Risk Assessment in Real Estate Investment Projects

When the future is uncertain and an investment is durable and illiquid the decision to invest at a certain point in time contingent to new information to come as well as a correct assessment of risks are a key issues especially in times of global financial crisis. The existence of a well-functioning capital market allows investors with different time patterns of income and desired consumption to agree on whether real estate investment projects should be undertaken. In order to estimate discount rates for real estate assets, firstly we need to know how to measure risks and identify the relationship between risks borne and risk premiums demanded by investors. Risk affects investments and cannot be fully eliminated. Increases in both idiosyncratic and systematic risk lead developers to delay new real estate investments because they feel not confident in the estimated values and the assessment of the project’s riskiness. Investors have to determine how much risk they can tolerate, the return they need and its timing. Aim of this paper is to provide a theoretical framework to address risk and uncertainty in real estate investment valuation procedures. The paper proposes a model for risks assessment that will help to evaluate risks and opportunities of real estate assets and investments taking into consideration different aspects of the project and related risks (market risk, valuation risk, market growth risk, operating risk, etc.). Real estate development is in fact a multiphase process involving land development, followed by residential and/or commercial development, ending with the eventual marketing phase of the development through the sale or leasing of the completed site. While all three phases of the housing industry are interrelated, each stage involves various risks which are differently allocated between landowners, land developers, and the homebuilders. More rigorous risk assessment measures within the property investment industry are here designed to operate initially at the level of the individual asset and then extended to the framework drawn from conventional theory which operates primarily at the portfolio level.