If an investor uses a higher discount rate for investment value, what happens?

• A. Investment value increases as discount rate increases.
• B. Investment value decreases as discount rate increases.
• C. Investment value remains the same regardless of discount rate.
• D. Investment value equals market value when discount rate equals cap rate.

Answer: (B)

When you value an investment by summing its expected future cash flows and discounting them back to today, the discount rate is the price of future money. Raise that rate, and each future cash flow is worth less today, so the total present value falls. In real estate, investment value is the present value of the expected cash flows discounted at the investor’s required return. So a higher discount rate reduces that value. For a simple example, if you expect a fixed cash flow forever, increasing the rate lowers the present value from, say, 125,000 to 100,000 as rates rise, illustrating the inverse relationship. The idea that value would stay the same or that it only matches market value when the discount rate equals the cap rate isn't a general rule—the discount rate mainly drives the present value downward as it increases.