NPV Financial Analysis - Q1/2021
The Net Present Value (NPV) is the sum of all cash inflows and outflows attributed to a property, each being discounted back to a Present Value (PV).
The main principle behind NPV analysis, is the value of a cashflow, discounted or reduced, for the purpose of timing. This is primarily attributed to the opportunity cost of money, with a PV factor applied to the cashflows, under the premises that a Dollar today holds more value than a Dollar received at some time in the future. For an investor, the sum of all the discounted cashflows is the NPV of the rental stream (property). Alternatively, for a tenant it is the NPV of the total discounted outflows, comprising a lease commitment for a premises.
The key is to identify expected cashflows associated with a rental, or investment property. The primary outflows for a Lessee (tenant) are the rent, outgoings, carparking, fitout costs and other sundry costs, such as cleaning and make good. A possible inflow for a tenant is an incentive paid by the Lessor (property owner) to secure the tenant. Conversely, the reverse applies with a Lessor, as inflows are the rental and outgoings etc. Whereas, an incentive paid to a tenant by the property owner would be classified as an outflow.
It is important to accurately estimate the cashflows from a business, budgeting and investment perspective, when comparing NPV's between different properties (or options).
One limitation of the NPV model is the difficulty in accurately estimating the Discount Rate. This is often a subjective decision, rather than an objective measure. In the standard NPV model, the Discount Rate includes the impact of inflation.
Ideally, a spreadsheet model of NPV calculations should begin with a section summarising the assumptions to be adopted, such as the rental inflows, outflows and the discount rate.
The benefit is a concise summary of the assumptions adopted, including a direct link into the spreadsheet. This avoids a repetitive manual entry process, together with the possibility of making mistakes. In addition, it is easier to monitor any changes in the key assumptions adopted.
Intercommercial Property Group uses NPV financial analysis as a key component of its property analysis and decision-making criteria.