Ch.

15 - Investment & Risk Management

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1. How did risk management develop into a formal

discipline?: From the insur- ance industry
2. What are the three ways of controlling loss?: Avoid
Loss
Limit Loss

Reduce Loss
3. What are the four main reasons that investors
invest their equity capital?: - Return rate
Property appreciation
Diversification
Tax benefits
4. What is often said about development in the real
estate industry?: Because the real estate industry is
cyclical, the real estate industry is often said to have
a tendency toward cycles of overdevelopment
5. If investor Jim is skilled at predicting when to buy
or sell property based on property types and
economic conditions, what investment strategy
would he be most likely to use?: Market timing
6. What is arbitrage investing?: The investment
strategy based on the ability of an investor to
recognize the differences in prices that buyers are
willing to pay for the same real estate investments
that are located in different markets.
7. Define financial leverage.: The benefits that may
result for an investor who borrows money at a rate of
interest lower than the expected rate of return on
the total funds he or she invested in the property.
8. What kind of risk results from a slow real estate
market with few buyers and sellers?: Liquidity risk
9. List three risk management procedures. (See
screen 23 for other correct answers.): Diversification
Property management
Shifting risk to insurance companies
10. Use of a triple-net lease is an example of which
risk management proce- dure?: Shifting risk to
tenants
11. List two types of hedging mechanisms.: Purchase
options
Interim financing commitments
12. What are two alternatives to selling a property
that an investor can use if the property is not
performing as well as anticipated?: Refinancing
Renovating
13. Risk is the chance of experiencing a loss. Risk is
always the outcome of a decision or a series of
decisions. Risk management in business usually
requires giving prior thought to potential problem
areas.

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Ch. 15 - Investment & Risk Management

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Risk management is an ongoing process that

changes constantly. However, it is a process with
distinct milestones that are sequential in
application.

The main task of risk management is to identify the

risks faced by the busi- ness. Once risks have been
identified, they need a plan of control. Risk control
deals with dealing with loss in three ways:

Avoid Loss
Limit Loss
Reduce Loss: The first control deals with the issue of
avoiding the risk or not entering into the risky
situation in the first place. The second control deals
with limiting the frequency of losses, that is reducing
the number of times a particular event can occur.
The third control deals with reducing loss when an
event does occur.

Investors must consider many variables when

purchasing income properties. These factors include:

Market factors
Occupancy rates
Tax influences
Level of risk
Amount of debt financing and
Proper procedures to use for measuring return on
investment Investors invest their equity funds for
four main reasons. Return Rate

Property Appreciation
Diversification
Tax Benefits
14. When deciding about investing in certain
properties, it is always impor- tant that investors
carefully make forecasts of future cash flow. Real
estate investors follow a number of strategies and
investment styles:

Investing in Core Properties

Investing in Core Properties with a Value-Added
Strategy Property Sector Investing
Contrarian Investing
Market Timing
Growth Investing
Value Investing

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Ch. 15 - Investment & Risk Management

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Strategy as to Size of Property

Strategy as to Tenants
Arbitrage Investing
Turnaround/Special Situation
Opportunistic Investing
Investing in Trophy or Blue Chip Properties
Developments: Financial leverage is defined as the
benefits that may result for an investor who borrows
money at a rate of interest lower than the expected
rate of return on the total funds invested in the
property.

Different types of risk carry investment risk

characteristics that investors must consider when
deciding among alternative investments. Risk types
are:

Business risk
Financial risk
Liquidity risk
Inflation risk
Management risk
Interest rate risk
Legislative risk
Environmental risk
15. There is no way to avoid risk when dealing with
real estate investments. However, risks can often be
significantly reduced with relatively simple risk
management procedures. Here is a list of those
procedures.

Reducing risk through careful selection

Diversification
Market research
Property management

Shifting risk to tenants

Shifting risk to insurance companies
Hedging to control risk: After all possible risk control
techniques have been
put in place, some amount of unavoidable risk still
remains. Before making any commitment of funds to
a real estate project, most rational and well-informed
real estate investors will do the following:

Specify investment objectives with reference to the

return on investment, the timing of the return and
acceptable risk levels.
Identify the major risks that are involved and
calculate them as completely as

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Ch. 15 - Investment & Risk Management

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possible.
Eliminate some risks, transfer others through
insurance or other techniques and limit the
remaining risks to acceptable levels.
Make decisions to accept or discard specific
investments, based on whether the expected returns
justify carrying the remaining risks in light of how
the project will contribute to the investor's overall
objectives.
Many things can change during the time period an
investor holds a property that affect the actual
performance of the property. Another factor that an
investor looks at is the potential benefits associated
with leverage. Factors such as these could cause
the investor to consider selling the property.

If an investor has less financial leverage than when

he or she first financed a property, the investor may
choose refinancing as an option.

Instead of selling one property and buying another,

an investor could consider renovation as an option.

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device: Chapter 15 Summary
16. Installing sprinklers in a factory to control the
effects of a fire is exercising what risk control
technique?: Reducing

17. Which style depends heavily on market research

and the ability of an investor to understand changes
in the economic environment and its effect on all
types of real estate?: Growth
18. Which kind of risk occurs when the real estate
market is slow with not many buyers, sellers or
transactions?: Liquidity

19. Which of the following is not a reason people

invest?: Interest rate
20. What investment style uses economic and
demographic research to come to the belief that one
property type will outperform other property types?: -
Property sector investing
21. Which of the following statements about risk is
false?: Putting all possible risk controls in place will
eliminate all risk.
22. All of the following strategies are alternatives to
selling a property except which?: Optioning
23. Risk is best defined as what?: The chance of
experiencing a loss
24. Which of the following is not one of the three
ways to control risk?: Accept 25. How many
recognized steps are there in decision-making?: Five

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