Investing in real estate can be tricky. One of the most important things to keep in mind is doing the right calculations to make a profitable investment. Can the discounted cash flow formula help?

Table of Contents

  1. What Is Discounted Cash Flow?
  2. When Should Real Estate Investors Calculate Discounted Cash Flow?
  3. Pros and Cons of Calculating Discounted Cash Flow
  4. How to Calculate the Discounted Cash Flow Formula
  5. What Counts as a Good Discounted Cash Flow?
  6. What Other Calculations Should I Be Using for My Real Estate Investments?
  7. Recap

In this article, we will look at what the discounted cash flow formula is and how it is an essential aspect of real estate investing. Then, we will discuss some additional important features of investing and where to find such tools.

What Is Discounted Cash Flow?

The discounted cash flow formula is a commonly used calculation in real estate investing that serves to determine how profitable an investment can be. Also, it even goes as far as to help predict the viability of an investment. It does so by projecting the income of a property for the future. The discounted cash flow helps to form the estimated current value of the investment property.

Overall, the discounted cash flow analysis formula helps to figure out the value of a company or investment. It is done by attempting to figure out how much cash it will produce in the future. The cash flow formula is usually used in conjunction with the Net Present Value or NPV. Basically, the discounted cash flow formula is used to obtain the NPV and predict cash flow for the future.

Below is the formula for discounted cash flow:

Discounted Cash Flow Formula

What Should Be Included in the Discounted Cash Flow Formula?

When you are doing your calculations for your discounted cash flow approach formula, it is essential to include all of the correct information. Below are some metrics to keep in mind during your calculations.

  • Initial Cost: The Initial Cost is either the purchase price of the property or the closing costs.
  • Holding Period: The Holding Period is typically used for investment properties between 5-15 years, although it can change depending on the type of real estate investment or investor.
  • Financing Costs: Any costs within the initial purchase or expected costs after, usually interest rate costs.
  • Projected Cash Flows: The annual income of a rental property you are expected to make.
  • Sale Profit: The projected profit the owner will make upon the sale of the investment property after the holding period.
  • Additional Year by Year Costs: Any other costs such as property taxes, maintenance, and repairs. Basically, they are other costs besides the financing costs.

When Should Real Estate Investors Calculate Discounted Cash Flow?

The discounted cash flow approach formula should be used in any situation where an individual purchases something with the expectation of that purchase making them more money than the initial amount spent in the future. In terms of real estate, it is usually some sort of investment property. The property can be in the form of a rental or a fix and flip.

Real estate investors tend to use the discounted cash flow formula in their investment properties to determine how much profit they will potentially generate from their initial investment. If after using the formula you come to the conclusion that in a few years the discounted cash flow formula is almost the same value as the current value of the home, it wouldn’t be a great investment.

Related: Flipping Houses for Beginners: What You Need to Know Before Starting

Pros and Cons of Calculating Discounted Cash Flow

Though the cumulative discounted cash flow formula is an excellent tool for determining the fundamental value of an investment, like any strategy, it also comes with a few drawbacks. Below, we will look at some of the biggest benefits and limitations of the discounted cash flow formula.

Pros:

1. Precise

One of the biggest pros of the discounted cash flow formula is that it is extremely accurate as it uses your specific numbers. By completing the calculation with the numbers on your personal investment, you are able to come to a more exact calculation.

2. Determines Value of a Business

Unlike other formulas in real estate investing, it focuses on the objective rather than the subjective. It can determine the value of your own investment business without the influence of the subjective housing market.

3. Considers Your Investment in the Long Term

The formula is a good way to look at the long-term value of your investment. Its entire economic life is considered in the discounted cash flow formula.

4. Helps Calculates the Internal Rate of Return

The discounted cash flow formula helps investors also calculate the internal rate of return on investment. This It eful to compare them to similar investments to determine how successful it is.

Cons:

1. Requires a Lot of Data

There is a lot of data required for calculating the discounted cash flow, such as financial data and economic data. It can be difficult to acquire all the said information, as well as ensure it is commonly accurate. Though if done right in the end, it can be extremely accurate.

2. Very Sensitive to Projections

As the formula requires exact information, it makes it very sensitive to its projections of cash flow in the future. Additionally, it can impact the growth rate.

How to Calculate the Discounted Cash Formula

To perform calculations using the discounted cash flow formula, you simply follow the one below:

Discounted Cash Flow Formula

As doing the above calculation by hand may be tricky for people who are not familiar with complicated formulas, there are platforms that offer the discounted free cash flow formula. You just enter the information on the site and they do the calculations for you. Though it can be very helpful, always ensure you choose a reliable site.

What Counts as a Good Discounted Cash Flow?

Though what is considered a good discounted cash flow can fluctuate depending on the person, usually, it can be agreed by all that as long as the discounted cash flow is higher than the present cost, it is a good one. If at any time your discounted cash flow is lower than the initial cost of investment value, it may not be the best investment opportunity.

Although anything higher than the present cost is good as it means you are making more money on your investment, there are still other factors to consider. If the discounted cash flow is only a tiny bit higher, you would need to take into account if it is worth the investment in the long run. There is likely another property out there that will provide a significantly higher discounted cash flow and will be a better opportunity with a higher return on investment.

Related: How to Get the Highest Return on Investment Property

What Other Calculations Should I Be Using for My Real Estate Investments?

When trying to find the most successful investment properties, you should be utilizing multiple calculations before committing to a location. It is because the data is the best way to determine how profitable your property can be. Besides the discounted cash flow formula, you should be performing calculations every step of the investing process. Visit Mashvisor for all of the best investing tools.

Mashvisor offers investing tools for every step of the process, whether it be finding a profitable property or calculating the investment value of a specific location in the long run. Our tools use your information, as well as data from reliable sources such as Airbnb, to perform our calculations. It is to ensure our users are making the best decisions in real estate investing.

Below, we will look at some of Mashvisor’s most popular tools to help you make complicated real estate decisions.

Property Finder

If you’re looking for a potentially profitable investment property, use Mashvisor’s Property Finder tool. The tool helps investors find the best place to buy a rental property. We consider your wants and needs for property and compare them to successful housing markets to find the best location.

We offer filters you can change to only look at properties with your requirements. It helps to save time instead of looking at every property available in a given location. Below are some of the filters we offer to specify our search:

  • Property Type
  • Budget
  • Location
  • Rental Strategy (Traditional vs Airbnb)
  • Number of Bathrooms
  • Number of Bedrooms

Real Estate Heatmap

Another great tool to find successful locations is the Real Estate Heatmap. Investors can use the real estate heatmap to look for new areas to invest in. In our tool, we zero in on profitable housing markets by conducting a neighborhood analysis. It helps investors find the best location for an income property in their budget.

In our neighborhood analysis, we determine how successful a location is by looking at the real estate data. Similar to the discounted cash flow formula, our analysis focuses on accurate data and metrics to conclude if a location is a good investment. Below are some key metrics in our analysis:

  • Median Property Price
  • Average Rental Income
  • Cash on Cash Return
  • Occupancy Rate (either traditional or Airbnb)

The Real Estate Heatmap is the best way for investors to expand their portfolios and invest in new and successful housing markets.

Discounted Cash Flow Formula - Mashvisor's Real Estate Heatmap

Investors can use Mashvisor’s Real Estate Heatmap to find and invest in new successful housing markets.

Investment Property Calculator

If you are interested in a tool that helps to calculate the discounted cash flow formula for you, use Mashvisor’s Investment Property Calculator. The calculator is an excellent resource for investors to use to determine profits and cash flow on their properties. We use reliable data from sources such as Airbnb or the MLS, as well as up-to-date trends to perform our calculations. Additionally, we use your data for your property.

The first thing our rental property calculator does is calculate estimated costs for tour property. They can include property tax, interest rates, and repairs or maintenance the property may need. If your property also fits the requirements, it also may consider HOA fees.

Next, the calculator provides a comprehensive rental strategy. We compare how the investment will perform as a traditional rental vs as an Airbnb. To do so, we compare the metrics to see which will be more profitable, and therefore, successful overall. Below are some key metrics we look at:

  • Cap Rate
  • Cash on Cash Return
  • Cash Flow
  • Rental Income
  • Occupancy Rate

The Investment Property Calculator is an excellent resource for determining how much passive income your investment property can generate.

Related: What Is a Good Cash on Cash Return?

Recap

This article looked at what the discounted cash flow formula is and how it benefits real estate investors. Overall, the discounted cash flow formula is great for calculating how profitable and viable a real estate investment can be in the long term. Additionally, it can help show how successful a business can be by looking at the value of its investments.

Investors should always use the calculations when trying to find new investment properties or see how valuable their current ones are. You can do the calculations using the discounted cash flow formula by yourself or by outside sources who will do them for you. Whichever you prefer, it is key to make sure your data is accurate.

In addition to the discounted cash flow formula, we suggest you also utilize some of our tools mentioned above. Specifically, our investment property calculator tool is an excellent way to find every essential calculation all in one place. Mashvisor’s algorithms show users data they can trust to make successful real estate decisions. Using all of the above sources together will help you make the most money in real estate.

To start looking for and analyzing the best investment properties in your city and neighborhood of choice, sign up for a 7-day trial, followed by a 15% discount on your quarterly or annual subscription.




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