Coherent risk measures in real estate investment
| Pages | 479-493 |
| Published date | 12 July 2011 |
| DOI | https://doi.org/10.1108/14635781111150358 |
| Date | 12 July 2011 |
| Author | Roger Brown,Michael Young |
| Subject Matter | Property management & built environment |
Coherent risk measures in real
estate investment
Roger Brown
IMOJIM Investments, Alpine, California, USA, and
Michael Young
Arizona State University, Goodyear, Arizona, USA
Abstract
Purpose – The purpose of this paper is to propose a new way to measure risk in real estate
investment, which departs from traditional statistical methodology borrowed from finance.
Design/methodology/approach – An argument is advanced for the use of so-called coherent risk
measures for real estate investment decisions. Central to this class of measure is the computation of
spectral risk, a measure that covers the spectrum of an individual’s risk aversion function. Intuition
being hard to observe, empirical data from two large databases are presented as support.
Findings – At the heart of the controversy is a discussion of the nature of risk and how it should be
measured. This paper seeks common ground where peace may be made between these two warring
factions. Scenarios are tested wherein different risk aversion functions are used to compute spectral
risk for different sectors. Ex-post analysis shows that reasoning of this nature can lead to improved
risk-adjusted investment results.
Practical implications – The route to finding an appropriate risk measure for real estate
investment has been tortuous. It is not certain that the destination has been reached. Complicating the
task is a considerable gap between academic and practitioner methodology, the former relying on the
mathematics of objective probability, the latter dwelling quite successfully in a habitat of subjective
risk measures.
Social implications – It is widely accepted that risk represents a cost to society. Real estate, as a
repository of roughly half the world’s wealth, can be viewed as having risk of a structurally different
nature. The better understanding of this risk reduces the cost to society.
Originality/value – For practitioners, spectral measures offer formal support for something they
have been doing their entire careers: evaluating risk subjectively. The simple dot product of weights
and ordered outcomes is an extension of the widely used “Best case – Worse case – Most likely”
methodology that has served professionals well for decades. Perhaps a by-product of spectral
measures is to bring academics and field gladiators closer together. If there is merit to a new way of
thinking about risk independent of its implementation, real estate investment could benefit from that
thinking. Among those who doubt that everything is “normal” are those who believe that previous
attempts to explain risk in real estate have fallen far short of the mark. The challenge to those still not
satisfied by the spectral approach is to offer an alternative that represents both a departure from and
an improvement of the old methods.
Keywords Real estate, Riskmanagement, Risk assessment, Investments
Paper type Research paper
I. Introduction
Public consciousness of how extreme events affect everyday life began with the failure
of long term capital management (LTCM) in the Fall of 1998. Ten years later, the
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/1463-578X.htm
The authors wish to thank Seth Chandler, Bob Rimmer, Kevin Dowd and Marlyn Hicks for
helpful comments and suggestions.
Coherent risk
measures
479
Received December 2010
Accepted March 2011
Journal of Property Investment &
Finance
Vol. 29 No. 4/5, 2011
pp. 479-493
qEmerald Group Publishing Limited
1463-578X
DOI 10.1108/14635781111150358
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