Sensitivity analysis for real estate investments is a logical extension of partitioning to determine which portions of the forecast merit further refinement.  Whereas partitioning emphasizes the relative importance of various sources of cash flows, sensitivity analysis reveals how forecasting errors will affect the present value of actual after-tax cash flows.  The technique consists of altering components of the forecast one at a time and studying their impact on investment value or the present value of the equity position.

Using a sensitivity analysis to assess the impact that changes in rental rates, cap rates, interest rates, etc., have on the ROI is an essential tool in real estate analysis. It can be an eye-opening experience.  

The relationship between percentage changes in annual net operating income and percentage changes in investment value will be demonstrated in our spreadsheet.  For a more in-depth discussion of how a sensitivity analysis is used in real estate, please see this article (click here).