Optimal Holding period calculation

Archived in the category: Real Estate Terms & Definitions
Posted by admin on 18 Apr 13 - 0 Comments

Economically the most accurate method of calculating optimal holding period is based on net present value. We can calculate NPV of the investment, when it would be hypothetically sold in each year – starting from year 1 going till, for example, year 30. Then the highest NPV is chosen from these 30 values and the according year will be the optimal holding period. Since it is calculated from NPV, it takes in account the time value of money and is counted with Cash Flow after taxes. Sometimes the optimal holding period is shorter than the length of the mortgage and the reason is the shortening tax shelter, due to a smaller interest part of the mortgage payments every year. In the first years of mortgage, most of the mortgage payment is an interest payment with small principal payment and since the interest part is tax deductible, it creates higher tax shelter.

Another method for estimating a holding period is using return on equity calculated for every year. When the return on equity starts to decline, it can be a good point for resale. This method is simpler; however it does not count with the time value of money and depends significantly on the estimated appreciation. Therefore it is not very exact.

Both of these methods use estimation for future market conditions and therefore might not work correctly if the market is unpredictably changing in certain times. Therefore they should not be used as the only decision for selling a property, more as supportive information.

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