What is a sensitivity analysis and why does it matter?

Sensitivity analysis is a powerful tool used in decision-making and financial modelling that helps users understand how changes in key inputs or assumptions can impact the output of a model. In property development, sensitivity analysis is critical for assessing the financial feasibility and risk of a proposed development project.

Return on Cost (ROC) is one of the most common metrics used to measure the profitability of a project relative to the total development costs. ROC is calculated by dividing the profit of the project by the total development costs.

1 What is a sensitivity analysis and why does it matter

An example of a sensitivity analysis is a simplified development appraisal of a 4-bedroom house. The table assesses the impact of changes in key variables, such as revenue and construction costs, on the financial outcomes of the project. The horizontal axis represents the expected Gross Development Value (GDV) of the property, while the vertical axis represents the build costs.

By analysing different cells of the table, users can see how changes in key variables affect the ROC of the project. This allows developers to identify and manage risks more effectively, as they can quickly see how different scenarios impact the financial outcome of the project.

Using the example below, we can quickly see two scenarios:

  1. What happens if the GDV drops by 5% and build costs increase by 5%? The ROC drops from 32% down to 22%
  2. What happens if the GDV drops by 15% and costs go up by 15%? The ROC drops from 32% down to 3%

5 What is a sensitivity analysis and why does it matter

The sensitivity table in Aprao appraisals provides a visual representation of risk, allowing users to assess the risk profile of the project at a glance. The table is colour-coded, with cells that fall below the expected return on cost highlighted in red, cells that meet the expected return highlighted in green, and cells between the two highlighted in shades of red and green.

Aprao automatically produces a sensitivity analysis on all projects, creating a table like the one above in one click that is included on all appraisal reports. 

An upcoming update to the sensitivity analysis feature in Aprao appraisals will also allow users to choose residual land value as the outcome in the sensitivity analysis table, providing developers and land valuers with a whole new perspective on property development projects.

Sensitivity analysis is a critical tool in property development appraisals, helping developers make more informed decisions and manage risks more effectively.

Existing Aprao customers can log in to use sensitivity analysis right now and new customers can sign up to a 14 day free trial right here.

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