In his 2005 book, Everything was Forever, Until It Was No More: The Last Soviet Generation, Alexei Yurchak introduced the term ‘hypernormalisation’.
The book concentrated on the circumstances that existed in the Soviet Union during the time following Stalin but before perestroika.
Yurchak contends that, although everyone was aware of the system’s flaws, politicians and citizens were consigned to upholding the pretence of a well-functioning society because no other options could be envisioned.
Over time, pervasive fakery was accepted as real and thus became a lived reality. Yurchak labeled this phenomenon hypernormalisation.
Something similar has been at play in real estate. Over the last decade and a half, property investors have become hypernormalised to extremely loose monetary policy.
it is hard to overstate how pervasive the impact of persistently expansive monetary policy has been.
“Lower discount rates and cheap debt have supported higher pricing”
Most directly,lower discount rates and cheap debt have supported higher pricing. Furthermore, compressed yields on low risk, liquid debt instruments have meant asset allocators have favoured real estate as they search for income. In addition, parts of the occupier market have been supported by cheap capital. Plentiful equity has spurred growth in the technology sector, for example, while favourable conditions for borrowers have enabled some weaker companies to survive.
Everyone knew this could not last forever, but had to act as if it would until it stopped. Now it has.
A clear signal came from the European Central Bank last week. It increased its three interest rates by half a percentage point in a move that was unprecedented in more than 10 years. In a single move, the bank ended eight years of negative interest rates.
Significantly tighter monetary policy has been expected by bond markets. As in the US, government bond yields in Germany are about 1.5% higher than at the start of the year.
Property yields are likely to follow that move upwards, but if history is a guide, it will be with a lag. On such occasions, the slow-moving nature of real estate can be a source of opportunity. Today, investors may be able to exit their holdings at a relatively modest discount to peak pricing. That may not be the case over the next few years. With heightened growth concerns, those with assets that they need to dispose of over the medium term should act with urgency.
To act appropriately, real estate investors need to do three things.
First, shift perceptions of what is normal. It may not be easy, given how used we became to expansive monetary policy, but it’s time to accept a new reality.
Second, think long term. Taking a discount to valuation can hurt short-term relative performance, but it can be in the best interests of investors in the long term. This is particularly true if – as would be reasonable today – you expect the next stage in the cycle to provide attractive entry points for the redeployment of capital.
Third, know that it is going to feel hard. Crystalising losses hurts, even if it is just a loss relative to a peak valuation, rather than the entry price.
“One of the best-known cognitive biases is loss aversion, which causes us to feel losses more keenly than gains”
In a sense, it hurts more than it should. One of the best-known cognitive biases is loss aversion, which causes us to feel losses more keenly than gains. We see this in housing markets when, during a downturn, people resist selling at a price below the level they originally paid.
Loss aversion can be a block to rational decision-making, leading us to be excessively hesitant to realise losses. So, this is an occasion where your gut is particularly likely to send a false signal. A dispassionate, data-driven approach is essential.
Indeed, the key is to make hold/sell decisions purely on a forward-looking basis and not to anchor to historic valuations or price points.
Of course, we cannot know the future. It would not be appropriate to advocate the wholesale repositioning of a portfolio based on the expectations of a change in the monetary policy regime. But holding assets for too long is a trap it’s easy to fall into at this stage in the cycle. Don’t let it happen to you.
