Complete Guide to Using a Net Present Value Calculator

Financial calculators can tell you a lot about real estate, property investment, and running a rental management business. One of the main things people use them for is to predict and calculate profits and how valuable an investment is (or could be).

Net present value is one of the calculations that help measure the success, or future success, of a potential investment- but what exactly does it mean, and how can you apply it to real estate?

This comprehensive guide has the answers- with a few examples of what this calculation looks like for this industry.

What Is Net Present Value?

Net present value (NPV) is a measurement comparing the value of cash outflows and cash inflows over time. It looks at the difference between the two and finds the current value of predicted future cash flows to determine whether or not it is a good investment.

The calculation works by adjusting the future cash flow value to find out what it is worth today. Using a discount rate, it assesses the present values of sums of money expected to be earned in the future. That way, the figures are comparable without inflation and other factors influencing the numbers.

How Is Net Present Value Calculated?

Before we look at formulas, let's talk about what is needed to calculate NPV.

First, an investor has to estimate or predict the amounts and timings of future cash flows in and out.

Next, they must pick a discount rate to be applied to the figures to account for the time difference. The rate picked should be the same as the minimum rate of return that is acceptable for the initial investment.

NPV Formula

The formula for an NVP calculation where only a single cash flow at a specific point in time looks like this:

• i = the discount rate
• t = the time periods

Calculating NPV with multiple cash flows looks a lot more complicated. In this case, the equation looks like this:

• i = the discount rate
• t = the time periods
• Rt = net cash inflows or outflows

These variables should be altered to fit your investment opportunity.

The discount rate, as discussed, should match the minimum rate of return for the investment. The time period can be the number of years, number of months, etc.

Your cash flow amounts are the incomings and outcomings you expect to occur in those time periods. These should not be adjusted- just input them at face value.

What Factors Affect Net Present Value?

The primary factor influencing NPV is the balance between what you need to spend and what you expect to come back in. Like any investment, you want to know that you can earn more than you put in.

Many people question why a discount rate is applied to an NPV calculator. Obviously, the discount rate you put into the calculation affects the value that comes back significantly, but it is an important inclusion.

In a world with a positive interest rate, today's dollars are worth more than tomorrow's dollars. As time goes on, inflation eats away at the value of a dollar. If invested, that dollar can generate returns.

You need to apply a discount rate for the minimum acceptable rate of return for your dollar to determine if it is worth taking the risk. If you could earn 8% risk-free by putting that money into a treasury bond, for example, you need to know this investment can earn you more.

If an investment cannot generate higher returns than you could get by leaving your money in a savings account or a low-risk bond, then it is probably not worth undertaking.

Example of a Net Present Value Calculation

Say, for example, your initial investment costs came to $800,000 (including your down payment, closing costs, renovation expenses, etc.).

You apply a discount rate of 5% and want to calculate your NPV for five years.

To begin with, you would calculate what you expect to earn through the property each year. In this industry, that is most likely your rental income. Let's say you expect to earn $25,000 each year in rent.

Next, you would calculate your operating expenses and other outgoing cash flows. Assuming you do not have any one-off expenses over the next five years and your expected annual outgoings for the property are $5,000, you would input $20,000 each year for five years.

The calculator will automatically apply the discount rate annually and show you that the expected NPV for this property is $6589.53.

How did we get to that figure? At face value, you would have made $20,000- but the cumulative discount rate over the five years reduces that sum.

Some calculators will also show you your internal rate of return (IRR) based on these numbers- as well as your gross return on investment to date.

What Is a Good NPV?

Any calculation that brings back a negative NPV (less than o) means an investment is probably not a good one. An NPV of zero is neutral, meaning it is only expected to cover the inflation discount- and is, therefore, not a good use of your time or money.

All investors want a positive NPV, but what figure one person considers good might not work for another. It depends on risk tolerance and investment strategy- and it is up to the individual what number they want to see.

Limitations to Be Aware Of

The biggest drawback of an NPV calculation is the fact that it is based on assumptions, and the figure is an estimate. Predictions of future cash flows are not guaranteed facts- they are essentially guesses (albeit educated guesses based on the data available).

A net present value calculator doesn't show the whole story, and if an assumption about what will happen with expected cash flows turns out to be incorrect, the actual NPV could be very different.

How Does DoorLoop Help?

DoorLoop helps people manage their properties and maximize profitability from their investments. The rental property business has many ins and outs, and managing tenanted properties as a way to increase your NPV is one that brings a lot of tasks with it.

Being a landlord or running a rental property business is an exciting and fulfilling way to generate profits through real estate, but only if you have a smart solution in place for running things.

DoorLoop provides all the tools you need to take your property business to the next level- boosting productivity, profitability, and efficiency.

Keep track of your cash flow with a full suite of accounting tools and built-in reporting systems. Use DoorLoop calculators to measure important financial data and generate income with less hassle with a fast and convenient online rent collection portal.

These are just some of the ways DoorLoop makes a difference- it provides support from every side. From marketing and listing to lease and maintenance management- DoorLoop does it all.

If you want to find out more and see firsthand what DoorLoop could do for your business, schedule a free demo today to get started!

Summary

Calculating NPV helps you establish whether or not a property is a good investment, but it should not be the only indicator you use. It has other uses too, but across the board, relies on the estimations regarding the future value of cash flow.

Financial calculators are useful tools but should be used as a guide in this case.

DoorLoop can help you optimize profitability in your current rental properties and make it easier to keep on top of finances. Make your life easier and take your business to new heights.