The net present value (or NPV) is a measure of real estate investment widely used by investors in an investment real estate analysis for a specific purpose: the net present value tells the investor if a property will reach its target rate of return and , therefore, it should attract the investor’s capital in that investment.
Here is the technical interpretation.
What attracts us to James Bond or Sandra Bullock Net Worth? Well, for one they are spies and they go around the world to save him and do all sorts of things in the process. They fight with their own hands and weapons; It drives cars, planes and helicopters in the most hasty way; Challenge all kinds of hazards and use a range of sophisticated gadgets as a means to achieve ends. Well, if your son wants his own gadget to become a spy, or at least pretend to be, there’s good news for you: the Spy Net Secret Mission Video Watch.
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The net present value model is based on a decision rule that states that if the discounted present value of future benefits is equal to or greater than the cost of those benefits, it is a profitable opportunity. While, if the present value of future benefits is less than the cost of those benefits, the rate of return will not be achieved and it is very likely that the investor should take another look.
Well, let’s frame the idea with a simple illustration.
When you put your money in a savings account (that is, invest your capital), you expect it to earn interest (that is, to provide future benefits). The bank issues the refund and you are willing or unwilling to commit your capital based on your acceptance of that refund. For example, while you could deposit $ 10,000 to earn an interest of 3.8%, you might not make the investment to earn 1.2% interest.
Fair enough. But suppose the bank does not quote an interest rate. Only the amount of money that may be charged in the future. Only next year will collect $ 10,300 with a deposit of $ 10,000 today. If you did not mention an interest rate, how would you know what return your investment is earning?
That is the dilemma facing real estate investors when they analyze the income of the properties. There is a projection for both the amount of the investment and the future benefit, but no mention is made of the performance. The investor has no idea what rate of return is achieved based only on that data, and therefore there is no way to adequately compare it with other potential investment opportunities.
This is where the net present value comes in.
The NPV allows you to connect an objective return to a property and then informs you if the future cash flows (benefits) generated by that property will be sufficient to achieve that return on your capital investment or not.
How does it work
The NPV discounts all future cash flows at the desired rate of return to arrive at the present value of those future cash flows and deducts that amount from the initial equity (or capital invested). The result is a dollar amount that will always be negative, zero or positive.
How to interpret
1) Negative amount in dollars: this means that the present value of future benefits is less than the amount invested and that the specified rate of return is not met. In other words, you may want to move to another property.
2) Amount of zero dollars: this means that the present value of future profits is equal to the amount of the investment and that the desired performance is perfectly fulfilled. In other words, the property will achieve the return you want but no space to spare.
3) Positive dollar amount: this reveals that the desired rate of return is met with space to spare. In other words, you may have found a guardian.
Undoubtedly, it is worth knowing the net present value, and when used properly it can help you evaluate your next real estate investment opportunity. But keep in mind that it is only one aspect of the investment analysis in real estate, it should not dictate an investment decision and it is not free of deficiencies.
Yes, the VAN will give you the opportunity to evaluate projects using the same rate of return requirements, but will not provide any useful information about one project over another from a risk point of view.
Finally, I should add that the NPV is not practical to calculate without using a financial calculator or real estate investment quality software. If you are serious about investing in real estate, then invest in a good real estate software solution that offers net present value along with other real estate analysis functions that also benefit you.