What Is Sensitivity Analysis?
Sensitivity analysis = change one input, see how the output moves. A deal that pencils at 5% vacancy-rate might break even at 12%. Run scenarios: vacancy 5%, 8%, 12%; expenses 38%, 42%, 46%; rent −5%, flat, +5%. In Detroit, an investor ran 9 scenarios. Base case: 6.2% cash-on-cash-return. Worst case (12% vacancy, 46% expenses): 1.8%. He knew his cushion. He bought. Year 1 hit 10% vacancy—he was prepared.
Sensitivity analysis is a deal-analysis technique that tests how returns change when key assumptions shift—vacancy, operating-expenses, rent, interest rate. It reveals breakpoints and risk.
At a Glance
- What it is: Vary inputs, observe output changes
- Why it matters: Stress test; find breakpoints
- Key inputs: Vacancy-rate, expenses, rent, rate
- Output: Cash-flow, cash-on-cash-return, dscr
- Use it for: Go-no-go-decision; risk assessment
How It Works
One-way sensitivity. Change one variable at a time. Vacancy: 5%, 8%, 12%. See how cash-flow and cash-on-cash-return move. Find the break-even vacancy—where cash-flow goes to zero.
Two-way and multi-way. Change two or more variables. Vacancy + expenses. Rent + rate. More realistic but harder to interpret. Use a spreadsheet-analysis or rental-property-calculator.
Common variables. Vacancy-rate—most deals are sensitive. Operating-expenses—underestimate and you're in trouble. Rent—below-market-rent capture can slip. Interest rate—affects refinance and debt-service.
Interpretation. If the deal only works at best-case assumptions, it's fragile. If it still pencils at worst-case, it's robust. Aim for a range where the worst case is acceptable—not home run, but not disaster.
Real-World Example
Ava in Memphis. She modeled a 4-plex. Base: 8% vacancy, 42% expenses, $3,800/month rent. Cash-flow: $6,200/year. Cash-on-cash-return: 5.8%. She ran sensitivity. Vacancy 12%: cash-flow $3,100, CoC 2.9%. Expenses 46%: cash-flow $4,800, CoC 4.5%. Rent −5%: cash-flow $4,200, CoC 3.9%. Combined worst case (12% vac, 46% exp, −5% rent): cash-flow $800, CoC 0.7%. She decided the base case was strong enough—the worst case was thin but positive. She bought. Year 1 vacancy hit 10%. She was ready.
Pros & Cons
- Surfaces risk
- Informs go-no-go-decision
- Identifies breakpoints
- Can't model everything
- Garbage in, garbage out—base case must be solid
- Analysis paralysis risk if overdone
Watch Out
- Over-modeling: 20 scenarios won't help if the base case is wrong. Nail the base first.
- Correlation: Vacancy and rent can move together in a downturn—consider combined scenarios.
- Action: Use the output. If worst case is unacceptable, pass or renegotiate.
Ask an Investor
The Takeaway
Sensitivity analysis stress-tests your deal-analysis. Vary vacancy, expenses, rent. Find your breakpoints. If the worst case is unacceptable, walk or renegotiate.