Present Value
The lump-sum value today of a string of future cash flows discounted back to today at a specified discount rate. In real estate, the Present Value of a real estate investment is the price that an investor would be willing to pay today for a string of future real estate cash flows so as to achieve a given target return (discount rate). In order to calculate Present Value, a discounted cash flow statement must be built forecasting the future net cash flows of a real estate investment.
Net Present Value is the Present Value of investment inflows (i.e. positive cash flows) less the present value of investment outflows (i.e. negative cash flows). In most cases, this means calculating the present value of all future cash flows, and subtracting the amount paid for the investment in time zero.
So, if the Present Value of an investment is $1,000,000 and the investor must pay $750,000 to acquire that investment, the Net Present Value would equal $250,000 ($1,000,000 – $750,000).
In Excel, the Present Value is best calculated using the NPV() function, not including the value in time zero in the selected range. NPV is arrived at by calculating the Present Value and then subtracting the amount invested in time zero.
Putting ‘Present Value’ in Context
Overview of the Scenario
Summit Capital Partners, a real estate investment firm specializing in Core-Plus industrial properties, is evaluating the acquisition of the Prairie Logistics Center, a 250,000-square-foot warehouse located in suburban Chicago, Illinois. The property is fully leased to a single tenant on a triple-net lease, with a lease term remaining of 8 years. The tenant’s annual rent is $1,000,000, and Summit Capital Partners expects to sell the property at the end of the 8-year period for $14,000,000. The firm uses a discount rate of 8% to evaluate the deal.
Calculating Present Value
Summit Capital Partners builds a discounted cash flow (DCF) model to project future cash flows. The cash flows consist of:
- Annual Net Rent: $1,000,000 for 8 years.
- Sales Proceeds: $14,000,000 in year 8.
Using the formula for Present Value:
PV = ∑ CFt / (1 + r)t
Where:
- CFt = Cash flow in year t
- r = Discount rate (8% in this case)
- t = Year of the cash flow
Summit calculates the present value of the projected cash flows.
DCF Breakdown
- Years 1-8 (Net Rent): Each year’s rent of $1,000,000 is discounted back to the present at 8%. The total present value of the rent cash flows over 8 years is approximately $6,310,403.
- Year 8 (Sales Proceeds): The sales proceeds of $14,000,000 are discounted back to the present at 8%. The present value of this future cash flow is approximately $7,000,000.
The total Present Value is the sum of these discounted cash flows.
Key Figures
The Present Value of the Prairie Logistics Center’s cash flows is calculated to be $13,310,403. Summit Capital Partners is considering an acquisition price of $10,000,000.
Net Present Value
Net Present Value (NPV) is calculated as:
NPV = PV - Initial Investment
NPV = 13,310,403 - 10,000,000 = 3,310,403
The positive NPV indicates that the investment is expected to generate a return above the target discount rate of 8%.
Decision-Making
Summit Capital Partners uses the Present Value and NPV as part of its investment decision framework. With a positive NPV of $3,310,403, the firm concludes that acquiring Prairie Logistics Center is a highly attractive investment opportunity. The strong NPV demonstrates that the property will not only cover the firm’s required return of 8%, but it will also provide substantial additional returns over the 8-year holding period.
This hypothetical scenario illustrates how Present Value helps investors assess whether the future cash flows of a real estate investment justify the acquisition cost.
Frequently Asked Questions about Present Value in Real Estate Investing
What is Present Value (PV) in real estate investing?
Present Value is the lump-sum value today of a string of future cash flows, discounted back at a specified discount rate. In real estate, it represents how much an investor would pay today for future cash flows from a property to achieve a desired return.
How is Net Present Value (NPV) different from Present Value?
Net Present Value (NPV) is the Present Value of all future investment inflows minus the cost of the investment. For example, if Present Value is $1,000,000 and acquisition cost is $750,000, the NPV is $250,000.
How did Summit Capital use Present Value to evaluate their investment?
Summit Capital Partners calculated the Present Value of future rent and sale proceeds for Prairie Logistics Center using a discount rate of 8%. The PV came out to $13,310,403, and with a $10,000,000 acquisition cost, the resulting NPV was $3,310,403—indicating a strong investment.
How do you calculate Present Value in Excel?
Use Excel’s =NPV() function to calculate the Present Value of future cash flows. Note: do not include the initial investment (time zero) in the selected range; subtract it manually to arrive at NPV.
Why is discounting future cash flows important?
Discounting adjusts future cash flows to reflect their value today, accounting for time value of money and investment risk. It helps determine whether an investment meets required return thresholds.
What role does the discount rate play in Present Value calculations?
The discount rate reflects the investor’s target return or required rate of return. A higher discount rate reduces Present Value, indicating greater perceived risk or return requirements.
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