Question

When using a Discounted Cash Flow analysis, how does a longer period of free rent at the start of a lease affect the Net Present Value of the asset?

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A longer period of free rent at the start of a lease decreases the Net Present Value of the asset because it reduces the total cash inflows and pushes those inflows further into the future. Net Present Value is a calculation used to determine the current value of a series of future cash flows by discounting them back to today&#x27;s dollars using a required rate of return. Because money received sooner is worth more than money received later due to the time value of money, delaying rental payments means the present value of those payments is lower. When a tenant receives a rent-free period, the landlord collects zero revenue for those months, which creates a gap in the cash flow stream. When these future cash flows are discounted to the present, the absence of early-stage income combined with the mathematical impact of discounting causes the total value of the investment to drop compared to a lease that begins with rent payments immediately. For example, if a landlord grants a six-month rent abatement, the cash flow for months one through six becomes zero; because these months are closest to the present, they would have had the highest present value had they been paid, so losing them results in a significant reduction in the total Net Present Value.

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When using a Discounted Cash Flow analysis, how does a longer period of free rent at the start of a lease affect the Net Present Value of the asset?

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