Anyone familiar with the board game Risk will know the winner will be the player who correctly assesses the risks associated with taking over countries. The path to success in the 1959-published game is intertwined with an understanding of its title.
The same could be said for real estate fund investing. The traditional style nomenclature of core, core plus, value-added and opportunity strategies and the spoils they bring when executed efficiently are understood by even the most junior of market players. But like Hasbro’s classic, most of those who have prevailed victorious have undertaken an exhaustive reading of the risks in the environment they operate first.
We enter 2010 on the back of at least two dire years for many global investment managers. Addressing the consequences of past, over-zealous capital campaigns remains high on the agenda for many, but re-addressing the investment strategy ahead is of paramount importance for most. A vital part of that process is in the understanding of the risks behind the four traditional strategies, the definitions of which have altered little in spite of the significantly evolved investment market of the past few years.
Today, many firms are, with a degree of uniformity, creating metrics of risk analysis to present to their investors prior to engaging them into one strategy or another. Sector bodies such as the European Association for Investors in Non-Listed Vehicles (INREV), the equivalent body in Asia (ANREV) and the real estate performance firm, IPD, are doing likewise to aid the process.
The individual approach
Peter Hobbs, managing director and head of global research at RREEF, the alternative investment management business of Deutsche Bank, says the firm is seeking to be more explicit about the risks its investors undertake in any given deal. “The industry is going the same way,” he says. RREEF offers a range of strategies to its investors from core to opportunistic, and Hobbs argues the paths to adopting these strategies are entwined with various prior risk considerations. “We could say core but what does that actually mean?” he asks. “Being explicit about the various dimensions of risks, such as the amount of leverage, development exposure and income certainty is a better way for articulating and executing the strategies than some catch-all description.”
In a specific example of investment risk analysis ING Real Estate Investment Management, the real estate investment management arm of Dutch financial group ING, examines the economic and financial systemic risk of a given target country, among other factors, before making a suggestion on one of its vehicles.
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Peter Hobbs, managing director and head of global research at RREEF |
Jeremy Plummer, managing director of global multi manager at Richard Ellis, classifies three types of risk for its investments: market risk, property-specific risk and leverage. While property specific risk and leverage are relatively self-explanatory, market risk, he explains, considers aspects such as the reach and volatility of a given sector. He offers the example of care homes, which are high risk in that the number of investors focused on the sector is limited, but low risk in terms of stable cash flows as tenants tend to stay solvent and remain in one asset longer.
The group approach
In June 2008, INREV determined that investment style was a “bundle of risks” and that identifying and examining these risks in line with current style classifications would enable it to create a more adequate classification instrument for new funds. Two months ago, the association sent a sample of funds from the books of its 320-strong members reflecting core, value-added and opportunity strategies, to a working group for analysis. Lonneke Lowik, director of research and market information told PERE, the fruits of its labour are expected to be revealed in April at INREV’s annual conference.
“Our first approach was based on IRR and leverage,” Lowik explains. She says, plummeting valuations led to inevitable style drift as leverage ratios increased, bumping vehicles up the risk curve and consequently from one strategy to another by accident. “We are now examining the definitions of risk, the various combinations of which will help decide what fits with which strategy,” she says.
RREEF’s Hobbs regards INREV’s ambition to be more transparent about the risks that investors undertake with the various strategies as important. But he forewarns: “Nothing can be clear for quite some time as there is much less capital raising. Although they can set out the framework it is only as funds are launched that the results of their work will become clear. But investors do want more transparency and reporting and the INREV guidelines, not just the rating criteria, but broader guidelines, are very helpful in bringing that transparency.”
Following INREV’s agreement with ANREV to adopt its working practices and guidelines, the organisation formerly known as the
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Timothy Bellman, global head of research and strategy at ING REIM |
The Investment Property Databank (IPD) is one organisation that has already made inroads into providing risk assessment instruments. Since 2005, IPD has offered its RiskWeb service, a web-like diagram which evolves as the user inputs information related to its vehicle [p. 30]. Designed by current Legal & General strategy advisor Gerry Blundell and IPD manager for North America, Simon Fairchild, the RiskWeb enables a manager to chart the risk profile of a given fund in areas including income, vacancy rate, asset mix, lease length, covenant strength and tenant concentration.
Malcolm Frodsham, research director at IPD says: “When you go through the story of a fund you usually find that all the aspects of the web have affected the portfolio return.” He argues that measuring fund outperformance or poor performance is made more straightforward as a result. While IPD predominantly monitors core funds, the same instrument could prove useful to vehicles further up the risk curve.
Hobbs says that tools such IPD’s RiskWeb are useful in understanding, managing and explaining risks of different investment strategies. Such tools are helpful in focusing on areas such as leasing risk, quality of income, lease length, credit quality, exposure to voids and non-income producing asset. But he points out that the web was based on the UK market and needs to be adapted to the specific risks encountered in different markets around the world. There is, he says, also scope to include a broader range of capital market factors, most particularly relating to leverage.
Investors currently active are deploying their capital down the risk curve when making their real estate allocations and this applies to both funds and separate accounts. But as with the game of Risk, there’s always a right time for the investor to strike, regardless of where they are in a cycle. Investment managers and the bodies that represent them are scrutinising the multitudes of differing and evolving risk factors in global real estate investing today in an effort to enable them to do just that.
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