Advances in quantifying risk in commercial real estate lending

Abstract

There are strong forces in the commercial real estate industry pushing banks and investors to take more quantitative approaches in assessing risks. This quantification will affect everything from loan approvals to deal structures and loan pricing. There are four main drivers for the use of quantitative tools: 1) The Basel II regulations that require banks to have risk models to calculate their minimum capital requirements; 2) The pressure to increase returns by using more complex financial structures; 3) The need to ensure that senior managers can monitor the effect of these complex structures on the risk of the portfolio; and 4) Concern that the world has become more interlinked, increasing the risk of several sectors melting down simultaneously. This article discusses some of the ways that risk can be measured, the requirements of the new regulations and how risk measurement tools can be used to increase profitability and reduce risk in structuring new deals. Copyright © 2008 John Wiley & Sons, Ltd.