Today Sun Tzu’s writings are applied as lessons on how firms can navigate change and succeed in the market economy, or even be used by people to get ahead at work & navigate office politics. As we confront the “battle” we find ourselves in today with the COVID pandemic, how can we use these learnings and tactical insights to prepare our real estate portfolios for the ongoing market uncertainty and volatility? A family office’s property portfolio cannot afford to take a ”wait & see” approach, to sit on the sidelines, as the pandemic convulses the real estate markets.
Let us relate the lessons drawn from the artist of war, combining his wisdom, strategic and tactical guidance, with the experiences gained from navigating the previous real estate market shocks, recessions, and crashes that have impacted real estate in recent decades. What can the master tactician teach us about mitigating risks in a property portfolio, and how we can convert these threats and weaknesses into opportunities and strengths.
4 lessons drawn from Sun Tzu’s writings that will provide the necessary steps family offices and property investors will need to heed, to mitigate risks to their real estate assets during the turbulent COVID-19 market environment;
1. “The greatest victory is that which requires no battle”
Striving to pre-emptively balance the well-being of tenants, to allow preservation of long-term income performance, and ultimately capital values should be the goal as we head into the pandemic battle. Property owners and managers will need to make complex and subjective decisions for each property, as they weather the attack of the pandemic on their property holdings, whilst maintaining a strategic overview of their wider portfolio of investments.
Do not wait until tenants default on rental payments before you engage with them, as relations with your foot-soldiers, who make up the income-producing infantry of your portfolio’s army, will deteriorate into internal combat. In these volatile economic conditions, the challenging battle of finding new occupiers to fill vacant space is one that is best avoided where possible.
Through early engagement, connection and diplomacy, you can find effective and mutually beneficial outcomes, which will help ensure the maintenance of your longer-term rental cash flow. Early and open dialogue with tenants will make for more effective tenant retention tactics, like the timely implementation of rent relief options, and allow for a more successful tenant-orientated strategy going forward.
Property owners must be aware they do have a measure of control over the risks relating to rental flows and operating expenses. These include the tenant mix, covenant strength, and lease duration, along with the efficient management of costs and maintenance of properties. A tenant risk profile ranking can be advantageous for decision-making. How well capitalised are your tenants; are they able to ride out this storm? Will their space requirements be revised as the economic landscape evolves, and consumer markets shift and adjust to life with COVID? These risks can be built into dynamic cash-flow models to assess impacts on revenues in the coming months.
Consider whether ‘hard’ financial metrics alone are sufficient to capture the relative performance of your real estate and investment portfolio. Could a performance management system and strategy map that allows for the effective control of a family offices real estate portfolio through the integration of both ‘hard’ and ‘soft’ KPIs, alongside your investment portfolio and business holdings, be more beneficial over the longer term? Such a change in approach can allow for the true alignment of your portfolio of investment properties with your family office’s acknowledged purpose and values, or an agreed-upon impact thesis your office may have developed.
2. “Water shapes its course according to the nature of the ground over which it flows”
The only certainty in life is change, hence there are no constant conditions. Just as water retains no constant shape, so in warfare, we should be fluid and adapt to the changing landscape.
Here Tzu is imploring generals to shape their course of action by the conditions of the field. Family offices should not simply repeat tried tactics that gained them a win in the past, but instead, let their methods be regulated by a variety of circumstances.
When looking at your real estate portfolio, determining the highest and best use of a property, given the changing needs and requirements of tenants post-pandemic, will optimise the potential of your asset. Considering its current use, future potential uses, and the relative cost and benefit of making proposed changes, will allow for the optimisation of your real estate asset’s long-term value, both individually, and across a portfolio. The bottom line is: where there are potential alternative uses, which direction provides that greatest return?
Where you are looking to bring new assets into your portfolio, target your due diligence, keeping in mind the evolving occupier market, and consider whether the physical design and structure of a property will allow for the flexibility and agile behaviour that is required to defeat the impact of shocks like the Pandemic going forward.
Bringing the values and purpose that drive your family offices investment strategy, and the relevant economic, social, and governance (ESG) performance of your direct real estate holdings, into consideration when making buy or sell decisions for your portfolio. This will help to bring fluidity to the portfolio, enabling adaptation to the changing needs of occupiers, and future-proofing long-term value by increasing the liquidity of your assets in the investment market as we move forward. Is now the time for a refurbishment or repositioning of an asset, incorporating your ESG strategic goals and principles into the redesign, repurposing, and retrofitting of an existing property?
3. “Only those who are thoroughly acquainted with the evils of war can thoroughly understand the profitable way of carrying it on.”
Addressing today’s rapidly shifting field of battle requires more, rather than less, information and analysis, with calls for increased transparency being made by owners of portfolios of real estate investments. Knowledge is power in the current environment, with the market changing from month to month or even week to week! Whether you own a trophy asset or a portfolio of property investments, timely insight into the performance of your real estate is essential. Both on the micro-level, being drawn from inside your portfolio, along with targeted due diligence on potential investment targets, or on the macro-level, with market data, research, and analysis.
An abundance of raw data alone will not be much use, and with this data now being readily served up by the PropTech industry, you can be easily overwhelmed by the huge volumes of property info now available at the click of a mouse button.
This is when real estate education, market knowledge, and insightful and professional guidance become paramount. Seek out the right counsel, one who can select and analyse from this sea of data, relying on their experience and market insight, and who can convert it into practical knowledge and analysis. This will enable you to identify the relevant threats and risks and allow their conversion into profitable opportunities.
4) “In the midst of chaos, there is also opportunity”
For investors looking to maximize the value of their portfolio, there may well be strategic motivations to locking in portfolio values that reflect the currently depressed market conditions. We should never let a serious crisis go to waste! For example, a family office contemplating a portfolio strategy to minimize capital gains and reduce the tax burden for assets located in a capital gains tax environment. Including strategies such as share-holder restructuring, or moving real estate assets through an estate freeze to a family trust. A downturn in the market, where real estate values can be written down to reflect depressed occupancy levels, actual and expected rental income levels, and a perceived reduction in investment market sentiment and liquidity, combine to make this an opportune time to enact such a strategy.
For some portfolios, share restructuring may be advantageous. While other family businesses that hold property assets may wish to establish or update Family Trusts that hold shares indirectly for family members
to facilitate opportunities for income splitting and estate planning. When dealing with such complex matters, always work closely with a regulated valuation or appraisal expert within the specific market the asset is located, along with reputable tax and legal advisors, to understand the long-term value and legal implications fully.
Sun Tzu provides insightful guidance on how we must maintain a future-focused outlook for property investments. Having visibility and clarity into your property holdings, and the respective markets they are located within, allows your family office to act nimbly and respond positively to the challenges and threats that arise. The decisions you make now will determine the health of your real estate portfolio when the coronavirus turmoil eventually subsides.
The only certainty in life is change. There are certainly no constant conditions in the global real estate markets. Adopting a fluid approach to property investment and management will allow for a forward path of least resistance.