How to Use Net Present Value to Evaluate Property Price

Any real estate investor who has tried to evaluate the price for a rental property with time value of money consideration has undoubtedly used net present value (NPV).

Although it should not be used as the only factor to decide whether a real estate investment provides a good buying opportunity, NPV does provide the investor with a quick and easy way to determine whether the price that will be paid for the property will yield the investor's desired rate of return (discount rate).

What is net present value?

NPV is the difference between the present value (PV) of all future cash flows produced by a rental property and the amount of cash investment (or, initial investment; i.e., down payment and closing costs) required to purchase the property. For example, let's assume that the real investor desires a 10% yield on all future cash flows, must invest $100,000 cash to purchase the rental property that might produce those cash flows, and wants to know whether the price he will pay achieves his desired yield. He would calculate NPV.

Here's how it works.

First, all future cash flows would be discounted back at 10% to determine the present value of those cash flows. Secondly, the $100,000 initial investment would be deducted from the PV. The difference between the two is the NPV. For example, if the present value winds up equaling $110,000, the $100,000 would be subtracted to determine a net present value of $10,000 ($110,000 - 100,000 = 10,000). Whereas, if the PV calculates at $90,000, the NPV would be -$10,000 ($90,000 - 100,000 = -10,000).

What does it mean?

Whenever the NPV is greater than zero, it means that the discounted value of the future cash flows is greater than the initial investment. In other words, you are getting a good deal and getting a rate of return that is actually higher than the discount rate you desire (in fact, you can pay $10,000 more for the property and still achieve a 10% yield). Likewise, any NPV less than zero means the opposite. You are getting a lower rate of return than you desire, and would have to pay $10,000 less for the property to get a 10% rate of return.

A proforma income statement that includes a calculation for net present value is available for you to preview in a sample real estate investment property analysis report.

About the Author

James R Kobzeff is an active real estate broker and developer of ProAPOD. Quality real estate investment software - real estate investment analysis software - real estate investment blog.

For More Info Visit
http://hot-us-real-estate.blogspot.com/
http://seized-real-estate-propertyinvetment.blogspot.com/