!Your Browser has JavaScript Turned-off.
You will experience a more productive service at this Web site if you turn JavaScript ON.

Download_Free_Trial

Buy_Now

Real Estate Investment Software

Real Estate Investment Software Home > Real Estate Articles > Profitability Index

Profitability Index

By Juan Cabrera, MBA realbench.net

EMAIL | PRINT

The Profitability Index measures the Cost-Benefit of a proposed real estate investment property.

The profitability index is an alternative way of stating the net present value (NPV), also known as benefit/cost ratio. The Profitability Index is a great indicator of how good of an investment you are making. It's especially useful if you can only invest a limited amount on a real estate investment property. You can calculate the Profitability Index for multiple real estate investment possibilities, and the one that has the highest profitability index value is the one where you should focus your resources.

A profitability index of 1.0 means you achieved exactly your goal rate of return, greater than 1.0 means you have exceeded your goal rate of return, and below 1.0 means you failed to reach your goal rate of return.

How to calculate the Profitability Index?

	Present Value Of Future Cash Flows
Profitability Index	= --------------------------------------
	Initial Cash Investment

Example:

An investor purchases a real estate investment property and puts $20,000 in down payment and closing costs. The net cash flows for year 1, 2, 4 and 5 are forecasted to be $700, $900, $1,150, $1,375, $1,500 and $125,000 respectively. And the investor is planning on selling the real estate investment property on the fifth year for $125,000.

Initial Investment	: $75,000
Year 1 Cash Flow	: $700
Year 2 Cash Flow	: $900
Year 3 Cash Flow	: $1,150
Year 4 Cash Flow	: $1,375
Year 5 Cash Flow	: $1,500
Year 5 Sale Proceeds Cash Flow	: $125,000

STEP 1: Required Rate of Return

Required Rate of Return (RRR) = 11.94%

STEP 2: Year 1 Net Present Value

	$700
Year 1 NPV=	-------------
	1
	(1 + 11.94)

Year 1 NPV= $625.32

STEP 3: Year 2 Net Present Value

	$900
Year 2 NPV=	-------------
	2
	(1 + 11.94)

Year 2 NPV= $718.20

STEP 4: Year 3 Net Present Value

	$1,150
Year 3 NPV=	-------------
	3
	(1 + 11.94)

Year 3 NPV= $819.79

STEP 3: Year 4 Net Present Value

	$1,375
Year 4 NPV=	-------------
	4
	(1 + 11.94)

Year 4 NPV= $875.61

STEP 5: Year 5 Net Present Value

Year 5 Cash Flow= Rental + Sale
Year 5 Cash Flow= $1,500 + $125,000
Year 5 Cash Flow= $126,500

	$126,500
Year 5 NPV=	-------------
	5
	(1 + 11.94)

Year 5 NPV= $71,961.11

STEP 6: Add up all the Net Present Values

Discounted Cash Flow =	Year 1 NPV
	Year 2 NPV
	Year 3 NPV
	Year 4 NPV
	Year 5 NPV
	----------
	Total Discounted Cash Flow

Discounted Cash Flow =	$625.32
	$718.20
	$819.79
	$875.61
	$71,961.11
	----------
	$75,000

STEP 7: Substitute formula values

	Present Value Of Future Cash Flows
Profitability Index	= --------------------------------------
	Initial Cash Investment

	$75,000
Profitability Index	= --------------------------------------
	$75,000

Profitability Index

= 1.00

Which means you have accomplished exactly your rate of return for the real estate investment property.

RealBench is an excellent Real Estate Software that automatically calculates the Profitability Index, as well as other eight real estate indicators. Click here to learn more about RealBench. Purchase this efficient real estate system now.

>>Real Estate Articles...

ARTICLE CATEGORY:
Profitability Index, Real Estate Profitability Index, pi, Real Estate pi, Investment Profitability Index

Gross Rent Multiplier	Cash on Cash Return	Profitability Index	Internal Rate of Return	Debt Coverage Ratio
Break Even Ratio	Loan To Value Ratio	Capitalization Rate	Net Cash Flow	Real Estate Risk Management and Metrics

Last Updated May 28, 2010