RISK AND REAL ESTATE INVESTMENT

1. RISK AND REAL ESTATE INVESTMENT LEARNING OBJECTIVES • Calculate and interpret the basic measures of risk for individual assets and portfolios of assets. • Identify the problems with, and limitations of, traditional sources of real estate risk and return data. • Incorporate information regarding project riskiness into the investment decision-making process. • Describe sensitivity analysis.

2. RISK • The Concept of Variability • The expected rate of return = E(R). E(R) = Sum of (oix pi ), where oi is the value of the ith observation and pi is it’s probability.

3. RISK PREFERENCES • Risk-Averse Behavior • Risk-Neutral Behavior • Risk-Loving Behavior

4. MEASURING PROJECT- SPECIFIC RISK

5. Risk Estimates

6. RISK MANAGEMENT • Three primary tools may be employed by investors to minimize their expose to risk: • avoid risky projects • use insurance and hedging • diversification

7. PORTFOLIO RISK • Diversifiable Risk: (unsystematic risk) can be eliminated by holding assets that are less than perfectly correlated. • Nondiversifiable Risk: (systematic, or market risk) is the risk remaining in a fully-diversified portfolio.

8. Diversification and Risk

9. Covariance and Correlation

10. OPTIMAL PORTFOLIO DECISIONS • Investors base their investment decisions on its contribution to the portfolio’s risk and return. • Efficient investments increase the portfolio’s expected return without adding risk. • Efficient investments decrease the portfolio’s risk for a given expected return.

11. Expected Risk and Returns of a Portfolio

12. OPTIMAL PORTFOLIO ALLOCATIONS

13. HISTORICAL RETURNS & RISK

14. HISTORICAL CORRELATIONS (1979-99)

15. ACCOUNTING FOR RISK • The investor’s required rate of return is (E(Rj)). E(Rj) = Rf + RPj where Rf is the risk free rate and RPj is a premium for bearing risk.

16. ACCOUNTING FOR RISK • Asset Pricing Model to Estimate Risk • Sensitivity Analysis