Ch 15: Forecasting and Analyzing

Risks in Property Investments

Applying Quantitative and Qualitative Forecasting

Methods,Together With Risk Analysis, to Evaluate
Real Estate Investments.

1
Click to begin presentation .
 Property Investments:
Long Term Risky Assets
Property investment analysis requires the full
application of all capital budgeting techniques:

Forecasting: quantitative (i.e statistical) from Ch 3

qualitatative ( i.e judgmental) from Ch 4.
Risk Analysis: RADR and CE from Ch7.
Risk Analysis: Sensitivity and Break-
even Analysis from Ch 8. 2
 Property Investments:
Long Term Risky Assets
More Risk Analysis Techniques:

Simulation from Ch 9.
Scenario Analysis from Ch 10.

3
 Cash Flow Forecasting For An
Income Producing Property
Forecasting Rent:
(a) rent under the lease- this is detailed in
the lease covenants
(b) market rent – rent may be adjusted
under the lease covenants, and on
lease expiry. Market rent forecasts
combine both qualitative and
quantitative techniques.
4
 Cash Flow Forecasting For An
Income Producing Property
Forecasting Operating Expenses :
sometimes current expenses are grown forward
using a common inflation index, such as the
Consumer Price Index.
Forecasting Vacancy Rates:
a common method is to forecast these rates as
an annual average percentage of the lease
rental. 5
 Cash Flow Forecasting For An
Income Producing Property
Forecasting The Resale Proceeds:
The “resale proceeds” is equivalent to a salvage or
terminal value in general industrial projects. Its
value is critically important to the project’s initial
accept or reject decision.
Usually the forecast value is the discounted value of
future net rentals beyond that point, using the
investor's required rate of return for the investment
life span of the property.
6
 Rental Property Investment:
A Forecasting Example
Typical historical data set, for quantitative forecasting.
Gross New
Rents per % change building
Square Time Trend on previous Difference Estimated (square
Years Metre pa in Rents year from Trend % vacant metres)
-10 $37.00 $37.14 -$0.14 4% 27,000
-9 $41.00 $38.67 10.8% $2.33 6% 13,000
-8 $44.00 $40.21 7.3% $3.79 9% 47,000
-7 $42.00 $41.75 -4.5% $0.25 14% 58,000
-6 $41.00 $43.28 -2.4% -$2.28 18% 21,000
-5 $42.00 $44.82 2.4% -$2.82 15% 8,000
-4 $44.00 $46.35 4.8% -$2.35 14% 15,000
-3 $44.00 $47.89 0.0% -$3.89 6% 6,000
-2 $47.00 $49.43 6.8% -$2.43 3% 18,000
-1 $53.00 $50.96 12.8% $2.04 4% 24,000
7
0 $58.00 $52.50 9.4% $5.50 7% 29,000
 Rental Property Investment:
A Forecasting Example
Historical data with a prediction trend.
Trend Line of Rents Within Actual
Historical Data
T y p ic a l g ro s s re n ts

$60.00

$50.00 Gross
Rents
per
$40.00 Square
Metre
pa
$30.00 Time
-1 0
-9
-8
-7

-4
-3
-2
-6
-5

-1
0
Trend in
Years Rents
8
 Rental Property Investment:
A Risk Analysis Example
Typical Sensitivity Analysis: Rental Growth, Vacancy.

Sensitivity Table - changes in net present value arising from different rental growth rates and
different vacancy rates: rental growth is across the top row; vacancy pa is down the left column.
$148,835.48 0.00% 3.00% 5.00% 7.00% 10.00%
2.00% ($343,525.25) $3,189.95 $255,709.17 $526,463.76 $969,015.48
4.00% ($402,545.11) ($62,905.72) $184,460.05 $449,689.03 $883,209.09
5.00% ($432,055.03) ($95,953.56) $148,835.48 $411,301.66 $840,305.89
7.00% ($491,074.88) ($162,049.23) $77,586.36 $334,526.93 $754,499.49
8.00% ($520,584.81) ($195,097.07) $41,961.79 $296,139.57 $711,596.299
 Rental Property Investment:
A Risk Analysis Example
Typical Monte Carlo Analysis: Various Data.
Monte Carlo Analaysis
Typical Data Items to be Tested.
Investment:Constructing an Income Producing Building

Variable Probability Distribution Values

Min $110,000
Net Rent Triangular Av $130,000
Max$140,000

Letting Period Uniform Min 1 month

Max 6 months

Min 9.00%
Capitalization Rate Triangular Av 9.5%
Max 10.5%

Buliding Costs Normal Mean $600,000 10

Std Dev $50,000
 Rental Property Investment:
A Risk Analysis Example
Typical Monte Carlo Analysis: Several Data, 500 Iterations.
Possible net present values
25%

20%

15%
Probability

10%

5%

0%

11
 Property Investments: Summary
Property investment analysis requires the full
suite of capital budgeting techniques.
Forecasting is required to establish periodic net
rental income, and a final resale value.
Risk analysis is required to test the full range
of prediction variables :
Mature managerial judgment is required to
make the right decision based on the analytical
outcomes. 12