The use of simulation in property investment analysis

Abstract

Simulation is a powerful analytical tool which facilitates an investigation of financial risk through the examination of repeated outcomes from the same model. It is not, however, an easy matter to use simulation in a property investment context due to the existence of complex relationships between the fundamental components (such as the periodic cash flows, vacancy rates, letting up periods and capitalization rates). Seeks to examine a simple investment scenario in which the variations in net annual cash flows and final capitalization rate determine the overall viability of the investment. Shows that the relationship between these two variables and between the net annual cash flows over time significantly increases the investment′s risk. The use of asymmetric variables to describe these property characteristics is also discussed as are the interpretation of “expected” outcomes as either the “average” and the “most likely” result. These are all critical considerations if the simulation model is to provide a reasonable representation of the true investment situation and for the simulation results to be useful in the investment decision‐making process.