Share: Share on Facebook Share on Twitter Share on LinkedIn I recommend visiting cushmanwakefield.com to read:%0A%0A {0} %0A%0A {1}

Is risk aversion more damaging than demand shock?

Richard Pickering • 29/07/2020

In March this year, internet searches that included the word ‘risk’ spiked to their highest in recorded history; almost double the prevailing intensity for the previous 10 years. Objectively, levels of economic, business, health and social risk have all undoubtedly increased since the COVID-19 outbreak. However, risk means different things to different people.

What does ‘risk’ actually mean? And do we have more to fear from these new risks themselves, or instead from the way that we choose to respond to them? 

The Oxford Dictionary defines risk as ‘the possibility of something bad happening at some time in the future’. I suspect that most people would agree. But let’s unpack this. There are three elements:

(1) ‘possibility’ i.e. uncertainty,

(2) ‘something bad’ i.e. an adverse outcome, and

(3) ‘in the future’ i.e. not something immediate. 

Uncertainty is at the centre of most assessments of risk. We don’t know the outcome, because we don’t have sufficient knowledge. Partly that is because anything ‘in the future’ has some degree of uncertainty. If we were certain that something bad was going to happen, then there would be no risk and we could create a clear plan or price. It is therefore lack of knowledge that underpins risk.  

‘Something bad’ is more debatable. When most people think about risk, they are really thinking about the risk of loss. However, when investors consider risk, they typically mean something different. Risk to investors is essentially not knowing the outcome; the final result could be better or worse than expected, but either is a risk. For this reason, the degree of potential variance from a supposed outcome is the way that the risk of say a real estate investment is typically measured and expressed in its yield.  

Investors address risk by holding diversified portfolios. When these are sufficiently large, the asset specific risks are removed as part of a pooled return. However, most people don’t appraise risk this way. On a personal level, you or I will:

(a) care much more about loss than variance,

(b) not appraise uncertainty in any scientific or mathematical way, and

(c) make judgements based on experience or heuristics.

The problem with this approach is that humans are flawed. The overlay of behavioural economics (the psychology of economic decision making) eats theoretical principles for breakfast. Relevant to this discussion, we are neurologically risk averse. By that I mean that most of us are hardwired to overexpress downside risks and to adopt overly cautious approaches as a response. This distorts the best collective outcome. It is precisely this irrationality that we may need to fear more than the risks themselves in the period ahead of us. 

How does risk aversion create damage? 

There are sometimes very good reasons to be risk averse. This may for instance stem from a need to be certain. If you have fixed liabilities to discharge, with penal outcomes from not being able to do so, then you may be willing to sacrifice some benefit to avoid this risk. This might for instance be the risk of not being able to pay your mortgage for risk of losing your home – so you take a lower paid job with predictable income. It might mean not being able to retire unless your pension pot is sufficient – in which case you shift towards lower yielding cash investments in the period leading to retirement.  

It may also be because the damage arising from the risk is so severe, that any degree of risk is not tolerated. For instance, you may not be willing to go on public transport for fear of catching a deadly virus. Is this rational? Much depends on the circumstances. 

Firstly, one needs to consider the probability of the risk arising. At the time of writing there are ~750 daily reported new cases of COVID-19 in the UK. Grossing this up for asymptomatic / non reported cases, let’s say that the real figure is 3,750 cases. The mathematical chance of you contracting the virus today in a population of ~66m is therefore about 0.01%. Very low. If you’re not working in health care, or a resident of a care home this risk falls further.  

Meanwhile, the ratio of deaths to confirmed cases in the UK is ~15%. Pretty high. Hence there is a very low risk of catching something with potentially very severe consequences. In response to this most of us in the UK are taking a very risk averse approach. However, particularly those under 30 (for whom the mortality risk is very much diminished) are likely to be acting mathematically irrationally by staying indoors, not using public transport, or not going back into the office. 

This is the extreme, but risk aversion is also taking other forms. For example, at the start of the outbreak, people were very concerned about not having enough toilet roll. The spike in demand meant that toilet roll traded online at multiples of normal prices. The risk of not being able to secure it was misplaced, and the consequences of not being able to do so (whilst unpleasant!) were not life threatening. On the other side of this equation, hotel room bookings have fallen through the floor; perhaps due to health concerns. This again feels irrational based on the incidence levels, leading to good deals for customers and losses for operators. 

All of these things have real consequences both in the short and long term. In the short term, pricing is distorted. In the longer term, risk aversion is likely to lead to economic damage, and potentially societal change. We know that when the economy performs less well, consumer and financial risk aversion increases. To the extent that risk aversion is overexpressed, it will supress growth and ironically create greater risk of loss. We also know that the most significant economic impact of previous pandemics has stemmed not from mortality or from inherent output issues, but from risk aversion. When people don’t go to work, don’t go shopping, and sit on their cash the whole economy suffers.  

It’s not just consumers. Corporate risk aversion also increases in economic depressions. Businesses should be more rational about risk; however, this often falls down for two reasons. For businesses the comparable to death is business failure. Once in administration there are no second chances or the opportunity of better returns next year. A second reason is that businesses are run by people with the same human failings. No one wants to be labelled as the Chief Exec of a failed business, and shareholders won’t be that interested in an ex-post justification of the risks that were taken. For this reason, businesses will often overexpress the downside risk, and take actions to prevent it; worrying less about the foregone profit that results from these actions.  

How might this impact on the real estate industry?

The real estate industry is pro-cyclical and suffers when the economy suffers. Risk aversion is not in our interests in a generalised sense. There are also specific risks. The longer that people might perhaps irrationally choose not to use offices and retail units to work and shop, the greater the risk that these behaviours become hardwired with longer term consequences. But this perhaps oversimplifies things. As with all periods of elevated risk, smart people and businesses succeed.  

Entrepreneurs (who can defray risk onto others) and businesses that are capable of taking a longer view or rationalising short term risk will find mispricing opportunities. There are a number of sectors that have suddenly increased in relative attractiveness from a structural perspective. However, there will be a greater number of buyers chasing fewer of these opportunities. The question remains to what extent buyers will overpay based on an irrational degree of risk aversion. At the other end, some assets subject to negative trends might suddenly look well priced, particularly where sellers have few options. 

Another (awful) way of avoiding risk is to do nothing. Many conflate the act of doing nothing with taking no risk. They are not the same. Choosing to do nothing is an implicit affirmation of the status quo, which can carry significant risk. This includes keeping your current portfolio mix, holding back on repositioning plays and pulling out of transactions. As value drivers shift quickly in many directions, it feels difficult to arrive at the conclusion that the future will resemble the past. As Mark Zuckerberg once said, ‘The biggest risk is not taking any risk. In a world that is changing really quickly, the only strategy that is guaranteed to fail is not taking risks.’ 

There will be opportunities to do things differently arising from this period of change. The biggest winners as ever will be the ones who are willing to take a different path and look through the short-term risks. 

INSIGHTS

elderly woman
Article • Multifamily

How Long Does It Take To Fill An Elderly Care Home?

Our analysis shows that elderly care homes fill up at an average rate of 3.0% of capacity per month over the first 24 months of operation.
Patrick Collins • 28/03/2023
europe-banking-system-web-card
Insights • Office

European Banking System: Not a Simple Game of Dominos

Given the recent volatility in the Banking sector following the collapse of a few U.S. mid-sized to small banks causing concerns over the potential for a financial crisis, Cushman & Wakefield Research provides its analysis on what this means for Europe and the commercial real estate sector. 
Sukhdeep Dhillon • 28/03/2023
obsolescence-emea-webcard
Insights • Office

European Obsolescence Equals Opportunity

Repositioning: The Evolution of European Offices 
Emma Swinnerton • 14/03/2023
Residential market commentary
Article • Residential

Residential Market Commentary

Housing market activity in the UK has slowed, as rising interest rates, high inflation, and a weaker economy impact buyers’ confidence.
Millie Todd • 13/03/2023
emea-macro-outlook-mobile
Research • Economy

European Macro Outlook: What’s in a number?

Two consecutive quarters of negative growth is the technical definition of a recession. There has been a great deal of debate on whether the economies of the euro area and the UK are in a recession. If growth remains flat or is revised down for the final quarter of 2022, the underlying truth is that growth for the euro area and the UK has been subdued. Although the near-term outlook looks brighter than many expected six months prior, some downside risks remain. We continue to expect a mild recession in the UK and the euro area. In this report, we break down our baseline economic forecast and the implications it will have on CRE property sectors over the next couple of years.   
Sukhdeep Dhillon • 03/03/2023
Unlocking First Generation Beds For Generation Z Students & Investors
Article • Multifamily

Unlocking First Generation Beds For Generation Z Students & Investors

Sharing two bathrooms with six or more people in a block whose main point of interest is the laundry, with rent at less than £100 a week, is a memory of student life for millions. The often underappreciated stock of Purpose Built Student Accommodation (PBSA) has historically not been the centre of attention for investors; however, we believe that this is about to change. First Generation beds make up a third of all beds in the UK.
Olan Coyle • 27/02/2023
Life Sciences Golden Triangle Report
Insights • Lab

Life Sciences: Golden Triangle Report

Get insights on investment volumes, leasing take up, lab supply and pipeline, and investment into life sciences real estate across Cambridge, London, and Oxford.
Jamie Renison • 01/02/2023
property retrofit
Insights • Residential

The importance of retrofitting a residential property and how to do it

Retrofitting is the process of making alterations to an existing property to improve its energy efficiency and reduce energy consumption. Retrofitting our homes will be vital if we are to meet current net-zero targets.
Millie Todd • 27/07/2022
Southwark station empty escalator
Insights • Economy

UK Real Estate Market View

A regular update on the commercial real estate market in the UK.
31/05/2022
Industrial Landing Image
Insights • Logistics

COVID-19 Impacts on Manufacturing & Supply Chain

An update on the impacts of COVID-19 pandemic on manufacturing and supply chains.
Rob Hall • 18/08/2021
workers in coworking space blurred man walking past seated women
Research • Coworking

Coworking Trends

We outline the difference between the offers, along with market leading research on coworking trends across the world.
17/11/2020
Data Center Update Web Card
Research • Data Center

Data Centre European Secondary Markets Report

Data centre development across Europe has long centred around what were first known as the FLAP markets, major global cities each with deep business and financial sectors. As these markets continue to thrive, a host of newer locations have joined the data centre landscape.
Andrew Fray • 12/08/2020

Latest articles in this series

europe-banking-system-web-card
Insights • Office

European Banking System: Not a Simple Game of Dominos

Given the recent volatility in the Banking sector following the collapse of a few U.S. mid-sized to small banks causing concerns over the potential for a financial crisis, Cushman & Wakefield Research provides its analysis on what this means for Europe and the commercial real estate sector. 
Sukhdeep Dhillon • 28/03/2023
obsolescence-emea-webcard
Insights • Office

European Obsolescence Equals Opportunity

Repositioning: The Evolution of European Offices 
Emma Swinnerton • 14/03/2023
emea-macro-outlook-mobile
Research • Economy

European Macro Outlook: What’s in a number?

Two consecutive quarters of negative growth is the technical definition of a recession. There has been a great deal of debate on whether the economies of the euro area and the UK are in a recession. If growth remains flat or is revised down for the final quarter of 2022, the underlying truth is that growth for the euro area and the UK has been subdued. Although the near-term outlook looks brighter than many expected six months prior, some downside risks remain. We continue to expect a mild recession in the UK and the euro area. In this report, we break down our baseline economic forecast and the implications it will have on CRE property sectors over the next couple of years.   
Sukhdeep Dhillon • 03/03/2023
pillows on hotel double bed
Research • Hospitality

Hospitality Market Trends & Data

The latest hospitality market insights are based on the in-depth analysis of our extensive data sets, surveys of investors, operators and lenders and up-to-date market intelligence from our team members on-the-ground in all major European markets.

Bořivoj Vokřínek • 13/02/2023
Life Sciences Golden Triangle Report
Insights • Lab

Life Sciences: Golden Triangle Report

Get insights on investment volumes, leasing take up, lab supply and pipeline, and investment into life sciences real estate across Cambridge, London, and Oxford.
Jamie Renison • 01/02/2023
tech mesh graphic black background
Insights • Economy

Futures Cut - Future of Cities

Sign up for a personal view of the evolving role of real estate in a world of technological, social and business change, by Richard Pickering, Head of Innovation, EMEA.
Richard Pickering • 03/11/2022
Southwark station empty escalator
Insights • Economy

UK Real Estate Market View

A regular update on the commercial real estate market in the UK.
31/05/2022
Industrial Landing Image
Insights • Logistics

COVID-19 Impacts on Manufacturing & Supply Chain

An update on the impacts of COVID-19 pandemic on manufacturing and supply chains.
Rob Hall • 18/08/2021
workers in coworking space blurred man walking past seated women
Research • Coworking

Coworking Trends

We outline the difference between the offers, along with market leading research on coworking trends across the world.
17/11/2020
Ship with shipping containers
Insights • Retail

Retail & Supply Chain

2021 will continue to see growth in e-commerce and logistics demand and new retail supply chain models will be required to capitalise on the structural shifts in the sector.
Paul Durkin • 04/11/2020
George Roberts Cushman & Wakefield
Insights • Commentary

How 2021 Might Reshape The Real Estate Industry

We will look back at 2020 as the year in which COVID-19 accelerated forces of change. These forces will shape the industry for many years to come and for those that are able to interpret and take advantage of them, the opportunities are enormous. 
George Roberts • 04/11/2020
Data Center Update Web Card
Research • Data Center

Data Centre European Secondary Markets Report

Data centre development across Europe has long centred around what were first known as the FLAP markets, major global cities each with deep business and financial sectors. As these markets continue to thrive, a host of newer locations have joined the data centre landscape.
Andrew Fray • 12/08/2020

CAN'T FIND WHAT YOU'RE LOOKING FOR?

Get in touch with one of our professionals.
With your permission we and our partners would like to use cookies in order to access and record information and process personal data, such as unique identifiers and standard information sent by a device to ensure our website performs as expected, to develop and improve our products, and for advertising and insight purposes.

Alternatively click on More Options and select your preferences before providing or refusing consent. Some processing of your personal data may not require your consent, but you have a right to object to such processing.

You can change your preferences at any time by returning to this site or clicking on Cookies.
MORE OPTIONS
Agree and Close
These cookies ensure that our website performs as expected,for example website traffic load is balanced across our servers to prevent our website from crashing during particularly high usage.
These cookies allow our website to remember choices you make (such as your user name, language or the region you are in) and provide enhanced features. These cookies do not gather any information about you that could be used for advertising or remember where you have been on the internet.
These cookies allow us to work with our marketing partners to understand which ads or links you have clicked on before arriving on our website or to help us make our advertising more relevant to you.
Agree All
Reject All
SAVE SETTINGS