Risk modelling is an essential activity for many financial players. Hedge fund traders use returns analysis to gain an edge over the market, credit card companies use credit ratings to target selling, and the entire insurance sector relies heavily on their actuarial models.
However, in the real estate industry, risk modelling is a relatively new competency. Its application has been slower and more difficult because of the market complexity and diversity of assets, which is why early adopters who have started combining industry knowledge with risk modelling are set to gain an edge over those who still rely on expertise alone.
Let’s further dive into how risk modelling can mitigate risks for both real estate portfolios as well as for individual investments.
Analysing portfolio risks
Traditionally, a portfolio of assets is built by a series of “good” transactions that are expected to perform at par or, ideally, better than the market. The investment decision typically has two dimensions: 1) the expected return of the market, and 2) the knowledge about a particular geography and sector to identify the promising properties.
This works well if the objective is to be a specialist investment vehicle for those who want exposure to a particular market.
Take the Singapore office market as an example. If the objective is to provide specific exposure to that market as part of a diversified portfolio, and if the investors value that specialisation, then the strategy should focus on individual deals with high expected returns in that market.
However, many investors whose objective is to build a diversified real estate fund tend to create concentrated portfolios because they unintentionally get trapped in dealing only with familiar markets. The result is a portfolio with highly volatile returns. The unintentional concentration happens because the business isn’t explicitly measuring its volatility and correlation between markets.
How does OfficeBlocks help?
OfficeBlocks’ Market Intelligence Platform can help you achieve diversity across markets and segments.
The platform allows individuals from any location and any part of your organisation to access market knowledge and insights, rather than relying on third-party expertise or from a trusted investor who possesses such insights.
OfficeBlocks’ Portfolio Intelligence Platform provides diversification knowledge
To have successful investments across multiple markets, an investment committee must have the necessary information about expected returns, risks, and diversification. While expected return and volatility will vary from market to market, diversification depends on the market and the portfolio. Each time the fund buys or sells an asset, the diversification characteristics of all assets will change. When there are more than a handful of assets, it becomes impossible to balance that many factors. The Portfolio Intelligence Platform measures the diversified risk and return and provides the contribution of each existing and prospective asset.
Structuring individual transactions
Risk modelling is a competitive advantage when it comes to selecting and structuring complex individual transactions. Large transactions can become complex, with cascades of seniority and legal covenants triggering payments under different conditions. In these cases, it can be challenging to understand the interactions within a single deal.
OfficeBlocks’ Risk Intelligence Platform carries out detailed risk modelling on a lease-by-lease basis in view of revealing any “cracks in the deal” or any overlooked risk, such as two or more leases that are expiring simultaneously. These unexpected results can be used to question the deal, quantify the risk, and identify any need for restructuring.
Risk analysis is not just about avoiding risk – it’s about taking calculated risks. It offers quantitative perspectives that help differentiate between opportunities that may look similar on the surface but can yield entirely different results.