Modelling
How to stress test a real estate deal
One of the toughest questions in a real estate acquisitions interview is how you stress test a deal. Here is the framework.
By the CRE Modelling team
Four things to move, one at a time, and the question to ask of each.
1. Interest rate sensitivity
- How does an increase in interest rates affect your ability to service debt?
- Does the DSCR remain above 1.25x under higher rates?
Take a £9.0m loan on a building producing £0.84m of NOI, amortising over 25 years. Move the coupon:
Rates up: what happens to coverIllustrative figures, rounded.
| Coupon | Debt constant | Debt service | DSCR | |
|---|---|---|---|---|
| 1 | 6.0% | 7.8% | £0.70m | 1.19x |
| 2 | 7.5% | 9.0% | £0.81m | 1.04x |
| 3 | Cover required | 1.25x |
A 150 basis point move takes the deal from thin to underwater. If the lender wants 1.25x, the loan has to shrink or the price has to fall.
2. Vacancy rate fluctuations
- What happens to NOI and cash flow if the vacancy rate rises unexpectedly?
- Can the property still generate enough income to cover its operating expenses and debt obligations?
3. Cap rate movement
- What if market cap rates increase by 50 to 100 basis points?
- How does that impact the property’s value and your projected IRR?
4. Exit scenario
- What if you need to hold the property longer than expected due to unfavourable market conditions?
- How does this affect your return profile and investment strategy?
Stress testing is crucial to ensuring your deal can withstand market changes. The free test is a good place to practise it: sit it, then move the assumptions in the finished model and watch what breaks first.