Investors Are Playing Offense And Defense At The Same Time, On A Shifting Field With No Playbook
The coronavirus crisis presents a challenge unlike almost any other real estate downturn in living memory — how to play defense and offense at the same time.
There is a paradox at work. The U.S. and UK are facing historic recessions and big swathes of tenants are unwilling or unable to pay their rent. As a result, most real estate investors will have to deal with at least some problem assets in their portfolios. But those same issues create opportunities for investors, who have huge amounts of capital at hand to invest in the sector. Often it will be the same firms fighting fires and trying to take advantage of new opportunities. But how does that work in practice?
Partly this is a question of allocation of resources, how companies deploy people and capital. But doing this effectively is far from simple, and managers need a subtle understanding of human psychology and motivation as well as a solid business strategy to persevere as the outlook for real estate has never been less certain.
For investors, the first few months of the crisis were the most difficult in terms of understanding the problems they had, but the easiest in terms of where to allocate staff.
“During the first months of lockdown it would have been fairly efficient to reallocate staff if you needed to, because there wasn’t any trading going on and transaction volumes were way down,” LaSalle Investment Management Head of Debt and Special Situations Amy Aznar said.
Beyond the challenges of making sure staff were safe and well and transitioning to remote working, there were three main areas of existing portfolios that all of a sudden needed much more attention for investors and fund managers: collecting rent from tenants whose revenues may have dropped abruptly, engaging with banks over loans that might be coming under pressure, and dealing with calls from limited partners or equity providers who wanted as much information as possible about how their investments were faring.
These processes, which in a normal market take time and effort but should run fairly smoothly, suddenly became a lot more labour intensive.
“We’ve had more than 100 calls with existing and new investors over the past six months,” Clearbell Capital Senior Partner Manish Chande said. “Normally that amount of meetings would take us about two years.”
At such times of intense shock essentially it is all hands on deck, investors said — whatever your role was before, your new job became stabilizing the portfolio and working out where problems might be.
In general, deal origination professionals can quite easily be redeployed to undertake asset management roles if needed, investment executives said.
“Acquisition staff will underwrite the business plan for the asset, and often do that alongside the asset management team, so they can go back to those assumptions and tweak or reconfigure what is now needed,” New Star founder Mahbod Nia said.
But with the initial shock of the pandemic behind them, now the picture is less clear for investors, and strategy and allocation of resources are more complicated.
“We’re out of the acute stage, and into the chronic stage,” Tristan Capital Head of Investments Cameron Spry said. Like many investors, he said the most intense period of uncertainty about how portfolios might be affected is now over, and that from the summer onward, firms have been able to think about new investments as well as managing their own portfolio.
But this doesn’t mean there aren’t problems still to come, and this is likely to be a slow-burn downturn for the sector.
“You have to remember that historically, the peak in business insolvencies happens when the recovery has started, not in the middle of the crisis,” Spry said.
As government stimulus wears off, unemployment has the potential to increase, and tenants that might have hung on so far are unable to keep trading and hand back keys to landlords.
“You have to identify where the risk is, and if you’re in a hole, stop digging,” Origin Investments principal Michale Episcope said. “Once you’ve stopped digging you have to evaluate if you can fill it in or if you should just sell.”
He uses the example of the office sector, which has held up relatively well so far in most major cities in terms of rent collection, but where tenants could exit leases as they expire over the next few years, causing a rise in vacancy. Deciding to sell assets frees up capital, but takes away bandwidth that could be spent on acquisitions, Episcope said.
So if investors are living in a world where they will be dealing with issues in their existing portfolios for some time yet, but also trying to strike new deals, what is the best way of allocating staff, time and capital?
There are broadly two ways in which real estate investors configure their businesses in terms of managing existing assets and sourcing new deals.
Some firms, particularly larger investors with big portfolios undertaking numerous deals every year, have dedicated asset management and origination teams. Those that do argue that this has been a big advantage in the current situation.
“We have a dedicated team, and that means the origination team [is] free to look at new opportunities,” Moorfield Chief Investment Officer Charles Ferguson-Davie said.
Companies with dedicated teams for asset management, origination and finance generally report that not many staff from origination remain deployed on asset management. As News Star’s Nia pointed out: “In a sector like retail or hospitality, if a tenant isn’t paying rent, or no one wants to lease the space, there is no amount of extra resource that can change that.”
But there is an awareness that staff in areas like asset management or finance have been under significant strain, and that has required extra support from management.
“It has been intense, especially in the first few months,” Clearbell’s Chande said. “There have been a lot of one-on-one calls with tenants, banks or investors. We didn’t reallocate staff, but it required a lot of extra guidance and stewardship from senior management for staff who have been working very long hours in very difficult circumstances.”
Other firms prefer to have their staff undertake both deal origination and asset management, and they also feel this provides a benefit at moments like this.
“We don’t simply divide the team between ‘offense’ and ‘defense,’ we expect everyone to do a lot of both,” Crosstree Real Estate co-founder Sean Arnold said. “We’ve always structured our team on a ‘cradle to grave’ mentality so when you make an investment, you continue to manage it. But at a crisis time like this it’s also good from a mental health perspective to do both. You’re not just managing through issues and putting out little fires, you’re also being creative and thinking about opportunity.”
This picks up on a point that many investors who were active during the last financial crisis will realize: dealing with problem situations is psychologically challenging, and motivating staff to do it is hard.
“It is part of your job, but it is difficult to work knowing you are just looking to preserve value, rather than increase it,” Nia said. “Maybe it says something about compensation structures, but you get paid your carry or your bonus when you sell and crystallize your profit. Restructuring often means long hours for not much money.”
He adds that if a business has too many fires to fight, there may be no balance to strike, even if it has capital to invest.
“If you’re in operational sectors like retail or hotels, there is a lot of stress, and you may not feel like doubling down and investing more,” he said. “It’s just triage.”
For some leaders in the industry, it is not only about managing during a crisis: Hiring staff with a broad range of skills who can originate deals and asset manage is the best way to maximize value at any point in the cycle.
“The difference between asset management and acquisitions is often not about skill set, it’s about mindset,” Carlye Managing Director and Head of European Real Estate Peter Stoll said. “We hire people with a complete range of skills. Good asset managers need to know about acquisitions and financing, and deal originators need to know about asset management, as it helps them to underwrite deals.”
Stoll said that in the world of private equity, deal-makers are often seen as the “alpha” members of the team, with asset managers relegated to second class citizens. But he tries to avoid this with his own actions. It is particularly important not to create this divide when firms might be trying to manage problem assets but also strike new deals.
“The team often make fun of me, but I am always asking to see the floor plans of schemes we are refurbishing or developing, to get a sense of how the individual assets are being managed. I enjoy it, and I think it’s important.”
The problem with this philosophy in the current moment is, if you weren’t already doing it, it might be hard to manufacture now.
“If you didn’t have the right people or the right philosophy in the middle of March, you can’t create it now," he said. "If you haven’t focused on it in practice, it’s too late to try to pull it together on the pitch.”