How IXIS CIB Applies Value-At-Risk Calculation to Real Estate Investments

One of the activities of IXIS CIB, the investment bank of Groupe Caisse d'Epargne (3rd French bank) consists in structuring real estate investments and retaining part of the risk associated in its books. The transactions involved are generally highly leveraged sale and lease back transactions. Within the bank, Risk Control is in charge of quantifying risk associated with those investments and expressing opinion on the opportunity of these transactions. This is carried out through a 3 steps framework.First, Risk Control values the whole transaction in a completely independent manner, with its own model and assumptions for the business plan. Second, stress scenarios are applied on the various risk factors of the transactions which include exit prices, inflation rate, vacancy rates, capital expendituresÖ But such scenarios may be more or less biased, depending on traders' experience or market expectations.Third, we move from deterministic scenarios to stochastic ones and let random processes explore what future prices could be. Associating then a probability to occur to each scenario, we run Value-at-risk calculation. Therefore, Monte Carlo techniques, that are already widely used within the bank to value complex options or assess risks, have been adapted to Real Estate transactions. This approach is mainly risk oriented but it is also a powerful tool to compare projects between them in bid processes. Presentation shows step by step how this methodology works, one of the most interesting output is a distribution of the profit of the transaction. It also presents how, using the Merton's scheme of the firm, investor and debtor have opposite interest and how the profit distribution that was produced through Monte Carlo simulations could be used by the lender also to estimate his risks and expected returns.