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00) highlighted the need for more rigorous
risk assessment measures within the property profession. More specifically they
concluded that a new approach is needed which combines conventional analysis of
returns uncertainty with a more comprehensive survey of business risks.
This debate has been brought into shaper focus by the publication of the Carsberg
Report (2002), which emphasised the need for more acceptable methods of expressing
uncertainty, particularly when pricing in thin markets where information is deficient.
To this end recommendation 15 of the report exhorts that professional bodies
representing both valuers and end users should agree an acceptable methodology for
reporting uncertainty within the valuation, which can be readily communicated to
third parties. It is stressed that the methodology adopted must enhance the
decision-making process and not confuse end users. Interestingly the term risk does
not appear in recommendation 15 however an understanding of the difference between
risk and uncertainty is central to rigorous investment decision-making (Knight, 1921;
Hargitay and Yu, 1993; Byrne, 1996).
The aim of this paper is to present an alternative paradigm for the reporting of risk
based on techniques utilised within business applications. In particular it applies a
standard credit rating technique, based on the D&B, formerly Dunn and Bradstreet,
model to the determination of risk within property pricing – property risk scoring
(PRS).
The paper commences with an examination of risk analysis within investment
decision-making and the property industry drawing on the findings of the most recent
literature which assesses the utilisation of risk management approaches. Financial risk
management is outlined as applied through the D&B credit rating model and a similar
technique is applied to real estate through the development of a property risk score.
The paper explains the decision-making framework within which the property risk
score is applied and examples are advanced across each of the principal commercial
sectors.
2. Risk and uncertainty in property pricing
Investment decision-making is concerned with choosing optimal levels of both return
and risk; the risk return trade off. Consequently the principal source of uncertainty is
time as the forecasting of future events is difficult and becomes more unreliable as time
elapses. Uncertainty arises therefore from a lack of knowledge and information and on
this premise Hargitay and Yu (1993) construct a spectrum of uncertainty. The
spectrum ranges from certainty (full knowledge) at one end to total uncertainty (lack of
knowledge) at the other. In between there are two further points namely, risk and
partial uncertainty. Risk is defined as a situation where alternative outcomes and their
probabilities are known whereas in the case of partial uncertainty some of the
alternative outcomes are known but not their probabilities.
Risk and uncertainty are inherent parts of the valuation process. Property pricing as
a form of investment decision-making seeks to ascertain the present value of future
income and expenditure flows. In this context risk can be defined as the probability
that a target rate of return will not be realised. In other words, it assumes that all
outcomes together with their probabilities of occurrence are known. While the term