Net present value calculation

[eteb3]

I want to raise around £100k, and I think I could do that by selling a long lease (around 10 years) in a studio flat in my house. The leaseholder would sublet it.

(Yes, I could borrow, but there are reasons I don't want to do that.)

If I put myself in the investor's shoes, how do I calculate what I should pay for a 10-year lease, if I know what the expected rental is?

It's a NPV calculation, but I can't make sense of it. Roughly is fine. Thanks.

 

[UK Contractor Accountant]

selling a long lease (around 10 years) in a studio flat in my house

10 years is not a long lease

 

[Mark T Jones]

I dont know if you're familiar with terminology or method, but you can calculate the answer with this https://nochart.com/

 

[eteb3]

10 years is not a long lease

Ok, but it's more than the magic 7 years for SDLT purposes - and I think for new Renters Rights Bill purposes, too.

I dont know if you're familiar with terminology or method, but you can calculate the answer with this https://nochart.com/

Thank you - I'm not familiar enough!

My biggest puzzle the discount rate. I understand why this is normally applied. Now let's suppose rental income rises with inflation at the same rate as the present value of the investment is degraded by inflation. Do these cancel each other out, so that, for estimation purposes, I can run the NPV calculation at 0% discount?

 

[UK Contractor Accountant]

Don't forget income tax & CGT will be payable on the premium in the tax year granted.

Might need factor that in your calculations of the net amount you will receive after all taxes.

 

[Bobbo]

Do these cancel each other out, so that, for estimation purposes, I can run the NPV calculation at 0% discount?

Absolutely not. A discount rate should reflect the cost of capital. Given a ten year lease will almost certainly be unmortgageable, I'd be thinking of alternate rates of return on say 100,000. The yield on a 10 year gilt is currently 4.63% so I would expect a discount rate to be no less than that (likely higher).

Good point made by @UK Contractor Accountant re taxes. There are specific tax rules for how a premium on a short lease is taxed (and deductible for the investor) so you may need to factor that in.

 

[Mark T Jones]

Ok, but it's more than the magic 7 years for SDLT purposes - and I think for new Renters Rights Bill purposes, too.


Thank you - I'm not familiar enough!

My biggest puzzle the discount rate. I understand why this is normally applied. Now let's suppose rental income rises with inflation at the same rate as the present value of the investment is degraded by inflation. Do these cancel each other out, so that, for estimation purposes, I can run the NPV calculation at 0% discount?

Sorry, you'll need a property specialist for that one, I'm just a finance guy (but I know that property people use the HP12C

 

[GLAbusiness]

Back in the day when I used to do NPV calculation we used 10% as the discount rate. Basically it is trying to account for inflation. So, I suspect you wand a discount rate of expected inflation -- say about 2.5%... Happy to be corrected if someone has more up to date knowledge

 

[numbersrule]

Hi eteb3

Just so everyone is clear about the question you are asking, can you clarify that you mean 100k is the present value of the required raise which will accumulate via lease income over the next 10 years to 2035?

If that is the case then the calculation is:

NPV = Sum of ( Ct / (1 + i)^t ) for every year

Ct is the constant annual lease payment
i is the discount rate
t is the number of years left for each element of the summation

back analysing based on GLAbusinesses' 2.5% results in:

Required monthly lease payment = £952

( I have simply summed 10 years and divided the annual by 12 )

( the calculation needs modifying if you wish to have a more accurate figure based on monthly summation in which case the discount rate would also be monthly as opposed to annual rate ).

Monthly discount rate = ((( 1 + 0.025 ) ^ ( 1 / 12 )) -1)x 100 = 0.206%
Monthly lease payment £942.

However, if your intention is to use the lease income to cover the cost of a loan for 100k taken out now then the discount rate would need to be equivalent to the loan interest rate.

If you are on good terms with your lenders and you get a loan rate of say 6% then

Required monthly lease payment = £1,132

The higher the rate of return you need, the higher the discount rate and the higher monthly income needs to be. This is because higher discount rates reduce NPV.

Disclaimer: this makes no allowance for taxation and is merely an illustration of the NPV calculation.

 

[NewKidinTown]

If I put myself in the investor's shoes, how do I calculate what I should pay for a 10-year lease, if I know what the expected rental is?

so what's the answer?

 

[numbersrule]

If I put myself in the investor's shoes, how do I calculate what I should pay for a 10-year lease, if I know what the expected rental is?

so what's the answer?

That depends on the Tax position as has already been alluded to.

I need more information:

a) As OP seems to suggest they know what the expected rental is, would you divulge what it is?
b) What type of business is the Lessee ( Ltd ? ) ( more complicated if Sole Trader )
c) What type of business is the Lessor / OP?
d) Will the Lessor be opting to Tax?
e) Is the Lessee VAT Registered?

The NPV calculation is just the bare bones.

Furthermore my NPV illustration assumes a constant monthly lease payment.
However, if the Lessor wishes to add annual Indexation to the lease instalments then whilst that could be covered by the Lessee via a similar Indexation of their sub let rent income, it would mean that for the same Loan Amount Borrowed, the Lease and the Rent could start lower and end higher than my illustrative constants.

But again, the Tax position may elevate all the illustrations to ensure the Tax can be paid.

Taking the £1,132 net with Opted to Tax results in £1,358.40 but if Lessee is VAT Registered they claim back their Input VAT bringing the cost back to £1,132. If Lessee is a Ltd their CT would derive from their Gross Profit so assuming Lessee wishes to make 10% profit from which they pay their CT and assuming has low expenses / costs of 15% of Rental Income due to simple sub-let then the Lessee would need to charge 1132 / 0.85 / 0.90 = 1480 rent.

 

[MikeJ]

I think the OP is looking for an upfront payment. Sells the lease to someone for £100k. That person then rents the apartment out to someone else for (say) £1000 per month.

The question is, if he wants to raise £100k now what rent would the person that pays for the lease need to get per month over the next 10 years.

 

[numbersrule]

I think the OP is looking for an upfront payment. Sells the lease to someone for £100k. That person then rents the apartment out to someone else for (say) £1000 per month.

The question is, if he wants to raise £100k now what rent would the person that pays for the lease need to get per month over the next 10 years.

Thanks MikeJ

That scenario just needs an adjustment to make the discount rate relevant to the person that pays for the lease. Lets say that person is wealthy so they can afford to stump up the 100k. That would mean they are foregoing some interest on savings, say, which may be half way between my two illustrations of 2.5% and 6% hence 1,042/0.9/0.85 = 1,362.

Sounds like a lot for a Studio Flat for 10 years. Is the decor in good condition?

 

[eteb3]

MikeJ said:
I think the OP is looking for an upfront payment. Sells the lease to someone for £100k. That person then rents the apartment out to someone else for (say) £1000 per month.

The question is, if he wants to raise £100k now what rent would the person that pays for the lease need to get per month over the next 10 years.

Thanks MikeJ

That scenario just needs an adjustment to make the discount rate relevant to the person that pays for the lease. Lets say that person is wealthy so they can afford to stump up the 100k. That would mean they are foregoing some interest on savings, say, which may be half way between my two illustrations of 2.5% and 6% hence 1,042/0.9/0.85 = 1,362.

Sounds like a lot for a Studio Flat for 10 years. Is the decor in good condition?

That's right, @MikeJ

Thanks @numbersrule for all the figures - you've finally made sense of it for me, I think.

You're right it's a lot, and that's exactly what I was trying to find out - what passing rent would make the deal attractive? It's the whole of a ground floor, recently fitted out, but even so would not command that rent in this area. So either raise less or think again.

Thank you for all the contributions.

 

[eteb3]

I see I didn't answer your questions:

a) As OP seems to suggest they know what the expected rental is, would you divulge what it is?
£1100 max.
b) What type of business is the Lessee ( Ltd ? ) ( more complicated if Sole Trader )
Assume Ltd
c) What type of business is the Lessor / OP?
Partnership
d) Will the Lessor be opting to Tax?
No
e) Is the Lessee VAT Registered?
No

 

[numbersrule]

I see I didn't answer your questions:

a) As OP seems to suggest they know what the expected rental is, would you divulge what it is?
£1100 max.

You should think thoroughly about the Lessee's expenses. I have assumed 15%. But might that guess be overestimated in which case might the recalculation be close to £1100?

b) What type of business is the Lessee ( Ltd ? ) ( more complicated if Sole Trader )
Assume Ltd
c) What type of business is the Lessor / OP?
Partnership

These answers are in line with assumptions

d) Will the Lessor be opting to Tax?
No
e) Is the Lessee VAT Registered?
No

The fact that the Lessee is not VAT registered is OK because the Lessor is not opting to Tax.