Ch. 15 - Investment & Risk Management

Which of the following is not one of the three ways to control risk?

Accept

There is no way to avoid risk when dealing with real estate investments. However, risks can often be significantly reduced with relatively simple risk management procedures. Here is a list of those procedures. Reducing risk through careful selection Diversification Market research Property management Shifting risk to tenants Shifting risk to insurance companies Hedging to control risk

After all possible risk control techniques have been put in place, some amount of unavoidable risk still remains. Before making any commitment of funds to a real estate project, most rational and well-informed real estate investors will do the following: Specify investment objectives with reference to the return on investment, the timing of the return and acceptable risk levels. Identify the major risks that are involved and calculate them as completely as possible. Eliminate some risks, transfer others through insurance or other techniques and limit the remaining risks to acceptable levels. Make decisions to accept or discard specific investments, based on whether the expected returns justify carrying the remaining risks in light of how the project will contribute to the investor's overall objectives. Many things can change during the time period an investor holds a property that affect the actual performance of the property. Another factor that an investor looks at is the potential benefits associated with leverage. Factors such as these could cause the investor to consider selling the property. If an investor has less financial leverage than when he or she first financed a property, the investor may choose refinancing as an option. Instead of selling one property and buying another, an investor could consider renovation as an option. Click here if you would like to open this summary as a pdf, which you can then print or save to your device: Chapter 15 Summary

What are the three ways of controlling loss?

Avoid Loss Limit Loss Reduce Loss

What is often said about development in the real estate industry?

Because the real estate industry is cyclical, the real estate industry is often said to have a tendency toward cycles of overdevelopment

List three risk management procedures. (See screen 23 for other correct answers.)

Diversification Property management Shifting risk to insurance companies

When deciding about investing in certain properties, it is always important that investors carefully make forecasts of future cash flow. Real estate investors follow a number of strategies and investment styles: Investing in Core Properties Investing in Core Properties with a Value-Added Strategy Property Sector Investing Contrarian Investing Market Timing Growth Investing Value Investing Strategy as to Size of Property Strategy as to Tenants Arbitrage Investing Turnaround/Special Situation Opportunistic Investing Investing in Trophy or Blue Chip Properties Developments

Financial leverage is defined as the benefits that may result for an investor who borrows money at a rate of interest lower than the expected rate of return on the total funds invested in the property. Different types of risk carry investment risk characteristics that investors must consider when deciding among alternative investments. Risk types are: Business risk Financial risk Liquidity risk Inflation risk Management risk Interest rate risk Legislative risk Environmental risk

How many recognized steps are there in decision-making?

Five

How did risk management develop into a formal discipline?

From the insurance industry

Which style depends heavily on market research and the ability of an investor to understand changes in the economic environment and its effect on all types of real estate?

Growth

Which of the following is not a reason people invest?

Interest rate

Which kind of risk occurs when the real estate market is slow with not many buyers, sellers or transactions?

Liquidity

What kind of risk results from a slow real estate market with few buyers and sellers?

Liquidity risk

If investor Jim is skilled at predicting when to buy or sell property based on property types and economic conditions, what investment strategy would he be most likely to use?

Market timing

All of the following strategies are alternatives to selling a property except which?

Optioning

What investment style uses economic and demographic research to come to the belief that one property type will outperform other property types?

Property sector investing

List two types of hedging mechanisms.

Purchase options Interim financing commitments

Which of the following statements about risk is false?

Putting all possible risk controls in place will eliminate all risk.

Installing sprinklers in a factory to control the effects of a fire is exercising what risk control technique?

Reducing

What are two alternatives to selling a property that an investor can use if the property is not performing as well as anticipated?

Refinancing Renovating

What are the four main reasons that investors invest their equity capital?

Return rate Property appreciation Diversification Tax benefits

Use of a triple-net lease is an example of which risk management procedure?

Shifting risk to tenants

Define financial leverage.

The benefits that may result for an investor who borrows money at a rate of interest lower than the expected rate of return on the total funds he or she invested in the property.

Risk is best defined as what?

The chance of experiencing a loss

Risk is the chance of experiencing a loss. Risk is always the outcome of a decision or a series of decisions. Risk management in business usually requires giving prior thought to potential problem areas. Risk management is an ongoing process that changes constantly. However, it is a process with distinct milestones that are sequential in application. The main task of risk management is to identify the risks faced by the business. Once risks have been identified, they need a plan of control. Risk control deals with dealing with loss in three ways: Avoid Loss Limit Loss Reduce Loss

The first control deals with the issue of avoiding the risk or not entering into the risky situation in the first place. The second control deals with limiting the frequency of losses, that is reducing the number of times a particular event can occur. The third control deals with reducing loss when an event does occur. Investors must consider many variables when purchasing income properties. These factors include: Market factors Occupancy rates Tax influences Level of risk Amount of debt financing and Proper procedures to use for measuring return on investment Investors invest their equity funds for four main reasons. Return Rate Property Appreciation Diversification Tax Benefits

What is arbitrage investing?

The investment strategy based on the ability of an investor to recognize the differences in prices that buyers are willing to pay for the same real estate investments that are located in different markets.