This blog features insights into restructuring and workout of complex real estate situations in Europe, where formal insolvency outcomes typically result in liquidation and unecessary capital destruction. Questions of governance principles and ways-of-working are considered in relation to cross-border resolution of sub-performing and distressed situations, particularly when impacted by lasting periods of economic adversity.
It’s not often that an asset manager of private real estate comes into contingency cross-hairs of liability under criminal code. But it happens, even to good managers, typically as a consequence of the cross-border activities of a rogue operating partner. Such risk events can potentially pierce a fund structure to reach the executive board of the manager, not to mention impact to the fund vehicle itself. The approach in such situations must be swift and nuanced, working closely with legal counsel. An external commercial advocate, with experience in such matters, can add significant value by resolving the issues discretely and cost-effectively. Of course, the tried and true process of deep quantitative and qualitative analysis is necessary for the purpose of observing good governance principles and providing for approval of a coherent and viable strategic approach (and budget) to resolve the situation, without delay.
There are occasions when local vendors are found to be wanting of consideration for introductions or referrals. This is really the prerogative of the cross-border investor if this manner of business is reciprocated. There are no circumstances in the workout of a complex situation where such an occasion is acceptable. On the contrary, it suggests the vendor in question is part of the problem. Fees should be recognized only for the work a vendor is instructed to do, which pertains to their professional competence. Such vendors need to be removed from the project in a swift, orderly and respectful manner. A strong workout advocate expects vendors to make referrals for the benefit of the investors as a matter of courtesy.
Making mistakes is fundamental to life and business. It comes with taking risk. One cannot be successful without taking risk or making mistakes. This is true for working out complex situations in real estate. There are always a number of viable ways to optimize a workout undertaking. There is not usually “one” best way. One must accept that a reasonable number of mistakes will be made. A good workout advocate will take some risk – one cannot be moribund in process and excessive decision-making. Afterall, the team must move swiftly and cost-effectively to achieve an ambitious set of objectives. Of course, this is done within the context of a robust set of pre-approved asset management plans. Similarly, governance principles are observed just as purposefully as in the normal course of business and daily-working-habits. But the net quantum of mistakes should be immaterial in relation to achieved outcomes. Consider a battleship at sea taking fire in a messy skirmish in choppy waters. Some strikes are unavoidable – one must beware not to take a hit below the waterline.
One cannot simplify the complex question of gender. It’s a vast and profound challenge of our time. In the process of change there are three interacting participants; instigators, resistors and the large body of passive players. Consider the absurd historic timelines of women’s right to vote around the world; from first published articles to activism, incremental change of law, to participation. Its an astonishing set of data. What does one do today to be non-passive, to have an impact? It’s a trap to merely say that one is generally open to diversity or to have documented policy that is not actually practiced. There are too many biases affecting our daily decisions. But if one believes productivity gains are derived from disrupting inhibitors to change this can be a driver for deliberate action. There is no question gender diversity outperforms. What is the next step, how does one optimize performance through gender diversity? Is there not an opportunity to recruit highly skilled under-valued professionals in our industry for aspirational roles and reward them for performance? It seems to be a “moneyball” equation. Isn’t this the undeniable future in business – productivity growth and competitiveness?
European real estate has changed considerably since the Great Financial Crisis. Consider the expansion of special accounts and non-bank lending or private and public bond issuance. Capital has gravitated to large managers. Housing affordability is a crisis in core cities. The rhetoric of co-working platforms has verged on the absurd. And so on. The composition of real estate markets change from one cycle to the next. But when a narrative comes to the fore that “It’s Different This Time”, the end of a cycle is always near. This has always been an inherent attribute of the asset class and remains so today. Market imbalances are never indefinitely sustainable. The invisible hand of the market will inevitably take its course, eventually. The consequences of a long expansionary cycle will be the same as always. With down-market real estate cycles there is no escaping, unavoidable capital destruction. Will this force of destiny ever change for real estate? Yes, it will. Digital, technological and financial innovations, in the passage of time, will smooth out market imperfections. But it’s not different this time.
Times of broad economic disruption can wreak havoc on a real estate portfolio investment strategy and lay waste to large amounts of capital. This is inherent to the asset class. Consequently, tax efficient, multi-jurisdictional investment structures can be rendered obsolete. The cost-effectiveness of structuring comes into question when a complex situation is one of capital recovery. An obsolete structure only compounds erosion of capital. Proactive quantitative and qualitative analysis should support decision-making for rationalizing structures in good time, where possible. An investment structure of any kind should never be adrift. Management must always be moving forward, optimizing capital preservation and recovery on a marginal cost-benefit basis, according to well-defined and vetted asset management plans. Ideally, the marginal cost is not so high that capital is unnecessarily left to waste. Capital is divine. Every reasonable effort should be made for the benefit of financial stakeholders.
What does a good set of standard operating procedures look like? They are only observed when lacking or poorly practiced. Good SOPs are hardly noticeable at all. This is akin to something Muhammed Ali once said. “It’s Just a Job. Grass Grows, Birds Fly, Waves Pound the Sand. I Beat Up People.” The poetry of this is that a good set of SOPs functions with deliberate purpose, always moving forward. What is fundamental is that they are specifically articulated to support a coherent set of governance principles – alignment of interests, transparency, decision-making support and risk management systems. No one can argue with good SOPs practiced in daily-working-habits. This is how one should wake up in the morning.
“We are sinking, we are sinking”, exclaimed a distressed Englishman’s voice over the radio. “Hallo, this is the German coast guard” came a reply. “What are you thinking about?” Indeed, there are many challenges for cross-border capital recovery in Europe. Complex real estate situations bring interpretation of local law and governance principles into sharp focus, information is lost in translation, local market structures and customs can be confounding even for the best managers. Asset management operations are stressed with the heavy workload generated by disruptive market cycles to preserve returns and preserve or recover capital. There is a clear cost-benefit stage for integrating specialist asset management support and taking defensive or proactive measures to steer clear of unnecessary calamity and the compounding workload that comes with chaos. A specialist workout and capital recovery firm has practiced processes in-place for working with cross-border operating partners and service providers, rebalancing alignment of interests, restoring transparency and robust decision-making procedures and implementing appropriate risk management measures for the situation at hand. These undertakings, which can be substantial, need to be done swiftly and cost effectively. But this is how such a practice wakes up in the morning, just like the coast guard.
Manners Maketh Man, it has been said. This is even more so in complex real estate situations, where vulnerabilities are exposed, confidences among business partners are at risk and tensions run high. When a situation can turn either to a path of voluntary resolution or formal legal procedures out of mere frustration, loss of patience or spite, there is no measure of diplomacy that can be wasted. One must be respectful at all times, exercise the most basic good graces and observe a spirit of patience and honesty in dealing with matters at hand. Determination is always needed to get a handle on numbers and move a situation forward in a coherent direction. However, good manners and diplomacy make the way easier for everyone involved and give voluntary resolutions a fighting chance.
A fully invested fund has committed all or nearly all of its capital to investments. Under stable market conditions, there should be no open or unfunded positions when a fund is fully deployed. Either a residual balance of committed capital is in-place to cover funding requirements or there may be provisions for proceeds from divested positions to be reinvested. But what happens when an investment portfolio is impacted by economic disruption which in turn impairs investment underwriting and creates unbudgeted open positions. This can cause immense strain on a manager’s operations. Likewise, governance principles can come under pressure. One can easily understand how quickly complex situations can develop from such events. A good manager will rise to the challenge. This is real estate.