STRATEGY
ANALYSIS
A Real Risk Assessment IS YOUR APPROACH TO RISK MANAGEMENT WORKING?
By Steve Streetman
ow many of you have heard knowledgeable real estate investors discuss risk? In sober tones they describe “risks” like loss of tenants, market risk, title claims, competition. And their “risk man- agement” approaches are to always buy title insurance, don’t build if there are other projects in the pipeline, only buy where there are diversified economies, and don’t buy if the leases are all due at the same time. The advice is not necessarily bad (though it could be in some situa- tions) but it is not based on a risk assessment and the items identified as risks are better characterized as “threats.” As a real estate investor who performs quantitative risk as- sessment in other areas of my pro- H
fessional life, I have been dismayed at the lack of formal risk assessment in real estate investing. The half measures usually used may mislead real estate investors or result in losing deals unnecessarily or paying extra funds for no benefit. What is a real risk assessment? Kaplan and Garrick in their semi- nal paper from 1981 identify risk by asking three questions:
sess the overall risk of a real estate investment. But in most real estate discussions of risk, they talk about what could go wrong and never ask how likely it is or what would be the consequences. If it is a scenario that is highly unlikely or that would result in only minor consequences, it may not be a risk worth worrying about. In the “risks” discussed in the first paragraph, all are “what could go wrong” with no assessment of likelihood or consequences. And that’s the problem. Until we assess likelihood and consequences, we can’t really know what, if anything, we should do about the risks. In formal risk assessment we often structure these questions for estimation as “threat,” “vulnerabili- ty,” and “consequence.”
1. What can go wrong? 2. How likely is it? 3. What would be the conse- quences if it happens?
These questions describe a spe- cific risk scenario. A comprehensive set of these scenarios (with all three questions answered) allows us to as-
72 | think realty magazine :: june 2020
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