What Is Time Value of Money?
Time value of money says a dollar today beats a dollar tomorrow. Why? You can invest today's dollar and earn returns—compound interest grows it. And inflation shrinks tomorrow's dollar's buying power. So $100,000 in 10 years isn't worth $100,000 today—it's worth less, depending on your discount rate. In real estate, TVM drives cap rate selection (higher cap = more weight on near-term cash flow), holding period decisions, and exit strategy timing. A 6% cap values today's NOI more than a 4% cap does.
Time value of money (TVM) is the principle that a dollar today is worth more than a dollar in the future—because you can invest it and earn compound interest, and because inflation erodes purchasing power over time.
At a Glance
- What it is: A dollar today is worth more than a dollar tomorrow
- Why it matters: Drives discount rates, cap rate selection, and deal comparison
- Key idea: Future cash flows are discounted to present value
- Formula: PV = FV ÷ (1 + r)^n (present value = future value discounted by rate r over n periods)
- Real estate link: Cap rate and discount rate reflect TVM
PV = FV ÷ (1 + r)^n
How It Works
Present value. Future cash flow ÷ (1 + discount rate)^years = present value. $10,000 in 5 years at 8% discount = $10,000 ÷ 1.08^5 = $6,806 today. The higher the discount rate, the lower the present value—you're saying future dollars are worth less to you.
How it applies to real estate. Cap rate is a form of discount rate. A 6% cap means buyers value $1 of NOI at $16.67 today ($1 ÷ 0.06). A 4% cap means $25. Lower cap = more value placed on future income (growth expectations). TVM is baked into every income approach valuation.
Holding period and exit. A BRRRR investor cares about near-term cash flow and refinance timing—TVM favors faster cycles. A 30-year buy-and-hold investor discounts appreciation and rent growth over decades—different TVM lens.
Real-World Example
Jacob's TVM comparison. Deal A: $300,000, $18,000 NOI (6% cap), no growth expected. Deal B: $300,000, $15,000 NOI (5% cap), 3% rent growth expected. On a pure income approach, Deal A looks better today. But Jacob values the growth—at an 8% discount rate, Deal B's 10-year cash flow stream has higher present value. TVM lets him compare apples to apples. He chose Deal B for the growth profile.
Pros & Cons
- Provides a framework to compare deals with different timing of cash flow
- Explains why cap rate varies—growth expectations change the discount
- Informs holding period and exit strategy
- Compound interest and inflation are TVM in action
- Standard in finance—applies across investment property types
- Discount rate selection is subjective
- Long holding period makes small rate changes swing value a lot
- Doesn't capture illiquidity or management burden
- Can over-complicate simple cash-on-cash return analysis
Watch Out
- Discount rate trap: Too low and you overvalue future cash flow; too high and you undervalue growth
- Ignoring TVM: Treating $1 in year 10 the same as $1 today understates the value of near-term cash flow
- Inflation assumption: Inflation erodes nominal cash flow—use real discount rates for long holds
Ask an Investor
The Takeaway
Time value of money says a dollar today beats a dollar tomorrow. It's baked into cap rate, discount rates, and income approach valuation. Use it to compare deals and size your holding period.