The quantification of risk
Chapter 6 of Practical Finance for Property Investment takes a closer look at the risks associated with investing in property. Earlier in the text, we discussed estimating the appropriate risk-adjusted discount rate to use for a property valuation. In this chapter, we look at risk in more nuanced ways. First, we examine more traditional methods of answering questions such as, “What happens to my rate of return if the realized exit cap rate on my property turns out to be far higher than what I had anticipated?” Data tables and scenario analyses are well-suited to address questions such as this. However, oftentimes an investor will want to answer questions that are best phrased as, “How likely?” The chapter explains how Monte Carlo simulations can be used to incorporate the concept of probability in a real estate setting. In reading this chapter, property investors will learn the benefits and potential pitfalls of all of these methods of assessing risks of a property investment. In conclusion, the chapter presents a case study illustrating how risk assessments can help the decision-making process of an investor contemplating turning her condo into an investment property.