Managing risk in realty
The recent terror attacks on Mumbai have exposed the vulnerability of real estate companies and projects.
It has put the spotlight on the significance of efficient risk management initiatives and adequate insurance cover for an industry that’s already reeling from the effects of the global recession, says Rajesh Kulkarni
Circa early 2007, construction companies were a rage at the stock markets, demand had never been better notwithstanding the stratospheric rates. Analysts across broking firms were busy voicing a rosy future for this industry, predicting a compounded annual growth rate of 40% over the next five years.
They did not anticipate the fall. Beginning with the sub-prime crisis in the US, the collapse of major global financial institutions (many of whom had extensive investment exposure to Indian realty firms), the world was in the grips of a mammoth economic crisis. Closer home, with interest rates on the rise and potential buyers putting off property purchases indefinitely, demand slump was looming large.
With banks refusing to throw the much needed financial lifeline to beleaguered builders, completed projects finding no takers in spite of a slew of freebies and discounts, the real estate community, once the toast of India’s growing economic clout, was caught staring at the bottom of the barrel.
The recent terror attacks in Mumbai, the country’s financial nerve centre, while exposing the country’s security and intelligence loopholes, have also added to the woes of the realty community.
According to industry experts like Pranay Vakil, chairman of the real estate advisory, Knight Frank India, the recent attacks on Mumbai are likely to have a ‘ripple effect’ on real estate volumes in Mumbai and the rest of the country. Others like Himanshu Malik, a senior analyst with a leading real estate-focussed PE firm states that the attacks would adversely impact investor and end-user sentiments across the country.
“Already demand for real estate in Tier II and III cities like Pune, Chandigarh and Bhopal has slumped by nearly 35%. Developers are also deferring projects due to higher borrowing costs,” says Malik. “This is only going to worsen an already bad situation.”
But Jaya Deshmukh, vice-president (marketing) with the Pune-based developer Gera Developments Pvt. Ltd disagrees. She says: “I don’t think the terror attacks will directly impact our industry. There will be repercussions on the economy, followed by a trickle down impact on sectors like tourism.”
Asked about the negative sentiments that have engulfed the real estate industry, Deshmukh says: “Traditionally realty prices have always been on the upswing and hence a safe haven for both investors and buyers.”
“Moreover risk involved is directly proportionate to demand generated and India still faces a huge shortfall of housing units, so the demand is very much there,” she continues. “Hence at a macro level, I don’t think the industry is a high risk proposition, while in case of individual projects there are several ways of assessing the risks involved.”
Deshmukh agrees that its time developers put efficient risk management initiatives in place to safeguard their interests and those of their investors.
She says: “Risk management services are now an integral part of the industry. At Gera Developers, all our projects go through a stringent risk review. We follow the same procedure while taking decisions like launching or initiating a project.”
Understanding risks involved
Risk management is a term which embraces the strategies of managing, measuring or assessing risk. It involves transferring the risk to another party, avoiding it, reducing the effects of the risk, and accepting some or all of the consequences of a specific risk. Risk management becomes all the more important when it is contextualised with property.
“Efficient risk management in construction should ideally involve the entire project team,” says real estate consultant Indu Shahani.
“It’s an ongoing process that involves identifying the potential risks associated with a particular project and initiating measures to contain or nullify them. The analysis may include new risks, secondary risks, scope changes, change orders, estimate and schedule items and actual costs that provide a graphic depiction of the changing nature of project risk over time.”
According to industry experts, there are various risks involved at different stages of any construction activity.
“At a broad level, construction risks largely relate to key design issues and adherence to efficient project management from inception to completion to minimise risks from time or cost overruns,” explains Malik. “It is crucial to examine the developer profile and track record of the projects undertaken by the developer, to control such risks,” he adds.
“If risks can be defined as uncertain events, one needs to differentiate between uncertainty that can be attributed to typical common cause variations (like contractor resources not available when required, delays in decisions, or logistics issues),” says Kiran Kothekar, director, Vector Consulting Group, a management consulting firm and leading implementer of Critical Chain Project Management (CCPM) initiatives that has worked with clients like Tata’s and the Godrej Group.
“These risks are known before the start of the project. Then there is uncertainty attributed to special causes like a major strike or major scope change, earthquake and so on,” adds Mohanty.
Retail projects like shopping malls are also not without their share of pre- and post-construction risks. “One of the primary pre-construction risks in a retail project relates to potential delays in land acquisition which can escalate project costs,” says Raviraj Nair, project manager (retail), Swastik Group.
“Then there are other concerns like ensuring a clear title with all the mandatory clearances and compliance to development control norms like floor area ratio.”
According to Nair, market risks can be classified into two primary categories, namely demand risks and revenue risks. “While demand risks involve an educated assessment of the demand potential of a retail project, the revenue risks are dictated by the lease rates negotiated by the promoter and the tenant and the occupancy levels on completion.”
Other risk factors involve operational risks which can be defined as improper maintenance of facilities and services at a project, which if left unchecked could have an adverse impact on its revenue generation. “It’s an aspect that can be avoided by appointing a professional facility manager to ensure smooth running of the project at all times,” says Nair.
Risk mitigation and monitoring
Risk mitigation and the development of appropriate response actions is often the weakest part of the risk management process – the ongoing management and monitoring of identified risks, and the addition of new risks to the model, require constant vigilance.
“One needs to focus only on identifying and mitigating the special causes,” says Kothekar. “Trying to mitigate risks due to common causes is at best waste of time or worse it leads to more buffered task durations and subsequent wastages in execution. The common cause variations should be managed by effective management of project buffers.
However in most construction projects where people use traditional project management techniques, the buffers are inbuilt in the milestones.
“Removing the buffers from the milestone and using it to protect the project as a whole (as per CCPM methodology) helps manage the common cause risks. When risk assessment processes are focused on managing special causes, it is beneficial to the project.”
Outsourcing property management services to professional companies is another viable option that is finding increasing acceptance among domestic developers keen on minimising potential risk factors to ensure optimum revenues. A recent case in point is that of SmartCity (Kochi) Infrastructure Pvt Ltd that has roped in the US-based construction risk management major Hill International for its business park in Kerala.
As per the two-and-a-half year Rs37.3 crore contract, the American firm will provide project management services that include project administration, document control, budgeting, construction tendering, cost management and claims management, for the development of the 300 acre project that is being developed as a Special Economic Zone (SEZ).
Spotlight on insurance
Insurance companies, brokers, and risk managers serve as an extension of their client’s risk management functions.
Consultants come up with professional advice regarding property protection and business disruption exposures, resulting in efficient solutions that meet the client’s needs. Advice can include hazard identification and evaluation; as well as recommended improvement programs and risk management alternatives to reduce cost.
In the aftermath of the Mumbai terror attacks and the heightened risk perception of real estate and infra projects that followed, there has been a renewed focus among leading developers to boost their insurance cover.
“The attacks also brought to the fore our vulnerability,” admits a leading builder on conditions of anonymity. “We are now evaluating ways and means of safeguarding our assets and insurance cover is one of options that are actively under consideration.”
‘Insurance per se is still at a very nascent stage in India from a macro perspective,” feels Deshmukh. “With regard to insurance for the realty sector, the industry is still maturing iwn this direction. From a developer point of view, adequate insurance cover is just one of the available options for mitigating risks.”
While many developers point to a lack of comprehensive realty-focussed insurance offerings as one of the primary reasons for not insuring their assets, Anuj Gulati, director, ICICI Lombard General Insurance disagrees. He says: “We provide customised products wherein the services range from risk monitoring, sharing of industry experience with our customers, various risk mitigating measures and regular risk inspections. The objective is to provide an end-to-end solution under one roof and regularly improve the service level quality.”
Elaborating on the extent of his company’s exposure to real estate as part of its risk management portfolio, Gulati says, “We have leading construction companies as our key clients within this domain. However our company follows strict underwriting norms while undertaking the risk of companies in the construction and realty domains.”
Stressing on the importance of insurance as an ideal tool for real estate companies to mitigate risks in times of a liquidity crunch Gulati states there are several options that cater to the requirements of the infra space.
“For example, for the construction industry we have the Contractors All Risk Policy while players in the manufacturing segment can opt for the Erection All Risk Policy. These are standard products that can be further customised to suit a customer’s specific requirements.”
Other insurance majors like Tata AIG who offer risk management services have a team of experienced risk management/loss control specialists who undertake risk management activities for clients. This includes a survey of the client’s facility to identify possible loss causing events which could result in property damages and business interruption.
Reviewing probability and severity of the loss causing events also forms an important part of the risk assessment process wherein the risk engineer would advise the insured on loss control measures and the latest risk management tools being practiced globally. This would not only lead to better risk management, but also a possible reduction in premium for the insured.
The application of risk management procedures in construction can give early visibility to potential “problem areas” and opportunities, where effort and money can be expended early in the design and construction phases to reduce vulnerability, insurance costs, business or mission interruption, and claims.
“Most project management practices in construction sector are limited to making a Gantt chart of milestones which are then revised again and again to reflect the new reality,” says Kothekar. “The plans in many cases follow execution rather than the other way round. The problem is not so much about using specialised services but about using the right tool to manage the project.”
Early risk identification ensures that design and team effort is concentrated in critical areas, focusing the project team’s attention on actions and resources where there is a major risk exposure, or where the greatest time/cost savings can be made through reengineering and streamlined project management.