When modelling real estate private equity deals, or real estate portfolios...
Do you guys ever use Monte Carlo simulations* (whether Crystal Ball or your own programming)?
Do your risk guys use these (if you are at a bank, or financial institution)?
What about you RE junior debt / mezz guys? Do you use it?
I haven't seen many (rather any) people use Monte Carlo simulations in practice. Just sensitivity and scenario analyses.
As a quick aside, I'm not sure if I remember correctly, but does Argus use a Monte Carlo type process (behind the scenes) to deal with / model lease renewal optionality and such?
*Monte Carlo analysis is a type of predictive modelling / forecasting / optimisation analysis, based on simulating how a project / security reacts to uncertainty. Usually software based.
I've seen it used for modeling loss to lease for mulit-fam. That's it.
http://jrdelisle.com/cases_tutorials/FinPrimTuts/jTut_ArgusPortfolioV9…
See page 19.
Personally, I think MC sims add another level of unnecessary complexity to an already tedious underwriting process. Its like how quants approach trading.
Agreed. One can argue there is only marginal value-add to add a layer of complexity to a relatively simple asset class. However, it does make your group/shop look nice when presented in pitch/flip books even though most people do not even know how it really works.
I have never used it in real estate, and I know my fund's risk / portfolio management guys do not either. I do not work at a debt fund.
Argus has special Monte Carlo simulation functionality, but I haven't used it. I believe for the standard reporting, it's just going with a probability-weighted outcome.
It would seem to me that in general real estate is much better suited to the "what if"-style scenario and sensitivity analysis one would typically do as opposed to trying to simulate results over a continuum.
Thanks for the replies. I tend to like to use an "if what" analysis as well. Sometimes gives us a reality check and helps us focus on how we could lose money.
Would be interested to hear from others with regards to Monte Carlo simulations.
Used it for prepayment models and MBS pricing. Not my own code though, had a developer/quant on the desk put it together for us. Seems to be widely used in that world.
Thanks for the input guys.
I haven't seen it used in practice for development project / options, but from a bit of academic research that I've been reading it seems that there might be applications for MC simulations in assessing development options/phasing and other real options within real estate. Or maybe students just wanted to use some software to make pretty charts for their dissertations...
Two academic papers on this... http://dspace.mit.edu/bitstream/handle/1721.1/54853/609649539.pdf?seque… http://dspace.mit.edu/bitstream/handle/1721.1/26739/59820836.pdf
It does look cool / sophisticated though presentation-wise. I have a feeling that it would be useful as a way to second guess models made by development managers which tend to be overly optimistic from what I've seen.
^exactly what you caught on there with that last point. The only time I've really seen anything like MC used is on a Fund marketing document used for trying to sell to LPs. It looks cool and professional.... but for actually making decisions, I think considering the range of outcomes in your mind instead of randomly generating x possibilities does the trick
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