Cyclical growth, drift and variable holding period
All investors have the ability to choose their exit timing. Real estate investors are galvanized to long holding periods by institutional factors such as high transaction costs. Thus, the investor must pick an exit time that maximizes his long term return (which we model as net present value in the plot below). As we are interested in only positive net present values, we provide show the zero NPV plane. Above this plane all values are positive.
The cycles that affect income and value are often not synchronized.Thus the investor must keep his eye on not only how income changes but how the relationship between income and value changes. We shall simplistically view this latter as the capitalization rate. The zero plane changes based on the direction of capitalization rate change over the holding period. All IRRs at the end of all possible holding periods are shown in the table. These are the intersection of the NPV plot with the zero plane at different points in time.
The overall picture shows that successful investing requires understanding the connection between the discount rate, the direction of capitalization rate change and the holding period.
