Price Sensitivity Analyses

 

Acquisition • Disposition

Price Sensitivity: Explained

Written by: Bryce Berta

Sales Executive for TheAnalyst PRO and Commercial Real Estate practitioner

Every broker and investor wishes they had a crystal ball that could show them exactly how every deal was going to go. Unfortunately for us mere mortals, prophecy is not quite feasible at the moment. However, the next best thing is easily attainable and it's called a Price Sensitivity Analysis.  Let's say you are looking at a cash flowing property like a small multifamily development. To understand how this investment will perform, there are three key areas that we need to look at. First, how much money are we going to pay for this asset? Second, how much is this investment going to pay us every month? Lastly, how much are we going to sell this property for? For the most part, the market tends to dictate rental rates. So, figuring out cash flows is fairly straightforward. We can look at the current rental market and find comparable properties upon which to base our assumptions. However, we still need to figure out what we can pay for this property. We probably know what the seller wants for it. It's usually in bold on the front page of their OM. But, how much can we negotiate and still get the return we are looking for? The same goes for the disposition. If the market goes haywire in a few years, are we still going to meet our investment targets?

sample created by Bryce Berta

  

Looking at this matrix, we can see that the asking price of $16,000,000 gives us a CAP rate of 8.52% based on our assumed cash flows. But what if we get into a bidding war and have to pay 5% or 10% above ask? Well, that would push CAP rates down to 8.11% and 7.74% respectively. Looking down the line, we can see that our IRR and Cash on Cash would be impacted fairly significantly. On the other hand, if we can negotiate the price down by 5% or 10%, the reverse would be true.  

sample created by Bryce Berta

   

What about when we go to sell this asset? What does the future hold? Well, we can set a range of possibilities and project what the impact of those possibilities would be. In this instance, I set our assumed disposition CAP rate to 8% and set the matrix to a half a percent and full percent both above and below. If I thought there was going to be more volatility, I could set this range to be as wide or as narrow as I want. 

Now, we can see what would happen if we sold this asset at each of these given CAP rates over the next five years. We can see the appreciation or depreciation of this property’s value. We can see what the actual sales price would be as well as our overall Internal Rate of Return. 

If you are a sophisticated investor and have a hard drive full of Excel models, this may be something you could do in an afternoon. But, for someone with a subscription to TheAnalyst PRO, this is a 20 minute task. No finance degree required.