Peter CHAMPNESS Presentation

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Real Estate Risk Assessment

PaM

SustainableReal

Estate

Markets

Restoring

Confidence

in

Financial

Markets

Peter Champness

MIPIM

Cannes

March 2011


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improvingperformanceinbankingandrealestateinvestment

itrium2011

BackgroundtoRiskAssessmentinRealEstate(PaMModel)

TEGoVA2003standard

EuropeanPropertyFederation20032005report

RICS2007report

BasleII &BasleIII

UNECE/REM

(i) UNECEPolicyFrameworkforRealEstateMarkets Principle7(Transparency/Valuation)

(ii)FutureadvisoryworkREpropertyandmarketriskevaluationforREbackedfinancial

products

Investors and financial market analysts require a more scientific approach tounderstanding holding risk, liquidity and volatility in RE Markets.

The regulatory gap exposed by inadequate information on real estate risk has eroded

prudent mortgage underwriting practice and hampered the effectiveness of monitoring byregulators and the role of Rating Agencies.


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Volatility acharacteristicofrealestatemarkets.

Realestate

investment

is

differentiated

from

stock

market

investmentby:o Heterogeneityofassetsandplayers

o Illiquidity Largelotsizes

o Significantlygearing bankborrowing

o Cyclescharacterisedbyleadsandlagsduetosupplyconstraints

o Mediumtolongrunholdperiods

o Opacity limitedmarketdata

Lackoftransparencyandilliquiditycontributetovolatilityandundermineinvestorconfidence.


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Howdowemanagerealestaterisk?

Indices,suchasIPD,trackhistoricmarketperformance.

Valuationassessesspotmarketprices. Modernportfoliotheoryfacilitatesportfoliodiversification,concentration;

moderatingsectorrisk.

The quality of real estate as collateral for loans is recognised by credit riskscoring, loan to value ratios (LTV) and interest cover.

Research; Identifying the demand and the supply pipeline and shifts in capitalmarkets provides transparency and aids understanding of the dynamics of realestate markets.

AmorerobustprocessoffundamentalanalysisofREassetsisvitaltomoveriskmanagementoutoftheDarkAges.


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ActiveREmarketsandeconomiesdependonbanklending

RELendingisconstrainedbybalancesheetissues,regulatorygoldplating,lackofinterbanklending&moribundsecuritisation(ABS)markets

ReignitingthemarketforABSisessentialtofreeupbankbalancesheetstoenablelending,facilitatingeconomicgrowth

Looking

ahead,

aself

sustained

revival

of

the

ABS

market

requires

fundamental

changes.Itishightimetorisetothechallengesoftransparency,standardisationandproductsimplicity.Thisiswheretheindustryhastostepupitseffortsinordertohelpdecisivelyinrestoringconfidenceinthesecuritisationmarkets.

JosManuelGonzlezPramooftheEuropeanCentralBank

Fundamentalreal

estate

analysis

(PaM)

can

enhance

confidence

in

theperformanceofdebtandequity investmentinrealestateandderivativefinancialproducts


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PROBLEMOFRISKINREALESTATELENDING

APPROACHTOREALESTATELENDINGRISK

PROPERTYMARKETANDRISKRATINGSYSTEMS

REVIEWOFVALUATIONSTANDARDS

OUTLINEOFTEGOVAPROPERTYMARKETANDRISKRATINGSYSTEM

PRACTICALAPPLICATIONOFPROPERTYMARKETANDRISKRATINGSYSTEMS

REMRECOMMENDATIONSANDPOLICYOPTIONS

Potential scope of work REM-Real Estate Risk Assessment


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disastrous 10

very poor 9

poor 8

mediocre 7

slightly belowaverage

6

average 5

slightly aboveaverage

4

good 3

very good 2

excellent1

ExampleofthenewapproachtoriskinitiallypromulgatedbyTEGoVA PaM

PaM is complementary to Valuation. But Valuation sets out only what a typical

purchaser would pay in the spot market on a specific valuation date. Valuation can be

affected by transient market sentiment. It is no indicator of the medium and long

term sales prospects of a property.

PaM is a method of measuring the underlying quality of a property and midterm

marketability.

PaM provides an analysis of the risks and potential inherent in a property or portfolio.

Credit risk scoring is not specifically incorporated the focus is on the asset.

Itassessesfourkeypropertyfundamentals:

i Market

ii Location

iii Property

iv Cashflow


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OverallPropertyMarketRating110

Quality/marketability/sustainablevalue

4Quality

of

cash

flow

30%

Tenantsituation/rental &valuegrowth/lettingprospects/vacancysituation/expenses

3Property 20%

Construction/layout/sustainability/energyperformance

2Location 30%

Suitability/standing/transportinfrastructure/facilities/environment

1MarketEnvironment 20%

Socioeconomic/demographic/realestatecycle

disastrous 10

very poor 9

poor 8

mediocre 7

slightly below average 6

average 5

slightly above average 4

good 3

very good 2

excellent 1

Property and Market Rating Model


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RealEstateMarketRatingiscomparabletoRatingAgenciesCreditScores

Aaa to AA3 A1 to A3Baa1 to

Baa2Baa3 to Ba1

Ba2 to

Ba3`B1 B2 B3 to Caa Moody's

AAA to AA A+ to A-

BBB+ to

BBB BBB- to BB+

BB to

BB-B+ B B- to C

S & P

excellent very good goodabove

averageaverage

below

average

poor/

special

mention

very poor/

substandarddoubtful loss

Internal Bank

Ratings

1 2 3 4 5 6 7 8 9 10

Property &

Market Rating(PaM)

Excellent very good goodslightly above

averageaverage

slightly

below

average

mediocre poorvery

poordisastrous


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PaM

Identifies: UnderlyingAssetQuality/Sustainability ofvalues

RelativeVolatility similartoBetaratings

Liquidityorrelativemarketability

Provides: Enhancedtransparency

Enables: Informedanalysisandportfoliodiversificationbyrisksegmentation(abottomup

approachtorisk)

Effectiveportfoliomanagementoptimisingfutureperformance

Riskappraisal


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HowPropertyandMarketRatingaddvalue?

1. Investors

(DraftAIFM

Directive

requiresRiskManagement)

1. Transactions

2. PortfolioManagement

3. Analysis

4. Marketing

5. Reporting

2. Banks

1. BasleIII

2. Loanpricing

3. Management

4. Coveredbonds/securitisation

5. Riskmanagementteamdialogue

withproperty

bankers

3. Valuers(KSWS3)1. Valuationcheck

2. Consistency

3. Riskpremiums

4. Analysis5. Qualityofadvice

Risk

Economic

Environment

Asset

Cash Flow

Property

Market


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Property&MarketRating

PaMSoftware

Development

Concept

Concept:

Lowcost

Userfriendly

Quickandefficientinuse

o Developmentindiskformat(CDs)

o FutureDevelopmentmaybewebbased

PaM

CashFlow

PropertyEconomy


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Contact

Peter Cha mpness

Itrium Limited

Oa kdene HouseMayfield

East Sussex TN20 6EJ

United Kingdom

+ 44 (0) 759 7979 [email protected]

Peter CHAMPNESS Presentation

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