Sensitivity analysis is the part of underwriting that treats the model as a decision tool rather than a sales document. A base case tells you what happens when assumptions hold. Sensitivity analysis tells you what the deal asks of you when they do not.
In real estate, small changes in a handful of variables drive most of the downside. Rent comes in lower than expected. Vacancy runs higher for longer. Expenses drift upward. Interest rates change refinancing math. Exit pricing softens. Sensitivity analysis forces those variables to move and measures what breaks first: cash flow, liquidity, DSCR, refinance proceeds, or investor returns.
Sensitivity Analysis in Practice
A good sensitivity framework answers a short set of practical questions:
- How much deterioration can the deal absorb before it requires a capital injection?
- What inputs have the largest impact on equity returns?
- What variables create permanent impairment versus temporary pressure?
- What has to happen for the refinance or sale to work the way the model assumes?
- What is the downside outcome that remains survivable, and what is the one that becomes unacceptable?
If you cannot answer those questions with numbers, you are relying on narrative.
The Variables That Move Outcomes
Most underwriting models contain dozens of inputs, but only a small number tend to drive outcomes, particularly in the first two to three years of ownership. On the income side, results are usually dictated by how quickly in-place rents can be brought closer to market, how much economic occupancy actually holds once vacancy and credit loss are accounted for, and how concessions and renewal spreads behave during stabilization. These factors determine whether projected revenue shows up on schedule or lags long enough to create early cash strain.
Expenses tend to introduce their own form of pressure. Property taxes can reset after purchase and move independently of rent growth. Insurance premiums and deductibles can change abruptly. Repairs, maintenance, and unit turns often run higher than modeled during the early phase of ownership. Payroll and contract services also matter, especially in assets that require more hands-on management. These costs rarely move in isolation and tend to drift upward together.
Capital and financing assumptions frequently become the binding constraint. The interest rate at acquisition matters, but the refinance rate usually matters more. Amortization and the resulting debt constant determine how much income is consumed by debt service. DSCR requirements at refinance often limit proceeds well before loan-to-value does. Reserve requirements and the timing of capital expenditures further influence liquidity during the hold.
Exit assumptions round out the picture. Exit cap rate, transaction costs, and the level of NOI achieved at sale all shape terminal value. Since exit NOI is itself the result of rent growth and expense behavior over time, exit sensitivity is rarely independent of earlier operating assumptions.
Example of Sensitivity Analysis
Assume a small multifamily acquisition priced at $1,500,000.
- Stabilized NOI in the base case: $105,000
- Base cap rate: 7.0%
- Loan: 70% LTV ($1,050,000)
- Interest rate: 6.25%, 30-year amortization
- Annual debt service (approximate): $77,500
- DSCR at stabilization:
Now stress the deal in ways that reflect how problems actually show up.
Stress 1: NOI comes in 10% lower than expected
NOI becomes $94,500. Debt service stays $77,500. DSCR drops to:
The deal still pays its mortgage, but the buffer is thinner. Cash flow to equity compresses hard because debt is fixed.
Stress 2: NOI comes in 20% lower than expected
NOI becomes $84,000. DSCR becomes:
This is where the experience of ownership changes. One expense shock or one vacancy spike pushes coverage below 1.00x and the property stops supporting itself without help.
Break-Even Occupancy
Break-even occupancy is one of the most useful stress tests because it translates underwriting assumptions into operating reality. It answers a basic question: how much of the building needs to be occupied for the property to cover its fixed obligations. The standard calculation divides operating expenses plus debt service by gross potential income:
If you prefer to avoid gross income assumptions, the same idea can be expressed as a break-even NOI equal to debt service plus required reserves, which can then be compared to realistic downside NOI scenarios.
Break-even analysis is most informative when it is run under two conditions: current in-place income and stabilized income. Early in the hold, break-even occupancy often tells you more about risk than long-term return projections. If break-even occupancy is high in year one, the deal requires liquidity regardless of how attractive it looks in year five.
Refinance Sensitivity
Refinance sensitivity is where a large share of otherwise solid deals break down. Pro formas often assume a refinance that returns equity, reduces risk, or both. In practice, refinancing is usually constrained by DSCR rather than appraisal value. A clean refinance sensitivity links three variables together: NOI at the time of refinance under a conservative stabilization path, the interest rate available in that market environment, and the lender’s required DSCR.
Consider a property projected to produce $115,000 of NOI in year five with a lender requiring 1.25x coverage. That requirement caps allowable annual debt service at $92,000. The loan amount supported by that payment depends entirely on the interest rate and amortization available at the time. Lower rates support larger proceeds. Higher rates do not. A property can appraise well and still fail to refinance at the proceeds assumed in the model.
Exit Cap Rate Sensitivity
Exit cap rate sensitivity should be handled directly. Sale price is a function of exit NOI divided by the exit cap rate:
If exit NOI is $120,000:
That entire range exists on identical operating performance.
Exit sensitivity matters most when returns are heavily back-ended. If the equity story depends on selling into a tight yield environment, the model needs to show what happens when buyers demand a higher yield.
How to Approach Sensitivity Analysis
A useful sensitivity package does not rely on dozens of tables. It focuses on a small number of tests that mirror how deals tend to fail. One-way sensitivities are useful for ranking impact, showing which variables move returns and which ones pressure survival metrics such as cash flow and coverage. Early in the hold, survival metrics usually matter more than return metrics.
Two-way sensitivities are most effective where real constraints bind. Pairing vacancy and credit loss with expense inflation captures operating stress. Pairing refinance rates with NOI at refinance captures refinancing feasibility. Pairing exit cap rates with exit NOI captures terminal value dependence. These combinations reflect how problems tend to show up together rather than in isolation.
Scenario analysis ties these elements together. Real downside rarely comes from a single variable moving on its own. Vacancy increases while concessions rise. Insurance costs jump while repairs run higher. Interest rates move up while exit pricing softens. A scenario test bundles these movements and answers one practical question: how much cash is required, when it is required, and how long the pressure lasts.
Conclusion
Sensitivity analysis forces the model to answer specific questions: how much cash the property can burn before it needs support, how far income can fall before debt service becomes a problem, and what assumptions have to hold for a refinance or sale to clear. When those inputs are stressed, the model stops being aspirational and starts behaving like an operating forecast. You can see where liquidity gets used up, where coverage tightens, and where returns depend on conditions you do not control.