The path to eliminate problems before they occur Calculating risk is an attempt to
GRASPING THE CONCEPT OF RISK THEORY IS IMPORTANT FOR RISKMANAGEMENT PLANNING : Roughly speaking, events that occur with high frequency are prone to have more variation than events that occur less frequently while less frequent events may mean less variation. Symmetrically speaking, consider that high frequency events having low consequence may have an aggregate severity equal to low frequency events having high consequence. Reducing variation of outcome through tighter controls reduces total severity of con- sequence, which is how you will apply risk management to your business. EXAMPLE OF RISK MANAGEMENT INDICATORS IN REAL ESTATE Imagine two Renters, A & B. Renter A paid rent consistently late, on the fourth day of the month with rarely any variation. Plotted on the curve, the av- erage would show a high frequency of late rent as averaging -four. Renter B determine probability of an outcome. A conceptual understanding of how those numbers are derived is critical for effective implementation of risk management practices. A grasp of risk theory only requires a bell curve illustration and a sprinkling of a few statistical terms when combined with practical real estate examples. The bell curve figure has a symmetrical area under the curve that (eventually) totals 1.00 (one). Where: μ = [mu, (pronounced “mew”)] is the data mean, the average, (expected outcome or return) 𝝈 = [sigma] the standard deviation, shows six equidistant intervals, known as the range (99.7% of 1.00)
μ–3𝝈 μ–2𝝈 μ–𝝈 μ μ–𝝈 μ—2𝝈 μ—3𝝈 Any given point in the graph is a probability of an event or an accumulated series of events. Events are plotted in relation to the frequency they occur (height) and distance from average (left or right of centerline). Closely plotted points indicate the deviation from average is low; loosely plotted points mean less predictability (the deviation from average is high).
is different. The average is one, which would indicate rent is paid on average a day early. Except many of the plots are largely spread out into the negative teens and twenties, with a few plots at 30, 40, and 60. Which has higher variation? Which has more risk? Which can you be more confident of getting paid rent on a given day? As a separate event, the number of opportunities that a basement will flood may be far less than opportu - nities for rent to be paid on time, yet, the financial consequence may be quite severe. A sump pump with bat- tery backup is installed, so all should be okay, right? Now evaluate the same two renter households. Consid- er Renter A vs. Renter B. Would you consider the likelihood of tampering with the sump pump between Renter A and Renter B as the same? Why or why not? Statistics attempt to bring togeth- er all events of different types, each having probabilities and frequencies of their own, and normalize them into a single measure (expected outcome) that you determine is important. Man-
aging the causal factors that impact the outcome is up to you. APPLICATION OF RISK MANAGEMENT PRINCIPLES WITHOUT STATISTICS The key is to identify possible caus- es that prevent achieving the expect- ed outcome. It has been established now, with the iterative cycle of real estate opera- tions, even though an event never gets tested or realized (a failure does not occur), that risk remains inherit in the system. A step most overlooked is a critical thinking exercise that accounts for possibilities of what can go wrong. Possibilities considered are possibili- ties managed. Proactive vs. Reactive. Identification of 95 percent of causes are either obvious or routine enough to identify with a smidge of critical thinking. Reducing variation and consequences of those causes is a qualitative and subjective exercise. Tighter controls and mitigation plans are how risk management can be ap- plied to your business to reduce loss- es and improve gains. The sum of all
32 | think realty magazine :: june 2020
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