*1.3.6. Monitor and report effectiveness of risk treatments*

364 Risk Management – Current Issues and Challenges

appropriate manner.

*1.3.5. Treatments of risks* 

 identifying options to treat the risk; selecting the best treatment option; preparing a risk treatment plan; and implementing a risk treatment plan.

who may consider one or more of the following [3]:

achieve the same outcome;

who is best able to control it; and

risk or both;

become threats in due time.

 risk level is low and the benefits presented by the risk outweigh the cost of managing it; risk level is so low that it does not warrant spending time and money to manage it; and

A unacceptable risk is when a business is bound to experience significant losses and such losses cannot be tolerated. In such an event it is important to address and treat the risk in an

Risks may be dealt with in several ways; it can be avoided, reduced, shared or retained. Risk is avoided when appropriate decisions are taken to eliminate all possible pitfalls thereby preventing the situation from occurrence. In most decision making processes, calculations are made and ideas are contemplated to strike a balance between the cost and effect. In such

In other cases, risk is shared between the stake holders in terms of how profits and losses are shared. This is done mainly to share the impact of a risky event when it occurs. For example, in the era of globalization it is challenging for the companies to enter new markets and countries. In order to minimize uncertainty and exploit business situations that may exist, companies often decide to share risk; careful consideration and research undertaken by the companies often suggest risk sharing. Risk sharing develops opportunities while engaging all partners in achieving strategic goals and the gains and loss are then shared accordingly. The nature of strategies to mitigate risk often depends on the experience of the risk manager

avoid the risk by deciding not to proceed with the activity or choosing another way to

control the risk by reducing the likelihood of the risk occurring, the consequences of the

transfer the risk by shifting all or part of the responsibility of the risk to another party

retain the risk after accepting that the risk cannot be avoided, controlled or transferred.

It seems the simplest of all methods of addressing a risk is by retaining an identified risk that may not potentially impact upon the operations of a business. It is important to continuously monitor such risks for in the absence of careful monitoring, the risks may

A dedication towards risk management often projects a wiser professional image to the community. In doing so, the stake holders recognize the fact that the concerned organization

situations calculated risks are accepted and a high risk situation may be reduced by:

risk presents opportunities that are much greater than the threats posed by it.

Every organization irrespective of size clearly strives to reduce the risks involved. In order to reduce risk organizations have to align their policies and structures in a consistent manner and constantly monitor business activities. Also, there is a need to allocate resources (financial, human resource, technology etc.) efficiently to improve performance and to win the approval of all stake holders. It is also important to ensure personnel working at different levels in the organization report to the appropriate authorities when a risk is identified. Such a culture enables an organization to document and then undertake suitable and timely measures to avert risks. In the risk management process, data capture and reporting can provide valuable insights into the risk management process. A sample risk management planning template is shown in Table 1. As discussed, risk management team play a vital role in identifying and addressing risks.


It is necessary to constantly monitor and evaluate the strategies that are employed to manage risks. This is because risks do not remain the same - new risks are created, existing risks are increased or decreased, some risks may no longer exist and previous or existing risk management strategies may no longer be effective. In the end risks can originate from accidents, legal liabilities, natural causes and disasters, uncertainty in financial markets, credit risk, project

failures (at any phase in design, development, production, or sustainment life-cycles), or events of unpredictable root-cause. Several risk management standards exist including those from the Project Management Institute, National Institute of Science and Technology, Actuarial Societies, and ISO standards. The risk management definitions, methods and goals vary widely according to the context of project management, security, engineering, industrial processes, financial portfolios, actuarial assessments, public health and safety and real estate.

Importance of Risk Analysis and Management –The Case of Australian Real Estate Market 367

**Corporate governance**

> **Housing management**

**Figure 5.** Internal risk Source: adapted from Sheryl and Adam [14]

**Property management (construction)**

**Financial management**

also need to be updated with the changes in conditions.

perform their duties will delay the project and overshoot budgets.

Property owners are liable for any discriminatory acts.

technique and stock review technique.

Insurance also plays a vital role in financial management of a project or investment. Adequate insurance is needed to cover the various risks that may be involved such as the type of property, its location, exposure to natural calamities etc. to name a few. Insurance

Internal risk

**Legislation compliance**

**Property management of a construction project:** During the construction of a new project the builders needs to plan their inventory and keep control of their stocks irrespective of the size of the project. Stock control starts from buying goods to using and maintaining them, and also reusing or reordering as required. Quality of the stock also plays a vital role in real estate business. To maintained quality several techniques are adapted. Just in time technique (where items are ordered when necessary and used immediately), minimum stock level

Contractors play an important role in success of a construction project. They are responsible for recruitment and supervision of employees working on the project. Contractors are also responsible for material management coordinating with suppliers thus acquiring necessary goods in time for the construction phases. Poor response from the contractors or failure to

**Legislation compliance**: Often a property holder has to disclose his personal and financial information to third party. Protecting information plays a key issue in this business. Once all the parties are ready to proceed it is necessary to have a privacy act is in place so that all information is secure. The corporation act provides the guidelines for conflicts or issues arising in construction or maintenance of a property. There are several agencies that provide comprehensive legal services to better understand the litigations involved. Antidiscrimination law and disability service act also play an important role in real-estate.

Occupational health and safety (OH&S) also arises in real-estate and a number of OH&S compliance officers are usually assigned to monitor the safety and health; for example, conditions provided to the workers at construction sites. OH&S officer duties include

An important aim of the paper is to study and review the real estate market in Australia to identify risk and rewards as well as compare the Australian market conditions and performance with the rest of the world. Therefore, the focus of the next section is on risks in the real estate market.

### **1.4. Types of risk associated real estate market**

#### **Figure 4.** Types of risk in real estate market

As is the case with every other industry, there are several risks in the real estate market. For example, there exists a risk factor in land procurement; housing development; asset management; property management; tenancy management to name a few [13]. The risks may be classified as internal or external risks (Figure 4 ). In turn, the internal and external risks can be divided into various other risk categories shown in Figure 5 and Figure 6 [14]. Builders, project managers, owners and investors who plan to make an investment or hold an investment in the property market may need to consider one or more of the following risks and then implement appropriate strategies for their projects to be successful.

#### *1.4.1. Internal risk*

Internal risk can be divided into financial management, human resources, property management, legislative compliance, corporate governance and housing management as shown in Figure 5.

**Financial management**: A detailed analysis of any proposed or existing projects need to be conducted for project viability. It is also important to plan the cash flow and management of the same. A poor cost control may lead to a budget over shoot and the project may run into un-chartered territories. When it comes to servicing the debt due care needs to be given to income streams - to take into account either reduction or loss of future income streams. In this regard, banking organisations need to be diligent in testing the capacity to repay the loans that are being offered. Fraud often occurs in real estate market mainly involving the use of false documents regarding number of properties, outgoing fees or rates, income streams and so on.

Importance of Risk Analysis and Management –The Case of Australian Real Estate Market 367

**Figure 5.** Internal risk Source: adapted from Sheryl and Adam [14]

366 Risk Management – Current Issues and Challenges

**1.4. Types of risk associated real estate market** 

**Figure 4.** Types of risk in real estate market

the real estate market.

*1.4.1. Internal risk* 

shown in Figure 5.

failures (at any phase in design, development, production, or sustainment life-cycles), or events of unpredictable root-cause. Several risk management standards exist including those from the Project Management Institute, National Institute of Science and Technology, Actuarial Societies, and ISO standards. The risk management definitions, methods and goals vary widely according to the context of project management, security, engineering, industrial processes, financial portfolios, actuarial assessments, public health and safety and real estate.

An important aim of the paper is to study and review the real estate market in Australia to identify risk and rewards as well as compare the Australian market conditions and performance with the rest of the world. Therefore, the focus of the next section is on risks in

As is the case with every other industry, there are several risks in the real estate market. For example, there exists a risk factor in land procurement; housing development; asset management; property management; tenancy management to name a few [13]. The risks may be classified as internal or external risks (Figure 4 ). In turn, the internal and external risks can be divided into various other risk categories shown in Figure 5 and Figure 6 [14]. Builders, project managers, owners and investors who plan to make an investment or hold an investment in the property market may need to consider one or more of the following

Risk Internal risk

External risk

Internal risk can be divided into financial management, human resources, property management, legislative compliance, corporate governance and housing management as

**Financial management**: A detailed analysis of any proposed or existing projects need to be conducted for project viability. It is also important to plan the cash flow and management of the same. A poor cost control may lead to a budget over shoot and the project may run into un-chartered territories. When it comes to servicing the debt due care needs to be given to income streams - to take into account either reduction or loss of future income streams. In this regard, banking organisations need to be diligent in testing the capacity to repay the loans that are being offered. Fraud often occurs in real estate market mainly involving the use of false documents regarding number of properties, outgoing fees or rates, income streams and so on.

risks and then implement appropriate strategies for their projects to be successful.

Insurance also plays a vital role in financial management of a project or investment. Adequate insurance is needed to cover the various risks that may be involved such as the type of property, its location, exposure to natural calamities etc. to name a few. Insurance also need to be updated with the changes in conditions.

**Property management of a construction project:** During the construction of a new project the builders needs to plan their inventory and keep control of their stocks irrespective of the size of the project. Stock control starts from buying goods to using and maintaining them, and also reusing or reordering as required. Quality of the stock also plays a vital role in real estate business. To maintained quality several techniques are adapted. Just in time technique (where items are ordered when necessary and used immediately), minimum stock level technique and stock review technique.

Contractors play an important role in success of a construction project. They are responsible for recruitment and supervision of employees working on the project. Contractors are also responsible for material management coordinating with suppliers thus acquiring necessary goods in time for the construction phases. Poor response from the contractors or failure to perform their duties will delay the project and overshoot budgets.

**Legislation compliance**: Often a property holder has to disclose his personal and financial information to third party. Protecting information plays a key issue in this business. Once all the parties are ready to proceed it is necessary to have a privacy act is in place so that all information is secure. The corporation act provides the guidelines for conflicts or issues arising in construction or maintenance of a property. There are several agencies that provide comprehensive legal services to better understand the litigations involved. Antidiscrimination law and disability service act also play an important role in real-estate. Property owners are liable for any discriminatory acts.

Occupational health and safety (OH&S) also arises in real-estate and a number of OH&S compliance officers are usually assigned to monitor the safety and health; for example, conditions provided to the workers at construction sites. OH&S officer duties include

inspecting construction sites and providing support to internal clients. It is important to report any hazard or incident and all incidents should be attended to and documented for future reference.

Importance of Risk Analysis and Management –The Case of Australian Real Estate Market 369

**Funding**: The availability of funding depends on a number of aspects such as the economic situation in general, market performance, and credit based upon any future cash flow. Some factors that influence economic performance are: change in political regime, rise in the price of raw materials, emergence of a new competitor and disruptions in production process. Market performance usually depends on changes in interest rates, changes in laws, and political and financial market factors. The risk of loss of principal or loss of a financial reward stemming from a borrower's failure to repay a loan or otherwise meet a contractual obligation falls under the funding risk. It is important to take into consideration as many of the previously mentioned factors while undertaking an investment decision, even when one already has an investment portfolio. Investors often anticipate future cash flow situations while borrowing money to pay a current debt. The failure of the anticipated cash flow leads to credit risk. However credit risk can be considered less likely since most often the investors are compensated by way of interest payments made by the borrower in end.

**Regulatory environment**: Investors in real estate projects should be aware of the local, state and federal laws and regulations. These laws depend on economic, credit and market risk as explained above. Failure to comply with the rules and regulation often leads to delays or in the worst case - complete scrapping of the project; all of which may lead to a complete or

**Reputation:** The reputation of a project developer often attracts investor attention and also provides favorable environment for investments. Joint ventures and partnerships are possible if the reputations are well known and have been built over time - providing partners the opportunities to win potentially new clients and investors, as well greater opportunities for new investments. An investor has to study the "people" perception of the organization and the credit history and rating of the project developer. An investment made into a company with poor credit history may end up losses of the principle amount invested. It could also be wise for an investor to know the value of the tangible and intangible assets and the market

**Competition:** Property market plays an important role in the economy. There are several players in the market who usually try to attract investors. While a healthy competition is good for growth in the industry, it is important for the investors to research exactly what they are being offered because the agents often utilize high pressure selling strategies to gain client's cash. It is possible that in the process the investors may receive inappropriate financial advice. For example, consumers may not be aware of non-disclosed information

**Partnership:** Partnership plays an important role in investing, as it reduces the impact of potential risk on the individual or company investment. For an investor to be successful in a real-estate partnership it is important to know the partner well and therefore trust plays a vital role. The role of each partner does need to be well defined and documented. Having a clear legal document will protect the interest of all partners. It also important to plan and document an exit strategy for all involved, because personal situations may change over time. Clearly, before a partnership agreement is made it is necessary to conduct a detail

value of the organization into which an investment is being planned.

partial loss of capital invested.

pertaining to advice they receive.

research to become self-confident about the deal.

**Corporate governance**: Corporate governance plays an important role in risk management in the real estate industry. It is important to properly align the ideas, interests and decisions of managers to the interests of both internal and external shareholders. For example, failure to recruit appropriate personnel may lead to conflicts of interest. If the conflicts are not managed effectively they may have a substantial impact on the company bottom line. It is required and expected of the managements or boards of construction companies always carefully analyze performance in terms of the market so that they are able to keep track of their company's performance and progress in a dynamic environment. It is also expected that the managements re-inspect and update their policies and procedures to meet the market trends and demands of all concerned stakeholders.

**Housing management:** A holistic management of the investment made in real estate can be defined as housing management. Housing management includes keeping track of maintenance and financial arrangements. As a common and popular practice the management of an investment property is outsourced to property management companies who appoint property managers to manage and oversee duties as required. Property managers on a daily basis are responsible for taking maintenance requests, collecting rent, dues or other fees and are responsible for the overall upkeep of the property. They also perform routine property inspections and organize inspections for the owners. Poor performance of the property managers leads to more grievances for the tenants as well as the owners.

#### *1.4.2. External risk*

External risk depends on a number of factors such as economic risk, funding, regulation, environment, reputation, competition, partnerships and natural disasters (Figure 2.6). Each of the factors noted are discussed briefly in turn.

**Figure 6.** Eternal risks Source: adapted from Sheryl V and Adam W, 2008

**Funding**: The availability of funding depends on a number of aspects such as the economic situation in general, market performance, and credit based upon any future cash flow. Some factors that influence economic performance are: change in political regime, rise in the price of raw materials, emergence of a new competitor and disruptions in production process. Market performance usually depends on changes in interest rates, changes in laws, and political and financial market factors. The risk of loss of principal or loss of a financial reward stemming from a borrower's failure to repay a loan or otherwise meet a contractual obligation falls under the funding risk. It is important to take into consideration as many of the previously mentioned factors while undertaking an investment decision, even when one already has an investment portfolio. Investors often anticipate future cash flow situations while borrowing money to pay a current debt. The failure of the anticipated cash flow leads to credit risk. However credit risk can be considered less likely since most often the investors are compensated by way of interest payments made by the borrower in end.

368 Risk Management – Current Issues and Challenges

market trends and demands of all concerned stakeholders.

of the factors noted are discussed briefly in turn.

**Regulatory environment**

**Funding**

managers leads to more grievances for the tenants as well as the owners.

**Figure 6.** Eternal risks Source: adapted from Sheryl V and Adam W, 2008

future reference.

*1.4.2. External risk* 

inspecting construction sites and providing support to internal clients. It is important to report any hazard or incident and all incidents should be attended to and documented for

**Corporate governance**: Corporate governance plays an important role in risk management in the real estate industry. It is important to properly align the ideas, interests and decisions of managers to the interests of both internal and external shareholders. For example, failure to recruit appropriate personnel may lead to conflicts of interest. If the conflicts are not managed effectively they may have a substantial impact on the company bottom line. It is required and expected of the managements or boards of construction companies always carefully analyze performance in terms of the market so that they are able to keep track of their company's performance and progress in a dynamic environment. It is also expected that the managements re-inspect and update their policies and procedures to meet the

**Housing management:** A holistic management of the investment made in real estate can be defined as housing management. Housing management includes keeping track of maintenance and financial arrangements. As a common and popular practice the management of an investment property is outsourced to property management companies who appoint property managers to manage and oversee duties as required. Property managers on a daily basis are responsible for taking maintenance requests, collecting rent, dues or other fees and are responsible for the overall upkeep of the property. They also perform routine property inspections and organize inspections for the owners. Poor performance of the property

External risk depends on a number of factors such as economic risk, funding, regulation, environment, reputation, competition, partnerships and natural disasters (Figure 2.6). Each

**Reputation Competition**

**Partnerships**

**Natural disasters**

External risk

**Regulatory environment**: Investors in real estate projects should be aware of the local, state and federal laws and regulations. These laws depend on economic, credit and market risk as explained above. Failure to comply with the rules and regulation often leads to delays or in the worst case - complete scrapping of the project; all of which may lead to a complete or partial loss of capital invested.

**Reputation:** The reputation of a project developer often attracts investor attention and also provides favorable environment for investments. Joint ventures and partnerships are possible if the reputations are well known and have been built over time - providing partners the opportunities to win potentially new clients and investors, as well greater opportunities for new investments. An investor has to study the "people" perception of the organization and the credit history and rating of the project developer. An investment made into a company with poor credit history may end up losses of the principle amount invested. It could also be wise for an investor to know the value of the tangible and intangible assets and the market value of the organization into which an investment is being planned.

**Competition:** Property market plays an important role in the economy. There are several players in the market who usually try to attract investors. While a healthy competition is good for growth in the industry, it is important for the investors to research exactly what they are being offered because the agents often utilize high pressure selling strategies to gain client's cash. It is possible that in the process the investors may receive inappropriate financial advice. For example, consumers may not be aware of non-disclosed information pertaining to advice they receive.

**Partnership:** Partnership plays an important role in investing, as it reduces the impact of potential risk on the individual or company investment. For an investor to be successful in a real-estate partnership it is important to know the partner well and therefore trust plays a vital role. The role of each partner does need to be well defined and documented. Having a clear legal document will protect the interest of all partners. It also important to plan and document an exit strategy for all involved, because personal situations may change over time. Clearly, before a partnership agreement is made it is necessary to conduct a detail research to become self-confident about the deal.

**Natural disasters:** In the real real-estate market, location plays an important factor in the investment decision. A property purchased at an appropriate location is expected to provide a good return on the investment. One of the main factors affecting location is the potential exposure to natural calamities such as bushfires, floods, sea level raise and erosion to name a few. If the location has a history or is likely to be exposed to a natural disaster it can be expected that the property prices will eventually be exposed to the risk. Therefore, it is wise to not be enticed into such toxic locations. Other factors that need to be accounted for are the costs of maintenance of properties and the nature and level of insurance required for risky locations, if chosen.

Importance of Risk Analysis and Management –The Case of Australian Real Estate Market 371

The house price-to-income ratio has been the main focus in Australia. The house price-toincome ratio is comparatively high when compared to other countries. Also, the price-toincome ratio in Australia since has been more than 40% higher than the long term average. In the next sections a discussion of the fundamentals that govern the house prices in Australian residential housing market is examined. Also, the potential risks and rewards to

the investors are explored in terms of the risk analysis framework presented earlier.

*2.1.1. Some aspects of the residential finance system in the U.S. and Australia* 

residential market price growth against the rest of world.

common than in Australia.

Source: RBA [21]

**2.1. Introduction: How Australian real estate compares to the rest of the world.** 

Since the U.S. housing crisis, analysts have been speculating about the potential housing bubble in the Australian residential property market. A report by Real Estate Institute of Australia (REIA) argued that analysts primarily focused their attention on the higher house price-to-income ratio in Australia as compared to other countries (REIA 2010). Moreover, it is observed that the house price-to-income ratio levels are at levels that are similar to that in the US before the housing market there crashed in 2008. The raise in the price-to-income ratio in Australia since 2003 by over 40% higher than the long term average adds fuels the speculation. However, it is important to analyze the fundamentals that govern Australian

In the US, the residential finance system played a significant role in the housing bubble of 2008. The regulation, residential finance institutional arrangements, and mortgage characteristics aided the excessive demand for housing finance. Housing finance was available and offered to borrowers with poor borrowing capacities. Consequently, excessive borrowing led to the housing bubble and the collapse of the financial system in the U.S in 2008. There are some fundamental differences in the lending practice in Australia when compared to the US [21]. In Australia the lending process is highly regulated by the institutional arrangement. The lending practices enforce the regulatory provisions on financial institutions forcing them to avoid excessive risk taking behavior. Table 2 outlines the characteristics of housing loans both in the U.S and in Australia. The table highlights the systemic susceptibility to riskier mortgages in the US and that availability of such funds to finance the mortgages were more

**Australia US**

Securitization is low in housing finance Securitization is high in housing finance

Regulation is high on mortgage loans No full recourse of mortgages

Full recourse of mortgages No full recourse of mortgages

No negative amortisation of loans yes

Non-conforming loans Subprime loans

**Table 2.** Mortgage characteristics of Australia as compared to US

#### **1.5. Risk and reward**

The nature of risk definition and management process is such that it should be integrated into "the philosophies, practices and business plans" of any individual investor or large organization's culture (Hillson [5], p.240). It is certain that there are many risks involved in real-estate market as mentioned. While real-estate provides variety of investment options every investor has to find their comfort level upon taking risks involved. It is not easy to decide if a selected property for investment is appropriate, but the decision should be made based on the consideration of all the factors discussed earlier. In the end however, the willingness to take risks largely depends upon individual preferences and circumstances.

The elements that usually determine the scale of risk or reward are the amount of money that is invested, length of time investment, rate of return or property appreciation, depreciation, fees, taxes, inflation etc. While it is natural for the individual and organizations to invest and expect returns it is important the investors make the informed choice to reduce the odds of losing the principle invested. The potential risks and rewards in investing in the Australian real estate market are investigated next.

## **2. Real estate scenario in Australia**

The speculation about Australian housing market has been intense since 2003. First it was the international monitory fund (IMF) which warned of the housing bubble in Australia "would bust" [15]. In mid-2008, IMF stated that the Australian property market was overvalued by about 25% [16]. In more recent times (April 2010), "The Economist" house price indicators estimated Australian house prices were the most overpriced in the world (56.1% overpriced against long-run average of price to rents ratio) [17]. The US based analysts Jeremy Grantham (Boston-based hedge fund GMO analysts co-founder) and Heather Hagerty (Fidelity Investments), were also speculating whether or not the Australian residential market is experienced a housing bubble, after the US housing crisis. According to Edward Chancellor [18], a US-based investment strategist and financial author, Australia was "in the midst of an unsustainable housing bubble that could burst at any time" and the "house prices are more than 50% above their fair value - a once in 40-year event." (p.1). In 2011 Morgan Stanley's global strategist Gerard Minack said that "we've had 20 years where the Australian consumers have been willing to borrow more to buy an asset that they believe always goes up in value. The classic sign of an asset bubble." and that "home prices are 30 to 40% above fair value [p.1, 19].
