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Seems directly forward, hard to argue with these numbers doesnt it? In fact, theres a entire lot of information lacking here that could exchange this calculation. How lengthy did he very own the condo? How much pastime did he pay? What other expenses have been incurred besides renovations? Repairs, maintenance, and many others. And finally, the time value of money. The $600,000 he received these days is worth less than $600,000 when he bought the condo.
I used to laugh at this concept, thinking it to be irrelevant. Its in any way but. Let me illustrate.
Year 2001 bought condo for $500,000
Year 2004 spent $10,000 on renovations
Year 2006 spent $35,000 on renovations
Year 2007 spent $5,000 on repairs.
Year 2008 sold for $600,000
At a rate of even 2% for inflation, which is only true in fairy tales and government statistics, lets see how this pans out. Well take the $600,000 received in 2008 as an instance. Im going to just regress $600,000 back to 2001 to to find out its value and compare apples to apples with the $500,000 paid for the condo.
2007 $588,000
2006 $576,240
2005 $564,715
2004 $553,421
2003 $542, 352
2002 $531,505
2001 $520,875
Total gross profit= $20,875
Now we deduct expenses. For the sake of efficiency, Ive regressed the expenses too, if have been going to regress, we should regress all numbers.
$9412 + $31,637+ $4429= $45,478
Now lets run the full numbers.
Purchase $500,000(2001 dollars)
Profit after sale in 2001 dollars. $20,875
Expenses $45,478(2001 dollars)
Loss $24,603
I havent factored in realtor fees or pastime costs. Both are significant. I increased the price of this condo by $one hundred,000 in 6 years, a very organic and natural increase by anyones standards, and still this person lost money. Lets say we remove the renovations? Yes, probably a favorable idea, but we might also likely should decrease the sale price as well. The net effect would depend on how wisely the renovations have been finished. Some renovations add more value than others, and some add no value at all.
This is one instance of how sophisticated investors view investments. They know the power of pastime and inflation, whilst the average person thinks theyre too minor to consider. In this state of affairs, even a puny 2% inflation cost this homeowner $80,000 in potential profit, and I can guarantee you that inflation is greater than 2%. How? Easy. What did you pay for milk 5 years ago? 10 years ago? Add 2% per year and see if you come to todays price. I guarantee you wont. Use goods wherein inflation is impossible to hide, like milk, meat, and vegetables, and youll start to see how immoderate inflation surely is.
This instance is likely one of the fundamental principles to investing. You should understand the power of these concepts prior to you can ever be a successful investor. Most individuals think investing is all about selecting a hot stock and developing a millionaire. In reality, rich individuals do very little of that. Instead, they will use a concept called leverage if they wish to take a risk for an outsized gain. What does this mean?
Leverage is just borrowing money or using existing collateral to achieve access to more money. In our previous instance, making 13% is a pretty safe investment, but lending $seventy five,000 isnt enough to make big money, so how can we make critical money with this system? Thats wherein leverage comes in. Actually, its used in many investing models, but well focus on this one.
Wealthy individuals share a few things in common, and Im going to explain them in this article. This may sting a little, so be forewarned. They all view their condo as a place of dwelling, not an investment. Yes, I know that sounds like lunacy to a North American thoughts. How can something worth so much money not be considered an investment?
Simple. Wealthy individuals are almost always financially literate and understand the power of pastime, the time value of money, and return on investments. Your neighbor next door calculates how much he made on his condo like this:
Paid- $500,000
Spent- $45,000 on renovations
Sold- $600,000.
Profit- $fifty five,000
Now lets reverse the state of affairs. You can play the rich investor instead. I think youll enjoy this end of the strong buy lots more.
Lets say you decide to lend money for mortgages and massive ticket goods, like boats, cabins, and place of dwelling renovations. Well say you lend out $seventy five,000 for a place of dwelling renovation to a nice couple who wish to do some updates to their place of dwelling. Lets vacation down the numbers. Well use 5% as an pastime rate, a very low rate, but in the interim about average for a loan like this. The loan will be over 7 years.
2001 Loan of $seventy five,000 Monthly payments of $1056.14
2001 Interest(your profit) $3462
2002 Interest $3001
2003 Interest $2518
2004 Interest $2010
2005 Interest $1477
2006 Interest $917
2007 Interest $330
Total Interest Received $10,253 Return on Investment 13.67%
But lets be fair, the time value of money would eat into your profits, but notice your largest pastime revenue comes early on, which implies you lose less due to inflation. Now inflation is more your friend than your enemy, like it was prior to. On the flip side, the couple who borrowed from you agreed to pay 5% pastime, but in reality they paid in excess of 10% due to compounding pastime. I wonder if they would still prefer to do their renovations if they knew they would cost an extra $5000-$10,000.
Suppose you are rich and have access to money at three% because you have assets that may be used as collateral. You can access 20 million at three%. The three% becomes your expense in this state of affairs, and your objective is to lend out money at a rate upper than three%, but care for a low risk profile in your investments. You to find you can get 5% with very little risk. The 2% becomes your profit, but now its 2% of 20 million, which is lots greater than 5% of $seventy five,000. I think you can do some quick math in your head to get an idea how this works.
