Can someone show me the mathematic equation to derive a rate of return in RE

[thefed]

After reading this passage, I wondered if there's an easy way to figure this out. I think I could fake it, but am wanting to get someone else's opinion;

There are four parts of understanding the numbers of real estate: appreciation, cash flow, loan reduction and tax benefits and how they work together to produce a rate of return on equity that you have in a property.


I UNDERSTAND each of these 4 parts, but am not sure how to put it all together for a standardized (if there is such a thing) "rate of return" over a given length of time.

MY guess is to figure ou a time, say one year. In that year, you assume 3% appreciation, include cash flow from renting (or sitting vacant), figure out how much of your note is paid off after one year, and the tax deductions, if any, you get from owning the property. you add and subtract to get your total gain or loss, and compare it to your initial investment.

 

[brewer12345]

If you have a messy calculation like this with lots of cash flows, the best way to figure out your return is Net Present Value (NPV). Basically, you lay out all the cash flows (in and out) on a spreadsheet at the time they occur, net them in each given period, pick a discount rate, and discount the cash flows back to the present. So if you lay out all your cash flows and discount the net cash flows at, say 10% a year, and you end up with a positive number, it means that you more than meet your hurdle rate of 10% returns. If you solve for what discount rate gets you a zero NPV, you have your rate of return on the project.

 

[thefed]

If you have a messy calculation like this with lots of cash flows, the best way to figure out your return is Net Present Value (NPV). Basically, you lay out all the cash flows (in and out) on a spreadsheet at the time they occur, net them in each given period, pick a discount rate, and discount the cash flows back to the present. So if you lay out all your cash flows and discount the net cash flows at, say 10% a year, and you end up with a positive number, it means that you more than meet your hurdle rate of 10% returns. If you solve for what discount rate gets you a zero NPV, you have your rate of return on the project.

uh huh..... :

 

[brewer12345]

uh huh..... :

Well, you did ask. If you want a more detailed explanation, search the web on "NPV" or "Net Present Value". Any finance textbook (even an intro one) will have a discussion of this concept.

 

[thefed]

I'll look into it. I'm just playin' with ya brewer. Just didnt make much sense since I dont knwo what a discount rate means, among other things.

Gives me a place to start though!

Thanks

 

[retire@40]

I would think you would want to look at how much benefit you are receiving from your total investment.

So if you put $100,000 into the investment, and you got $5,000 in appreciation, got $10,000 in rental income, paid $6,000 in mortgage interest, and got a tax write-off generating a $1,000 tax benefit, the formula would be:

5000+10,000-6,000+1,000 = 10,000 / 100,000 = 10%

There would be more +/- numbers for things like insurance, water bills, repairs, etc, so those would also be factored into the formula.

 

[brewer12345]

I'll look into it. I'm just playin' with ya brewer. Just didnt make much sense since I dont knwo what a discount rate means, among other things.

Gives me a place to start though!

Thanks

OK. A discount rate is just the interest rate you choose to apply to a given future cash flow to get it back to a present value. A dollar today is more valuable than a dollar in 5 years. To figure out what that future dollar is worth, you have to discount it by some rate. Say we pick 7%. So in Excel, you would take that 5 year out dollar and divide it by (1.07)^5. I get about 71 cents. If we think that dollar is a sure thing, we would pick a lower discount rate. If its a risky proposition, we pick a higher rate.

Doing an NPV calculation is just a whole big spreadsheet of these fairly simple calculations. If you can forecast the cash flows and choose an appropriate discount rate, you can value any asset (stock, bond, RE, whatever).

 

[califdreamer]

It can get even uglier if you want to calculate the Internal Rate of Return (IRR).  Basically, lay out the cash flows as Brewer said but set NPV at zero and solve for the discount rate.  You can find IRR calculators on the internet.

I would think you would want to look at how much benefit you are receiving from your total investment.

So if you put $100,000 into the investment, and you got $5,000 in appreciation, got $10,000 in rental income, paid $6,000 in mortgage interest, and got a tax write-off generating a $1,000 tax benefit, the formula would be:

5000+10,000-6,000+1,000 = 10,000 / 100,000 = 10%

There would be more +/- numbers for things like insurance, water bills, repairs, etc, so those would also be factored into the formula.

I've never calculated an IRR on any of my investments.  Retire @ 40's idea works fine for me.

 

[Arif]

That WAY to much work for me. I just do like Retire @40 and use my fingers and toes if it gets dicey.

 

[thefed]

That WAY to much work for me. I just do like Retire @40 and use my fingers and toes if it gets dicey.

lol