Real Estate Math Primer

Hello, All:

This is a primer on real estate math. For many of you this is quite familiar and basic and for others it can be a good refresher.

This primer is on how to calculate appreciation, equity, and the difference between the two metrics. I’ve also included some HP financial calculator keystrokes. Please note Hewlett-Packard Co. has no idea who I am. It just makes the best calculators. For Texas Instruments fans, I will soon develop the corresponding keystrokes for TI financial calculators.

How to calculate appreciation

Values in real estate are caused by appreciation. Real estate value tends to go up over time - which is called appreciation. It doesn't just happen, and it is a result of various market factors such as other homes on the property and the number of buyers in the market. It can also be based upon current economic conditions which as we all know right now is causing perhaps flat values or reduced values, and some loss of value in some cases. We've lost some appreciation from prior years which the experts are telling us perhaps were not real anyway, but nonetheless we have still experienced a positive average increase in value over time.

When more buyers into the market and start competing for the available properties, which is a market force, and as those buyers purchase available inventory, causing the supply of those homes to reduce -- prices will tend to rise. Basically this is simple demand and supply macroeconomics.

The U.S. Census Bureau says the median value of a home in the US from years 2002 to 2005 averaged a compound annual increase of 7%. In other areas of the United States, for example California -- the median home value increased at a compound rate of 20.1% during that same period.

Let's say in Utah right now we have, in lieu our current flattened economy, over the last five years have recorded an average of 7% appreciation. Let's also say we bought a home for $225,000 three years ago.

So what is the home worth -- starting at $225,000, three years ago, at 7% appreciation annually?

Here is one equation to do it;

$225,000 X (1.07) X (1.07) X (1.07) = $ 275,634.68. This is the correct amount.

Why can't we just multiply $ 225,000 by 21%? 21% would be three years of 7%, wouldn't it? Here's an incorrect equation:

$ 225,000 X (1.21) = $ 272,250. That's less than the first answer, isn't it?

So, no: just using 21% won’t work. It’s not the correct equation because it doesn't compound the first or second year's appreciation in its calculation. It just calculates 21% of $225,000 and doesn't include the value achieved after year one and year two.

------- Fast Calculator Maneuvers Instead -----

But let's just use our trusty HP financial calculators and calculate this quickly and quite screwing around with equations. Here are your calculator keystrokes to do the foregoing problem quickly…

Turn on your HP calculator...

Press CCCCC [ CLX ] ...to clear your display.

Enter CCCCC225,000 [ CHS ] ... change 225,000 to -225,000*

Press CCCCC[ PV ] ... outflow of $225,000 is our present value - the amount spent on the house.

Press 7 CCCCthen press [ i ] ... The appreciation rate for one year from the example above.

Press 3 CCCCthen press [ n ] ... which is the numbers of years since we bought the house.

Press CCCCC[ FV ] ... the FV keystroke will calculate the future value of the house = 275,634.68

* Hewlett-Packard and most financial calculators use the minus symbol to indicate the value (money) left us -- we spent it -- we placed it outside of our wallets so to speak. Notice after pressing the Future Value key, your answer is positive -- meaning that's what your value is now -- to you -- your asset - your good.

So, if we bought a house for $225,000 three years ago and it appreciated at an average rate of 7% each year, it is now worth $275,635.

How much appreciation is ours in dollar terms?

The dollar amount of appreciation is the ending value less the beginning value:

275,635 CCCCCEnding / market value

225,000 CCCCCBeginning / Purchase price of the property

50,635 CCCCCAppreciation. Nice.

But...$ 50,635 is not equity.

How to calculate equity…

Equity = Market value - Debt (the mortgage)

$ 275,635 = Market value after the appreciation is added in. Let’s say the borrowers put a 10% down payment on the purchase and mortgaged the rest:

225,000 CCCCCPurchase price.

202,500 CCCCCMortgage: $225,000 - $22,500 (10% down)

73,135 CCCCC Equity

Applause. We’ve properly calculated appreciation and equity.

Off the top of your heads….what does the dollar difference between equity and appreciation represent?

---

‘Glad that real estate prices cycle and will come back.

This business will certainly teach us patience, eh?

From My Porch

Mike B. Class Star®



ClassStar presently offers two, 3-hour core courses. Your business and referrals are appreciated.

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