Historically, using The World's Greatest Real Estate Deal Analysis Spreadsheet™ most people use a static rent appreciation rate and price appreciation rate.
In other words, when analyzing a deal they used 2 or 3% for rent appreciation.
And, 2 to 3% for price appreciation.
You could do some changes to these appreciation rates by using the rent OVERRIDE feature:
And, you can do a similar thing with the price OVERRIDE feature lower on the spreadsheet:
But the OVERRIDE feature… as good as it is… is limited in its ability to stress test a property and… unless you create an amalgamation of all your properties into one deal… impossible to use to stress test your entire portfolio at once.
Enter the Real Estate Financial Planner™ software.
In the past you may have heard me talk about using the
But, earlier this year I added a new one-click stress test button that allows you to take your existing plan and stress test your portfolio with about a dozen different market conditions. More on this in a bit.
Different Types of Portfolio Stress
There are 3 categories or types of real estate (and other investment) portfolio stress:
- Market Corrections
- Market Cycles
These should NOT be unexpected… we know about them and that they happen and approximately how likely they are to happen.
If you’re not planning for these, you should be.
Here is a table and some select quotes from “Shocks and the Unexpected: An Important Factor in Retirement” from the Society of Actuaries®.
Select quotes from the report:
- “Shocks are important and multiple shocks do occur. About one in five retirees (19%) and one in four (24%) of retired widows experienced four or more shocks during retirement. In contrast, 28% of retirees and 13% of retired widows had not yet experienced any shocks.”
- “Difficulties tend to increase with the number of shock events. Shocks and unexpected expenses affect the majority of retirees. Families that deal well with one or two shocks may find the situation becomes increasingly difficult when faced with additional shocks.”
- “The most common shocks reported were home repairs and dental expenses. The two most frequently mentioned financial shock and unexpected expense items are home repairs and upgrades (28%) and major dental expenses (24%).”
- “Assets decline. More than one in three who experienced shocks had their assets reduced by 25% or more because of those shocks.”
- “Spending reductions. More than one in 10 who experienced shocks had to reduce spending by 50% or more because of those shocks.”
- “Long-term care, divorce and long-term help to children were the most troublesome. Retirees felt they could make adjustments and deal with unexpected expenses in a number of areas, but not with major long-term care events requiring paid long-term care, or divorce after retirement. Adult children receiving longer term support was also a major issue.”
- “Devastating shocks were low in frequency. The survey included some shocks that could easily be devastating, including fraud, foreclosure of home and bankruptcy. All these shocks had low frequency.”
- “58% of parents had experienced illness/disability compared to 15% of respondents”
- “4% of parents had experienced a loss of capacity as compared to 1% of respondents”
- “23% of parents had gone on Medicaid as compared to 14% of respondents”
- “8% of parents were reported to have experienced major home repairs/upgrades as compared to 28% of respondents”
A sudden drop in prices, rents and values.
We use the
You select which
Then, the software will:
- Reduce the Property Value of the selected
Propertiesby this random percentage, and
- Reduce the Monthly Rent of the selected
Propertiesby this random percentage (that will come into effect on lease renewal), and
- Reduce the Account Balance of the selected
Accountsby this random percentage
- M Markets – Up, then down, then up, then down… then return to what it was doing prior
- W Markets – Down, then up, then down, then up… then return to what it was doing prior
- V Dip – Down then up… then return to what is was doing prior
- “Inverted V” – quick run up and give some back
- Sawblade – perpetual dip then rise
- Flatline – no increase in price/rents
The number of year is the time it takes to go through the entire 4 stage cycle:
- 4 years – 1 year per stage
- 8 years – 2 years per stage
- 12 years – 3 years per stage
- 20 years – 5 years per stage
M Market Cycle Examples
Here's an example of how an M Market cycle might be modeled in the Real Estate Financial Planner™ software.
First, you can see that we might model the appreciation rate to be +3% for a couple years (the first upstroke of the M), then down -3% for the next two years (the first downstroke in the M), then up 3% then back down 3%. After that, the appreciation rate returns to whatever the user had set for the property to begin with. In this case, it happens to be 3%.
Having the appreciation rate above it impacts the value of the property as shown in the chart below:
If we zoom in, we can see the M shaped pattern emerging in the property price.
Since the rent appreciation rate was similar to the price appreciation rate, you can see the impact on True Cash Flow™ below:
And, finally, we also set the yearly rate of return for the account to be the same as the property appreciation rate and rent appreciation rate. You can see that as well below:
Demo of One-Click Stress Testing
The rest of the class I opted to demo the new one-click stress testing button for the Real Estate Financial Planner™ software.
Once you click the “Assess Market Risk” button, the software creates a number of new
Click on the spot marked “2” to see a comparison of all the
Or, click on the spot marked “3” to be able to see any
And, when you're done, clean up the clutter by deleting the