Communicating Investment Risk to Clients: Property Risk Scoring

Abstract

Investors require to be fully briefed on the risk profile of their investments. The UK valuation profession has been criticized for inconsistencies and failures to reflect risk and this was reinforced by the Investment Property Forum/Investment Property Databank (2000) which highlighted the need for more rigorous risk assessment measures within the property profession. The requirement of Basle 2, that banks must be more explicit about the risks of lending, has given added impetus to the desire for improved techniques for assessing and communicating risk. This study presents an alternative methodology for the scoring and reporting of investment quality risk – Property Risk Scoring – which utilizes the Analytic Hierarchy Process (AHP), a multi‐criteria decision making tool developed by Saaty (1980, The Analytic Hierarchy Process, McGraw Hill, New York, NY). The researchers asked senior valuers in the UK profession to identify, and score, the investment quality risks of prime offices at the date of valuation. The focus is on the principal elements of investment quality risk comprising yield movement, lease length, rental movement and change in occupier demand. Analysis of the results enabled the development of a generic market model to be used to risk score individual property investments. The results are reported on a 1–5 scale, similar to the widely accepted D&B credit rating technique, thus aiding market acceptance.

Keywords:

• Risk perception
• investment quality
• analytic hierarchy process

Acknowledgement

The authors would like to thank the RICS Education Trust for their financial support of this project.

Notes

1. http://www.bis.org/publ/bcbs107.htm

2. Following Baum et al. (1996), the following definitions appear to be accepted. Market Price refers to the sum of money actually paid for an asset. Valuation is the estimate of the most likely selling price (market value). Worth is the underlying investment value.

3. http://dbuk.dnb.com/

4. Bender, et al. (1999) investigated locational preferences for commercial real estate in Geneva, Switzerland, using an AHP methodology.

5. Expert Choice, Inc, Pittsburgh, PA.

6. CBRE; Datastream.