Importance of Sensitivity Analysis in Residual Valuation

Study Notes

What is Sensitivity Analysis?

Sensitivity analysis is a technique used to determine how changes in variables affect the outcome of a valuation model. In the context of residual valuation, sensitivity analysis helps to identify the most critical variables that impact the estimated land value.

Why is Sensitivity Analysis Important?

Sensitivity analysis is crucial in residual valuation because it:

Helps to identify the key drivers of the land value
Allows for the testing of different scenarios and assumptions
Provides a range of possible outcomes, rather than a single point estimate
Enables the identification of areas of uncertainty and risk

Steps in Conducting Sensitivity Analysis

To conduct a sensitivity analysis in residual valuation:

Identify key variables: Determine the variables that have the greatest impact on the land value, such as construction costs, rental yields, and discount rates.
Establish a base case: Establish a base case scenario with a set of assumed values for each variable.
Vary variables: Vary each key variable individually, while holding all other variables constant, to assess the impact on the estimated land value.
Analyze results: Analyze the results to determine the sensitivity of the land value to changes in each variable.

Tips for Conducting Sensitivity Analysis

Use realistic ranges: Use realistic and plausible ranges for each variable to ensure that the analysis is meaningful.
Consider multiple scenarios: Consider multiple scenarios to capture a range of possible outcomes.
Prioritize variables: Prioritize variables based on their impact on the land value to focus on the most critical variables.

Interpreting Sensitivity Analysis Results

When interpreting the results of a sensitivity analysis:

Identify key drivers: Identify the variables that have the greatest impact on the land value.
Assess uncertainty: Assess the uncertainty associated with each variable and its impact on the land value.
Consider scenario planning: Consider scenario planning to anticipate potential outcomes and develop strategies to manage risk.

What is Sensitivity Analysis?

Sensitivity analysis is a technique used to determine how changes in variables affect the outcome of a valuation model.
It helps to identify the most critical variables that impact the estimated land value in residual valuation.

Why is Sensitivity Analysis Important?

Identifies key drivers of land value
Allows for testing of different scenarios and assumptions
Provides a range of possible outcomes rather than a single point estimate
Enables identification of areas of uncertainty and risk

Steps in Conducting Sensitivity Analysis

Identify key variables that have the greatest impact on land value (e.g., construction costs, rental yields, and discount rates)
Establish a base case scenario with assumed values for each variable
Vary each key variable individually while holding all other variables constant to assess the impact on estimated land value
Analyze results to determine the sensitivity of land value to changes in each variable

Tips for Conducting Sensitivity Analysis

Use realistic and plausible ranges for each variable
Consider multiple scenarios to capture a range of possible outcomes
Prioritize variables based on their impact on land value

Interpreting Sensitivity Analysis Results

Identify variables that have the greatest impact on land value
Assess uncertainty associated with each variable and its impact on land value
Consider scenario planning to anticipate potential outcomes and develop strategies to manage risk