Noi calculation investopedia7/27/2023 ![]() ![]() The intuition behind IRR and NPV is that it allows us to determine how much an investor should pay for a property, given his required rate of return, or discount rate. This ensures that the initial investment made in a property achieves the investor’s return objectives, given the projected cash flows of the property. Typically, the investor’s required rate of return is used as a discount rate, or in the case of an institutional investor, the weighted average cost of capital. What is the discount rate used for in commercial real estate analysis? In commercial real estate the discount rate is used in a discounted cash flow analysis to compute a net present value. In other words, discounting is merely the inverse of growing. When solving for the present value, the problem is one of discounting, rather than growing, and the required expected return acts as the discount rate. When solving for the future value of money set aside today, we compound our investment at a particular rate of interest. The discount rate is the rate used in a discounted cash flow analysis to compute present values. Another way to think about the cap rate is that it’s the inverse of the popular price/earnings multiple used in the stock markets. The cap rate is simply a measure that quantifies property value per dollar of current net income. Thinking of property value per dollar of current net income achieves this objective. What is a cap rate in commercial real estate useful for? Because individual properties differ greatly in size and magnitude, it’s helpful to talk about property prices and values in a common language. ![]()
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