Scenario Planning and Real Estate Decision Making
What is Scenario Planning
Scenario planning is a collaborative, strategic-thinking process used to make long-term flexible plans. The primary objective of scenario planning is to connect perceptions about the future to the need for making current decisions. A key tenant of scenario planning is that all of our knowledge is about the past, and all of our decisions are about the future. Scenarios acknowledge that we cannot know the future and seeks instead to combine facts about what we know with known and unknown driving influences of your company’s future.
Scenario planning outcomes are not predictive forecasts. Instead they are a collection of projected futures, and are intended to establish the boundaries of our uncertainty and the limits to plausible futures. Scenario planning recognizes that many factors may combine in complex ways to create somtimes surprising futures.
The chief value of scenario planning is that it allows decision makers to make and learn from mistakes without risking catastrophic failures in real life, because the operating strategy that eminates from the scenario planning process is resilient. Resiliency is established through an understanding of where contingency planning needs to be built-in to the operating strategy. Its an opportunity to rehearse the future, and perhaps avoid, or be better prepared for, the Black Swan.
How Scenario Planning is Done in Business
Scenario planning for business has been adapted from the military’s methods used in simulation games. These games combine known facts about the future with plausible alternative social, technical, economic, environmental, educational, political, and aesthetic (STEEEPA) trends. These known facts and trends would then be overlayed by known and unknown uncertainties. The goal is to blend the facts, trends and uncertainties into a limited number of consistent views of the future that span a wide range of possibilities.
Typically, an outside consultant will guide a group of in-house managers through the following steps:
Determine the company’s operational strengths and weaknesses
Determine the company’s key drivers of future change
Organize those drivers into a viable framework
Draft 8-10 mini scenarios of what the future holds
Reduce those scenarios to 2-3
Expand those 2-3 scenarios with more detail
Identify the important issues that come out of developing those scenarios
Limitations of Scenario Planning
Scenario planning is not about predicting the future, but rather about giving serious consideration to multiple futures as possible realities. It also is a flexible vision of the future that allows learning and adjustments, as the future unfolds. Once scenario planning is done the real work of developing flexible strategies and appropriate monitoring systems begins. In this context, scenario planning is one piece of an overall management system. It is a living and breathing tool that helps guide a manager’s understanding of the daily course of events and what it means to his stated objectives.
How Does Scenario Planning Apply to Real Estate Decisions
Scenario planning can have the same benefits for a real estate company as any other, since real estate firms face the same risk management issues. Furthermore, a modified and simplified version of scenario planning can be applied to individual assets. Many individual assets have a value creation timeline that can span significant market corrections. Developers of mid to high-rise buildings will commit capital to a project well in advance of monetizing its value. The interim between groundbreaking and sellout can have enormous influences on asset value, the developer’s ability to repay construction debt, and the amount of return the developer realizes on its equity. An investor’s purchase of an occupied and stabilized office building will depend on future market lease rates, operating expense increases, the availability and cost of long-term acquisition debt, and the trend of future capitalization rates for his ultimate return on investment. The number of identifiable drivers of these factors influencing real estate value is significant. The various ways these drivers can interact and produce different outcomes is large. Trying to predict which scenario will be the actual future is not worthwhile, but the act of entertaining multiple ways of how your key drivers might play themselves out is an invaluable real estate risk management tool.
