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after spending almost 10 years in real estate private equity working for and with some of the largest institutional firms in the u.s i can tell you from first-hand experience that these shops take their analysis very very seriously to a level that most individuals or smaller time investors just don't take the time to do and whether you're investing in deals for your own portfolio or buying real estate on behalf of equity partners understanding the different ways a real estate acquisition could turn and the impacts of those events on returns is huge in making sure you're protecting your downside and doing your due diligence on deals you're putting your hard earned money into and while a standard pro forma model is both helpful and necessary to analyze and value commercial real estate deals there are a few additional tools i like to add to an acquisition analysis that i've learned to really value during my time in the private equity space to make sure that any deal i'm analyzing actually checks out so to help you take your real estate investment analysis process to the next level in this video what we'll do is walk through three of my favorite analysis tools to use as an addition to a standard real estate financial model when analyzing new deals and a few reasons why you might want to consider implementing each so analysis paralysis is a very real thing and it's easy to get stuck analyzing a million different scenarios and never taking any action which is by no means the goal of this video however by the end of this video what i do want to do is to make sure that you are aware of some of the lesser known real estate investment analysis techniques that are commonly used by sophisticated institutional real estate private equity firms and how you can use those same techniques to minimize your downside maximize your upside and feel more comfortable with the risk you're taking on when investing in commercial real estate so let's start with number one on this list and this is something that tends to come standard in the models of many institutional firms and that is a sensitivity analysis a sensitivity analysis measures the effect of changes to key assumptions in the model on the most important return metrics on your deal which are usually the irr equity multiple cash on cash or mixture of all three of these things so for example a sensitivity analysis might show what happens to the irr on the deal if cap rates were higher or lower than initially projected when the property is sold what might happen to the average cash on cash return on the deal if rent growth is higher or lower than projected during the hold period or what might happen to the equity multiple based on how many years the property is held this type of analysis tends to be so helpful and so widely used because of its real-world application and how easy it is for investors to see the impact of various different scenarios on the specific return metrics they care about most in one single snapshot a sensitivity analysis can show investors what happens if the exit cap rate on a deal is 5.5 or 6 or 6.5 percent and what the irr of the project at each of these exit cap rates is going to be for a 5 7 or 10 year hold period this type of analysis can even show the effects of changes in model inputs on two key return metrics at the same time like the irr and the equity multiple which makes these tables even more efficient to use as an investment analysis tool ultimately sensitivity analyses help investors understand their downside and upside scenarios and probably most importantly for many individuals and institutions investing in commercial real estate understanding if the potential worst case scenario is actually something they can live with either way this is an extremely helpful tool in managing risk and something that many institutional firms will use to protect their downside and make sure that that potential downside is clear to investors in the process now next up on this list also has to do with analyzing the effect of multiple scenarios on the returns of the deal and this is the levered versus unlevered return comparison or looking at returns on the project both with and without debt similar to the sensitivity analysis this allows investors to see in one place how much projected returns are dependent on debt assumptions in the model and whether or not the deal could potentially stand on its own even without a loan on the property and while levered returns or the returns with that on the deal are going to be the metrics that measure the true cash inflows and outflows to and from investors unlevered returns can provide a more balanced fundamental view of the deal itself that might not be as clear when looking at returns on a levered basis specifically the difference between levered and unlevered returns is also a measure of risk with levered irr and cash on cash return values that are significantly higher than those same metrics on an unlevered basis often indicating that investors could be taking on a significant amount of default risk to get to those return targets now there isn't necessarily a rule of thumb around how much higher leverage return value should be than unlevered returns on the same deal but in most cases for a property acquisition with standard debt levels of about 60 to 70 percent of the purchase price you'd usually see levered irr values at about 1.75 to two times those same unlevered returns with a deal that comes in at about an eight percent unlevered irr often shaking out to about a fourteen or fifteen percent irr on a leverage basis however if that ratio starts to get really out of whack where leverage returns end up being three or even four times the unlevered values for that same deal this can often indicate that the deal is significantly levered up through several layers of financing and there's probably going to be a pretty big default risk on the deal as a result and finally aside from the levered versus unlevered and sensitivity analyses the final analysis i like to run on new deals that i'm analyzing is an irr partitioning specifically between cash flow from operations and cash flow from sale proceeds the word partition means to divide into parts and when real estate investors partition the irr that's exactly what they're doing this process essentially involves separating out the cash flows between normal operations and sale proceeds discounting each of those cash flows by the irr on the deal based on when those cash flows are received and then finding the percentage of the present value of the total cash flows that each component of the deal makes up this specific analysis is really helpful to make sure that you're not too heavily dependent on your sale value to generate returns and that you won't take too much of a hit if market pricing isn't exactly where it was projected to be five seven or 10 years into the future again with this analysis there isn't necessarily a rule of thumb here regarding what percentages are optimal and this is going to depend a lot on the whole period of the deal but in a way that's also kind of the point of this analysis for shorter projected hold periods in the three to five year range it's not uncommon to see 75 to 85 of returns coming directly from sale value which shows you very clearly how much of your return potential is tied up in the success of the eventual sale of your deal and if the market tanks in three years and you're forced to sell the property at that time due to a loan maturity or other market factors this will tell you that around eighty percent of your return potential could be wiped out almost completely at that time if market conditions don't line up with projections for longer term hold periods the percentage of returns coming from sale value often drops to somewhere between about 55 and 65 percent for a standard deal with an irr projection in the low teens and this can significantly shift the risk profile of the deal in a much more positive direction and also makes returns much less reliant upon hitting a home run when the property ends up being sold ultimately the goal of any real estate financial analysis is to understand what projected returns might look like given a set of assumptions around how the deal might perform and these three analysis techniques are some of the most helpful tools i've picked up throughout the years to make sure that i can live with my downside i'm managing my risk and my returns aren't solely tied to the whims of the market when the property is ultimately sold and if you want to learn how to implement these and other types of analysis techniques into a real estate financial model to help you analyze deals more effectively as always make sure to check out our all-in-one membership platform breaking the cre academy a membership to the academy will give you instant access to over 120 hours of video training on real estate financial modeling and analysis including content on how to build out the three analysis tools we talked about in this video you'll get instant access to our entire library of pre-built acquisition development and waterfall models for multi-family office retail and industrial properties and you'll also have access to private one-on-one email-based career coaching if you're looking to break into the industry for the first time and looking for some additional personalized feedback on your own unique scenario and if you like this video and want to see more content on this channel around deal analysis make sure to hit the like button to let me know and let me know in the comments some analysis techniques you like to use when analyzing deals on top of just taking a look at basic return metrics generated by a basic pro forma as always thanks so much for watching guys i hope you found this helpful subscribe to the channel if you haven't already to see more videos like this every single week and i'll see you in the next video you