Financial Modeling is essential for making decisions to acquire, keep or sell investment real estate. The central aim is to provide a framework evaluating options and risks. Financial modeling is also utilized for decisions regarding material capital expenditures and leases. Financial modeling is used regularly by operating businesses to make a variety of decisions. Properties with multiple complex leases particularly benefit from the use of complex software such as Argus to evaluate the effect of leases terminating and being renewed overtime. Financial modeling is also used to evaluate complex iterative scenarios with multiple options.
Research and analysis for the subject property or business, industry and submarket is the first step in preparing a financial model. The financial analyst reviews three to 10 years of historical data including both revenue and expenses, with as much detail as possible. (In many cases, 30 to 100 line items of expenses are analyzed.) "Spreading the data" provides insights into typical levels of revenue and expenses and anomalous data points. Industry data such as IREM and BOMA for real estate provides additional context for evaluating whether historical expenses are typical, low or excessive. There are similar industry data reports for a variety of businesses, organized by SIC code.
Research and analysis regarding the current status and health of the market and probable future prospects for the market are the next step in preparing a financial model. For real estate, data such as occupancy rates, rental rate trends, economic vacancy, properties under construction in the metropolitan area, properties under construction in the submarket, proposed construction in the metropolitan area, proposed construction in the submarket, and likely trends for operating expenses are considered in developing a financial model. Similar financial model research is performed for operating businesses to gain insights into current and future trends.
The financial model considers both historical data and research regarding the current health and outlook for the market. The conclusion is summarized in a presentation of probable future cash flows. In some financial models, multiple scenarios are prepared to address the possible impact of uncertain material influences. Analysis of the cash flows often includes calculations of net present value or internal rates of return (IRR).