week 2 risk anlysis

Question 1

risk management process

Answer 1

A) Risk identification
B) Risk analysis and evaluation
C) Risk response

high risk = high reward

Question 2

As a recurring process during the property development cycle

Answer 2

identify the risk
assess the likelihood of the risk occurring
control - what can be done to reduce the impact of the risk
monitor - has the situation changed are there new risks emerging

Question 3

risk management stratergies

Answer 3

avoid
transfer
reduce
retain

transfer = insurance against a particular risk e.g. Crain falling

Avoid risk: Answer: forward material price contracts (buy materials now)
Issue: concerned with the time value of money or price of materials rising. Will the material price rise?

Transfer (share or mitigate) risk by: insurance, having a partner

Mitigate: Change to cheaper resources

Accept fate: “it was a risk I was prepared to take”

see slides

Question 4

most significant development risk factors are

Answer 4

1. Environmental Risk (Biggest risk – what does the site offer? Can you get your ideal site, can you undertake your intended project on the particular site?)
2. Time delay Risk (cash flow modeling methods – assignment 2)
3. Land cost Risk (residual analysis – Assignment 1)

Question 5

what are the 5 chronological stages of risk – Past Exam Question.

Answer 5

34 property development risk factors were identified throughout the chronological stages in the property development process; namely:

1. pre-construction stage: 10 risk factors
2. contract negotiation stage: 4 risk factors
3. formal commitment stage: 3 risk factors
4. construction stage: 8 risk factors
5. post-construction (completion) stage: 9 risk factors

Question 6

explain pre construction risks (high to low)

Answer 6

environmental: heritage, ecology, contamination
approvals: zoning, compliance, conditions, developer contributions

Political: lack of support from local community, council, government

Experience with type of development, ability to manage development

Market: research, location, portfolio, diversification

Title: land title problems and encumbrances

Consultants: Design quality, reliability of consultant’s report

Physical: Difficult land form and existing improvements

Feasibility: assumptions, financial performance benchmarks, risk analysis

infrastructure: availability of services, water, traffic, social infrastructure

Question 7

contract negotiation property development risks (high to low)

Answer 7

lan costs (allowing for reasonable profit)

acquisition terms (fair, provide flexibility)

Building contract terms (allow control of costs)

Financial terms (not onerous)

Question 8

formal commitment property development risks

Answer 8

scope and adequacy of insurance coverage

all legal documentation executed

binding pre-commitmements to lease and or purchase

Question 9

post construction property development risks

Answer 9

timing of development (cycle risk)

changes in market value and cap rates

unfavourable changes in demand and supply

leases and sales pre commitments fail to complete

project commerce materially alters

Question 10

Towards better modeling and assessment of construction risk: insights from reading 2:

Answer 10

o ‘Although the ‘Probability–Impact’ risk model is prevailing, substantial efforts are being put to improving it reflecting the increasing complexity of construction projects.’
o Risk can be managed, minimized, shared, transferred or accepted.
o Traditionally the focus has been on quantitative risk assessment (Tah and Carr, 2001) despite the difficulties encountered in obtaining objective probabilities, and frequencies, in the construction industry. This difficulty stems from the fact that construction projects are very often one-off enterprises (Flanagan and Norman, 1993)
o In fact, risk in many cases is subjectively dealt with through adding an approximate contingency sum (Kangari and Riggs, 1989). Therefore, individual knowledge, experience, intuitive judgement and rules of thumb should be structured to facilitate risk assessment (Dikmen et al., 2007b

Question 11

explain property cycles

Answer 11

o A developer who understands the nature of the property cycle is able to plan a project ensuring (as much as is possible) that it is completed and released into the market at the best possible time, further reducing the risk and maximising the return on the development.
o A smart developer will also carry out his own research to establish the impacts of the cycle on their business and adjust their development strategy accordingly.
o Understanding property cycles will assist a developer to minimise their exposure to risk and maximise the likelihood of success.

Question 12

existence of property cycles

Answer 12

o At a starting point, property cycles can be defined as: ‘Processes which repeat themselves in regular fashion’.
o Predicting the timing and magnitude of these rises and falls in the marketplace has never been achieved to absolute perfection in any property market throughout the world.
The perfectly symmetrical example of a cycle in Figure 5.1 is unrealistic

o Property market characteristics which contribute to property cycle behaviour include:
o Limited availability of reliable property data.
o A time lag between the purchaser–seller transaction occurring and the release of this information into the public domain.
o The unique nature of each parcel of land and also each building.
o Property and real estate is a large ‘lumpy’ asset.
o The highest and best use of land is constantly changing.
o Land is physically only in one location and can’t be moved.
o Most investment in property is by individuals who infrequently trade.

Question 13

type of property cycles

Answer 13

o Each property developer needs to conduct their own research into each individual market to identify the length and amplitude of the cycles in their prevailing market area (Figure 5.2). A generic property cycle does not exist.
(a) Short-Term Cycles
o Commonly accredited to Clement Juglar (1819–1905), these short-term cycles refer to a period of between 7 to 11 years and were based on historical financial information. Also known as the fixed investment cycle. E.g. short term supply and demand influences of prices
(b) Medium-Term Cycles
o (Ref: Kuznet): the medium-term cycle is typically over a period of 15 to 25 years. E.g. number of international students near monash, expected public transport and public facilities to be created
(c) Long-Term Cycles
o With a complete cycle stretching over a period of approximately 45 to 60 years, this theory was based on a number of ‘long waves’ where there was a series of oscillations with an initial over-investment in capital. E.g. number of children per family
(d) Extremely Long-Term Cycles
o This cycle is based on international relations and refers to four generations over a period of 100–120 years (Modelski 1987). Significant events include the timing of global wars and variations in the balance of global power. E.g. large scale migration

Question 14

explain short term cycles

Answer 14

a) Short-Term Cycles
o Commonly accredited to Clement Juglar (1819–1905), these short-term cycles refer to a period of between 7 to 11 years and were based on historical financial information. Also known as the fixed investment cycle. E.g. short term supply and demand influences of prices

Question 15

explain medium term cycles

Answer 15

Medium-Term Cycles
o (Ref: Kuznet): the medium-term cycle is typically over a period of 15 to 25 years. E.g. number of international students near monash, expected public transport and public facilities to be created

Question 16

explain long term cycles

Answer 16

o With a complete cycle stretching over a period of approximately 45 to 60 years, this theory was based on a number of ‘long waves’ where there was a series of oscillations with an initial over-investment in capital. E.g. number of children per family

Question 17

explain extremely long cycles

Answer 17

o This cycle is based on international relations and refers to four generations over a period of 100–120 years (Modelski 1987). Significant events include the timing of global wars and variations in the balance of global power. E.g. large scale migration

Question 18

explain business cycles and structural change

Answer 18

o As many property developments and investments are closely linked to the economic and business frameworks, there is usually a relationship between property cycles and business cycles.
o This relationship is highlighted in Figure 5.3 where there is a clear relationship between (a) the property market, (b) the over-arching ‘real economy’ and (c) financial markets or the ‘model economy’.

o The interaction of the short-run business cycle with property cycles creates great variability in a developer’s plans and the ability to progress schemes at different times.
o The developer also needs to be responsive to the more evolutionary changes which occur in occupier preferences as a result of long-term changes in the structure of the economy.

(a) The business cycle
o Research in the last decade or so has established the nature of the link between the economic, or business, cycle and the property market.

o Three important cycles have been identified, all of which exhibit different periodicity: the business cycle (which drives the occupier market),
the credit cycle (which influences bank and institutional funding)
and the property development cycle itself.

(b) Structural change
 Underlying the short-term business cycle are longer-term shifts in occupier requirements which result from structural changes in the economy.
 Developers (and investors) who monitor these long-term changes can begin to create new types of products (buildings) ahead of the rest of the market; equally they can avoid being left with buildings which have a diminishing ‘shelf life’.

Question 19

surviving a market downturn

Answer 19

o Since the market constantly fluctuates in cycles, the central question to be asked is not if a market downturn will occur, but when will this downturn actually occur?
o The inevitable downturn tests the survival skills of real estate developers with little or no cash inflow whilst somehow managing to keep on top of their existing repayment liabilities.
o The lack of cash-flow usually forces a property developer to downsize or cease operations with a loss of goodwill.
o The cyclical nature of real estate markets can have a positive or negative effect on the operation of a real estate developer.
o As observed in Figure 5.4 the optimal scenario for a property developer is when supply equals demand, i.e. avoiding an under-supply or over-supply relationship.
o The model in Figure 5.5 highlights that an external structural change (e.g. higher or lower lending interest rate as set by the government) can affect the real estate market and also affect the level of market demand.

o	After there is a downward shift in the demand curve (Figure 5.5), this then creates the over-supply scenario in Figure 5.6 where this is a clear gap between the original Q(0) and the new Q(1). 
o	At the same time there is a decrease in the agreed sale price of each lot, down from the original P(0) to a lower P(1). In order to return towards equilibrium there are only two realistic options, these being either to (a) increase demand or (b) decrease supply. 
o	Since the real estate market is lumpy and not able to quickly reduce supply (i.e. it may take years), the property developer must be able to survive a sustained long-term period of depressed prices until the market recovers to a supply equals (or is less than) demand scenario. 
o	Every successful property developer has a formal plan for surviving a major market downturn and prospering on the other side of the cycle during the upturn. 

A successful real estate developer would argue the most important three words are actually ‘timing, timing, timing’

Question 20

• Provide an outline of at least one quantitative approach to risk analysis

Answer 20

seminar answers

Question 21

• Discuss a number of relevant risk factors for each stage.

How would you mitigate them?

Answer 21

seminar answers