Why a lack of advanced modeling techniques? Anyone who uses probabilistic modeling justification for this?
From what I have seen, real estate modeling (at least on an asset level) seems to be relatively rudimentary in comparison to almost all other financial sectors, could anyone possibly speak to why very few firms utilize advanced modeling techniques and probabilistic modeling in real estate? Or if your firm does use these techniques, what programs are you using and in what context are you using this?
Because there are so many variables in a real estate deal that are subject to change, that running probability analysis above and beyond pretty simple sensitivity matrices becomes a dumb mental jerk-off exercise that is not grounded in reality.
Take a traditional development deal. Things that are almost guaranteed to change from start to finish--construction duration, actual start date, final hard costs, the size and rent on the initial pre-lease, the pace and lumpiness of the cash flows from the balance of the lease-up, the interest carry on floating debt, the property tax bill at stabilization, the actual value of concessions, how much density you actually get approved...there are a billion items that change. Better to come up with a concept you think stands a reasonably likely chance of being built and run that on general market assumptions, than do a circle jerk.
Some shops do it though, I think it is an incredible waste of time and analysis by paralysis.
Complete waste of time, totally agree. You really only need to have one case in real estate investing in my mind, the downside case. If you are comfortable with this case and still think the deal is good, then you don't need to spend time doing a ton of what-ifs on every other slight change in variable.
I think there is an important distinction to make here: portfolio level vs asset level. In regards to a asset-level analysis, these types of sensitivity's or analyses are largely a waste of time, however, on a portfolio level. I work on the asset level side but I would venture to assume this type of analysis is being done on a portfolio level at some shops. Can anyone speak to this?
Even at fairly large funds, this doesn't happen as often as you think (we don't do this deep of an analysis). Again, you're basically trying to predict a range of values, so rather than wasting time doing a billion+ combinations of different variables going up and down, most shops pick one metric and piggyback off that. For example, most groups will play with the exit cap rate and run down, base, and up side cases based on that. It gets you to the same place as if you do a ton of different rent growth projections, starting market rents, cap ex contingencies, etc. There are a lot more variables that can go into a real estate deal than almost any other asset class, so it's a lot more head trauma to do some of these 'advanced' metrics. If someone did this and was pitching us as the LP, candidly I would think they don't know what they're doing. I would have a much higher confidence level in a developer that walks into the meeting with a simple range of values based on one or two variables changing and then being able to speak to the process, as opposed to giving me a simulation that's taken into account all 1,956,345,754,342 possible combinations that are all based on pure speculation anyways.
If you want a practical guide for doing this in the RE industry, I highly recommend https://www.amazon.com/Flexibility-Estate-Valuation-under-Uncertainty/d…</a">this book.
That said, I've talked about this with people who work at major REPE and development firms that invest many billions of dollars, and they don't seem to do anything more complex than scenario analysis. The authors of the linked book are academics who are trying to increase the sophistication of the industry.
Academics who probably have never developed/managed/investing in a single development project. The most successful real estate investors/developers I know do simple back of the napkin analysis to determine project feasibility. They generate tremendous alpha through their ability to buy well located land below market and/or cut leases at above market rates with favorable legal terms to landlord.