Risk analysis uncovers how new fundamentals impact asset values

Risk is an intrinsic feature of commercial real estate investment, yet quantifying it is surprisingly elusive. Without risk, investors wouldn’t generate returns; despite this key role in an investment, more owners than you might think fall short in accurately measuring risk or its impact on investment quality. Traditionally, the cap rate has represented the summary of a property’s downside exposure. It is used as an all-in-one expression of market demand, asset quality, property value and return. Cap rates offer a clear path to making side-by-side comparisons between prospective investments—but as a measurement of risk, it falls short. No single criteria can fully capture the nuances of so many factors. For this reason, it is important to do a multi-factor risk assessment.

To go beyond cap rates and provide better insight into risk exposure, valuation professionals have begun analysing a robust list of characteristics that affect investment performance individually then quantifying how each category impacts a property’s valuation. This approach is a powerful tool that gives investors both a deep understanding of the investment’s vulnerabilities and the opportunity to develop targeted defensive strategies to drive value and enhance returns.

Although value and risk are intertwined, they are ultimately separate metrics. A valuation analysis gives investors a monetary expression of their property or portfolio; it is effectively a price tag. A risk report, on the other hand, is an in-depth explanation of the many factors that could explain why the property’s value could be negatively impacted both now and into the future. Knowing the ‘why’ arms investors with an opportunity to be proactive rather than reactive in making investment decisions and managing assets throughout the investment lifecycle.

This relationship between value and risk is an established principle of commercial real estate investment, but defining risk and its impact on value has been a subjective undertaking. “Valuers have traditionally taken a qualitative approach, based on their professional opinion,” says Tyrone Hodge, Global Head of Risk Advisory, Value and Risk Advisory at JLL. “We are starting to look at it in another way, by developing a spectrum of factors that impact value. To collect and assess those factors, we lean heavily on data and analytics.”