From the Winter 2018 Issue
Use Human Behaviour in Finance
to Manage the Decision-Making Process
Every individual is exactly that… an individual. We all come from varied backgrounds of unique experiences that form who we are, what we value and why we do the things we do. We want to feel included, understood, appreciated and most of all heard. This is why when you are trying to finance a retrofit project in a condominium, it takes more than telling people what needs to be done; you have to convince them it needs to be done!
To help you understand this complex world of both finance and human behaviour, we have integrated behavioural economic principles into the decision-making process with six easy steps that will help you smoothly advance retrofit projects while maintaining an integrated and inclusive condominium community.
1. Engage relevant industry professionals early. We do not know what we do not know.
In the early stages of a retrofit project you will find that many directors, owners and property managers fall victim to their own biases before they understand the problem.
One of the common biases we tend to see is known as “confirmation bias.” Most individuals are subject to confirmation biases where they search for, interpret, focus on and remember information in a way that confirms their preconceptions. Often this bias will take over because we fail to ask the right questions about new concepts and our own beliefs (Image 1).
The financing and completion of retrofit projects is invariably unique from project to project and so, requires the expert advice of lawyers, engineers, contractors, and financial institutions to understand what processes and timelines are involved in their completion.
Directors should not only speak with, but also invite, all relevant third-party experts to discuss the project implications with owners early to help them overcome their own biases. By doing this, the directors can avoid stumbling into a situation where confirmation bias takes over, and a simple misunderstanding halts a project.
2. Understand current/ future financial obligations. Our financial decisions inconsistently change over time. Would you rather receive $500 today or $505 tomorrow? Would you rather receive $500 in a year or $505 in a year plus one day? In scientific testing individuals overwhelmingly choose $500 today and $505 in a year plus one day from now. This type of decision-making is known as dynamic inconsistency or temporal discounting and shows diminishing returns to perceived value over time (Image 2).
With many retrofit projects outside the purview of what reserve fund monies can be used for, it is essential to outline the financial baseline, potential counterfactual and expected outcome of the project. Where the financial baseline is the current state of finances, the counterfactual would be the future financial obligations if the retrofit did not occur including higher expected energy costs or increased maintenance costs in some cases, and the expected outcome where energy savings or future earnings potentials and other non-monetary benefits are described.
Laying out all the possible scenarios will provide for a holistic view of the situation and allow for an objective decision-making process to take place as recommended in Step 6. This evaluation should outline the impacts and costs of the project(s), both monetary and non-monetary.
3. Communicate the project impacts to the owners. It is thought that the pain of losing is psychologically about twice as powerful as the pleasure of gaining (Image 3).
We see this aversion to loss play out in our lives every day when we try to make smart money decisions. We hesitate to make a decision that deviates from the status quo because deciding presents the possibility of making the wrong decision. By framing the project from a perspective of loss, the likelihood of approval may be increased.
4. Determine sources of project funds. If the reserve fund monies are not available for the retrofit project, the financing will be drawn from either the budgeted annual expenses of the corporation, an assessment to the unit owners, or where necessary a loan obtained from a financial institution. Loan availability is subject to implementation by both legal and financial institutions who should be engaged in Step 1 of financing a retrofit project. All options, including their financial outcomes, should be presented to the unit owners. By engaging outside financial professionals early, creative solutions that combine the three options can be developed to match the needs of the entire condominium population.
5. Determine project timelines. Not all projects are alike and so, with strategic planning, the burden of the financing of these projects can be reduced or deferred. By laying out the timelines for project start and completion with your financial expert – an appropriate financing scenario can be derived that minimizes impact to the owners.
6. Identify which projects to pursue first. Often a corporation will have many projects which require completion and will need to be prioritized. The best way to analyze the priority of projects is through the development of an impact cost matrix (Image 4).
This matrix lays out the potential projects on a 2 by 2 grid where the projects should be pursued in ascending order. By laying out the projects with owners in such a manner, it is easier to cohesively determine the priority for pursuing such retrofits as one person’s priority may not be another’s.
By following these six steps, you will be providing a holistic service to owners and bringing together what can at times be a disjointed population. Often the frustration experienced while pursuing one of these projects is simply the result of misunderstanding and miscommunication. By opening the communication channels and applying simple behavioural decision-making concepts, the next retrofit should be to everyone’s benefit!
Matthew Solda is the director of CondoCorp Term Financing with Mor- rison Financial. Matthew obtained his MBA from the Rotman School of Man- agement and is a civil engineer. He has worked across financing and human behaviour roles in a consultative capac- ity and is now a specialist in providing financing to condominium corporations for the major repair or replacement to common elements. Morrisonfinanical.com