A macro-economic indicator-based risk management strategy for the small property investor
Steenkamp, Jan Hendrik
ABSTRACT Risk to small property investors manifests in the cash flow of the investment and it should thus also be managed in the cash flow. From a practical point of view it is logical that that risk management strategies be incorporated into a property investment at the inception stage of the investment. The cash flow of a property thus needs to include applicable risk management strategies as part of the feasibility study of the investment. The chief manner in which small property investors deal with risk in an investment, is by making conservative allowances in the projected cash flow of the investment. Internal risk is thus managed to a degree, but the small investor is still vulnerable to market risk which originates from outside the investment. Market risk however, is relatively successfully managed by the Institutional Sector of the property market through the application of Modern Portfolio Theory and the use of the portfolio as a vehicle to diversify internal risk. The portfolio vehicle also allows the quantification of external- or market risk, thus creating the opportunity for effective management. It is however believed that the same principles of Modern Portfolio Theory as applied in the institutional sector of the property market, may be applicable to small direct property investments, to formulate an investment risk management strategy, which is embedded in the conceptual stages of the investment and thus reduce the reliance on often, ineffective, active management and remedial strategies during the holding period. The main obstacle however, is that the application of Modern Portfolio Theory requires an industry bench mark or index, which is representative of the market and against which performance may be measured measured. The application of such an index to the small direct property investment is however extremely limited due to a difference between the scale at which small investments function and the scale of the market that an index represents. A substitute for a benchmark to act as a market indicator is thus required, which must be reflective of the market within which the small investment operates. This report investigates the possibility of deriving an investment-specific benchmark or a hypothetical return curve, based on the relationships that exist between the macro-economy and the property market. If it is indeed possible to establish the credibility of such an alternative market indicator, it would therefore become possible for small property investors to apply the risk management principles inherent to portfolio investing and incorporate these principles in the feasibility cash flows of small direct property investments.
property, investment, South Africa