Sensitivity Testing properties

3 Replies

Big companies use sensitivity testing on ROA's(return on assests).   They run the numbers at the projected output to see if it is a good investment, then they run them at 90% and 80% to see if it still cashflows.  Is there a way we could  get this option in the calculator program, any thoughts BP?

Originally posted by @Jack Frost :

Big companies use sensitivity testing on ROA's(return on assests).   They run the numbers at the projected output to see if it is a good investment, then they run them at 90% and 80% to see if it still cashflows.  Is there a way we could  get this option in the calculator program, any thoughts BP?

There are numerous calculators you can get out there.  Anything decent will allow you to adjust your vacancy assumtption, and you can just keep increasing until you hit break even and see what that vacancy level is.

Not sure if this is the best place to post this but you could put a larger amount in the vacancy field to see if it still cashflows.

A common mathematical model that companies use for a problem like this is known as a Monte Carlo Simulation. Essentially it takes a distribution of a bunch of variables, randomly selects a value from each distribution, runs some sort of equation or algorithm using these random values, captures the result of the iteration, and then repeats this process many thousand times (5-10k times is typical). The final result is that you'll get a normal distribution of results for your model that sufficiently takes into account the possibilities of all the variables that feed into it and how they relate to each other.

So in this case, you could provide a random distribution of all of the operating expenses, debt service, appreciation/depreciation rates, etc. and see how it affects the cash flow of the property. You're essentially simulating buying the property 10,000 times with different conditions each time. You could then definitively look at the distribution of results and say, "x% of trials resulted in positive cash flow." Something like this could prove to be very useful in modeling a multi-family since it has a lot more variables than a SFH would, but it could prove useful for either.

So your next question might be, "That sounds great, but how do I make a MCS?" While a lot of companies will probably rely on a data scientist or programmer to work on a complex version of a MCS, you can find some free (or at least not super expensive) programs or Excel add-ons that will be much more user-friendly.  I have more experience with the former than the latter, but I might be able to help you get started.