Net Present Value

4 Replies

I'm using an investment analysis program that allows me to input NPV (can input a percentage for before tax and after tax to help determine the value of an investment opportunity). My question is how important is it in deciding an investment. From my understanding it is used to compare the current investment to another lower risk option available. The ratios that have been using are 5% before tax and 3% after taxes. Would love feedback on my understanding.

Thanks

@Brian Sealey NPV like IRR ard DCF are great for convincing an investment committee, outside investors or sophisticated jv partners to come on board a deal because they're comparing what you're offering to what other shops have. But, if it's just you in the deal and/or the property is a fourplex that kind of analysis is total overkill.

When you go to a bank for financing they're not running those kinds of numbers because what's really important is that they're comfortable the property will throw off enough cash flow to cover debt service with a margin of safety and be worth enough that they can recover their principal if you default.

Those two things should be an investors main concerns as well; does the property comfortably throw off enough cash to make it worth my while and will it be worth more in the future than it is today? If the deal is an income property, i.e. 5+ unit apartment building, self storage facility, mobile home park, office building, retail center, etc then the value can be calculated from the Net Operating Income capitalized at some given rate. If the property is a house, duplex, triplex, fourplex (some say anything under 10 units is a plex) it's value will be determined by comps and therefore isn't an income property that running numbers on will produce anything meaningful.

And speaking of meaningful numbers one of the biggest problems with NPV, IRR and DCF is that the results are very influenced by things that happen in the future, which is very difficult to predict. So much of their returns are generated by what amounts to educated guesses and so much of a property's return is generated by how it is operated that the two can be pretty incomparable.

Good hunting-

Thanks for the response. Analysis Paralysis for me it seems. Thanks for helping me come to terms with this

I am assuming you are looking at a smaller income property as Giovanni mentioned 'plexes'. In these cases it is very difficult to normalize current condition. If a quad has one 10'year old boiler, how long is it going to last? If an apartment building has 100 hot water heaters that are 6 years old you can start predicting with more surety. On smaller properties it's more of a guess when major repairs will come up.

NPV is mostly useful for determining whether spend with a delayed sale makes sense. So let's say building an office building, then takes 2 years of holding below cost before the space is absorbed completely, then sold off to another company in 5 years.

The biggerpockets 50% rule and 2% rule are more useful for comparing different properties. Usually I will take these rules and start to normalize them for the conditions of the specific deal. It's not as fancy as IRR or NPV but the way those calculations leverage the base assumptions means if your off on a factor it can swing the valuation way off.

@Tyler Weaver  that makes a lot of sense. It once again helps realize that I can over think things. Practical is the key. I'll look up the 50% rule. Thanks 

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