Conceptual framework for real estate transactions. What risk metrics are needed as decision support system? Considerations for German market participants

Publication Date21 Mar 2020
AuthorWerner Gleißner,Cay Oertel
SubjectProperty management & built environment,Real estate & property,Property valuation & finance
Conceptual framework for real
estate transactions
What risk metrics are needed as decision
support system? Considerations for
German market participants
Werner Gleißner
TU Dresden FutureValue Group AG, Leinfelden-Echterdingen, Germany, and
Cay Oertel
IREBS, Regensburg, Germany
Purpose The purpose of this paper is the development for a conceptual framework with regard to the risk
management of real estate positions as foundation for transaction decisions. In this context, the current market
environment and legal obligations are the main drivers for market participants to improve their risk
management practices. Based on this environment, a practical but science backed model is outlined.
Design/methodology/approach The paper uses a conceptual approach based on the existing literature to
develop a practical decision support system. In addition, the current risk management best practices are
outlined to illustrate the corporate and methodological foundation for the decision support system.
Findings The conceptual model development reveals a clear necessity for the supplementation of price to
value measures. Additional measures are derived from theoretic considerations based on Monte Carlo
Simulation approaches to the risk management of property investments. These additional risk metrics support
investors in order make risk-appropriate decisions.
Practical implications The resulting decision support system can be applied to the risk management of
transaction decisions. Here, the model can be applied in any investment decision to support portfolio
management considerations from a comprehensiverisk management perspective. Investors can implement the
system as part of their transaction procedure.
Originality/value The existing body of literature mainly focuses on macroeconomic ratios in the context of
decision support. In contrast, the present paper reveals a corporate decision support system, which is supposed
to foster decisions of market agents especially with regard to potential price and value divergences and
tightening legal obligations.
Keywords Real estate risk management, Asset price bubble, Risk aggregation, Property valuation, Downside
risk, Transaction decisions
Paper type Conceptual paper
1. Introduction and risk management requirements
The central challenge for the risk management of institutional real estate investors is
the idiosyncratic risk exposure from the individual property. Accordingly, the risk
management of direct real estate assets focuses on the ex ante residual risk of the
individual objects cash flows (in line with Azevedo-Pereira et al., 2002)anddiffers
largely from classic risk management techniques of for example equities (Booth et al.,
2002). For institutional real estate investors, the main requirements which determine
the risk management of their real estate positions can be divided into two large
(1) Asset characteristics and corresponding current market environment and
(2) Legal obligations.
Real estate risk
The current issue and full text archive of this journal is available on Emerald Insight at:
Received 31 January 2020
Revised 6 February 2020
Accepted 6 February 2020
Journal of Property Investment &
Vol. 38 No. 3, 2020
pp. 245-262
© Emerald Publishing Limited
DOI 10.1108/JPIF-01-2020-0014
Most importantly, since real estate entails characteristics such as heterogeneity, low
transparency as well as high complexity among others (Am
ee-Manesme and
emy, 2018), the risk management of those positions is highly challenging due to
market incompleteness. Accordingly, in these incomplete markets the divergence of the
intrinsic value and prices are a typical and potentially dangerous outcome, as outlined by
Benning-Linnert (2018)[2]. The resulting price bubbles in real estate markets are typically
driven by monetary expansion and expansion of lending[3].
The vast monetarystimulus of global centralbanks (especially in Europeas consequence of
the debt crisis andsubsequent Quantitative Easing)represents this expansivepolicy, which
causes realestate prices to be seen as detached from otherdeterminants such as buildingcosts
of population growth, for example as displayed for the US housing market (see Figure 1).
The outlined characteristics of the asset class and the current market environment
especially affect the most interesting situations within a property assets life cycle: The
buying or selling decisions. Since transactions of properties are cost- and time-intensive, and
the assets also yield long maturity periods (Fabozzi and Xiao, 2019), misperceptions about the
risk of the intrinsic value of an assets can have crucial consequences for the equity position of
acquiring or selling investors.
In addition to the named fundamental asset characteristics and current market
environment, the legal obligations for institutional real estate investors are of interest,
since they experienced a tangible tightening in recent years based on Basel II and III or
Solvency II. Accordingly, investors are now heavily urged to improve their risk management
practice of real estate positions to avoid losses (Panagopoulos and Vlamis, 2009).
In Germany for example, most institutional real estate investors, such as real estate
operating companies (REOCs) or REITs are legally subject to the Aktiengesetz(AktG).
Central risk management related paragraphs are x91 and x93 AktG, which force corporations
to implement proper risk management practices and gather appropriate information for
business decisions, such as real estate transactions. Importantly, the following decisive detail
needs to be underlined: Neither the named practices nor the term appropriate information are
precisely defined, but are left subject to interpretation and individual business model design.
The outlined legal freedom to design the individual risk management system, including
transaction decisions is a central motivation for the present article from a legal point of view
for corporations.
The second large group of investment vehicles, namely investment fund companies and
their risk management is regulated by the Kapitalanlag egesetzbuch (KAGB), or more
precisely by x29 KAGB. Interestingly, legislators introduced the supplementary minimum
1880 1900 1920 1940 1960 1980 2000 2020
Population in Millions
Index or Interest Rate
Home Prices
Building Costs
Interest Rates
Source(s): Own presentation
Figure 1.
US residential property
parameters as potential
illustration of asset
price bubbles (1890

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