Net Present Value - Saving Money
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.
Peter Flynn - Director Intercommercial Property Group
Intercommercial Property Group is an independent consulting firm providing strategic property advice and delivering effective property outcomes.