How do you test assumptions for a real estate development project?

1 Identify key assumptions

The first step is to identify the key assumptions that drive your development project. These may include market demand, supply, rents, vacancy, absorption, costs, financing, taxes, fees, and regulations. You should base your assumptions on reliable data sources, such as market studies, appraisals, surveys, comparable projects, industry reports, and expert opinions. You should also document your assumptions and their sources for future reference and validation.

2 Build a financial model

The second step in the development process is to build a financial model that reflects your project. This tool projects the cash flows, returns, and performance indicators of the project over time. You can create your own financial model using spreadsheet software, such as Excel, or use a template or software solution designed for real estate development. Your financial model should include a project description with basic information about the development, a development budget with all costs involved, an operating pro forma with projected revenues and expenses, financing assumptions with terms and conditions of debt and equity financing, a cash flow statement with net cash flow calculation for each period, and return metrics that measure profitability and risk.

3 Run a base case scenario

The third step is to run a base case scenario using your financial model. A base case scenario is the most realistic and probable scenario that reflects your current assumptions and expectations. You should use your base case scenario as a benchmark to compare and contrast other scenarios and sensitivities. You should also check your base case scenario for accuracy, consistency, and reasonableness. You can use various tools and techniques to validate your financial model, such as error checks, cross-checks, sensitivity tables, and charts.

4 Run alternative scenarios

The fourth step is to run alternative scenarios using your financial model. Alternative scenarios are hypothetical scenarios that reflect different assumptions and outcomes. You can use alternative scenarios to test the impact of various factors and events on your development project, such as changes in market conditions, costs, financing, design, and timing. You should run alternative scenarios that cover a range of possibilities, from optimistic to pessimistic, and from best case to worst case. You should also run alternative scenarios that reflect your specific goals and objectives, such as maximizing returns, minimizing risks, or achieving a target performance.

5 Analyze the results

The fifth step is to analyze the results of your scenario testing. You should compare and contrast the results of your base case scenario and your alternative scenarios, and identify the key drivers and risks of your development project. You should also evaluate the trade-offs and implications of each scenario, and assess the feasibility and attractiveness of your development project. You can use various tools and techniques to analyze your results, such as graphs, charts, tables, dashboards, and reports.

6 Adjust your assumptions and strategy

The sixth and final step is to adjust your assumptions and strategy based on your scenario testing. You should use your scenario testing as a feedback loop to update and refine your assumptions and expectations. You should also use your scenario testing as a decision-making tool to adjust and optimize your strategy and plan. You may need to modify your development project in terms of scope, design, timing, financing, or exit. You may also need to reconsider your development project in terms of feasibility, profitability, or risk.

7 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?