Managing Risk - It's More than Insurance

When you think of risk management as it relates to property management, the first thing that might come to mind is, 'we have an insurance policy for that...it is covered.' However, risk management is much more than an insurance policy. 

 

Last fall, my property management students participated in the Core Net Corporate Real Estate Academic Challenge as part of their assignment for the course and looked systematically at risk in a global real estate portfolio. In consultation with the Insurance and Risk Management professors at Saint Cloud State in addition to resources provided by Core Net, we created curriculum to think about and evaluate risk from a real estate management perspective. 

The risk management process can be broken down in these five steps: 

1. Identify risk exposures in real estate. Think about potential risks that could impact the real estate you manage. Examples could be cyber risk, natural disaster, supply chain disruptions, political risk, urbanization or changes in surrounding development, corruption, infrastructure changes (roads, rail, air, etc.), technology, or many others. 

2. Analyze risk exposures through risk mapping. Through risk mapping, you would think about categorizing your risk as high frequency and high severity or low severity. An example that I put together is below: 

For each property you manage, the incident might fall into a different category on the map. For example, in this map, I place power outage as high frequency and low severity but when I worked at a management office for a Class A office building in Edina and the power went out for hours at a time on a monthly (sometimes weekly) basis in warm months, it became high severity, and the owner of the property ended up purchasing expensive back-up generators to mitigate the impact to the building occupants. The idea is to think about each specific property and its unique circumstances in order to map the risks so that you can think about the best way to manage them. 

3. Evaluate risk management methods. This brings us to step three, what are the methods to manage risk? The first method is to retain the risk or self-insure. For low severity risks like maintenance issues or a tenant that does not renew, retaining might be the solution. Create a reserve fund to cover extra expenses (or decrease in revenue) from these types of risk. A second method to manage risk is to create a non-insurance risk transfer through a waiver agreement with a tenant in a lease or a contractor in vendor agreement. Financial hedging is another method. The textbook definition of hedging is an investment taken out to limit the risk of another investment. For example, a corporation may choose to build a factory in another country that is exports its product to in order to hedge against currency risk. Or a real estate example, a real estate company might choose to have 10% ownership stake in a building to secure services business like management, leasing and construction. An insurance contract is one type of hedging, where a building owner buys a policy to limit the financial exposure of a specific event like a fire, flood, or natural disaster. One building I managed had an environmental insurance policy that was meant to cover additional remediation cost from changes in regulation. When the policy was taken out, the building owner had spent millions of dollars in environmental remediation to meet regulatory compliance. Years later, regulatory compliance changed and looked at vapor intrusion (in addition to soil and groundwater contamination) so the insurance policy had to pay out for additional costs to meet the new compliance standard. The final methods of risk management are loss control and avoidance. A preventative maintenance program to catch roof leaks or electrical problems before you have a serious problem minimizes costs. And proactively choosing to avoid certain risks, like tenants with poor credit history, can save money in the long run. 

4. Choose the method. Once you have mapped out risks for your property and evaluated methods for management, you can choose the method that is right for each risk. Remember that for each property the risk and the method might be unique. Although you might be doing many of these things on your property already, have you ever taken the time to step back and think about it?

5. Review and evaluate. And this brings up to the final, and perhaps most important, step. the "de-brief" or evaluation. Any plan is useless without successful implementation and perhaps the most important part of implementation is to look back to determine what worked, what did not work, and what should be changed or altered for the future.