PAYBACK PERIODThis real estate invetment metric is discussed along with several other investment performance measures with examples in the e-book Real Estate Investment Mathematics. The simplistic formula below can provide an estimate of this measure, if the anticipated cash flow from the property is expected to be constant through time. PP = Equity Investment Cost / Annual After Tax Cash Flow (15) This measure has several limitations. First, the annual-cash flows of a property are seldom constant, especially if it is a large one with multiple tenants. Second, this measure ignores cash flows to the investor after the payback period. Third, it ignores any potential appreciation gains. In order to apply (15) one needs tocalculate the After Tax Cash Flow (ATCF). The formula for calculating ATCF is the following, assuming that borrowing is used: ATCF = NOI– (Taxable Income * Tax Rate) – Debt Service (16) Taxable Income in (16) is calculated as follows: Taxable Income = NOI – Depreciation – Interest Payment (17)
Example (continuing from previous) Equity Investment Cost = $250,000 NOI = $100,000 Depreciation Rate = 2% Interest Payment = Loan Amount * Interest Rate = 0.06 * 800,000 Debt Service = 69,748 Tax Rate = 25% With this information we can now calculate the taxable income, the ATCF and period needed for payback: Taxable Income = 100,000 – 0.02*1,000,000 – 48,000 =100,000 – 20,000 – 48,000 = 32,000 Tax payment = 32,000 * 0.25 = 8,000 ATCF = 100,000 – 8,000 - 69,748 = 22,252 PP = 250,000/22,252 = 11.23 Thus, in this example, the "payback period" is 11.23 years. This is an excerpt from the e-book Real Estate Investment Mathematics.
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