Like many others, if you have no idea about real estate investments, Cost-Benefit Analysis, net present value is not less than an alien word for you. In simple terms, it is the way you measure the investment performance of a property. To calculate its value, you have to convert the investment cash flows into an amount that will help a real estate investor make correct analysis and comparison decisions. The value holds true in either of the two cases; you want to optimize your funds at a given time or lower a cost to get a particular benefit.
If you are writing a case study or Foreign Direct Investment on real estate value calculations, you need to know about the components to calculate or interpret net present value.
The future sale proceeds you will receive or expect to receive during the time of owning a property are discounted back with the discount rate to measure the present value of funds added to your primary investment. It is the best way to define net present value. (Brand Management)
Let's take a look at the components.
- Holding period
At a given time, you want to hold the property or invest in the property. It can be five years, ten years or more, but it can never be for perpetuity. (Dissertation Structure)
- Primary Investment
It is the net cost of investment. You can calculate it by adding the loan point to the property's price and deducting it from the total amount of the loan. Suppose Procter And Gamble pays $ 100000 for a property and get a loan for $ 70000 at one point, their primary investment will be the price of the property ($100000) minus the loan ($80000), that is $20800
- Cash flow
It is the estimated funds that are collected at the end of each year. You can calculate the cash flow by deducting the operating expenses, debt services and taxes from the property's rent.
- Sale proceeds
The amount that you expect to receive by selling the held property is sale proceeds. However, you have to deduct the brokerage commissions, remaining loan balances and tax from the sale of the property from the actual sale price to get the nets ale proceeds.
- Discount rate
In easy terms, it is the minimum rate of return you want to receive from holding and being the property owner.
If you are a student or a practised expert, learning about the net present value is crucial if you are interested in real estate. You can better understand the components of the net present value from the discussion above.