Risk Appetite

I am loving this term called Risk Appetite. No risk, no venture! Are you money hungry or cash hungry? They both are different.

The term risk appetite belongs in financial industry. However, this term is co-relating in real estate and construction industry as well.

In this article we are trying to understand the term Risk Appetite through asking questions in different manner. Once we completely understand the term; we will answer all questions ourselves by using common sense. Yes, sometimes, you need a consultant to answer specific questions. Nonetheless, as an investor, you are responsible for your homework.

We will talk about:

1. Risk Appetite
2. Risk Tolerance
3. Unacceptable Risk
4. Risk Management

What is Risk Appetite?

In simple English, following questions should come up in your mind.

1. How much can your investment be in danger zone?
2. What is the possibility of risk that you are about to take?
3. What is the likelihood of your success in investing in real estate or in any thing in general?
4. What is the probability of your Return on Investment (ROI)?
5. What are the threats of your investment?

Although, all these questions are directly related to any financial institution; but they are related to any single investor.

How to co-relate Risk Appetite in Real Estate?

First thing, investment in real estate is investing liquid cash. Real estate investment is always cash hungry.

1. Can you really make an investment?
2. Do you have liquid cash to purchase a residential or commercial entity?
3. Have you done research and due diligence on the entity that you are about to invest?

There are several factors that influence risk appetite.

Before the investment

Understand your home and company culture. The investment will directly impact household and employees. You may have to cut down some expenses, remove wants and focus on the priorities and needs only. Calculate each and every expense you can think when investment is going to start.

I wrote an article earlier about this. Please read and click on Types of Cost in Real Estate. Real estate requires huge liquid cash investment.

During the Investment

A famous MBA analysis on SWOT which stands for Strength, Weaknesses Opportunities, and Threats analysis should be done before the investment.

Nevertheless, the SWOT analysis is also done when a real estate is in construction phase. Sometimes, the material price may go up while constructing your house. The economic situation may go down. You may have to increase the security to keep out the looters and hoodlums. Keeping safety while labours are on site and keeping safe the material so that it is not stolen. Insurance plays a major part at this point.

Sometimes; you have to stop the construction and play delay tactic. An investor must understand who are the contractors in Pakistan? How much experience they have in construction? What electric and plumbing materials are they going to use? What about other material? How can contractor save money?

After the investment

The investor does not stop investment when the house is constructed. Now, you need monthly maintenance on your newly constructed home sweet home.

You need to calculate and gather all the expenses you can incur on a monthly basis.

For example…

1. Property Taxes
2. Building maintenance
3. Utility bills such as electric, gas, water, telephone, Internet
4. In case of power outage; generator and petrol usage, if any
5. Solar panel cost for power outage if any
6. Maids, gardener, driver, chefs, etc.
7. Old-age cost includes health cost, hospital visits, medicines cost
8. Entertainment cost all the time includes eating outside, kids fun cost
9. Education cost for self, spouse, kids
10. Charity, if any
11. Transportation cost includes, car, motorcycle, bicycle, bus, taxi and it depends on the size of your household
12. Parking cost includes parking on the main street, parking inside house if the space is available
13. Gatekeeper cost; this should be included in the building maintenance cost
14. Security guard cost
15. Internet of Things (IoT) cost if you need more luxurious way of living

Are you scared enough to not to invest in real estate? Do you understand the risk hungry investment?

I hope you do. After all, no risk, no venture!

Who are your competitors when investing in real estate? An investor is the self-competitor in investing in real estate. Oh, how is that possible?

You are directly competing with your mindset and your consistent liquid cash investment in real estate when needed to finish the project.

Then you are competing with your relatives and your neighbours in terms of lifestyle.

What lifestyle do you need as an individual? Have you ever wondered why people migrate to other countries? Is it because of money or lifestyle? That’s something to ponder on. So, what exactly is risk appetite?

It is simply the amount of investment that you can risk in construction of a house very easily.

Risk Tolerance

Risk tolerance is simply doing something different from the usual way of constructing.

For example, your risk appetite for normal quality steel rebar is PKR 100.00 but you need to upgrade your steel rebar for PKR 50.00 when normal quality can do the job.

The upgrade cost on the building material is your risk tolerance.

Now, your cost becomes PKR 150.00.

You accepted this deviation (change) as this upgrade satisfies your future planning.

Again, any change in the actual planning is risk tolerance.

I would say risk tolerance is an emergency fund that you keep for urgent basis.

Unacceptable Risk

Unacceptable risk would be if your upgrade cost (risk tolerance) is associated with another cost. This another cost may not your personal need; but it is indirectly a need of the upgrade cost.

For example, a bigger truck is needed to move building material which is oversize; an insurance is required to move this oversize material; city permit cost is required to move this oversize material.

Here comes your project manager who can save you money in handling all this.

Risk Management

You have to manage all investment risks through risk management system. You may use technology and will assist you easily or you can simply use your common sense.

Whatever you do; make sure you put every financial and non-financial transaction in writing.

That’s the simplest way of managing any risk.

The question arises that how a person (a real estate investor) in Pakistan will use technology in risk management system?

1. There are free apps to download
2. You can put all your expenses in spreadsheet
3. Have pencil and paper all the time with you when you are on site
4. Jot down your thoughts so that you won’t forget, you have

For example:

An investor is always at a risk when investing cash. Their family members are also at risk and this could have a ripple effect on other entities.

Types of Risk Factors

1. People risk – self, household, relatives, labours, neighbours, etc.
2. Site risk – soil test, personal and material security, etc.
3. Process risk – contractor’s process of handling the construction
4. Technology risk – what construction technology is used in construction? Do you need CCTV, Internet on construction site?
5. Financial risk – Do you have money?
6. Competitive risk – material purchasing
7. Market risk – country economic situation
8. Reputation risk – emotional risk of being a loser
9. Compliance risk – government permits
10. Strategic Risk – includes change of plan, government actions, operational actions, economic actions, political actions, distraction, etc.

Personal and corporate investment after Covid-19 is not easy at all. The inflation in 2023 and beyond in Pakistan at all industry level is all time high. The standard of living is not improving.

An average Pakistani is facing an economic hardship. I would say, Pakistanis are a true risk manager at all levels. They are street smart, curious and can easily manage their funds.

Other Similar Readings

1. 4 Truths About Real Estate Investing
2. The Duties of Building Contractors
3. Bringing Transparency to Skilled Labour Hiring