Development Risks: Analysis, Valuation

and Regulation

Prof. Mikhail M. Soloviev2015

Valuation & Development Business

Principle role of Risk

• The pair “Investment Potential - Risks” is one of the main characteristics for investment attractiveness and development for all hierarchy levels of economics: country, regions, etc.

• Measure of risks is reflected through different kinds of expert data and quantitative coefficients: • qualitative estimations, ranks;

• discount coefficients – in the DCF concepts, e.g. for investment projects analysis & business-plans;

• yield – for risk reflection in Real Estate market statistics, for development projects analysis, etc.

Sample: The RF REGIONS’ ranking:investment potential & risks

LOCO &GROWTH

POTENTIAL

PROBLEMS SPECIAL ATTENTION

90s-2005

High Potential

High Risks

TOP REGIONS:Moscow Moscow region (oblast)S-Petersburg

Ural regionsKhanty Mansy (Oil-Gas)Volga regions Rostov-Krasnodar (Sochi)

Low Risks& Potential

EUROPE Prosperity of the 2007-2008

Investment Prospects &City Risk-Free

Moscow: both extreme ranks

CITIES

RISK-FREE

INVESTMENTS

«EuroProperty» Data (2004)

Risk is a probable loss. In principle waited results of any realized processes may be worse because of different negative factors influence.

So the Development Risks (in our course context) are the probable development results losses because of negative factors acting, interaction problems between participants of the real estate development projects.

Development Risks: basis concepts

CONSUMERS (RE Investors)

BUILDERS

DEVELOPMENT

SOCIETY,AUTHORITUES

FINANCIALINSITUTIONS

Environment

DEVELOPMENT

SOCIETY,AUTHORITUES

Risks of problematic interactions with Authorities and Society

• Authority risk influence– Planning permission (Town Planning rules)– General plan’s zoning, restrictions, etc.– Demands for RE improvement / Planning Gain

• Society influence– Objections (protests): green, historical, cultural,

ecology, environment pressure, etc.– Public opinion– Mass media pressure …

Risks of interactions with Authorities and Society

BUILDERS& …

DEVELOPMENT

Risks of problematic interactions with Builders & other Contractors

Problems and influences:• To find reliable & high quality contractors

for the project management, projecting & building works, & other special activities.

• To fulfill all the project works – in time (good planning & work organization, in

time delivery, etc.) – with confirmed quality level (TQM-systems) – according to the confirmed quantity calculations

• To have good decision making means for analysis and possible corrections

Risks of interactions with Builders & other Contractors

DEVELOPMENT

FINANCIALINSITUTIONS

Financial Risks

• To find corresponding creditors / banks (good rank, traditions, previous experience …)

• To confirm corresponding credit conditions (credit line, %, repayment conditions, penalties…)

• Financial risks during the project realization (materials and contractors works prices alters, current payments problems, additional demands expenditures, e.g. for environment protection, etc.)

• Difficulties with the project results profitable (in time and with VfM) market realization.

Financial Risks

Development Project: possible balanced finance diversification

BANKS

CONTRACTOR

FUTURE CLIENT DEVELOPER

STRATEGYINVESTOR

CONSUMERS(RE Investors)

DEVELOPMENT

Risks of interactins with investors (consumers, results buyers)

Risks of interactions with investors (consumers, results buyers)

• Risks concerned with the concrete investor participation in the project financing according to confirmed conditions.

• Risks concerned with alters of investor demands for the project characteristics.

• Risks - with the project results selling to the investor in time & according to waited cost.

• Risks concerned with problems to operate efficiently with the unsold developed object.

DEVELOPMENT

Environment

Risks of external and internal environment influences

• External environment influences - such as conditions and tendencies:– Economy of state, region (investment rank,

GDP, recession, growth potential, reforms …)– Social, Political, Ecology, etc.– Market competitions and competitors acts …

• Internal conditions and tendencies– Financial and other principle characteristics – Internal alters (reforms, alters in strategy,

renewing plans, portfolio alters, etc.) – Management (staff, leadership, experience …)

Risks of external and internal environment influences

Developer Portfolio Strategiesduring the crisis process

Selling part of projects

RISKS: ANALYSIS and MEASURE

CONCEPTS and METHODS

•Sensibility concept and methods•Stochastic approaches

•Others (e.g. net-analysis / critical way, decision-trees, analogies, etc.)

Sources of the development risks are concerned with insufficiency of information (for project, participants, market environment, etc.), e.g.:

(1) information uncertainty,(2) inaccuracy or non-

correspondence,(3) information absence or not in time, (4) non-synonymous (diapason), etc.

Risks’ sources

WAITED RESULTS

FACTORS of INFLUENCE

Sensibility Risk-Analysis Concept

Y=Y(xi, … xj) Ym

xim

xjm

∆Y (∆Xi) – deviations of results

MODEL of Interacting

Ym

Sample of the diapason data influence (onto the Capitalization Value)

CHARACTERISTICS / DATA DESIGNATIONS MEANING

RENT (annual) g ($/m²) 400-360 (-10%)RENTING SQUARE S (m²) 2000USING SQUARE I (%/100) 0,8OPERATIONAL INCOME giS ($) 640000 - 576000

MAINTENANCE (annual) J(S) ($) 100 000OTHER FACILITIES (annual) F ($) 60 000OPERATIONAL EXPENDITURES F+J(S) ($) 160 000

FUTURE PROFIT giS-(F+J(S)) ($) 480000 - 416000

CAPITALIZATION RATE (yield) k (%/100) 0,12

CAPITALIZATION VALUE A=(giS-(F+J(S))/k ($) 4000.000-3466.67 losses -13.33%

Risk Factors different influence onto the Capitalization Value

1. Operation Incomes• Rent payment (-10% -13.33%)• Adequate influence – in concern with

squares under renting (measure of filling)

2. Operation expenditures• Management, maintenance and other

facilities (+10% → - 3,33%)

• INDEXES Designations & Measure Quantity / Value• Rent index (annual) g ($/m2) 350-400• Square for renting S (m2) 2000• Occupation I (%/100) 0,8• Operational (annual) INCOME giS ($) 560000 - 640000

• Maintenance (annual) J(S) ($) 1000000• Other operational payments (a year) F ($) 600000• TOTAL Operational expenditures F+J(S) ($) 1600000

----------------------------------------• FUTURE NET INCOME giS-(F+J(S)) ($) 4000000 - 4800000

• Yield k (%/100) 0,12 - 0,14

• CAPITALIZED VALUE A=(giS-(F+J(S))/k ($) 28600000 - 40000000=======================

• Development expenditures B= (Bld+C+D)(1+р) ($) 25000000-27500000

• Project’s Profitability R=(A–B)/B *100 (%) Rmax=60% Rmin=4%

Input dataintegralextreme

deviationsand

profitabilityresults

Sensibility extreme analysis

– One-parameter methods • Sensibility analysis and ranking, • Boundaries and Extreme data definition, • Sensibility lines and Spider characteristics•

– Two-parameter methods• Pairs comparing,• Compensation opportunity seeking

(invariants)

– Multi-parameter methods • Scenarios analysis, • Multi-parameter compensations seeking

Variety of the Sensibility concept using

+ +• effectiveness and variety of practical using, • simplicity, operative and visual results presentation - -- probability component is absent - risk factor had already taken place: р=1.0- indefiniteness modeling only through static coefficient ranges (p=1.0)

Positive and negative properties of the Sensibility Methods

WAITED RESULTS

FACTORS of INFLUENCE: probable distribution

Stochastic Risk-Analysis: Monte Carlo Concept

Y=Y(xi, … xj) Ym

xim

xjm

∆Y (∆Xi) – probable characteristics of the results’ deviation

MODEL of Interacting

Ym

Information base includes probability characteristics on the model inputModeling results are output probability characteristics (e.g. as the probable density distribution)

Input dataxiStochastic alters

Stochastic Risk-Analysis: Monte Carlo information base

& results

Risk probability measure

Risk probability measure is connected with the probability density characteristics as the 2nd moment (Dispersion – D, or Average Quadratic Deviation - σ²)

σ² = Σ[(xi – x*)²] / n i={1,n},

x*– current meaning, xi – average (arithmetic) meaning.

MULTI-MODAL probability distribution function for NPV

Non-Symmetry NPV function

Probable image of different projects NPV

Project 1Project 2

Risk policy and regulations

Risk Avoiding Risk Decreasing

→0 →min

Probability Losses

Development projects’ (profitability)risk influence fields & risk policyOperation incomes Better MarketingOperation expendituresOutsourcingBuilding process Best contractingDeveloper expenditures Economy… …

ПРОБЛЕМЫ ЭКОЛОГИИ: СОЧИ-2014ПРОБЛЕМЫ ЭКОЛОГИИ: СОЧИ-2014

ГРУШЕВЫЙ ХРЕБЕТ

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РАЗМЕЩЕНИЕ ОЛИМПИЙСКОЙ ДЕРЕВНИ, САННО-БОБСЛЕЙНОЙ РАЗМЕЩЕНИЕ ОЛИМПИЙСКОЙ ДЕРЕВНИ, САННО-БОБСЛЕЙНОЙ ТРАССЫ И БИАТЛОННОГО КОМПЛЕКСА НА ТЕРРИТОРИИ ГРУШЕВОГО ТРАССЫ И БИАТЛОННОГО КОМПЛЕКСА НА ТЕРРИТОРИИ ГРУШЕВОГО

ХРЕБТАХРЕБТА

Replaced objects

Caucasus BiosphereReserve

Mountain Olympic objects*

Replacing number of objects from protected zone

To Coastal Cluster

Mountain Olympicobjects**

Risk avoiding: Ecology problems solving by Olympic objects Replacing

Earthquakes danger & Transcontinental Pipeline “East Siberia – Pacific Ocean”

Trajectory Variants

Lake BaikalSeismic zones

Strategic Alternative for Directionof the Transcontinental Pipelines

ArcticOcean

The East SiberiaOil-Gas provinces

Risks value and regulations in the management of organization

• Development risks take place among other acts & decision making of the organization.

So:

• Development risks are regulated together with other activities` risks.

• Development risk policy is chosen and realized together with other policies of the organization such as: economy policy, social responsibility, innovation strategy, etc.

Pass to Business Game “Auction: Land Site purchase for its Development”

Decision making in the market environment.

Land site Auction – Win for development project realization

– Providing the project efficiency.

So:• Choice and following to own “risk / economy” policy in the Action competition. • Decision making as the bidding price argued choice on the project efficiency value basis.