What's the easiest way to calculate a commercial lease's net present value?

1 What is NPV?

NPV is a financial metric that measures the profitability of an investment or project by discounting its future cash flows to their present value. A positive NPV means that the investment or project is expected to generate more money than it costs, while a negative NPV means the opposite. NPV can be used to compare different alternatives and choose the one that maximizes the value for the investor or the project owner.

2 How to calculate NPV for a commercial lease?

To calculate NPV for a commercial lease, you need to know the lease term (in years or months), the lease payments (monthly or annual), the lease escalation rate (the percentage by which the lease payments increase each year or period), the discount rate (the interest rate used to discount the future cash flows to their present value), and the lease costs (the upfront or ongoing expenses associated with the lease, such as broker fees, tenant improvements, maintenance, taxes, etc.). The formula for NPV for a commercial lease is: NPV = PV of lease payments - PV of lease costs. To calculate the PV of lease payments, you must multiply the lease payment by 12 and divide it by 1 plus the escalation rate. Then multiply that result by 1 minus 1 plus the escalation rate to the negative power of the lease term divided by the escalation rate and divided again by 1 plus the discount rate. To calculate PV of lease costs, divide the lease cost by 1 plus the discount rate to the power of time, which is the number of years or periods from present to when the lease cost occurs.

3 How to use a spreadsheet tool for NPV calculation?

A spreadsheet tool, such as Excel or Google Sheets, can make the NPV calculation easier and faster. You can use the built-in NPV function to calculate the present value of the lease payments and the lease costs, and then subtract them to get the NPV. To do this, you must first create a table with columns for Year, Lease payment, Lease cost, Discount factor, PV of lease payment, and PV of lease cost. Then enter the lease term, payments, escalation rate, costs, and discount rate into the appropriate cells. After this, use various formulas to calculate the lease payment for each year, the discount factor for each year, the PV of lease payment for each year, and the PV of lease cost for each year. Finally, use two more formulas to calculate the total PV of lease payments and costs before subtracting them to get your NPV of the commercial lease.

4 How to interpret the NPV result?

The NPV result can help you decide whether to accept or reject a commercial lease offer, or to compare different lease options. Generally, the higher the NPV, the better the lease deal. A positive NPV means that the lease payments are more than enough to cover the lease costs and provide a return on the investment. A negative NPV means that the lease payments are not enough to cover the lease costs and result in a loss on the investment. A zero NPV means that the lease payments are equal to the lease costs and provide no return on the investment.

5 What are the limitations of NPV?

NPV is a useful tool for commercial leasing, but it also has some limitations that you should be aware of. The accuracy of the inputs, such as the lease payments, lease escalation rate, lease costs, and discount rate, have an impact on the NPV result. Additionally, NPV does not account for the risk or variability of future cash flows nor does it consider the timing or frequency of cash flows. Moreover, NPV does not factor in the opportunity cost or alternative use of money when making a decision. Therefore, it is important to consider these limitations when using NPV for commercial leasing.

6 Here’s what else to consider

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