A.CRE

Present Value

The lump-sum value today of a string of future cash flows discounted back to today at a specified discount rate. In real estate, the Present Value of a real estate investment is the price that an investor would be willing to pay today for a string of future real estate cash flows so as to achieve a given target return (discount rate). In order to calculate Present Value, a discounted cash flow statement must be built forecasting the future net cash flows of a real estate investment.

Net Present Value is the Present Value of investment inflows (i.e. positive cash flows) less the present value of investment outflows (i.e. negative cash flows). In most cases, this means calculating the present value of all future cash flows, and subtracting the amount paid for the investment in time zero.

So, if the Present Value of an investment is $1,000,000 and the investor must pay $750,000 to acquire that investment, the Net Present Value would equal $250,000 ($1,000,000 – $750,000).

In Excel, the Present Value is best calculated using the NPV() function, not including the value in time zero in the selected range. NPV is arrived at by calculating the Present Value and then subtracting the amount invested in time zero.

Putting ‘Present Value’ in Context

Overview of the Scenario

Summit Capital Partners, a real estate investment firm specializing in Core-Plus industrial properties, is evaluating the acquisition of the Prairie Logistics Center, a 250,000-square-foot warehouse located in suburban Chicago, Illinois. The property is fully leased to a single tenant on a triple-net lease, with a lease term remaining of 8 years. The tenant’s annual rent is $1,000,000, and Summit Capital Partners expects to sell the property at the end of the 8-year period for $14,000,000. The firm uses a discount rate of 8% to evaluate the deal.

Calculating Present Value

Summit Capital Partners builds a discounted cash flow (DCF) model to project future cash flows. The cash flows consist of:

  • Annual Net Rent: $1,000,000 for 8 years.
  • Sales Proceeds: $14,000,000 in year 8.

Using the formula for Present Value:

PV = ∑ CFt / (1 + r)t

Where:

  • CFt = Cash flow in year t
  • r = Discount rate (8% in this case)
  • t = Year of the cash flow

Summit calculates the present value of the projected cash flows.

DCF Breakdown

  • Years 1-8 (Net Rent): Each year’s rent of $1,000,000 is discounted back to the present at 8%. The total present value of the rent cash flows over 8 years is approximately $6,310,403.
  • Year 8 (Sales Proceeds): The sales proceeds of $14,000,000 are discounted back to the present at 8%. The present value of this future cash flow is approximately $7,000,000.

The total Present Value is the sum of these discounted cash flows.

Key Figures

The Present Value of the Prairie Logistics Center’s cash flows is calculated to be $13,310,403. Summit Capital Partners is considering an acquisition price of $10,000,000.

Net Present Value

Net Present Value (NPV) is calculated as:

NPV = PV - Initial Investment

NPV = 13,310,403 - 10,000,000 = 3,310,403

The positive NPV indicates that the investment is expected to generate a return above the target discount rate of 8%.

Decision-Making

Summit Capital Partners uses the Present Value and NPV as part of its investment decision framework. With a positive NPV of $3,310,403, the firm concludes that acquiring Prairie Logistics Center is a highly attractive investment opportunity. The strong NPV demonstrates that the property will not only cover the firm’s required return of 8%, but it will also provide substantial additional returns over the 8-year holding period.

This hypothetical scenario illustrates how Present Value helps investors assess whether the future cash flows of a real estate investment justify the acquisition cost.

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