Present value applied to real estate
Present value
Present value helps you compare money received in the future with money you have today.
It answers a simple question:
How much is a future amount of money worth right now?
Because money today can be saved or invested, it is usually worth more than the same amount received later.
Why present value matters
You use present value when you want to:
- compare money at different points in time
- understand what future payments are worth today
- decide between options that pay now or later
The basic idea
Money received in the future is discounted back to today.
The discount depends on:
- how long you have to wait
- the rate of return you could earn elsewhere
The longer you wait, or the higher the rate, the lower the present value.
Present value formula
The standard formula is:
Present value = Future value ÷ (1 + rate)ⁿ
Where:
- future value is the amount you receive later
- rate is the annual return (or discount rate)
- n is the number of years
You do not need to memorise this formula to understand the concept, but it helps explain the examples below.
Example 1: rental property that almost breaks even
You are considering buying a small rental flat.
Assumptions
- Purchase price today: £200,000
- Net rental income: £10,000 per year
- Rental period: 10 years
- Sale price in year 10: £220,000
- Discount rate: 6%
Discounting the rental income
Each annual rent payment is discounted back to today.
The present value of a single year’s rent is:
- Year 1: £10,000 ÷ 1.06¹ = £9,434
- Year 5: £10,000 ÷ 1.06⁵ = £7,473
- Year 10: £10,000 ÷ 1.06¹⁰ = £5,584
| Year | Cash rent (£) | Discount factor (6%) | Present value (£) |
|---|---|---|---|
| 1 | 10,000 | 0.943 | 9,434 |
| 2 | 10,000 | 0.890 | 8,900 |
| 3 | 10,000 | 0.840 | 8,396 |
| 4 | 10,000 | 0.792 | 7,920 |
| 5 | 10,000 | 0.747 | 7,473 |
| 6 | 10,000 | 0.705 | 7,049 |
| 7 | 10,000 | 0.665 | 6,650 |
| 8 | 10,000 | 0.627 | 6,274 |
| 9 | 10,000 | 0.592 | 5,919 |
| 10 | 10,000 | 0.558 | 5,584 |
| Total | 100,000 | 73,600 |
When you discount all 10 payments and add them together, the total present value of rental income is approximately:
- £73,600
What this means in practice
Although the rent adds up to £100,000 over 10 years in cash terms, it is only worth £73,600 in today’s money at a 6% required return. The gap represents time, risk, and the opportunity cost of your capital.
Discounting the sale price
You expect to sell the property for £220,000 in year 10.
Discounted to today:
- £220,000 ÷ 1.06¹⁰ ≈ £122,900
What this means in practice
That future sale price sounds higher than what you paid, but in today’s terms it is worth far less. Inflation, uncertainty, and the delay in receiving the money all reduce its value.
Total present value and decision
- Present value of rent: £73,600
- Present value of sale: £122,900
- Total present value: £196,500
Compared with the purchase price:
- Cost today: £200,000
- Value today: £196,500
Decision insight
At a 6% discount rate, you are slightly overpaying. The numbers are close, which tells you the deal is sensitive to small changes:
- a small increase in rent
- a slightly higher sale price
- a lower required return
Present value highlights how thin the margin really is.
Example 2: higher yield, shorter holding period
You now consider a different property with stronger cash flow.
Assumptions
- Purchase price today: £150,000
- Net rental income: £12,000 per year
- Rental period: 5 years
- Sale price in year 5: £155,000
- Discount rate: 7% (higher risk)
Discounting the rental income
Using a 7% discount rate:
- Year 1: £12,000 ÷ 1.07¹ = £11,215
- Year 3: £12,000 ÷ 1.07³ = £9,796
- Year 5: £12,000 ÷ 1.07⁵ = £8,559
| Year | Cash rent (£) | Discount factor (7%) | Present value (£) |
|---|---|---|---|
| 1 | 12,000 | 0.935 | 11,215 |
| 2 | 12,000 | 0.873 | 10,476 |
| 3 | 12,000 | 0.816 | 9,796 |
| 4 | 12,000 | 0.763 | 9,156 |
| 5 | 12,000 | 0.713 | 8,559 |
| Total | 60,000 | 49,900 |
Adding all five discounted payments gives a total present value of rent of approximately:
- £49,900
What this means in practice
The rent totals £60,000 in cash terms, but its present value is £49,900. The shorter time horizon helps preserve value compared with a longer-term investment.
Discounting the sale price
- £155,000 ÷ 1.07⁵ ≈ £110,500
Even though the sale price is only slightly above the purchase price, its present value remains significant because the holding period is short.
Total present value and decision
- Present value of rent: £49,900
- Present value of sale: £110,500
- Total present value: £160,400
Compared with the purchase price:
- Cost today: £150,000
- Value today: £160,400
Decision insight
At a 7% discount rate, this investment creates value of around £10,400 in today’s terms. The higher rent and shorter duration outweigh the higher risk.
Important to note, the total return from the investment is not only £10,400, but 7% annually PLUS £10,400 . This makes the total return to be more than 7% annually.
What these examples show
Across both examples, present value makes three things clear:
- cash received later is worth much less than it first appears
- long holding periods increase sensitivity to assumptions
- strong early cash flow often matters more than headline sale prices
In practice, present value turns vague optimism into concrete trade-offs. It shows exactly where an investment works, where it does not, and how fragile the outcome may be if conditions change.