Definition of Reversionary Factor
The Reversionary Factor is a crucial concept in real estate and financial analysis, representing the present value of a future amount. It helps investors and analysts determine how much a sum of money to be received in the future is worth in today’s terms, based on a given discount rate and time period. The formula for calculating the reversionary factor is:
\[ \text{Reversionary Factor} = \frac{1}{(1 + i)^n} \]
where:
- \( i \) = interest rate (or discount rate)
- \( n \) = number of years (or periods)
Examples
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Example 1:
- Scenario: You expect to receive $100,000 in 20 years and want to know its present value at an interest rate of 8%.
- Calculation: \[ \text{Reversionary Factor} = \frac{1}{(1 + 0.08)^{20}} = 0.2145 \] \[ \text{Present Value} = 0.2145 \times $100,000 = $21,450 \]
-
Example 2:
- Scenario: You anticipate receiving $50,000 in 30 years with a discount rate of 12%.
- Calculation: \[ \text{Reversionary Factor} = \frac{1}{(1 + 0.12)^{30}} = 0.03338 \] \[ \text{Present Value} = 0.03338 \times $50,000 = $1,690 \]
Frequently Asked Questions (FAQs)
What is the purpose of the Reversionary Factor in real estate?
The reversionary factor is used to discount future cash flows to their present value, helping investors assess the attractiveness of a potential investment by understanding its current worth compared to future earnings.
How does the interest rate affect the Reversionary Factor?
Higher interest rates result in a lower reversionary factor, meaning the present value of future cash flows decreases as the interest rate increases.
Is the Reversionary Factor the same as the Present Value?
Yes, the reversionary factor is synonymous with the present value of one dollar to be received in the future.
What information do you need to calculate the Reversionary Factor?
You need to know the discount rate (interest rate) and the number of periods (years) before the future cash flow will be received.
How does the number of years affect the Reversionary Factor?
As the number of years increases, the reversionary factor decreases, indicating that the present value of future cash flows diminishes over a longer period.
Related Terms
Present Value (PV)
The current value of a future sum of money or stream of cash flows discounted at a specific interest rate.
Discount Rate
The interest rate used to discount future cash flows to their present value.
Net Present Value (NPV)
The difference between the present value of cash inflows and the present value of cash outflows over a period, used in investment appraisal.
Time Value of Money (TVM)
A financial concept stating that money today is worth more than the same amount in the future due to its potential earning capacity.
Online Resources
- Investopedia: Present Value (PV): Link to article
- Department of Real Estate, Finance and Law of Local Universities: [Link to resource]
References
- Brueggeman, William B., and Fisher, Jeffrey D. “Real Estate Finance and Investments”, 16th Edition, McGraw-Hill Education.
- Geltner, David, et al. “Commercial Real Estate Analysis and Investments”, 3rd Edition, OnCourse Learning.
Suggested Books for Further Studies
- “Real Estate Finance & Investments” by William B. Brueggeman and Jeffrey D. Fisher.
- “Commercial Real Estate Analysis and Investments” by David M. Geltner, Norman G. Miller, Jim Clayton, and Piet Eichholtz.
- “Principles of Real Estate Practice” by Stephen Mettling and David Cusic.
