Geoff Colvin wrote “The Upside of the Downturn” in the depths of the Global Financial Crisis. Few people were writing optimistic business books in 2009, so this one stands out.
Colvin presents that downturn as “The Greatest Opportunity,” arguing that the most challenging conditions determine winners and losers. “Periods of extreme stress and challenge are reliably when dramatic competitive change takes place,” he writes.
As real estate investors begin to face a more challenging economic and financial environment, these lessons could come in handy. Tightening of monetary policy, a more recessionary outlook, and declining real estate values mean we could be looking at another downturn. So, it is a great time to revisit some of the critical lessons from Colvin’s book.
To avoid wasting a good crisis, real estate investment managers need to accept a radical new reality and create new solutions to clients’ new problems. Fortunately, many new tools, technologies, and datasets are available to facilitate this adaptation.
Accept a radical new reality
Jack Welch said, “Confront reality – not as you wish it were, and not as it used to be, but as it is.”
This is essential advice today. Indeed, Colvin argues that “none of the other strategies for managing this recession will work until this one – facing a new reality and resetting priorities – has been fully pursued.”
This is challenging. Leaders can be very attached to existing strategies designed based on assumptions about favourable conditions. Letting go of these or admitting that previous actions may now seem like a mistake is hard.
Many will delay accepting the new reality, perhaps by insisting on waiting for more data. That delay is the source of opportunity which the more entrepreneurial will seize – you can react more quickly than others.
Remember Charles Darwin’s key observation that “it is not the strongest of the species that survive, nor the most intelligent, but the one most responsive to change.”
The critical change that real estate investment managers need to respond to today is the change in clients’ requirements.
Reassess customers’ needs
Downturns change customer behaviour. The opportunity to react to those changes ahead of the competition can provide an upside to the downturn.
Real estate investment managers need to understand that clients’ mindset has changed.
For many years, real estate benefited from the tailwinds of low interest rates: lower discount rates and cheap debt-supported pricing. Meanwhile, the search for income and returns meant asset allocators favoured property. Performance was strong, and investors sought managers that could provide access to the market quickly and efficiently.
Now interest rates are rising, and liquid assets have been repriced. Real estate no longer looks so attractive to asset allocators. Indeed, in many instances, denominator effects are working against further allocations to property. And investors are experiencing valuation declines. Losses have psychological effects. They make people more cautious.
The emphasis placed on different client requirements has changed markedly. Fund investors are likely to be more risk-averse and demanding of their managers.
There is no longer a race to get exposure to the real estate market. Instead, clients must see that their capital is being well managed to ensure exposure to the best real estate assets.
To satisfy clients, investors will have to prove they can select the right assets, follow a clear investment strategy with discipline and have a rigorous investment process.
Cautious clients are likely to be mindful of downside risks. They will want to see that a deal is assessed from every angle. In underwriting, they may need to see multiple downside scenarios to get comfortable with a transaction.
Paying fees when performance is good is one thing, paying them when values are declining is another. Clients tend to become more demanding and more cost-conscious in a downturn. They will look for investors to find and assess as many opportunities as possible. But also seize any investment deals that may be real gems. With fewer transactions occurring, investment managers need to expand their investment universe.
Clients will look for evidence that investment managers are changing and doing something different. Fortunately, the scope to make meaningful changes to meet client requirements is possible. New tools and datasets are now available – and a downturn may provide the perfect opportunity to drive changes in business practices.
Realigning business practices with new client requirements
Driving the change necessary to achieve operational excellence can be extremely difficult for businesses. Many tell themselves, “if it ain’t broke, don’t fix it” or “let’s wait and see,” rather than striving to implement an optimal model.
The problem is rarely that leaders need help to identify improvements or solutions. Rather, the difficulty lies in achieving buy-in to the need to change.
Getting buy-in to significant changes is much easier in a downturn, and, as Colvin emphasises, one reason they offer the best leaders great opportunities. When things are ticking along, organisations resist change. But downturns create a sense of urgency and, in today’s environment, people are ready to be led toward and invest in new ways of doing things.
Of course, the key is to be smart about it. Change is not the goal; improvement is the objective. So what major changes should real estate investors consider today to realign their practices with new client requirements? Here are five possibilities:
- In these uncharacteristic times, an investment team’s day-to-day may change from screening to execution to capital sourcing with less predictability. Utilising platforms that allow them to have a reliable screening capability will become an insurance policy that great deals are not missed.
- Take advantage of new data-driven and AI-based tools that provide hyper-efficient deal screening, allowing investors to review a broader range of opportunities and demonstrate a high level of selectivity, or even venture into adjacent neighbourhoods and markets.
- Exploit technology-driven underwriting that enables a deal to be underwritten quickly, accurately and efficiently under multiple scenarios allowing for a close examination of how downside risks and future upside conditions could influence returns.
- Leverage new datasets, non-traditional data and AI augmented datasets to better inform investment decisions. This provides an improved ability to assess the attractiveness of an asset through multiple facets. Deals can be informed by a far richer dataset than was the case until recently.
- Align investment processes with the potential of AI. With recent advances in AI, it may not be a “Jarvis for real-estate” that wins the day but more traditional data-and-inference efficient algorithms that allow investors to be aware of rapid changes in the market and capitalise on new trends and investment opportunities.
These improvements can be made without expanding teams. Indeed, technology allows companies to do more with less. And the use of innovative technological solutions will enable organisations to demonstrate to clients that they are making a clear break with the past in the way they source and assess opportunities.
Concluding thoughts
Never waste a good crisis. To capture the upside of this downturn, understand that a downturn changes clients’ requirements. React to those changes faster than the competition and use today’s sense of urgency to drive operational excellence. Leverage new technologies to improve the screening and assessment of investment opportunities.
It was relatively easy to attract capital in the run-up to this downturn. It is going to be distinctly more difficult in the next stage of the cycle. To own the recovery, act now.
