Multifamily Valuation Goes Monte Carlo

Multifamily Valuation Goes Monte Carlo

monte carlo simulation

If you’re planning on buying a multifamily investment property there are basic valuation models which include the gross rent multiplier, sales comparison approach, and the capital asset pricing model.

Using these models will help most investors to understand the pros and cons that a multifamily investment property has to offer them but, sometimes the basic valuation models don’t always provide enough data.

This is when it’s best to work with a Certified Commercial Investment Member (CCIM).

When you work with a CCIM they will use tools that take into account the long term and bigger picture using a much more encompassing analytical framework than most. This would typically take into account questions such as:

  • How many dollars go into the investment?
  • When do the dollars go into the investment?
  • How many dollars come out of the investment?
  • When do the dollars come out of the investment?

Then, utilizing various methods for calculating the investment metrics to quantify answers to these questions, for any given property, the following parameters would be calculated:

  • Capitalization rate
  • Before-tax cash on cash
  • Internal rate of return
  • Net present value

In the Real-World Things Don’t Always Work as Expected

Sadly, even the most sophisticated analysis is based on estimations of pure conjectures about future supply and demand market characteristics, as well as estimated property financial performance.

The reality when it comes to using data to value a multifamily investment property is that the data works as long as the world behaves within the analytical framework stipulated in the analysis.

But, in the real-world, things often do not go as predicted, we can forecast for known unknowns, but not for unknown unknowns. In these instances, you might look to a “Super CCIM,” if you should be so lucky as to find one who can explore a Monte Carlo analysis for you. Granted, this will be almost impossible, as even the most knowledgeable specialists in the commercial real estate industry may not be familiar with this analytical method.

About the Monte Carlo Simulation

Monte Carlo simulation is a computerized mathematical technique that allows people to account for risk in quantitative analysis and decision making. The technique is used by professionals in such widely disparate fields as finance, project management, energy, manufacturing, engineering, research and development, insurance, oil & gas, transportation, and the environment.

Monte Carlo simulation furnishes the decision-maker with a range of possible outcomes and the probabilities they will occur for any choice of action. It shows the extreme possibilities—the outcomes of going for broke and for the most conservative decision—along with all possible consequences for middle-of-the-road decisions.

The technique was first used by scientists working on the atom bomb; it was named for Monte Carlo, the Monaco resort town renowned for its casinos. Since its introduction in World War II, Monte Carlo simulation has been used to model a variety of physical and conceptual systems.

How Monte Carlo Simulation Works

Monte Carlo simulation performs risk analysis by building models of possible results by substituting a range of values—a probability distribution—for any factor that has inherent uncertainty. It then calculates results over and over, each time using a different set of random values from the probability functions. Depending upon the number of uncertainties and the ranges specified for them, a Monte Carlo simulation could involve thousands or tens of thousands of recalculations before it is complete. Monte Carlo simulation produces distributions of possible outcome values.

By using probability distributions, variables can have different probabilities of different outcomes occurring. Probability distributions are a much more realistic way of describing uncertainty in variables of a risk analysis.

Contact Us

When you work with a Certified Commercial Investment Member (CCIM), like Wolf Baschung and the MW Team, you can have confidence that we will apply the most sophisticated commercial financial analytical tools and methods to real estate investments in order to go beyond simple models.

Our company is your best resource in Los Angeles for investment sourcing, a brokerage for acquisitions, and of course full-service property management.

To learn more about the services we can offer you contact us at (213) 927-2117 or click here to connect with us online.