With ultra-low interest rates, recently-reduced lending margins and the abundance of international money flowing into the UK, CRE 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 CRE correction.
See the opportunity first - 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, i.e. 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 CRE are rarely cheap at the same time. So, savvy managers obtain cheap debt in times of boom, ready to deploy on cheaper CRE following 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 these are 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 which conveys a significant range of potential upsides and downsides.
Use Property Derivatives - sensibly
Property derivatives (PDs) are a quick and easy way of managing CRE market risk. By using PDs 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. PDs are best used to manage risk, not for naked speculation. Many organisations have regretted their use of derivatives without fully understanding them. As a rule, if you do not understand a tool, don’t use it.
Act swiftly and boldly 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 CRE correction, doing nothing is a poor approach. If the plan requires selling an asset at a loss, move quickly to avoid 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 which we all experience at such a time can be counteracted by considering the pre-determined value at which you become a buyer, based perhaps upon some long-term cycle average value of potentially available assets.
Provided you have the planned funding to last you through the down-turn period, property development should continue through a correction as 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 the lessons and make use of them next time
During the global financial crash, regulators and principal lenders must have wished for a clearer recollection of the previous CRE 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 in the period 2007 to 2012. Write it down and resolve to do that when the next correction occurs.
Let’s not waste the next crash.
This article first appeared in Estates Gazette on 25th July 2015