How to eat an elephant?

It’s been 18 months now, since hell broke loose. That is, if you’re referring to the Lehman collapse as the tipping point of hell.  We have been experiencing the consequences of this unprecedented crisis ever since. And still, as of today. What is taking the market so long to recover? An elephant.

What started off as the so-called subprime crisis, evolved into various successive financial and economic crises. For obvious reasons, which I will not resume here, real estate is strongly related to these crises. Both cause and effect. Broad market improvement is only possible after the elephant has been eaten and digested. The way this is done, may hold the key to market recovery.

The finance crisis caused the real estate sector to suddenly collapse after years of finance-supported ballooning of property prices. The effect of this sudden finance-drought has been close to catastrophic: falling prices, defaulting loans,  cash flow problems, bankruptcies, rising vacancies, failing and lacking of new transactions, etcetera. These processes have mutually acumilating effects and, as a result, a huge influence on the asset values in a very short amount of time. 

As the past two year have proven, most real estate market players are not able to adjust to rapidly changing environments. Especially when the necessary adjustments are huge, many property investors could not adapt to the altered situation. They simply couldn’t swallow.

The answer to “How Do You Eat an Elephant?”, is: “One Bite At a Time”. This holds for most investors. But it is not necessarily the best approach. Investors may be prepared to adjust the value of their assets, their portfolios, but only if they are being forced by circumstance and only in smaller portions. This approach has two effects: 1) revaluation of the portfolios takes time, as it is being spread out over multiple quarters; and 2) virtually no transactions take place, as potential sellers are not prepared to accept the actual market value, yet. The result: the only transactions that do take place are more or less forced sales. Meanwhile, assets are de facto overvalued, with unrealised capital losses still to swallow further down the line. It does not reflect reality and it incurs substantial risks. So, eating the elephant one bite at a time is a mere postponement of action and an actual denial of facts.

There seems to be an ‘Anglo Saxon’ approach when it comes to ‘rules on catering’, or going about a rapidly changing world. Instead of eating elephants one bite at a time, life is lived by the rule “wake up and smell the coffee”. Probably bound by culture, mentality, or even accounting principles, UK and US investors tend to take the loss when it appears. In full, that is. All right, losses are huge and are squeezing the results in a specific period. But as a result, all assets are valued at market, transactions do take place and there’s even room for profit, when circumstances improve. The downside of ‘smelling the coffee’ rather than ‘eating the elephant bite by bite’:  higher volatility, more boom-bust effects and some larger bankruptcies. However, the upside is eminent: when recovery kicks in, Anglo Saxon markets are the first to benefit. We can see that happening for instance in London nowadays. Time has come to sip a London cappuccino…