How to round numbers correctly for REI analysis

For Want Of A Nail
Image via JepQueens.com

A small rounding of initial numbers can lead to catastrophic results of real estate analysis. Correct rounding preserves the reliability of the analysis.

Table of Contents

Jon Kelly, an investor from Bethlehem, Pennsylvania gave advice on the rental calculator at BiggerPockets.com:

Adjust rent to what you would actually charge. I'm sure you look at rentometer or some other tool to find the average rent is $1,233. You won't what a tenant $1,233. Adjust to $1,200 or $1,250

Jon Kelly' advice mixes 2 values of rents:

  • Value for tenants. Indeed, it's desirable to round it up
  • Value for the rent calculator.  BiggerPockets' calculator doesn't need rounded data.It easily calculates unrounded values.  After all, it's the computer, not an abacus:
Abacus
Image via Wikipedia.org

The rounded rent value that is used for the tenant cannot be used for the property acquisition analysis. For real estate analysis, we need to have the rent as accurate as possible.

Example

The difference between the exact rent value of $1233 and the rounded value of $1200 is only $33. This is from the tenant's point of view.

The analyst has a different point of view. The $33 decrease in rent leads to catastrophic results in the bottom line of the analysis.

First, the rent will be charged 12 times per year. And the $33 reduction in monthly rent will reduce the annual income to $396.

Second, the analysis must account for 2 percent rent growth each year. As the rent increases, the loss from rounding off the incoming flow increases.

Third, we must add up all the annual damages from rent rounding over all 40 years. This will allow us to calculate what it will cost us in the long run to reduce the rent by $33:

Rounding Error Formula

The formula is calculated using the FreeMathHelp.com calculator.

The $33 rent rounding turns into the inbound loss of $23919.19 over the entire analysis period. See how the cumulative losses of the $33 rent reduction, increases rapidly each year:

Plot

A little rounding of the raw data can destroy the whole analysis. A profitable acquisition can start to look like a loss-making one.

For Want Of A Nail

Benjamin Franklin wrote in his Poor Richard's Almanack:

For want of a nail the shoe was lost.
For want of a shoe the horse was lost.
For want of a horse the rider was lost.
For want of a rider the message was lost.
For want of a message the battle was lost.
For want of a battle the kingdom was lost.
And all for the want of a horseshoe nail.

The Rules of Rounding

Rule #1. Use unrounded data as input parameters for the real estate analysis.

Rule #2. Only the final results of the analysis can be rounded.

Rule #3. Once the final parameters have been rounded, they cannot be used to obtain other analysis parameters.

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