Mitigating risk requires a proactive risk management game plan, and since buy and sell decisions for real estate investment firms rests on astute portfolio construction based on timely valuations, more and more asset owners are adopting preemptive risk abatement tactics.
Addressing today’s shifting landscape requires more, rather than less, information. Knowledge is power, and whether you have a single property or a portfolio of assets, timely insight is essential to determine tenant retention strategies, rent relief options and other risk abatement measures that will give you a better understanding of asset value.
Here are four steps owners, managers and investors can take to mitigate risks to your commercial real estate assets, especially in (but not limited to) turbulent times.
1. Conduct a sensitivity analysis to inform your decision
What will the short-term and the long-term performance of our portfolio look like? To achieve greater clarity for decision making, testing “what-if” situations helps to determine the effects of variables on investment returns and to ascertain potential outcomes. Conducting a sensitivity analysis can provide confidence when assessing a range of what-if scenarios.
Sensitivity analysis involves changing one variable at a time over a possible range of outcomes to evaluate the effect of each change. Most important, it can demonstrate the impact a change in variables would have on the value of a property or portfolio.
A sensitivity analysis can take into account a wide range of factors that might impact a property’s cash flow and computes how a change in each factor would affect value. For example, modelling cash-flow sensitivity can help forecast and address any potential shortfalls before they happen. It’s possible to model what monthly cash flows will look like under a wide range of different scenarios.
This reveals when cash flow deficiencies will occur and what strategies will be effective when. For instance:
When might you have to provide rent relief?
When might you require additional bank funding?
Do you need to defer your next project? This type of analysis can also establish most likely, worst-case and best-case scenarios.
As well, the results of these scenarios can be combined with insight into what peer companies are doing. This provides owners, managers and investors with an enlightening basis for comparison of best-case and worst-case for similar properties.
2. Appraise your commercial real estate assets
In the rapidly shifting market there’s a growing disconnect between valuations of real estate assets from even a few weeks ago and those of today.
Given the future impact the pandemic could have, timely updates on property value – to understand how markets and asset classes are performing and where your properties stand in the current market – are more important than ever before.
Conducting property and portfolio valuations at frequent, regular intervals can enable owners and investors to stay on top of what’s happening, meet reporting requirements and support investment decision-making with a transparent view into all assets.
For investment portfolios containing real estate holdings, having an appraisal completed in current market conditions may offer rebalancing opportunities. For example, if real estate is held as part of a larger investment portfolio, it may be overallocated right now as the other assets in the portfolio may have experienced a decline in value.
Conducting a valuation might be beneficial in reducing the allocation percentage of real estate holdings – without having to sell assets.
3. Assess highest and best uses of properties
Once properties have been updated with current-reality value and projections, review these assets subjectively to determine whether the current use of the property is the best use going forward.
Determining the highest and best use of a property can optimize its potential by considering the current use, potential uses and their corresponding value. The bottom line is: if there are potential alternative uses, which direction provides the greatest return?
Evaluate whether there might be a different use for a commercial real estate asset that could be more productive and profitable.
4. Conduct thorough due diligence before making decisions
Before making any strategic decision regarding a property, undertake thorough due diligence. This is critical for risk-informed decision making. Proper due diligence substantiates key assumptions when valuing opportunities and identifies benefits, liabilities, risks and uncertainties.
While the process is designed to address the specific circumstances of a property or group of properties, the scope generally encompasses commercial, legal, financial and tax due diligence. Bring qualified, experienced external advisors into the process to ensure reliable results.
Risks in real estate cannot be completely eliminated; they need to be managed to ensure they are compensated with corresponding returns. Equipping yourself with timely information and careful due diligence, you can strategically manoeuvre through any disruption or market downturn.
As opportunities arise, companies that are knowledgeable and prepared will be in the best position to capitalize.
Author
Jonas Locke
Vice President, Valuation Advisory
Author
Jonas Locke
Vice President, Valuation Advisory
