1 Ch 15: Forecasting and Analyzing Risks in Property Investments Applying Quantitative and Qualitative Forecasting Methods,Together With Risk Analysis, to Evaluate Real Estate Investments. Click to begin presentation. 2 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. 3 Property Investments: Long Term Risky Assets More Risk Analysis Techniques: Simulation from Ch 9. Scenario Analysis from Ch 10. 4 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. 5 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. 6 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. 7 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 0 $58.00 $52.50 9.4% $5.50 7% 29,000 8 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 -1 0 -9 -8 -7 -6 -5 -4 -3 -2 -1 0 Years T y p ic a l g ro s s re n ts Gross Rents per Square Metre pa Time Trend in Rents 9 Rental Property Investment: A Risk Analysis Example Typical Sensitivity Analysis: Rental Growth, Vacancy. $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 $711,596.29 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. 10 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% Buliding Costs Normal Mean $600,000 Std Dev $50,000 Typical Data Items to be Tested. Investment:Constructing an Income Producing Building Monte Carlo Analaysis [...]...Rental Property Investment: A Risk Analysis Example Typical Monte Carlo Analysis: Several Data, 500 Iterations Possible net present values 25% Probability 20% 15% 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 . 1 Ch 15: Forecasting and Analyzing Risks in Property Investments Applying Quantitative and Qualitative Forecasting Methods,Together With. Analysis, to Evaluate Real Estate Investments. Click to begin presentation. 2 Property Investments: Long Term Risky Assets Property investment analysis requires