How can you use sensitivity and scenario analysis to make better commercial real estate decisions?

1 What is sensitivity analysis?

Sensitivity analysis is a technique that allows you to measure how the value or performance of a commercial real estate project changes when you vary one or more key assumptions or inputs. For example, you can use sensitivity analysis to see how the net operating income (NOI) of a property changes when you change the occupancy rate, rental rate, operating expenses, or capital expenditures. Sensitivity analysis can help you identify the most critical factors that affect your project's profitability, as well as the range of possible outcomes based on different scenarios.

2 What is scenario analysis?

Scenario analysis is a technique that allows you to compare the value or performance of a commercial real estate project under different sets of assumptions or inputs that reflect different situations or events. For example, you can use scenario analysis to see how the internal rate of return (IRR) of a property changes under a base case, a best case, and a worst case scenario. Scenario analysis can help you assess the potential upside and downside of your project, as well as the likelihood and impact of various risks and opportunities.

3 How to use sensitivity and scenario analysis for commercial leasing?

Sensitivity and scenario analysis can be very useful for commercial leasing decisions, whether you are a landlord or a tenant. For landlords, these methods can help you determine the optimal rental rate, lease term, tenant improvement allowance, and vacancy rate for your property, as well as the break-even point and cash flow projections. For tenants, these methods can help you evaluate the affordability, suitability, and flexibility of different lease options, as well as the impact of rent escalation, operating expenses, and relocation costs. To use sensitivity and scenario analysis for commercial leasing, you need to have a financial model that incorporates the relevant variables and assumptions for your project, such as the lease structure, market conditions, tenant mix, and financing options. You can then use a spreadsheet software or a specialized tool to perform the analysis and generate charts, tables, or graphs that show the results.

5 What are the challenges of sensitivity and scenario analysis?

Sensitivity and scenario analysis can also bring some challenges to commercial real estate decisions. This process requires a lot of data and information to build a reliable and realistic model, as well as subjective judgment to select and prioritize the variables and assumptions. The quality and accuracy of the inputs and outputs may change over time or differ from reality, which can lead to a false sense of precision or certainty, potentially causing overconfidence or complacency. Additionally, interactions and interdependencies among the variables and assumptions may be overlooked, leading to unexpected outcomes.

6 How to overcome the challenges of sensitivity and scenario analysis?

To overcome the challenges of sensitivity and scenario analysis, it is essential to follow certain best practices. This includes gathering and verifying data and information from reliable sources, using a systematic and transparent approach to define and justify the variables and assumptions, testing and validating the model with sensitivity checks, error checks, and peer reviews. Additionally, it is important to apply a range of values and scenarios that reflect the uncertainty and variability of the market and the project. Furthermore, incorporating feedback from stakeholders and acknowledging the limitations of the analysis are essential for successful results.

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?