Real estate – Math behind it Saikrishnan G
Realtors’ free workshop… • For the consumption of gullible audience only • Simple and sweet • For every complicated problem, there is a simple solution that is wrong
What is Realtors’ logic? • A $250,000 property with 10% appreciation in 2 years $275,000 selling price • Since the down payment is (often) 10%, a 10% increase in property increased your principal by 100% • Don’t take it with a pinch of salt but a bucket of salt (What happens if 10% depreciation happens?)
What they are not telling you • Who pays the mortgage interest? • Home equity darling ? • HoA – Whaaaat ? • Property tax !!!
Opportunity Cost • Opportunity cost of X • Ceteris paribus • what is the extra cost incurred through undertaking venture X ?
Mortgage interest (100% of Interest) Home Equity (100% of interest payment) Home owners association fee Property tax Moving charges, penalties Garbage disposal fees New purchases (fridge etc.,) Tax1 Extra electricity bill, gas bill etc., Rent (liberally prorate the increase in rent) Tax2 Opportunity cost / year
Let’s put some numbers • The subtraction of costs incurred on LHS and RHS is the opportunity cost of buying a home. • If this amount is $15,000 this implies that you are paying 15 grand / year as the price for owning a home
What happens to the principal ? • We added the mortgage interest only but not principal • The principal (in P + I) you pay goes towards YOUR equity on the home • i.e., Had you paid $1000 on principal, and the house price didn’t increase at all, when you sell the home you will get $26000 ($25000 down + $1000 principal)
So.. How does one account for the principal paid ? • If you had paid $1000 towards principal in a year, the opportunity cost is • The S&P 500 return on the $1000 for that year (Vanguard 500 index) • Let’s say 8% is the return that year Opportunity cost on principal = $70
Total opportunity cost • Opportunity cost interest and other expenses calculated in slide 7 • times (1 + S&P 500 ret)num_yrs • Plus • Opportunity cost of principal calculated in slide 9 • Number in our example is ($15000 * 1.08) + $70 = $16270
Are you making a profit ? • Home Sale price • Less Broker’s commission (5-6% of the sale price) • Less Outstanding mortgage and home equity loan • MUST be greater than TOTAL OPPORTUNITY COST in slide 10