Introduction
Most investors are comfortable running standard underwriting models. But the difference between a good investor and a great one is stress testing—asking, “What if the worst happens?” Real estate markets shift, interest rates fluctuate, and tenant demand isn’t always predictable. Stress testing reveals whether your deal can withstand shocks.
What Is Stress Testing?
Stress testing is the process of running financial models under adverse scenarios. Instead of assuming everything goes according to plan, you model “downside cases” to see how the investment holds up.
1. What If Rents Drop 10%?
Rent growth projections often look great on paper, but what if they don’t materialize?
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If your $1,200/unit expected rent only brings $1,080, will the property still cover expenses and debt?
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A 10% rent decrease across 100 units means a $144,000 annual revenue loss.
If the deal only works under optimistic rent growth, it’s not stable.
2. What If Vacancy Rises?
Most investors assume 5% vacancy, but what if it jumps to 15%?
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Higher vacancy means less income but the same expenses.
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Many properties can’t withstand extended periods of high vacancy.
Stress testing reveals whether your operating reserves are adequate.
3. What If Interest Rates Increase?
With floating debt, even a 2% increase can erode cash flow dramatically.
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A $10M loan at 5% interest = $500K annual debt service.
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At 7% interest = $700K—a $200K difference.
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That can wipe out investor distributions.
4. What If Exit Cap Rates Expand?
A small change in exit cap assumptions can swing millions in valuation.
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Buying at a 5% cap and selling at a 5% assumes stability.
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If exit shifts to 5.5%, your sale price could drop by millions, crushing IRR.
Benefits of Stress Testing
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Investor Protection: Shows you’re realistic, not overly optimistic.
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Deal Screening: Eliminates weak opportunities early.
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Trust Building: Investors gain confidence knowing risks were considered.
Practical Tips
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Model at least 3 scenarios: base case, downside, and worst case.
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Always include vacancy stress, rent stress, interest rate stress, and exit cap stress.
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Build reserves to cushion against downside risks.
Conclusion
Real estate investing is about probabilities, not guarantees. Stress testing ensures your deal can survive unexpected shocks. If the numbers only work in the “best-case,” you’re speculating—not investing. Smart investors know: hope is not a strategy.
