Why Volatility Is An Inappropriate Risk Measure For Real Estate

The adequate measurement of real estate risk is of utmost importance for asset management and real estate portfolio management. Most real estate academics agree that volatility, commonly used as a measure of real estate risk, is inappropriate for that purpose. However, volatility is still a favored measure of many practitioners, especially for comparing the risk of real estate with other assets such as securities. And even real estate academics still use this measure due to its simplicity and because the perfect alternative has yet to be found. This paper, which is based on an extensive literature overview, expert interviews, and new empirical evidence, provides plausible reasons for the proposition that volatility should not be used for measuring the risk of real estate--neither within its asset class, nor in a multi-asset environment. Furthermore, a detailed comparison of three currently discussed perceptions regarding appropriate real estate risk measures is provided. In this context, the paper also discusses whether qualitative risk measures might be more appropriate or could be combined with quantitative risk measures. However, empirical evidence based on the data of two large German real estate asset managers shows that a scoring method, for example, is in-appropriate as well. Eventually, this paper provides some requirements for more appropriate real estate risk measures.