Net Present Value (NPV) is the dollar difference between the present value of all future cash flows a rental income property might generate discounted at some desired rate of return, and the amount of cash investment required to purchase that rental income property.
For instance, if the present value of all future cash flows generated from a property is $300,000, and the amount of cash required for you to purchase that property is $298,000, the net present value would be $2,000.
How it Works
First, let's consider what all the elements mean:
- Initial cash investment - This is amount of money an investor must invest out of pocket to make the property acquisition. Namely, the purchase price less the mortgage amount.
- Future cash flows - The revenue remaining each future year after payment for the operating expenses and loan, plus sales procceeds anticipated from a future sale.
- Discounting - The mathematical procedure for determining present value. In this case it would be the investor's desired rate of return.
Okay, now let's consider the investor's objective. He or she will use the net present value to determine whether or not the funds generated by the rental property are enough to satisty the yield they desire on their cash investment.
- A negative value indicates that the desired yield is not achieved
- A zero that the desired yield is exactly achieved
- A positive value that the desired yield is exceeded
How to Calculate
It's safe to assume that almost none of us can calculate NPV without the help of a financial calculator. But that's painstaking because financial calculators require so many key strokes—particularly for time value of money computations.
Okay, so let me show you a much faster and easier way to arrive at NPV using the Pro RE Calculator program I developed to overcome that obstacle.
Let's say that you want a 6% rate of return to invest $100,000 for a rental property projecting five annual cash flows of 2,000, 2,100, 2,200, 2,300, 2,400, plus cash proceeds of 130,000 anticipated from a future sale also in the fifth year.
Complete the appropriate form (see below) as such:
- The amount of your initial cash investment (CF0)
- Each of the annual cash flows (CF1) through (CF5). In cases where the cash flow might be a negative you would just add the minus (-) sign.
- The cash proceeds you anticipate from a future sale
- Your desired rate of return
The following image is a screenshot taken from Pro RE Calculator that shows you the calculation and NTV result (with explanation) from our example.
So You Know
The Net Present Value (NPV) calculation is included in the following ProAPOD solution:
Compute it quickly and easily.