While hoping for a continuously rising commercial real estate market, positioning for the unexpected can also create valuable opportunities.
With ultra-low interest rates, recently-reduced lending margins and the abundance of international money flowing into the UK, property prices have been pushed up to what some would regard as unsustainable levels. While these factors and the anticipated rental growth are likely to support the market for some time, we should now be considering how to manage and take advantage of the next correction.
Plan for the bust during the boom
For real estate companies, a crash is ‘won’ not by the crisis management developed after the crash commences, but by the planning and positioning undertaken during the boom. An early response to a market crash can be effective, but only in terms of mitigating the impacts of the situation.
To take advantage of post-crash opportunities and the subsequent upturn, carefully considered plans must be in place before the crash.
Have a plan, then implement it
Having a sensible and robust crash plan is good, but only if it is correctly implemented. The challenge is to implement a plan when you least expect it to be required – when the market is most confident. Resolve and determination are essential to execute the plan.
Plans should cover a broad range of scenarios. No two corrections are the same, so to avoid wasting precious time at the most critical point of the correction, an easily adaptable plan is required.
Capitalise on the good times
Debt and property are rarely cheap at the same time, so savvy managers obtain cheap debt in times of boom, ready to deploy on cheaper property after a correction. Of course, there is a hold cost of borrowing money that is not immediately needed for investment, but with current low interest rates and margins, this is reduced.
Understand the risk of your portfolio
Only by fully understanding the risks that might leave you insolvent can you avoid them. For investment property this is fairly straightforward, but for developments it is more complex.
One method of assessing portfolio risk is by adopting a risk dashboard using a ‘profit at risk’ approach, a metric that conveys a significant range of potential upsides and downsides.
Use property derivatives – sensibly
Property derivatives are a quick and easy way to manage property market risk. By using derivatives to sell synthetically at premiums to current market value, investors can anticipate a cash profit in the event of a correction – the time when that cash is most needed.
But financial market tools should be handled with care. Derivatives are best used to manage risk, not for speculation. Many organisations have regretted using derivatives without fully understanding them. If you don’t understand a tool, don’t use it.
Act swiftly when a correction happens
A downturn is always a surprise, but the natural human reaction to any shock is to freeze and do nothing. Faced with a property correction, doing nothing is a poor approach. If the plan requires selling an asset at a loss, then move quickly to stop your losses increasing.
Plan for the silver lining
When the correction happens, your pre-prepared plans to exploit the upturn will come to the fore. The pessimism that we all experience at such a time can be counteracted by considering the predetermined value at which you become a buyer, based perhaps on some long-term cycle average value of potentially available assets.
Provided you have the planned funding to last you through the downturn period, property development should continue through a correction because that is likely to be when construction is cheapest.
This is easier in the case of developments you plan to hold long term, as you are effectively upgrading the asset when it is cheapest to do so.
Learn lessons and use them next time
During the global financial crash, regulators and principal lenders must have wished for a clearer recollection of the previous property correction and the information they needed to manage the situation. As individuals, we too can learn from our experience of a market correction.
But memories are short, and easily eroded by the euphoria of a boom. My suggestion is therefore to ask yourself now what you wish you had done between 2007 and 2012. Write it down and resolve to do that when the next correction happens. Let’s not waste the next crash.
Nicholas Scarles, group finance director, Grosvenor Group
