Real Estate Valuation: NPV & IRR Analysis

NPV and IRR analysis can be applied to real estate valuation.

The standard decision rules apply, in that an NPV greater than zero or an IRR above the required rate of return indicates that the real estate investment should be undertaken.

IRR Challenges for Real Estate Valuation:

  • IRR cannot properly value real estate investments where cash flows begin positive and become negative for a period.

  • IRR may not properly rank mutually exclusive projects, when the size and timing of the cash flows are materially different.

After Tax Cash Flows (ATCF)

In order to perform a discounted cash flow valuation, analysts need to know a real estate investment’s after tax cash flows (ATCF) and after tax equity reversion (ATER).

ATCF = Net Operating Income – Mortgage Payment – Income Taxes

ATCF must be used in conjunction with a property’s After Tax Equity Reversion (ATER), which is realized upon sale of the property at the end of the investment time horizon.

ATER is conceptually similar to the terminal value in stock valuation.

After Tax Equity Reversion (ATER)

ATER: The non-operating cash flow generated by property sale at the end of the investment horizon.

ATER = Net Sales Price – Capital Gains Tax – Mortgage Balance.

ATCF and ATER are used to perform an NPV or IRR analysis and this can be done on a CFAI approved calculator (HP 12C or TI BA2+).

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