Real Estate Risk Management
Managing Risk In Commercial Real Estate Investment
MSCI RICS COBRA AUBEA Conference
As commercial real estate becomes an increasingly prominent part of institutional portfolios, attitudes towards risk management are evolving. From the multi-asset-class context to the ‘market’, ‘portfolio’, ‘asset’ and ‘tenant’ level, investors are changing the way they look at real estate risk. Considerable effort has been devoted to improving our understanding of real estate risk with a large body of existing literature but this is often poorly integrated into actual investment processes. Using MSCI’s unparalleled global data and models, this paper focuses on several key areas which are important to the discussion around real estate risk. The paper first considers real estate and the challenges of integrating it into a multi-asset-class portfolio before moving on to look at some of the underlying levels of real estate risk. The discussion in this paper helps to demonstrate the importance of building greater risk awareness through the investment process.
The Erosion Of The Real Estate Home Bias
Jean-Martin Aussant, Peter Hobbs, Yang Liu, Peter Shepard
The integration of real estate with other asset classes and greater scrutiny from risk managers are set to increase, not reduce, the moves for international exposure.
The traditional, home-biased focus of real estate investing is starting to change. The globalization of this opportunity set is being driven by the world’s largest Sovereign Wealth and Pension Funds, many of whom have explicit global real estate investment mandates. There is a broader trend, however, driven by the perceived diversification benefits of international real estate exposure. Many investors have started to understand the role of real estate in a multi-asset-class context, and this perspective tends to increase the demand for international real estate, furthering the decline of real estate home bias.
In this Research Insight, we use the Barra Integrated Model (BIM) and the latest Barra Private Real Estate Model (PRE2) to examine the drivers of risk and return in the international real estate market.
Risk Management: Looking through The Label
IPE Real Estate
Over-reliance on geographic, sector and style labels and an emphasis on volatility of total returns could be misleading investors. Matthew Richardson explains.
The traditional approaches to decision-making in direct real estate could arguably be improved. Two problems in particular are worth noting:
- There is over-reliance on geographic, sector and style labels; such labels, while useful in many ways, can mislead because they fail to capture the true risk of real estate assets;
- Too much emphasis is placed on the volatility of total returns; total returns data mask the marked difference between the volatility of income returns and capital returns.
Better results are obtainable by looking through sector, geographic and style labels at the underlying cash flows, although this is more challenging. The difference in volatility of income returns and capital returns merits far greater attention.
Risk Management: Differences In Class
IPE Real Estate
Despite their different characteristics, new research has found little differentiation between the long-term performance of value-added and opportunistic funds.
Some investors in closed-end real estate private equity funds use fund class labels – core, value-added and opportunistic – to help construct portfolios. Differences in fund risk can derive from investing in different property types, geographies, stages of building life and leverage, as well as the degree of fund focus in these areas and the timing of investment decisions by managers. Therefore, it is not clear how useful broad classifications of fund risk are for portfolio decisions when the variety of investment strategies is so large and their execution by managers is so critical.
Despite the fact that classes of funds differ in investment composition, they show that class has not been a reliable differentiator of performance between value-added and opportunistic funds. In their review of individual fund histories from vintages between 1980 and 2008, average performance does not differ between the two classes. This holds overall, for different periods, and for different metrics of performance. To vet funds, investors should more specifically evaluate fund strategies and management quality.
A Discussion Of The Monte Carlo Technique Applied To Commercial Property: Examining Risk In pPerspective
This paper discusses the application of the Monte Carlo simulation technique to commercial property investment feasibility studies. The paper is divided into five sections as follows:
- A discussion on the variables in commercial property returns 2. A critique of commonly used contemporary techniques for project feasibility analysis 3. An overview of the Monte Carlo risk analysis technique 4. Interpretation and analysis of simulation results 5. Utility, and inherent limitations, associated with modelling real world uncertainty using Monte Carlo