paradox Makes Real Estate Investing Easier | Ep 87

James: I've got a little quiz for you in a moment on the Furlo Capital Real Estate Podcast where we dive into the intricacies of passive real estate investing. And our mission is to equip people to invest wisely in both properties and people, no matter what paradox exists, so that together we can build wealth while improving housing.

I'm James, and this is my paradoxical, but yet awesome wife, Jessi.

I want like a. Webster's dictionary definition of paradox.

Two things. What is it? It's two things that cannot exist together. Okay. Right.

Jessi: Huh?

James: Yes. I think that's the definition of paradox. Two things that can't exist, like the classic, can God create a rock he can't lift?

Jessi: Oh, all right. All right. That's, it's like an impossible situation. Paradox.

James: Yes.

Jessi: Kind of

James: different than a catch 22. Right paradox. Yeah. There's also paradoxes about like, if you go back in time right. And kill your younger self, what happens to you? Yeah. Your, what happens to your future self? Fe yourself, but you can't go kill your, like there's, you know, that's paradox time, travel theories.

But what we're gonna talk about is the Ellberg paradox. Oh yeah, we're getting nerdy. I have no idea what that is, but here we go. I'm ready to nerd out. I'm gonna start it out with a simple little quiz. Okay. Oh, no popcorn quiz. I think I'm, I think I'm gonna get this right for whatever reason. In the, in, like, in the official, official example, they use urns.

Think of it like a bin. It's weird,

Jessi: like a urn. You put a dead person like ashes in

James: No, more like an urn that you put things inside of like like plants, right? Like a

Jessi: vase.

James: Yes. Yes. But use the word earn for an, for some reason. All right. Alright. Okay, so you have an urn a you have 50 red and 50 black balls.

Okay, so there's a hundred balls. Yeah. 50 red. 50 black. Yeah. In earn B there are also 100 balls, but there's an unknown mix of red and black balls. Okay. Okay. And you're asked what would you rather, do you get the, the question is, or the, the gamble

Jessi: mm-hmm.

James: Is you get a hundred dollars if you pull a red ball and if you pull a black ball, you get $0.

Okay.

Jessi: Okay.

James: Which one would you rather pull from? The first one or the second one? The first

Jessi: one. 'cause it's a known ratio.

James: Really?

Jessi: I think so. I mean, the other one is unknown, which it could be 70 red ones and 30 black ones. Yeah. But you don't know that. Hmm. So at least you've got a 50 50 chance if you do the first one.

James: That's true. That is the Ellsberg paradox. You just proved the out. 'cause they said they, they ran this experiment, Uhhuh, and they actually did a couple other variations of it, and overwhelmingly people went for the known odds. Sure. Over the unknowns. Even though

Jessi: it's possible,

James: it could be better possible, could be better.

Mm-hmm. So let me, let me make this, that

Jessi: totally makes sense to me.

James: So although

Jessi: I'm, I'm risk adverse, so. Like, I could see someone who is willing to take risks and be like, dude, yeah, let's try the one we don't know

James: might be better. So, so let me give you I think that's, you're right, that's the lower percentage of people.

Yeah. So let me give you an example of a different, of, of another way of looking at it. Uhhuh, which is kind of, this is the exact same thing. You're looking at a real estate deal.

Jessi: Yeah.

James: Okay. One of them, you can be a private lender and you will earn. 8%. Okay. On your money.

Jessi: Yeah.

James: Guaranteed. Yep. 8% on another one.

You're an equity partner, which has potential upside to earn, you say 20%. Mm-hmm. Which I make it extreme. Which one would you choose?

Jessi: How guaranteed is the. 20% one. That's a good question.

James: I mean, you know, it's dependent on tenants paying their rent and the repairs going Well, it's done by a sponsor who,

Jessi: I mean, if I, if I did my due diligence and was like, yeah, all right, I, I trust this, it's pretty likely that, you know, it'll, it'll pay out.

And if I, I think the big difference here is if I could assume the risk, like in your, in your primary example, if I had to have the a hundred dollars to survive. Like I'd do the known quantity.

James: Oh, interesting. Okay. If I

Jessi: didn't have to have it and I was like, yeah, we're just having fun, I might try the other one

James: really and see what might happen.

Jessi: Probably not. Probably not. That's the Of who I'm, yeah. Yeah. The honest answer is like, nah, I would still do the one that is a known quantity. Yeah. But with investing, I feel like there's more nuance there to be like, okay, I, I don't necessarily need the 20, 20% return today. I could wait it out and I could see if it works out.

You know it potentially for some investors, yeah, for some investors it might not. It might be like, no way. I, I can't risk it. I need the return. I need it guaranteed. I need it in a certain timeframe. Which is like, okay, you do the known quantity.

James: Yeah. But,

Jessi: you know.

James: Yeah. And so that's the interesting, yeah.

A hundred percent. Mm-hmm. And and my notes here was like, yeah. The issues you have with that second one, right? It's just like earned B where you don't know the sponsor. Like did they do their stuff? Right? You don't know what happens if a tenant leaves. Yeah. You don't know how realistic rent projections are.

Right? But here's the thing, it's not that it's a riskier investment. There's just more unknowns that make it. Ambiguous. Mm-hmm. So you can't ne it's, I get right, I understand that could be a much safer investment because you go, well it maybe it's risky to me 'cause of all these unknowns Sure. But, but it's like, what's the source of the risk?

Right. Does that make sense? Yeah. '

Jessi: cause if like theoretically, if, if you had the second example and you did know all there was to know it could be a better investment.

James: Right.

Jessi: You know, so it's like, it's not necessarily well, you're risky, you're totally better investment. Right. Yeah. The, the upside is better.

And if

James: there's a scrupulous sponsor who's done their due diligence and done it right,

Jessi: yeah. That is legitimately a better deal,

James: but most people will still go for the guaranteed return. Oh, it totally, it totally makes sense to you. The unknown, like because of the, the variability of the unknown Sure. Is, is pretty big.

And so that is what is called the Ellsberg paradox. Hmm,

Jessi: interesting.

James: Yeah, it is interesting. Right.

Jessi: Well, it's interesting in the sense of, oh, if you're working, oh, I keep going too with investors. And you are convincing them to invest in the second option. Yeah.

James: Yeah.

Jessi: Where you're like, there's some unknowns here.

You know, you, you've got to Right. For me, there's a higher bar through that I have to get over. Yeah. Yes. Yeah. What that looks like to convince, if you think

James: about the alternative, right? Maybe it's like. You'd be like, you know what, I'm happy to dump $25,000 into an indexed fund. Yeah. Because it just, it feels familiar.

Mm-hmm. You know what Vanguard is? You know what the s and p is? That feels like earn a, it's a known quantity. Yes. Yeah. Even though your annual returns. You know, are probably not gonna be as high. So here's the question, right? So, so you may decide not to invest in something again, not because you've actually fully identified the risk mm-hmm.

And reward for it. Mm-hmm. It's just there's a whole bunch of unknowns. Yeah. So next section I wanna talk about four things you can do to overcome the, the Ellsberg paradox. Okay. Of, you know, how do we minimize the unknowns Yeah. To a point where you can actually evaluate things. Yeah. Face to face. So so yeah.

First one, shocker. Acknowledge the feeling. You know, it's okay to, you know, to have that hesitation, but you gotta name it, to recognize, oh, this isn't necessarily a riskier deal. Okay. I just don't know enough about it yet.

Jessi: I just need to find out more information.

James: Correct. Yeah. Right. And, and so now you know where to go.

Second one, you wanna seek transparency, not necessarily perfection from the sponsor, right? So you ask questions until it feels more like that first earn.

Jessi: Okay. So you don't necessarily. It would be as if you took the second earn. You don't necessarily need to dump it out, count every single ball, find out your ratios, put them back in, and then decide.

It's like you need to trust that someone is looking at information and possibly telling you, yeah, this might have a better outcome. Here's why. Here's why I think it could, here's some of the risks and here's what I've, how I've mitigated them. So, yeah, yeah, yeah.

James: Okay. Exactly. And again, you're not trying to find the perfect investment that doesn't exist.

You're just trying to get rid of those unknowns. Yeah. Have they looked through the top right and done a quick count on the surface and be like, eh, surface wise Yeah. Is pretty good. What they could find out, have they pulled balls from other similar types of urns? Where they're like, yeah, you know, kinda business ratio, we're really gonna beat this one down.

But that's okay. Yeah. So you wanna ask questions, you know, downside protection, you maybe ask about the communication cadence. What could go wrong? Yeah. If, you know, risks just, and that's like when I do 'em, I have a, a risk and mitigation section. Mm-hmm. And I, my goal is to identify more risks than anybody else.

Jessi: Hmm.

James: Because I figure if I, like, if they're like, well, what about, yeah. And then it's there. They go, okay, good. James has thought about it. It's thought about it. Yeah. Like, that's, that's my goal. Yeah. And, and then have to say like, and here's what we're doing about it. Sure. And in some cases I'm like, yeah.

Like it's a risk. Sorry. And, and I've I'm doing a current raise right now and and that's been there's one particular risk that's out there. Yeah. Where I'm just like, I, I, it's

Jessi: not within your control. I can do about it.

James: It's like

Jessi: we just have to wait. It's a

James: risk, I feel like. It has to do with the market.

Mm-hmm. It's not growing essentially, but it's also not shrinking and it's not ginormous. Sure. I'm just like, sure. Yep. I'm like, I, that is what it is. It is, it's a risk. Yeah. But it's been this way for decades. Right. So, you know, but yeah, it's a risk. Mm-hmm. So yeah. Transparency, not necessarily perfection.

'cause the whole goal is to be able to be able to compare Apple. Mm-hmm. You know, as much as you can. Sure. Number three start small, but start. Hmm. So I was actually talking with a couple. Like a married couple. Mm-hmm. Earlier this week. And and they're interested in investing in real estate.

Mm-hmm. And and they're just like, man, we sat like, they're like, this was their issue. They're like, we have so many questions. There's so much. I don't know. Okay.

Jessi: Yeah.

James: And so they were just like, it's just sitting in a bank account.

Jessi: Yeah.

James: Pretty certain that's true. Like,

Jessi: yeah. Just a pile of cash.

James: Yeah. I mean, they've maxed out their 4 0 1 ks and other stuff, which is awesome.

Yeah. And, and they're like, do we do this? And my advice to them was like. A jump on with someone like me. Mm-hmm. Do a small, like do a small $50,000 investment, play along, learn as much as you can throughout the system. Mm-hmm. Or throughout that, that process and learn. I went, or if you're gonna go by yourself, do a smaller deal.

Mm. I'm like, don't go buy a big apartment. 'cause they have the kind of funds, like they could go buy a bigger apartment mm-hmm. If they wanted to. And I was like, yeah, don't. Just start small, do something instead. Get a, maybe not a single family home, but you know, get a one to four unit complex. Mm-hmm. Or, or given what they know, like a small office building mm-hmm.

Because they kind of know more about that world. Okay. But that was my advice to them was like, start small and you want. Because the first deal is always weird. Yeah. You know, and you're always learning a ton and you wanna do it until it doesn't feel that way anymore.

Jessi: Okay.

James: Yeah. That's like, that's getting rid of that earn be feeling.

Mm-hmm. Right.

Jessi: Yeah. You're, you're discovering more known quantities as you move forward.

James: Correct. Yeah. 'cause like one of their questions was like, I don't even know if we wanna do property management. Like, well, you know, if you start with a couple units Yeah. Try it. You'll very quickly find out, see if you like it, and or hire someone and see how that feels.

'cause you're not gonna get that. That behind mm-hmm. If they, if they mess up Yeah. Or just hire me and problem solve. But that's amazing. But yeah. And then and then the fourth one was just build relationship with sponsors, right? Mm-hmm. Because a lot of the unknown comes around. Yeah. You know, do they know what they're talking about?

And so you wanna, you wanna follow them Like, this podcast, good job. Mm-hmm. You want to, you just wanna talk to them. Where am I lost my place? Oh yeah. You wanna see what they're doing for past deals? Mm-hmm. You know how they do that? Like, I have a section called Portfolio and we talk about some high level numbers, and even some of 'em might jump into the more details of how it turned out.

Mm-hmm. If they do like videos or webinars you know, just get to know them. And the whole goal again is to move from this unknown. Things are ambiguous. I don't know where to go to. Okay. I, I know more information. Another. Another thing that I usually recommend is like, eh, there's some good books out there that aren't terribly long that I highly recommend.

Yeah. Reading, if you got it. Sometimes it's spending time on BiggerPockets, though less so these days. Just about

Jessi: the, the process of investing or Yeah. Familiarizing yourself. That's not for a particular

James: deal. Correct. It's just familiarizing yourself with the terms in lingo. Okay. I think it helps a lot Sure.

To do that. I know. I was, it at least

Jessi: makes you more comfortable.

James: Yeah. You know, I was looking at a cell tower. Lease buyback. So someone's gonna buy, we talked about this in a previous episode. Right. And and, and that was, I had so many terms. I'm like, I don't, this is all new to me. I gotta figure it out.

Yeah. And, and just like, and I had multiple conversations with multiple people to figure it out and that was how I finally was like, okay, I think I understand how to, how to analyze this. Yeah. And it's kinda a bummer. I had a couple of 'em get mad at me at the end 'cause they really thought I was gonna go with them.

I was like, dude, like I was talking to a lot of people and I can only, yeah. Only one. I mean, I would love for multiple people to buy this, but it doesn't work that way. Sure. And so so there you go. So those are four things, just quick actions that I think you can do to get over the Ellsberg paradox.

Yeah. Now you can impress your friends The next time you're out, be like, have you heard of the Ellsberg paradox? Let me ask you some questions about some red and black balls. And so and I think it just explains a lot about why sometimes people get stuck on not pulling the trigger on an investment.

Right. But you don't have to because you could build the systems and. Relationships to turn those unknowns into understood. Mm-hmm. And again, we're not looking for perfection. Mm-hmm. But it's just trying to be able to do a genuine compare Sure. Of what makes sense.

Jessi: Yeah.

James: And so. If you'd like to reduce some ambiguity my suggestion is to head over to furlo.com and you can read more about the different types of investments and I explain what it is to be an equity investor.

Sure. What it is to be a money lending type of investor and, and those types of things. Mm-hmm. Obviously listen to things like this.

Jessi: Yep.

James: Hop on the email list, all the fun stuff. Yeah. And that's how you very quickly overcome the Ellsberg paradox.

Jessi: Just ask questions.

James: That's it. Super.

Jessi: Have a conversation.

Super,

James: super easy. There you go. Alright, that's all I got. Super fun. Cool. Thanks for listening. If you did find this valuable, seriously, you should check us out at furlo.com and I would love to get a rating or review wherever it is that you listen to podcasts.

Jessi: Have a great day.