Forecasting and Analyzing Risks in Property Investments doc

Ch 15: Forecasting and Analyzing Risks in Property Investments Applying Quantitative and Qualitative Forecasting Methods,Together With Risk Analysis, to Evaluate Real Estate Investment

Ch 15: Forecasting and Analyzing Risks in Property Investments

Applying Quantitative and Qualitative

Forecasting Methods,Together With Risk

Analysis, to Evaluate Real Estate Investments

.

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

Property Investments:

Long Term Risky Assets

More Risk Analysis Techniques:

Simulation from Ch 9.

Scenario Analysis from Ch 10.

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.

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.

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.

Rental Property Investment:

A Forecasting Example Typical historical data set, for quantitative forecasting.

Years

Gross Rents per Square Metre pa

Time Trend

in Rents

% change

on previous year

Difference from Trend

Estimated

% vacant

New building (square 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

Historical data with a prediction trend

Rental Property Investment:

A Forecasting Example

Trend Line of Rents Within Actual

Historical Data

$30.00

$40.00

$50.00

$60.00

0 -9 -8 -7 -6 -5 -4 -3 -2 -1 0

Gross Rents per Square Metre pa Time

Rental Property Investment:

A Risk Analysis Example

Typical Sensitivity Analysis: Rental Growth, Vacancy.

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 $711,596.29 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.

Rental Property Investment:

A Risk Analysis Example

Typical Monte Carlo Analysis: Various Data.

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%

Typical Data Items to be Tested.

Investment:Constructing an Income Producing Building

Monte Carlo Analaysis

Rental Property Investment:

A Risk Analysis Example

Possible net present values

0%

5%

10%

15%

20%

25%

Typical Monte Carlo Analysis: Several Data, 500 Iterations.

Property Investments: Summary

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 :

Property investment analysis requires the full suite of capital budgeting techniques.

Mature managerial judgment is required to make the right decision based on the