Evidence of its Importance and Instruments to Handle it. The Real Estate Market Risk of Banks
||Evidence of its Importance and Instruments to Handle it. The Real Estate Market Risk of Banks
||8th European Real Estate Society Conference (26-29 June 2001) Alicante, Spain
||This paper deals with a risk that has been widely neglected in both academia and practice: the real estate market risk. It is an integral part of any real estate investment and therefore its existence has always been known—but not much else. Surprisingly, very little research has been done on the risk’s causes and effects or its importance, nor have real estate investors found ways to handle it. The paper starts by defining and classifying different types of real estate market risk. A closer look reveals that banks are exposed to the risk in many ways, be it directly (e.g., through real estate owned) or indirectly (e.g., through mortgage loans). In the second part of the paper evidence from several empirical studies is presented which underline the importance of the real estate market risk for financial institutions. The author uses a three-factor APT-model to examine the sensitivity of German bank stock returns to fluctuations of the real estate market. The results indicate that the German banks from the sample indeed have a significant real estate market risk, depending on the volume of their real estate-related assets. A review of the current literature on real estate risk management reveals that most banks are by no means in a position to manage real estate market risk effectively. This result combined with the discovered importance of the risk makes it necessary to develop new and better instruments for risk management. The author presents his ideas for various instruments for measuring and protecting against real estate market risk, i.e., a geographical information system and a sensitivity analysis, some of which have been successfully tested in a German bank. The paper ends with a description of the most urgent steps in the direction of a complete risk management system for real estate risks.
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