Would you rather have cash or income?
I was sitting at a closing recently, quietly working through a problem on the financial calculator. My agent asked what the app was on my phone. When I responded that it was a financial calculator, both my agent and the buyer’s agent were perplexed as to why I needed one, since the mortgage brokers do all the mortgage calculations.
This is a common misconception. A financial calculator is not a mortgage calculator, although it can do mortgage calculations. It is, however, one of the most important tools an investor has to evaluate deals.
Let me illustrate some ways you can do that. First, though, you need to be acquainted with your calculator.
At the top of it, you’ll see five buttons: N, I/YR, PV, PMT and FV. Each button stands for a piece of information you’ll need to do a calculation. If you know four pieces of the equation, you can find the fifth.
Here’s what each button stands for:
N – number of payments (in months); I/YR – interest/ yearly return; PV- present value of the loan or investment; PMT – payments and FV- future value.
Today we’re going to be solving for I/YR, focusing on the YR side which is the yearly return you can expect to make on a given investment.
So let’s evaluate a problem:
We had a mobile home on rented lot in Cartersville. The lot rent was $200/month. We approached the park owner and asked if we could get a discount if we paid an entire year up front. They offered us one month free.
Is a $200 discount worth paying $2,200 up front? Let’s see.
Pocket math says $200 off of $2,400 is an 8.3 percent savings.
However, when you plug it into the calculator you get:
N=12 (1 year); I/YR= ?; PV= -2,200; PMT= +200; FV=0.00
I/YR= 16.38 percent. Why is there a difference?
In order to answer that, let me ask you another question: if you could make $10,000 from flipping a house, is that a good deal? Most people would say yes! What if it took 300 years to do it? That changes things.
You see, the calculator takes time into consideration when it makes a calculation. That’s why it’s so important to know how to solve for I/YR. It gives you a way to measure, not just the amount you get back, but also the time it takes to do it.
The calculator told us that 16 percent was a great deal, especially with our savings account earning 0.01 percent.
Let’s look at another deal where we had to decide if we’d rather have cash or income.
We recently bought a double wide on a permanent foundation. We’ll be all in for $25,000 and it’ll rent for $700/month. If we rent it for ten years then:
N=120 (10 year); I/YR= ?; PV= -25,000; PMT= +700; FV=0.00
I/YR= 32.20 percent. BOOM!
That’s a tremendous return, but Ashley and I had a choice to make. The house would resale for about $65,000. After all closing costs, commissions and tax ramifications, we would be left with about $45,000, or a $20,000 profit. So:
N=6 (6 months); I/YR= ?; PV= -25,000; PMT= +0; FV=45,000.00
I/YR= 123.5 percent. Another BOOM!
Even though that’s much bigger return, we decided to keep the house because we have some notes we hold that’ll pay out in the next couple of years. This house will replace some of that lost income and help us to live financially free.
Earlier I said the calculator was one of the most important tools an investor has. But the most important tool is your head. The calculator can measure an investment for you, but it’s up to you to interpret those measurements to see if they fit your investing strategy.
Joe and Ashley English buy houses and mobile homes in Northwest Georgia. For more information or to ask a question, go to www.cashflowwithjoe.com or call Joe at 678-986-6813.