Russel`s quiz

[DeniseHamilton]

During the Calgary bus tour, Russel gave us this quiz:
If you buy the following property on the following terms, how long will it take to get a 100% return on the initial investment? –
Purchase price: $240,000.00
25% down payment 60,000.00
Mortgage 180,000.00 at 6% amortized over 35 years
Cash flow 0 (no losses, no gains)
Appreciation 3% annually (Calgary’s average annual appreciation is 5% to 8% )

Answer: 5 to 6 years -- not many investments provide a 100% return in that short of a time period.

How did he arrive at the 100% return?

 

[Nicola]

QUOTE (DeniseHamilton @ Nov 7 2008, 07:54 AM) During the Calgary bus tour, Russel gave us this quiz:
If you buy the following property on the following terms, how long will it take to get a 100% return on the initial investment? –
Purchase price: $240,000.00
25% down payment 60,000.00
Mortgage 180,000.00 at 6% amortized over 35 years
Cash flow 0 (no losses, no gains)
Appreciation 3% annually (Calgary`s average annual appreciation is 5% to 8% )

Answer: 5 to 6 years -- not many investments provide a 100% return in that short of a time period.

How did he arrive at the 100% return?

I just tried to figure it out and got this:
5 years: 38,226 increase in value plus 8815 principal pay down = 47,401
6 years: 46,572 + 10,918 = 57,490
7 years: 55,170 + 13,149 = 68,319

So, a little over 6 years (I think?)

 

[wbullock]

There`s a download in the members downloads section that has a sheet that shows how these calculations were done. I think it`s in the October workshops downloads.

Bill

 

[DeniseHamilton]

QUOTE (wbullock @ Nov 7 2008, 12:26 PM) There`s a download in the members downloads section that has a sheet that shows how these calculations were done. I think it`s in the October workshops downloads.

Bill


I searched, and even asked for help from the REIN office but we could not find it. Do you happen to remember what the download is called?

Thanks for your help.

 

[Jack]

QUOTE How did he arrive at the 100% return?

That return percentage is misleading.

It`s roughly a 100% return if you don`t consider the effect of time. But, if you have $60,000 (initial investment) and you invest it in something that provides you with roughly $117,000 in 6 years (future selling price based on 6 years of 3% appreciation and mortgage paydown), that`s an 11.77% real rate of return, although it`d actually be less if you considered inflation and taxes.

 

[wbullock]

Hi, Denise,

It is located at http://www.myreinspace.com/forums/index.ph...mp;showfile=491.

Bill

 

[Jack]

Hi Denise,I`ll break this down further. Purchase Price: $240,000-Compounded annually by 3% for 6 years: $286, 572.55

Mortgage: $180,000
-Paid down for 6 years with terms of 6% interest & 35 year amortization: $169,083.11

So, 6 years later, when you sell the place, you`re left with the following amount of equity: $286,572.55 - $169,083.11 = $117,489.44

So what`s happened here is that you`ve taken $60,000 and turned it into $117,489.44. And now we see how the "100% return" figure comes about:
-($117,489.44 - $60,000) / $60,000
--95.8%

But wait...

Your investors gave you $60,000 today, and they didn`t see a return for 6 years, meaning that you need to account for time. When you do that, you`re left with a slightly more reasonable rate of return: 11.85%, not adjusted for inflation, taxes, or transaction costs, all of which would bring the ROR down.

Just a piece of advice here - be very careful of offering someone 100% returns in a 5 or 6 year timespan. It`s not realistic. If someone came up to me, with this scenario`s numbers, and told me that I`d be earning a 100% return, I`d tell them that they`d need to have their head examined. Now, maybe I`m completely wrong here, as I`ve never presented to a potential JV partner before, and my real estate portfolio consists of a whopping 2 properties, but what I do understand is finance, and the rate of return on this deal is 11.85%, not 100% (assuming a 6-year hold). Still a respectable yield, but I would think that proper disclosure would be very important to investors, as the 11.85% may not be a sexy enough return on capital for them.

 

[MonteDobson]

Hi Jack,

What is the easiest way (or what is the formula) to convert simple interest to a compounded rate of return?

Thanks,

 

[Jack]

QUOTE What is the easiest way (or what is the formula) to convert simple interest to a compounded rate of return?

As in the case above? The easiest way was what I showed - find the equity gain by doing simple math, and then adjust for time. I would suggest getting a financial calculator. In these transactions (time value of money), you only need to know three of the following five variables: present value, future value, time period, interest rate, payment. For this one, I knew the PV ($60,000), the FV ($117,489), and the time period (6 years), and I wanted to find out the interest rate/rate of return.

Here`s a useful website for those without the aid of a financial calculator: http://www.easysurf.cc/vfpt2.htm#fva

And remember, you just need to know 3 of the 5 variables! Enjoy.

 

[JohnS]

QUOTE (Jack @ Nov 10 2008, 08:52 PM) Hi Denise,I`ll break this down further. Purchase Price: $240,000-Compounded annually by 3% for 6 years: $286, 572.55

Mortgage: $180,000
-Paid down for 6 years with terms of 6% interest & 35 year amortization: $169,083.11

So, 6 years later, when you sell the place, you`re left with the following amount of equity: $286,572.55 - $169,083.11 = $117,489.44

So what`s happened here is that you`ve taken $60,000 and turned it into $117,489.44. And now we see how the "100% return" figure comes about:
-($117,489.44 - $60,000) / $60,000
--95.8%

But wait...

Your investors gave you $60,000 today, and they didn`t see a return for 6 years, meaning that you need to account for time. When you do that, you`re left with a slightly more reasonable rate of return: 11.85%, not adjusted for inflation, taxes, or transaction costs, all of which would bring the ROR down.

Just a piece of advice here - be very careful of offering someone 100% returns in a 5 or 6 year timespan. It`s not realistic. If someone came up to me, with this scenario`s numbers, and told me that I`d be earning a 100% return, I`d tell them that they`d need to have their head examined. Now, maybe I`m completely wrong here, as I`ve never presented to a potential JV partner before, and my real estate portfolio consists of a whopping 2 properties, but what I do understand is finance, and the rate of return on this deal is 11.85%, not 100% (assuming a 6-year hold). Still a respectable yield, but I would think that proper disclosure would be very important to investors, as the 11.85% may not be a sexy enough return on capital for them.

Hi Jack. I`m not totally sure about the financial vocabulary here, but aren`t you two talking about two different things?
Wouldn`t the ROI, the Return on Investment, be roughly 100%. The ROI, as I understand it, just talks about money in and money out, and isn`t compared to time or anything, as it`s just a simple ratio.

Whereas, the ROR, the Rate of Return that you`re talking about, introduces that concept of time. So, both percentages are accurate, but they`re used differently as they measure different things.

Anyway, just my thoughts...

Have a good one, all!

JohnS

 

[Jack]

QUOTE Hi Jack. I`m not totally sure about the financial vocabulary here, but aren`t you two talking about two different things?
Wouldn`t the ROI, the Return on Investment, be roughly 100%. The ROI, as I understand it, just talks about money in and money out, and isn`t compared to time or anything, as it`s just a simple ratio.

Whereas, the ROR, the Rate of Return that you`re talking about, introduces that concept of time. So, both percentages are accurate, but they`re used differently as they measure different things.

Nope, just rhetoric, a return is a return is a return. Investors will want to know what return/ROI/whatever they will be getting on the $60,000 that they give to you. And that answer, whatever you`d like to call it, is 11.85% (annually) in this case.

 

[Jack]

And to make sure your calculation is accurate, you can always go:

(60,000)(1.1185)(1.1185)(1.1185)(1.1185)(1.1185)(1.1185)

=117,481 (close enough, there will always be a rounding difference which won`t materially affect the answer)

 

[ZanderRobertson]

The question was how long will it take to get a 100% return on the initial investment (nevermind the semantics of high finance), so as soon as you start sorting it annually, the question is moot.

If the question was how long would it take to get a 100% return annually, the only answer would be one year no?

That being said, it`s easy to see the value in having the correct terminology when presenting to potential investors, don`t want there to be any misunderstandings, like they think they`ll be getting 100% return in one year. Hey for that matter, don`t promise any return at all, it`s illegal isn`t it?

QUOTE (Jack @ Nov 10 2008, 11:37 PM) Nope, just rhetoric, a return is a return is a return. Investors will want to know what return/ROI/whatever they will be getting on the $60,000 that they give to you. And that answer, whatever you`d like to call it, is 11.85% (annually) in this case.

 

[JohnS]

QUOTE (Jack @ Nov 11 2008, 01:37 AM) Nope, just rhetoric, a return is a return is a return. Investors will want to know what return/ROI/whatever they will be getting on the $60,000 that they give to you. And that answer, whatever you`d like to call it, is 11.85% (annually) in this case.
I`m pretty sure I`m going to have to disagree with you on that, Jack. I mean, we have different terms to express different ideas. Now, sometimes the meanings are clouded, and sometimes the terms are misused, but that doesn`t mean that they don`t have different meanings.

Out of curiousity, I just went to an online financial glossary, and they had many, many different headings, all dealing with some aspect of `return`. So, I checked out one.

**************************


Return on investment
Definition

The overall profit (or loss) on an investment expressed as a percentage of the total invested. For example: A person invests £5,000 in the shares of a company and some time later has received £100 in dividends with the value of the shares now £5,200. The return on investment is: (£100 + £5,200 - £5,000) /£5,000] x 100 = 6%

******************************

As it mentions here, the ROI has nothing to do with time, as it clearly states at "some time later", meaning it could be one month, one year, or six years. I`m sure most of us would agree that 100% over 150 years would be pretty bad, but most people would agree that over 6 years would be pretty good. And so therefore it would only be misleading if you didn`t mention the period of time that you were talking about.

Have a good one!

JohnS

 

[MonteDobson]

I believe the point of the matter here is how you spin it and how it is disclosed to potential investors. A 100% return over 6 years sounds pretty good, but can also be spun as a ~16% annual return (simple interest) or as Jack mentions, an 11.85% annual return (compounded). Most financial comparisons are based on compounded returns so we as investors should likely be using this lingo.

Most investors I talk to want to know what their money will be worth after a certain time frame, the annual return and the inherent risks.

 

[DeniseHamilton]

You have all brought up interesting points and you have all been very helpful. Russel`s quiz was only meant to demonstrate the value in real estate investing because it appreciates over time and tenants pay down the mortgage - he did say 5 to 6 years, not one year. All of the information you have provided in this discussion is valuable in talking to JV partners. One can demonstrate how much the property will be worth in 6 years, and at the same time one can give JV partners the real rate of return when inflation, taxes, etc. are taken into account. Thanks to all of you for this great information and help.
Denise

 

[RussellWestcott]

Looks like there has been some great interest in this topic... Denise thanks for posting this question. We are just back from the Edmonton A.C.R.E.S. Program weekend, and we can confidently say that has been the best one to date, congratulations to all that attended and fully participated in the event.Congratulations for all members for paying attention and contributing to this discussion. By reading through this thread, it looks like there are three different questions/ tangents this thread has taken:[list type=decimal][*]Confirmation of the numbers of the simple example presented on the field trip.[*]Presenting calculations and different financial termsPresenting numbers to JV partners[/list type=decimal]
Each fairly different but some common fundamentals throughout the three themes

Many lessons below make sure you read through to the end...

#1) Confirmation of the numbers of the simple example presented on the field trip:
The question was: approximately how long would it take to earn back your $60,000 investment in equity growth if you invested it in a $240,000 piece of Real Estate that grew at 3% year and your mortgage amortization was based upon 35 years at 6%. The answer was a little over 6 years

Value at end of year 6= $286,572.55
Mortgage balance at end of year 6= $169,104.12
Equity at end of year 6 = $117,468.43... Factoring out original Investment of $60,000 = $57,468.43.

Actually the main intention of the example was to provide a point that you do not need Real Estate to grow at extremely ridiculous rates to create long term wealth for you and your family. The intention was to move us past the ridiculous double digit growth rates we were experiencing over the past few years and come back to something sustainable, and realistic.

#2) Presenting calculations and different financial terms:
REIN™ members have access to the following spreadsheet Click here for the Calculation spreadsheet
Use this spreadsheet to help with your future calculations (which was presented at the May 2008 REIN™ workshop)

The difference in the two analysis discussed in this thread is... one is based upon simple growth rate calculation (Total over the entire holding period), and the other is based upon compounded growth rate calculation (as represented on a % per year basis).

Download the spreadsheet and run some numbers through the analysis tabs.

#3) Presenting numbers to JV partners
When presenting an opportunity to a potential JV partner first understand `THE DEAL` is #3 on the list of things that are important to the `pitch` to your potential JV partner. The #1 thing your JV partner buys into first is YOU (your confidence, your credibility and your integrity). The #2 thing your potential JV partner buys into is your BUSINESS Plan/ Vision/ Management. Then the #3 thing the JV partner buys into is the DEAL (the numbers, analysis, property details... etc.).

All the people who I have ever presented an opportunity has already bought into me and my business before they ever see a number or a specific property... because if the person never buys into me or my business, I am just wasting my breath talking to someone about numbers and a specific property

Of all the people who I have talked to regarding an investment opportunity, I have tried to keep it as simple as possible, and spoke to the values of the people whom I was presenting to. Most of the people want to know the following information, as a starting point:

How much is the investment?[*]What are the risks?[*]What is the estimated time period for the investment?What is the estimate my money will be worth at the end of time frame?What are the exit strategies? (How do I get my money out if things go sideways?)This is not an exhaustive list of questions from your JV partners, but they are ones that are consistent amongst all potential candidates

Sometimes if you go directly to presenting someone the numbers of the deal you will confuse them and they will say no...

I will leave this post off with a story from one of my early Joint Venture presentations. About six years ago I presented a deal to a very good friend of mine. He had already bought into me and my Real Estate business, the last step was to confirm the details of the numbers.

After reading a book on financial calculations I thought I knew it all, I was talking to him about, Compounded Growth Rates, Discounted Cashflows, Net Present Values, Internal Rates of Return, after a hour of showing him these numbers he was so confused that he naturally said (a polite) no thanks. All of these terms and calculations were valid, but this candidate did not fully understand everything and confused minds always so no.

I bet if I would have showed him a simple estimate (based on clearly defined fundamental assumptions) of how much his investment would have been over the time period that he would today be a very happy JV partner.

I almost feel I did a dis-service to this friend by not simply presenting the opportunity and then let him decide if he needed more in-depth financial analysis to the deal. I say this now looking back on the properties I presented to him as they have gone up in value (more than the original estimate) and the net cash flow is over $300/ month on each property.

Perhaps I owe him a phone call and a second chance to see if I can better present another opportunity ... hmmm I think I`ll send him a note tonight!

Hope this helps...

 

[DonCampbell]

Always fun to have the accountants on the forum!

The key of the presentation is to show that even without cash flow and a minuscule capital appreciation that the return you can receive on your investment can be substantial. It is a way of illustrating apple vs orange comparison, and also to point out that you do NOT need markets skyrocketing at 20% to make money.