Net Present Value is a Valuable Tool for Analyzing Investment Property

Investment property is a worthwhile undertaking, if it creates value for the owner. In the most general sense, we create value by identifying an investment worth more in the marketplace than it costs us to acquire. The difference between an investment’s market value and its cost is called the net present value (NPV) of the investment. In other words, NPV is a measure of how much value is created or added by taking on an investment property.

Suppose you are considering the purchase of a property for $1,000,000. The property has a single, high credit-rated tenant; the lease is triple net and there are eight years remaining. The property generates $45,000 net cash per year. If 20% is the down payment and your required discount rate is 14%, what is the NPV on this property?

Since the cash flows are equal each year, we effectively have an eight-year annuity. Using an annuity table, we can determine that the factor for 8 years at 14% is 4.6389. If we multiply the annual cash flow by this factor we get $208,750 (these are the discounted cash flows). Subtracting our down payment of $200,000 we end up with $8,750, therefore, this is a good investment. Had the result been negative, then the effect on value would have been unfavorable and we would pass on this investment opportunity.

Sounds simple, doesn’t it? Calculating the NPV is fairly straightforward; however, the task of coming up with accurate cash flows, determining future market value of the property, and selecting the correct discount rate is much more challenging. HUNT Commercial Real Estate has the experience to provide comprehensive investing solutions, and licensed professionals across Upstate New York to give you expert local support.

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