Expected Value

Expected Value is a mathematical term used in probability and statistics to determine what a typical value might be. For a more detailed definition and discussion, check out wikipedia’s article.

Here’s how I use it with the Real Estate Financial Planner™ software to model my own real estate investments.

First, I model my entire real estate investing strategy by entering it in the software. See the How to Create a Real Estate Financial Plan™ post to get a good tutorial on how to enter in your own real estate investing strategy.

When I do my modeling I do include things like what properties I plan to buy, when, with what financing. I also consider if I am doing cash out refinances and when and how I plan on doing them. I consider whether I am re-leveraging up with cash out refinances or selling off properties to buy more. Or, am I paying off properties early and how I plan to do that (with cash flow as I earn it or in lump sums when I have enough to pay it off in full).

After I am finished modeling my entire strategy, then I go back and input a range of what I think could happen with things like appreciation rates (for each property), rent appreciation rates, maintenance, interest rates, vacancy rates, my income, my savings rate, etc.

Once I have established what can happen and the range of values for what can happen, I run  Monte Carlo analysis using all these different variable in the ranges I defined.

Once I have all those, every  Monte Carlo run is averaged (which is the  EV for all the possible  Scenarios) and I evaluate the range of outcomes.

I then “tweak my strategy” and rerun it to compare on strategy to another to see which I prefer from a risk and return and business I’d actually consider operating perspective.

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