How do you test variables to impact your valuation?

1 Why test variables?

Testing variables helps you to understand the range of possible values for your property, based on different scenarios and inputs. It also helps you to identify the key drivers of value, such as income, expenses, vacancy, cap rate, and discount rate. By testing variables, you can evaluate the risks and opportunities of your investment, and make informed decisions based on your objectives and risk tolerance.

2 How to test variables?

Testing variables can be done in a variety of ways, depending on the complexity and detail required. Sensitivity analysis is one such method, which involves changing one variable at a time while keeping the others constant to observe the impact on the value. This can be done with the help of a spreadsheet or calculator. Scenario analysis is another method, which involves changing multiple variables simultaneously according to different assumptions or situations. This too can be done with the aid of a spreadsheet or software. Lastly, Monte Carlo simulation is a method that involves generating random values for multiple variables, based on their probability distributions and correlations, and calculating the value for each iteration. This allows one to estimate the probability of achieving a certain value or return, and the volatility of the results; software or programming language is needed for this purpose.

3 What to test?

The variables you test for a valuation depend on the type and purpose of your valuation, as well as the data and information you have available. However, some of the most important and common variables to test are income, expenses, vacancy, cap rate, and discount rate. For example, when testing income, you can consider market trends, tenant mix, lease terms, and incentives. When testing expenses, you can look at property condition, maintenance requirements, and management efficiency. Vacancy should also be tested considering supply and demand, tenant turnover, and leasing activity. Additionally, cap rate should be tested based on market conditions, property quality, location, and risk profile. Finally, discount rate should be tested based on investor preferences, opportunity cost, and market expectations.

4 How to interpret?

Testing variables can help answer important questions about the value of your property, such as the best-case, worst-case, and most likely value. It can also help you identify the main factors that affect the value, as well as gauge your confidence in your valuation assumptions and estimates. Additionally, testing variables can help you determine the amount of risk you are willing to take for a given return and compare your property to similar ones in the market. Ultimately, this can provide insights into the implications of your valuation for your investment strategy and exit plan.

5 How to communicate?

When communicating your findings, it is important to consider your audience and purpose. Clear and concise language should be used, avoiding jargon and technical terms. Utilizing charts, tables, graphs, and diagrams can help illustrate and summarize your results. Additionally, the key takeaways and insights should be highlighted, as well as the logic and assumptions behind them. Providing a range of values, rather than a single point estimate, with an indication of the level of uncertainty and sensitivity is also beneficial. Acknowledging the limitations and challenges of your analysis, as well as suggesting areas for further research or improvement is recommended.

6 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?