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Stockdale Paradox & Impacting Alpha
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Oceanographic operations on the Coast and Geodetic Survey Ship PIONEER. Lieutenant Commander Harley Nygren on the platform.

“You must never confuse faith that you will prevail in the end — which you can never afford to lose — with the discipline to confront the most brutal facts of your current reality, whatever they might be.”

–James Stockdale

Survival is always the first order of business. This is just as true in business as it is in nature. In his seminal book, Good to Great, Jim Collins includes an episode about the Stockdale Paradox; which Robert Glazer brought up again in his Friday Forward missive last Friday. The story is about how the highest ranking POW in the Vietnam War, Jim Stockdale, survived over 7 years of torture at the Hanoi Hilton. The concept is not new. It is said that King Solomon’s ring was inscribed with three Hebrew letters on the gold band: gimel, zayin, yud which began the words, “Gam zeh ya’avor” - “ This too shall pass”. We see it again in the Bible, Corinthians 4: 17-18. It was also said to be one of Abraham Lincoln’s favorite sayings.

So how does the Stockdale Paradox Impact Alpha for property owners and lenders? The ugly truth, which must be confronted, is that the unintended consequences of government intervention due to the Covid -19 pandemic destroyed supply chains around the world while creating unprecedented demand by printing and distributing trillions of dollars. Exacerbated by an untimely war in Ukraine and new technology enabling people to live, work, play and buy stuff wherever and whenever they want, these actions have created massive inflation, which has pushed operational costs of owning real estate dramatically higher, while redefining the purposefulness of “space” as “experience”. This pressure on costs with an evaporation of 20%-40% of demand for office space, has set the stage for massive value destruction in Class B and C, and even Class A office. Class A & B has been reduced to land value. Class A is worth 30-40% of replacement cost. Industrial buildings are worth more than Class A office in many markets.

For those of you who have been around since the early 1980’s this is your 5th rodeo. In every single case, the survivors all saw that the only way to survive was to confront the ugly truth and walk through the fire repeating the mantra, “this too shall pass”. We will all get through this, but some will get through it better than others. As described I the Stockdale Paradox, it will not be the optimists. It will be the early movers who recognize the ugly truth about the value destruction that has only just begun and have an action plan to protect and preserve their equity so that they may survive this perilous financial storm.

What does that action plan look like? It’s very simple. In an era of accelerating asset deflation, the best strategy is to eliminate the corrosive effects of debt and monetize equity positions to allow for re-entry at a lower basis. Why feed the debt beast when the basis is 40% - 50% above market and the debt is correspondingly, 40% too high? The most at risk and controlling equity position would best Impact Alpha by selling the asset and redeploying the capital at a lower basis in either the same property or another property with better upside. Unlike the stock market, where it is very challenging, if not impossible, to “time the market” due to its extreme volatility, such is not the case in commercial real estate. It’s relatively easy to be out in front of the market and act quicky to preserve equity.

There are several institutional owners and lenders of high profile office properties that are acting now to do just that. With very strong balance sheets, the institutional equity, private capital funds and lenders can afford to “take the hit” now to reposition their investments where there is greater upside for profitable returns. Yes, the hit will not be pleasant and the pain in some cases severe, but it will not be life threatening and when this too shall pass, you will be glad you acted. You will have survived and be in position to thrive when the pendulum swings back in favor of growth investments.

Are you an optimist….or a realist?

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