The U.S. government plans to lend an addition $800 Billion to help ease the current economic crisis. According to Edmund Andrews of the New York Times, the government has already pledged close to $7.8 trillion dollars in financial obligations this past year alone. The additional $600 billion allocated to purchases of debt for Fannie and Freddie seems like a mere pittance. Several analysts feel that this will help increase liquidity, as the 30-year fixed-rate mortgages fell almost an entire point.
THE GOVERNMENT HAS ACCESS TO DATA NO ONE ELSE HAS
I have faith in that they will make the best decisions with the tools available to them, but understand that there is a great deal of uncertainty involved. Even the most powerful nation on earth can not effectively manipulate market forces with a high degree of certainty. Some investors will greet this news with optimism while skeptics will point to further fundamental weakness in our economy. Whichever side of the fence you are on, you must explicitly take into consideration changes in policy, uncertainty, and risk in making informed investment decisions
Though it is impossible to forecast financial events with absolute certainty, it is important to realize that it is the anticipation of certain events and the expectation of various rates of return that will determine the present value of investments and income producing property. As expectations change, so does the investment value.
Investors often use probabilistic and non-deterministic methods of analysis, depending on the situation and data available. One approach could include developing an expected cash flow and a standard deviation measure for each year, establishing probabilities of error, and investigating perfectly correlated, partially correlated, and uncorrelated cash flows.
Sensitivity analysis investigating how influential certain forecasts (rent, expenses, taxation etc) affect present value is often quite useful and easier to compute. Establishing different investment values under optimistic, probable, and pessimistic scenarios is quite effective as well. On the other scale of difficulty, if you have sufficient data, you could run Monte Carlo simulations which could help quantify risk in quantitative terms.
I would love to hear from our readers whether they incorporate changes in risk in their decision models and what approach they use. Though it’s easy to become overwhelmed with all the economic data and volatility in the market, there are plenty of analytical tools from the financial world that could greatly help Real Estate investors understand their investments.
Photo Credit: Mike Licht, NotionsCapital.com