Net Present Value (NPV) Simplified
What Is NPV?
Net Present Value (NPV) is the difference between what a real estate investment is worth today and what it costs to buy. Just like with IRR, you use the NPV to assess whether or not a deal is profitable or not, taking into account the Time Value of Money. You calculate the value today, what we call the Present Value, by projecting the future cash flows and discounting them by a Discount Rate. The Discount Rate is the return you require based on the risk of the deal. The higher the Discount Rate, the lower the Present Value of the investment and the riskier the deal.
(Hint: Ever heard of a Discounted Cash Flow (DCF)? That’s exactly what this is.)
How to Calculate NPV
Use the NPV() function in Excel and select the cash flows. If you have specific dates, use the XNPV() function as this will give more accurate results since it considers irregular cash flow periods (like months with different days). NPV() assumes all cash flows occur in equal intervals. For both functions, you will be asked to consider input a Discount Rate, and then select the cash flows. For both functions, you should NOT include the investment amount (found in Year 0) when selecting the cash flows. If you do this, Excel will think you want to discount the initial investment amount which is incorrect, since the initial investment amount is already in Present Value terms. Check out the example below and this will make a lot more sense.
You must be careful. Despite the functions being called “NPV”, they calculate the Present Value. Yes, this means that despite there being a function called “NPV”, it does NOT tell you the Net Present Value of an investment - these functions calculate the Present Value. In Excel, you must use either the NPV() or XNPV() to discount the future cash flows and then subtract the initial investment amount. Subtracting the initial investment amount is what makes it the “Net” Present Value.
How to Interpret the NPV You Calculated
There are 3 possible outcomes:
If the NPV of the investment is greater than 0 (NPV > 0), it is a good deal, because the Present Value of future cash flows is greater than the investment amount
If the NPV of the investment is less than 0 (NPV < 0), it is bad deal, because the Present Value of future cash flows is less than the investment amount
If the NPV is equal to 0 (NPV = 0), then you are indifferent about doing the deal, because the deal offers the same returns as other, similar investments
(Bonus: The NPV and IRR of investments are directly related, meaning that if your IRR analysis suggests you should do the deal (Project IRR > Required IRR), then your NPV analysis will give the same conclusion (NPV > 0))
Example
Below we have an example investment, the exact same one from the IRR lesson in fact. We purchase the property for $4,500,000 in Year 0, hold it for 5 years while collecting the cash flow, and then sell the property at the ending of Year 5. For this investment, we see that the NPV is greater than 0 (NPV > 0), therefore this is a good investment.
To calculate the NPV, I used the NPV() function and selected the Discount Rate and then all of the cash flows outside of the initial investment period (in the green boxes). This gave me a Present Value of $5,421,284. To get the Net Present Value, I subtracted the initial $4,500,000 investment from the $5,421,284 Present Value amount ($5,421,284 - $4,500,000 = $921,284).
Key Takeways
NPV helps you answer one of the most important questions in real estate investing: Is this deal actually worth doing? By comparing the future cash flows of a project to what you’d need to invest today, NPV gives you a direct, dollars-and-cents measure of value.
It’s not always intuitive at first — especially when discount rates and timing come into play — but once it clicks, it becomes one of the most useful tools in your modeling toolkit.
If you’re still working to understand NPV or want help applying it to a real deal or assignment, schedule a 1-on-1 session and get the guidance you need.