Real Estate Concepts: Simple Interest

Quite a number of millionaires have made their names in the real estate arena. Names like Spencer Strauss, Donald Trump, Kevin Myers, Bill Tappan, Jeffrey Taylor, Jane Garvey, H. Roger Neal, etc. are highly celebrated personalities not only because of their portfolio value but most importantly because of their concepts and strategies in real estate investment.

The most basic computation in evaluating the rate of return for a real property investment is the simple interest. Calculation of simple interest consists of 3 elements: principal, rate, and time. The principal is the initial amount of investment. The rate, also referred to as rate on investment (ROI), is the interest rate of your investment at a given period of time.

Let me give you an example, Ms. Anne has decided to invest his bank savings worth $10,000 to a newly developed, residential district in Detroit, Michigan. The property consultant mentioned an annual interest rate of 7% after 2 years.

Principal = $20,000 Rate = 5% Time = 2 year

Simple Interest = Principal x Rate x Time

= $10,000 x .05 x 2

= $1,000

In 2 years time, your $10,000 investment will earn $1,000. Your property’s value then will be principal plus interest or $11,000. Obviously this is a simple scenario using simple interest. What if you have 2 property investments that need proper evaluation? Referring to Ms. Anne’s case discussed above, she decided to add more money so that her total annual earned interest will reach $1,500 or 7.5% of initial investment (instead of $1,000). If she expects the interest rate to increase to 9% how much additional money does she need to achieve her target?

	P	R	T
Initial investment (period 1)	10000	.05	2
Additional investment (period 2)	y	.09	2
Total investment (total)	10000 + y	.075	2

Using the same formula:

Simple Interest = Principal x Rate x Time , since we have 2 investment periods, then

Simple Interest (period 1) + Simple Interest (period 2) = Simple Interest (total) , or

Principal x Rate x Time (period 1) + Principal x Rate x Time (period 2) = Principal x Rate x Time (total)

Substituting the values from the table:

(20,000 x .07 x 2) + (2 x .11 x y) = (20,000 + y) x .10 x 2

Solving for y will give you the value of $16,666.67. This means that Ms. Anne has to invest an additional of approximately $16,700 to attain her target.

Another computation frequently used in financing and economy is the compounded interest. Simple interest has lower yield or future value since the interest earned in compound is reinvested as capital. Knowing the fundamental interest calculation can help you make better offer to your clients. The properties you are selling can become more appealing if you can give them an idea how much it will worth after a period of time. If you are on the other side of the negotiation, you can evaluate the property on your own and even verify claims and assertions on a certain investment.