Value-at-risk: A specific real estate model

Value at Risk is a convenient and popular risk measurement tool. It represents the maximum potential loss on a specific portfolio of financial assets given a specific time horizon and a confidence interval. Principally Value at Risk is used in finance for risk management, financial reporting and capital requirement. In real estate, the calculation of this risk measurement is still rare even if it is now common to compute and disclose it in numerous other fields of finance. In particular, this calculation is even rarer in the case of direct real estate. In this paper we review the major issues face by real estate academics and practitioners to determine the Value at Risk of real estate investments. We propose a new methodology that we believe is more accurate and more relevant to compute Value at Risk of real estate portfolio. This model allows taking into consideration the specificities of a real estate portfolio such as the type of properties, the lease structures, the obsolescence or the possibility of vacancy. We analyze to what extend our proposed model allows a better Value at Risk assessment. To do so, we introduce the components of our model step by step, foremost by proposing the use of bootstrapping method, then by introducing the lease structure, then the possibilities of vacancies and finally the obsolescence of the properties. Lastly we propose a way to link all these characteristics in order to compute a relevant Value-at-Risk. After a brief review of literature on Value at Risk especially related to real estate, the paper describes the main methods used to compute Value at Risk. We then introduce a new model to compute Value at Risk of real estate investment. We test and compare the proposed model against the historical one. We conclude with a sensitivity analysis.