Net Present ValueAs a measure of investment performance, the NPV is the present value of all cash flows associated with a commercial real estate investment over its holding period discounted at the investor’s required rate of return. These cash flows include and the initial cash outlay for acquiring the property, which includes not only the purchase price but also any other acquisition and pre-acquisition costs, such as, transfer fees, legal fees, consulting fees for evaluating the property, etc. If the NPV is greater than zero then it mean’s that the investment return exceeds the investor’s required rate of return; if it is negative then it means that the investment will provide a return lower than the required return by the investor. The formula for estimating the Net Present Value of a cash-flow stream discounted at a discount rate or required rate of return d is: NPV = CF0 + CF1/(1+d) + CF2/(1+d)2 +...+ CFn/(1+d)n where In Excel, the NPV can be calculated by typing "=NPV(Range)"where the Range includes all the cells that contain the cash flows of the property in each period of the holding period.
NPV = -200,000 + 120,000/1.12 + 720,000/(1.12)2 - 150,000/(1.12)3 = -200,000 + 107,142.86 + 573,979.59 – 106,767.04 = 374,355.41 In our example, the cash flow stream has a Net Present Value significantly higher than 0 indicating that the investment’s return is considerably higher than the discount rate of 12% used, which also represents and the investor's acceptable rate of return. If the Net Present Value came out negative it would mean that the project has an expected return below the 12%.
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