What does a sensitivity analysis test in real estate finance?

A sensitivity analysis in real estate finance is designed to examine how the outputs of a financial model or investment performance change in response to variations in key assumptions. This analysis is pivotal for understanding the relationships between different variables, such as interest rates, rental income, operating expenses, or capital expenditures.

By adjusting these inputs and observing how they affect metrics like cash flows, internal rates of return, or overall project viability, real estate professionals can identify which variables have the most significant impact on investment performance. This process helps in assessing risk and making informed decisions regarding property investments.

For instance, if a sensitivity analysis reveals that small changes in rental rates dramatically affect the projected returns, an investor would recognize the high sensitivity of their investment to market changes. This knowledge allows for better planning and risk management strategies.

The other choices, while relevant to certain aspects of real estate finance, do not specifically capture the essence of what sensitivity analysis aims to achieve. They address important factors but do not focus on the changes in returns resulting from variations in assumptions, which is the core purpose of sensitivity analysis.