Sensitivity Analysis on Income Producing Real Estate

An introduction on real life assessment of the viability of real estate investments from the point of view of a lender.

Download the sensitivity analysis spreadsheet

Click here to download the spreadsheet

As you have read from past articles and the responses that I have given visitors in the forum, real estate investing is not that difficult to figure out. It is all about determining if the cash flow from operations { called the Net Operating Income or NOI } is enough to service the debt and provide enough money leftover to give you as the investor an adequate return.

Of course, the lenders care mostly about making sure that our loan can be repaid. I have always been surprised at the amount of people that think that the banker only cares about the value of the property being pledged as collateral. Trust me when I say that this is not the best kind of lender to have! A collateral lender is actually betting against you, in his mind the repayment of the loan will come from the sale of the collateral not from the cash that is being generated.

I would also like to repeat that I do not hold those “no money down!” gurus in high regard. While an argument can be made that it is possible to do these types of transactions, the great majority of people that get taken in and buy those courses will never make a penny.

Now that the adequate amount of rambling has been performed, let me get to describing what a sensitivity analysis is. In plain English a sensitivity analysis in the context of a real estate investment loan is a projection of what will happen to the cash flow produced by a property once changes in the occupancy rate and the interest rate being charged by the lender change. It helps answer the questions of:

Will there be enough money to pay the loan if the property losses tenants?

How many tenants does it have to loose before the debt service coverage is no longer enough to provide comfort to the lender?

What is the breakeven point before the property becomes a loosing proposition and the lender has to look at the owner to make up a shortage?

You can take a look at a simple sensitivity analysis by downloading the attached spreadsheet. This one in particular only has vacancy rate as a variable. This is because most loans have a fixed rate so there is no sense in accounting for that. It is possible to do a sensitivity analysis including changes in interest rate, but those are more common on business lines of credit where the rate is usually a floating rate that moves in tandem with a base market rate.

The little spreadsheet is very flexible. It has space for two loans in case that the property has both a first and second mortgage. Changing the occupancy rates in the projections allows you to play around with “what if?” cases and by trial and error you can get breakeven.

The following are some similar terms that are used to define comparable types of analysis. Essentially, what will happen to profitability or more importantly repayment if a variable or a couple of variables change:

Similar Terms:

“Stress Test”

“Proforma cash flow”

“Pro forma”

“Projections”

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