Real estate investor software solutions

Profitability index is an investment return measurement much like net present value (NPV) with one notable difference.

NPV finds "the dollar amount difference" between the sum of present values of all future cash flows and the amount of initial investment whereas profitability index finds "the ratio".

Example. Say the present worth of all future cash flows exactly equals your initial investment. The NPV would be zero (because there is no dollar amount difference) whereas the profitability index would be 1.0 (because there is no proportionate difference).

The Advantage of Using Profitability Index

The advantage of using profitability index to measure investment opportunities is that "it allows you to compare two real estate investment opportunities that require different initial investments". Primarily because profitability index is not sensitive to the amount of the investment.

As a ratio, profitability index allows you to measure "the proportion of dollars returned to dollars invested", and therefore allows you to easily compare PV and initial investment on any number of investment opportunities.

Here's how to make the calculation.

Profitability Index = Present Value of all Future Cash Flows / Initial Cash Investment

How to Apply

PROPERTY A. Requires a cash investment of $150,000 and you estimate the PV of all its future cash flows at $160,000. Calculate profitability index by dividing the PV of future cash flows by your initial cash investment.

$160,000 / 150,000 = 1.070

PROPERTY B. Requires a cash investment of $90,000 and you estimate the PV of all its future cash flows at $99,000. Calculate profitability index by dividing the PV of future cash flows by your initial cash investment.

$99,000 / 90,000 = 1.10

Okay, which is the better deal?

Remember profitability index measures the ratio between cash flow to investment. Therefore, the higher the ratio the more cash flow to investment. So in this case the profitability index reveals that Property B is more profitable than Property A.

Here's a quick way to see whether or not you meet you meet your investment goal with profitability index.

• An index of 1.0 means you have exactly achieved your desired rate of return (i.e., the price you need to pay for the property based upon its future cash flows discounted at your rate of return is exactly right).
• An index greater than 1.0 means that you've exceeded your goal.
• An index less than 1.0 means that you failed to achieve your goal.

Simply put. To meet your investment goal always be sure the profitability index is 1.0 or better.

So You Know

ProAPOD® Real Estate Investment Software computes profitability index automatically as you enter the property and mortgage data. Profitability index is recalculated in real time each time you make changes to the data so it is always accurate, and instantly posted to the appropriate reports. Learn more at www.proapod.com.

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