Sensitivity Analysis a Tool for Real Estate Agents

Sensitivity Analysis plays an important part in the selling and buying decisions of multifamily or apartment transactions.  What is sensitivity analysis?  It is an analysis that involves changing one value to see how “sensitive” the results of an investment are affected by that change.  What would happen if rents in your market increase by 10% or the operating expenses increased by 5%?

The most important approach to using a sensitivity analysis is OFAT, changing one-factor-at-a-time.  To be effective, you can only change one value at a time and analyze the results.  Then reset that value and change another value to see the effects.  That is the standard premise.  However in evaluating an apartment, if you increase rent the vacancy rate might also increase.  Increasing or decrease both the rent and vacancy rate might be logical.  But I would suggest doing each separately noting the individual results, then running both at the same time and comparing the results.

Real estate agents who work with investment properties should take advantage of the possibilities that sensitivity analysis will afford.  Varying rents, vacancy rate, operating expenses, cap rates and the cost of sale for an apartment would be measures that your investor would want to see.  Would it be helpful to show your investor the effects of changes in these values to the net operating income, cash flow before taxes, cash flow stream, the property’s value and the cost of sale?  Providing your investor with measurements based on “what-if” scenarios can be powerful.

Yes, a sensitivity analysis can be a powerful tool for a real estate agent, but there are drawbacks.  An analysis can have some pitfalls.  The first pitfall involves running an analysis on a value that is not important to your investor.  As an agent you should know what is important or helpful to your client.  The second pitfall is running an analysis just to manipulate the internal rate of return.  And the third pitfall is not valuing the impact of a sensitivity analysis and failing to perform one.

Sensitivity analysis, a tool that real estate agents should employ, a tool to be understood and a tool that can help in the selling and buying of multifamily or apartment transactions.