Sensitivity Analysis graph (du dil 7)So far we have been thinking about single factors or one-off events. But the property market is highly complex and there are numerous things that can affect the performance of the market as a whole, and individual properties in particular.
So you might want to do an analysis that considers two or more “What if?” questions at one and the same time. For example, we might want to know “what if interest rates go up at the same time as I struggle to find a tenant?”
This is where sensitivity analysis comes in as you can run one or more variables at one time.
Here’s a screen shot of simple excel spread sheet I put together that runs interest rates and voids.
You can see that by plugging in some simple formulae we can see what happens to our cash flow when interest rates and voids are at certain levels.
But of course we can also change the other input data to see what happens at different rent levels, if insurance payments go up or down, or if the costs of repairs go up or down and so on.
By using spreadsheets to calculate the result of changes in one or more variables we can get an overview of where potential problems lie. Using spreadsheets allows fairly complicated calculations such as the effect on the whole portfolio of changes in interest rates, void periods etc.
If you would like a free copy of this spreadsheet for your own use please email me at firstname.lastname@example.org.
So far we’ve looked at risk analysis in the context of buying properties to hold and let. It’s also useful to do ‘what ifs’ for other scenarios.
For example, if you are buying a property to renovate and sell, you can calculate the effect on profit of:
- increases in building costs i.e., what will happen if I overrun budget?
- increases in interest rates during the project period, which will impact on the notional or actual interest paid as holding costs and on the building costs
- an overrun of project i.e., if it takes longer to complete
or any combination of these.
Similarly, if you are buying to hold for capital growth and increase in equity, it may be interesting to calculate increases in equity using different growth rates for property values against changes in interest rates and so on and so forth.
Here’s to successful property investing.
Peter Jones B.Sc FRICS
Chartered Surveyor, Author & Property Investor