INDIANAPOLIS—Real estate and construction professionals are accustomed to calculating subjective risk scores and risk-adjusted return on capital, but some industry executives may not be considering certain risks that impact enterprise on a daily basis. Executives have been trained to reduce risk management to a checklist or calculation that is triggered only under particular parameters, rather than using risk assessment as an active part of daily decision making. Even commonly practiced decision models fail to adequately focus on assessing risk. Employing a simple decision model that focuses on risk assessment, while considering some of the most urgent risks facing the industry, will better equip you to navigate future uncertainties.

Implementing a Risk-Adjusted Decision Model

An enterprise risk management plan should be a priority for all organizations; however, a simple risk-adjusted decision model (RADM) will assist you with evaluating risk in daily decisions. Modify this model for discussion and training in your enterprise, or to implement a risk assessment and mitigation policy.

The model consists of two rules to follow and a series of questions to ask during the decision process.

Rules:

Risk = qualified impact to people or finances.

Mitigation = feasible sacrifice that produces a beneficial reduction in impact.

Questions to ask when making decisions:

What is the level of impact to people? The impact to people is high if a reasonable person under the circumstances would consider the impact unjustified, rushed, not the best or most accurate solution, or not clearly communicated.

What is the level of financial impact? A financial impact is high if it's outside budgeted parameters.

What mitigation measures are available to reduce impacts? Mitigation measures may include avoiding, transferring, limiting, or reducing impacts.

What is the next best alternative to the decision being proposed?

After mitigation, is the residual impact acceptable given the circumstances?

Utilizing a RADM is the first step toward soundly navigating the future. Understanding the likelihood and magnitude of certain impacts is equally important. One major category of risk facing our industry requires huge capital investment and impacts enterprise at every level. A second category may introduce you to market and financial sensitivity risks you haven't considered.

Human Resources and Human Capital Returns

It's well known the real estate and construction industry faces a shortage of qualified employees, but consider how this might impact investment in recruiting and employee professional development? Unemployment or underemployment is the most commonly shared risk identified by companies around the globe.[1] A 2017 survey of nearly 2000 respondents from public and private companies listed “failure to attract or retain top talent” as the seventh most critical business risk.[2] Construction workers ranked ninth out of four hundred and fifty-seven occupations on the labor shortage index, and the occupation faces a higher risk of labor shortage than 91.4% of all occupations examined.[3]

The inability to attract and retain talent is further exacerbated by its connected risks: over-worked staff; loss of productivity or opportunity; and inability to adequately plan for succession. If an organization is unable to attract qualified employees for open positions, it may also experience difficulty promoting from within. Existing employees may experience a loss of morale. Organizations that haven't planned adequately may risk losing top talent to organizations that provide more paid time off and promotional opportunities.

Adopting an aggressive recruiting and training program for new employees, and providing professional development benefits such as time off, and paid tuition for pursuing advanced degrees, may mitigate these risks. Consider an executive training program to promote talent from within. From the employee's perspective this is an opportune time to pursue professional certification or an advanced degree.

Fiscal and Market Sensitivity Risks

Returns subject to fiscal or market sensitivity should be adjusted regularly. The real estate and construction cycle has been in growth mode for several years. “The key to the next few years is to expand horizons, market by market, property type by property type.”[4] However, unforeseen risks may be lurking in asset bubbles and bubble zones, economic influences, or slow market growth.

An asset bubble can be described as a loss of value to an asset class such as specialized retail, or it could be loss in value to a particular piece of property due to market changes. Newer developments that attract tenants away from older developments can create an asset bubble. A potential bubble zone on the other hand is a geographic area, or urban center, where capital has been flowing and demand has been high for some time. Potential bubble zones include areas where property values have risen significantly in a short time period.[5] Connected risks include inadequate market research and substandard management practices.

Planning for these risks requires you to conduct a conservative assessment of your product and market diversification strategy, and your fiscal structure. The risks are obviously higher if your enterprise focuses on one product type in a few markets. Consider how sensitive your organization's financing model and capital reserves are to a series of rapid interest rate increases, or more stringent borrowing requirements. Produce a best practices methodology for market research, leasing and management. Finally, consider a capital expenditure plan that will allow you to make improvements to retained product during slower growth periods or market contractions.

Reviewing investment returns and sensitivity to risks is critical. Just remember that risk management plans and decision models should be specific to individual organizations and incorporated into strategic goals and performance metrics. Following these practices will produce appropriate risk-adjusted returns.

[1] World Economic Forum – The Global Risks Report 2018, 13^th Edition.

http://www3.weforum.org/docs/WEF_GRR18_Report.pdf (accessed February 15, 2018).

[2] Aon Risk Solutions – Global Risk Management Survey 2017.

http://www.aon.com/2017-global-risk-management-survey/pdfs/2017-Aon-Global-Risk-Management-Survey-Full-Report-062617.pdf (accessed February 15, 2018).

[3] Shortage of Skill: Construction & Skilled Trades – CECU: Career Education Colleges and Universities.

https://www.career.org/news/shortage-of-skills-construction-skilled-trades (accessed February 19, 2018).

[4] PwC and the Urban Land Institute: Emerging Trends in Real Estate® 2018. Washington, D.C. PwC and the Urban Land Institute, 2017.

[5] UBS Global Real Estate Bubble Index, 28 September 2017.

https://www.ubs.com/global/en/wealth-management/chief-investment-office/key-topics/2017/global-real-estate-bubble-index-2017.html (accessed February 19, 2018).

Eric A. Harvey is program director, Master of Professional Studies in Real Estate Development at the University of Indianapolis. The views expressed here are the author's own.

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Mitigating Risk in Real Estate and Construction

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