Sensitivity Analysis, Real Estate Analysts Use it to Evaluate Investment Property and So Can You!

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sensitivity.jpgSensitivity analysis involves changing one variable at a time over a possible range of outcomes to evaluate the effect of that change allowing real estate analysts to review each variable's impact upon the investment property's present value. Sensitivity analysis has become popular because easy-to-use investment analysis programs (template-based spreadsheet software for the computer) can calculate and recalculate a range of variables quickly and hence help the real estate analyst determine the best possible scenario for buying or selling investment property.

Here are three possible sensitivity analysis options you might want to consider the next time you are evaluating an investment property opportunity.

Price Sensitivity

A price sensitivity analysis changes a property's sale price in increments over a range of outcomes and allows you to evaluate how such things as cash requirement, loan amount and mortgage payment, cash flow before tax, cap rate, and cash on cash are impacted by that change.

For instance, suppose the asking price for the property is $500,000 and you are interested in knowing how much higher the cap rate would be if the price were reduced by $1,000, $5,000, or $10,000 dollars. Or, in the case of a seller, how much lower the cap rate would become if the price were increased by (in this example) the same amounts.

You would simply input an amount to "step" the variable (in this case the sale price) and the sensitivity analysis will display a range of prices (in increments to that step) along with the outcome for each one of those prices.

A simple preview of the analysis will tell you what you want to know, and more.

Down Payment Sensitivity

The down payment sensitivity is similar and equally easy.

Suppose you want to determine the cash on cash return based upon a range of down payment amounts. You would simply input an amount to "step" the down payment and can discover things like the cash requirement, annual mortgage payment, debt coverage ratio (DCR), cash flow before tax, and cash on cash return (depending on what software program you use for the analysis).

Again, the sensitivity analysis will show you a range of amounts for down payment along with cash on cash return and the other data for each amount.

Loan-to-Value Sensitivity

The loan to value sensitivity is a good way for you to evaluate the monthly loan payment based upon a range of loan amounts and interest rates. It is the same procedure but in this case, you want to step both, the loan and interest rate.

For instance, suppose you are trying to get the lowest possible monthly payment and would like to see a range of loan amounts within a range of interest rates. You simply input a dollar amount to step the loan and a percentage to step the interest rate, and Viola! Your report is created and you have several hundred variations to examine.

When you work with investment property (or intend to), or are investing in real estate, be sure to take advantage of sensitivity analysis. It has proven to be an excellent way to examine variables quickly, and not surprisingly has played a significant part in selling and buying decisions.

About the Author: James R Kobzeff

James R Kobzeff is a real estate broker and developer of ProAPOD Real Estate Investment Software - Rental property cash flow, rate of return, and profitability analysis.

Real Estate Investor Software - So those just starting to invest in real estate can determine whether the property makes money before invest.

Mortgage and Financial Calculator - Compute hundreds of mortgage, time value, and cash flow computations in seconds!

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