Using range of expenses in your profit / ROE estimates?

[J. Martin]

I know many members on BP use the 50% rule as a screening technique.. I was curious if anyone uses a range of estimates for expenses to estimate potential profit, rather than strictly 50% - either while they are prospecting, or after purchase..

For example, do you look at what your profit and ROE would be if your expenses sucked up 60% of your revenue? 40%? Decreased or increased rents? ("Stress testing") I think this is a more realistic way to assess the likely range of outcomes, rather than some "overly precise", but less informative calculations, where I see people estimating they will be earning $129.72/door this year, with a ROE of "approximately" 17.25834%..

I use a spreadsheet with 5 different columns and some have higher than expected expenses/vacancy, or reduce the rents by 10-15% to make sure I can handle less than ideal scenarios while still making a healthy return. For example, I may estimate an ROE of 8-12% (or whatever they might be) before principal paydown and appreciation, but after a plausible range of expenses. And I think my results will fall in that range a good majority of the time.. (approximately 82.7643% of the time.. just kidding!)

I used to only model my expected scenario and the downside risk. But I also do 1 or 2 to the upside now to estimate longer-term returns for some increased rents, which I also think is plausible. I learned years ago that if you only look at the negative, you may miss the boat on opportunities also.. If you don't price in your potential upside, you may lose out on lots of deals to others who are taking into account everything..

But this also gives you the ability to ask yourself, Am I comfortable with returns on the low side of that range if expenses are higher, or rents a bit lower, than I thought originally? Or if the market changes? Am I dependent upon increased rents to make healthy returns? Can I reasonably expect my returns to fall within that estimates the majority of the time? Thoughts? I think @Account Closed if he's got time for the forums..?

[Johnson H.]

@Bill Gulley - Ironic that you chimed in here as both J and I are bank examiners as well. =)