Risk Management as Practiced by International Real Estate Investors

1. Risk Management as Practiced by InternationalReal Estate Investors ERES conference June 2009 Author: Sascha Donner EuroFH – University of Applied Sciences, Hamburg Faculty: European Business Administration Supervisor: Prof. Dr. Ottmar Schneck With support from:

2. OBJECTIVE OF THE STUDY STUDY DESIGN SURVEY PARTICIPANTS RESULTS SUMMARY

3. OBJECTIVE OF THE STUDY STUDY DESIGN SURVEY PARTICIPANTS RESULTS SUMMARY

4. DESIGN AND METHODOLOGY PURPOSE Survey of risk management practices as employed by real estate investors at the international level PREVIOUS STUDIES Gibson, V.A./ Louargand, M. (2002) “Risk Management and the Corporate Real Estate Portfolio” Hyss, S. (2006) „Risikomanagementprozesse der Immobilienwirtschaft“ Dr. Peter & Company (2007) „Interne Studie über Risikomanagement“ Schwenzer, J. (2008) „Bedeutung und Ausprägung des Risikomanagements von Immobilien in Deutschland“

5. OBJECTIVE OF THE STUDY STUDY DESIGN SURVEY PARTICIPANTS RESULTS SUMMARY

6. DESIGN AND METHODOLOGY • STUDY DESIGN • Hypotheses: • Risks which are present in larger real estate portfolios can be effectively reduced by means of diversification or the use of derivatives. • Systematic and comprehensive risk management tailored to the real estate industry is lacking to a great extent.

7. DESIGN AND METHODOLOGY • STUDY DESIGN • Points of inquiry: • In what forms is risk management to be found among the various types of real estate investments? • What risks garner the greatest share of investor attention? • What methods and resources are employed in the risk management process?

8. DESIGN AND METHODOLOGY STUDY DESIGN Survey conducted via web-based questionnaire in English and German languages The questionnaire comprised 51 questions in 7 areas: A) General questions concerning participant’s firm B) Integration of risk management in the firm structure C) Risk identification at property level D) Risk analysis and risk assessment E) Risk management and risk controlling F) Communication and information flow G) Risk management methods Questions posed were predominately of a closed form. Isolated half-closed questions were used. In order to ascertain the distinct characteristics of the various aspects of risk management, scales (range 1 min. – 7 max.) were used, and rankings were performed by the participants.

9. STRUCTURE AND METHODOLOGY STUDY DESIGN 613 international real estate investors (representing 49 nations) were randomly selected from a database of 1,836 investors. The database had been compiled from publicly accessible information sources and with the support of REAG GmbH Frankfurt. Invitations to participate were sent out (83% of investors were written to by name), and reminder e-mails were dispatched after 1 and 2 weeks respectively. Duration of the survey: 3 weeks (12/01/09 – 31/01/09) Response rate: 8.2 % (50 Investors)

10. OBJECTIVE OF THE STUDY STUDY DESIGN SURVEY PARTICIPANTS RESULTS SUMMARY

11. DESIGN AND METHODOLOGY SURVEY PARTICIPANTS - Distribution according to investor type Detailed overview

12. DESIGN AND METHODOLOGY SURVEY PARTICIPANTS – Distribution according to investor type Summarized 19 % Real estate corporations and REITs 16 % Investment Funds 15 % Private Equity Investors 15 % Closed Funds 14 % Banks, Insurance companies, Pension funds 7 % Corporate 7 % Project developers 4% Other (advisory, management and leasing companies) 3 % Fund of funds

13. DESIGN AND METHODOLOGY SURVEY PARTICIPANTS – Geographical distribution 16 different nations

14. DESIGN AND METHODOLOGY SURVEY PARTICIPANTS Year of establishment Number of associates

15. OBJECTIVE OF THE STUDY STUDY DESIGN SURVEY PARTICIPANTS RESULTS SUMMARY

16. RESULTS A: General Questions Concerning Participant’s Firm - PORTFOLIO

17. RESULTS B: Integration of Risk Management in Company Structure Integration in company hierarchy

18. RESULTS B: Integration of Risk Management in Company Structure Assignment to company function *other: asset / portfolio management, investment committee, business management, purchasing, all areas

19. RESULTS B: Integration of Risk Management in Company Structure CRO vs. CCO In 32 % of firms there exists the position of Chief Risk Officers (CRO) In 44 % of firms there exists the position of Chief Compliance Officers (CCO)

20. RESULTS B: Integration in Company Structure Duties of Chief Risk Officers (CRO) Duties of Chief Compliance Officers (CCO)

21. RESULTS C: Risk Identification at Property Level 92 % of investors carry out regular inspections of property premises. Thereof: 84 % annually 13 % at least every 2 years 3 % less frequently 70 % have predominately direct contact to tenants. 34 % of investors survey tenant satisfaction. Thereof: 88 % annually 12 % at least every 2 years

22. RESULTS C: Risk Identification at Property Level Who identifies risks at the property level? • Risk identification takes place predominantly in-house. • Property managers carry practically no significance although they generally stand in the closest position to the property and tenants. • Problematic interface configurations. • 90 % of investors work with external property managers. 34 % have a compatible IT System.

23. RESULTS D: Risk Analysis and Risk Assessment Property risks according to significance

24. RESULTS D: Risk Analysis and Risk Assessment Who assesses risks? • Risk assessment takes place predominately within the scope of duties of the internal asset / portfolio management. • Interest and exchange rate risks are predominantly assessed by the finance department. • Other internal departments are rarely involved (assessment / risk management). • Risk management department?

25. RESULTS D: Risk Analysis and Risk Assessment Methods of risk assessment • There are three clearly dominant methods. • Methods involving probabilities are little used. • Gut feeling is given an important place after the “Big 3”.

26. RESULTS E: Risk Management and Risk Controlling Regularly and systematically monitored risks • 64 % of investors indicated that risk management guidelines in their firms are established. • At 36 % of firms there are risk managers for individual business areas.

27. RESULTS F: Communication and Information Flow Direct recipient of information Type of information conveyance gathered at property level

28. RESULTS G: Methods of Risk Management sorted according to significance • Three methods are dominant. • Early warning systems are little employed in risk management. • “Gut feeling” is given an important place.

29. RESULTS G: Methods of Risk Management Risk reduction • Diversification is the most important method, followed by derivatives. • Other: • “high EK-Quote” • “reaction to abnormalities” • “insurance” • “supervision” • “limit system” • “recognition and rectification”

30. RESULTS G: Methods of Risk Management Diversification and modern portfolio theory • Across: • Geographical regions • Use types • Tenant types

31. RESULTS G: Methods of Risk Management Diversification and Modern Portfolio Theory • ACQUISITION OF PROPERTIES • 56 % take into consideration the influence of newly acquired properties on the risks of the entire portfolio. • 26 % calculate the influence. • 18 % do not consider such influence at all. • PROPERTY ASSETS • 60 % take into consider the influence of changes in the risk profiles of individual property assets on the entire portfolio. • 18 % calculate the influence. • 22 % do not consider such influence at all.

32. RESULTS G: Methods of Risk Management Diversification and Modern Portfolio Theory • For and against - 50 : 50 • Naive portfolio selection

33. RESULTS G: Methods of Risk Management Derivatives • Almost exclusively classical hedging against interest and currency risks. • Real estate derivatives are “still” hardly used.

34. RESULTS G: Methods of Risk Management Excel vs. special purpose software • Excel is dominant. • 44% of investors use special purpose software. • Other: • MS Access

35. RESULTS G: Methods of Risk Management Ratings – use of ratings in the risk management process • Ratings are predominately not applied; if such are in fact used, then internal ratings. • Scoring vs. rating • External ratings: • - high effort • - high costs • Internal ratings: • - better data records • - fewer costs • - better control

36. RESULTS G: Methods of Risk Management Ratings – quality of rating agencies Rating agencies Real estate rating agencies „Very poor“ and „rather poor“ = 48 % „Very poor“ and „rather poor“ = 44 %

37. OBJECTIVE OF THE STUDY STUDY DESIGN SURVEY PARTICIPANTS RESULTS SUMMERY

38. SUMMARY

39. SUMMARY Adaptation of Risk Management due to the Credit / Real Estate Crisis? • 22 % no answer • 48 % no adjustment • 30 % wish to adapt their risk management • Following adjustments were named: • Focusing on finance and credit risks • Focusing on strategic risks • Increasing real estate know-how • Increasing reporting requirements • Standardization • IT-supported analysis • Persistence

40. Thank you for your attention!