Chapter 5 – Interest

• simple interest = Interest ÷ Principal
• opportunity cost – if you invest A with the cash, get x%, if you do B with the cash, get y% return. You cannot do both.
• rate of return (ROR) == interest. If you are a borrower, it is interest that you have to pay. If you are a lender, it is ROR that you get.

Chapter 6 – Compound Effects

1. Compound interest = Principal × power(1 + Interest rate, yr) – Principal
2. The Rule of 72: years to double = 72 ÷ ROR

Chapter 7 – EXPECTED VALUE (EV)

use probability x return to calculate the combined return. Example:

A typical flip insurance policy costs ~$1,000.

1. On about 1 out of 50 flips (2 percent), I’d have a small ($10,000) claim.
2. On about 1 out of 200 flips (0.5 percent), I’d have a big ($100,000) claim.
3. On the rest of the flips (97.5 percent), I’d have no insurance claim.”

Calc:

• Pay for insurance: 1k
• self-insure: 95.5% x 0 + 0.05% x 100K + 2% x 10K = 700.

So it save $300 to self-insure.

Chapter 8 – TIME VALUE OF MONEY (TVM)

It is basically the cash value decays over time. By how much? Reverse the interest rate calculation.

For example, RoR is 12%, 1k payment next year == 1k / power(1 + ROR, period) payment now. Period can be monthly, or yearly

Discount rate == ROR == interest

Future value (FV) = PV × power(1 + i, n)

Present value (PV) = FV ÷ power(1 + i, n)

Chapter 9 – DISCOUNTED CASH FLOW (DCF)

DCF = CF1 ÷ power(1 + i, 1) + CF2 ÷ power(1 + i, 2) + … + CFx ÷ power(1 + i, x)

Use case: 2M now vs 200K/yr for 25 yr

Solve: use above formula to figure out the PV for the 2nd case, and compare with 2M.

Chapter 10 – NET PRESENT VALUE (NPV)

NPV = investment today as negative number + DCF

how to use it:

1. price a deal: a property asking for 77K today, cash flow $9600/yr for next 10 yr, is it a good deal? assume discount rate = 12%,  -77K + 9.6k/1.12 + .. = -22758. So it is cash negative (cumulative) after 10 yr. We should offer 77000 – 22758 = 54242 (from number perspective). Market condition/buyer competition/seller expectation is another story.
2. borrow money to buy a property: property offers at 100K, you need to take out from HELOC at 5% interest (use 5% as discount rate), cash flow 2k/yr, sell after 5 yr at 130K. NPV is $8950.3 after the sale. So it is a worthy deal.
3. net present value deal: avoid deals with negative NPV

Chapter 11 – INTERNAL RATE OF RETURN (IRR)

How to choose between two deals here: invest 100K with NPV 8k after 5 yr, or invest 1M with NPV 20K after 10 yr? Answer: use IRR

brutal force: basically the same calc as NPV, but tweak the discount rate until NPV reaches 0. The final discount rate is IRR.

xcel: XIRR(values, dates) – values is the cashflow column. The initial investment is filled in as a negative cashflow. The dates are cashflow date column.

Chapter 12 – REAL ESTATE TAXES

• Flip or wholesale – taxed as ordinary income
• Rental – taxed as capital gain, and other benefits to lower tax.
• Who to judge: IRS is the king to say one way or another. Your intent is the biggest defense.

Adjusted basis = Purchase price + Purchase costs + Capital expenditures + Selling costs – Depreciation

Taxable gain/Loss at sale = Sale price – Adjusted basis

Chapter 13 – TAX BENEFITS OF REAL ESTATE

Why REDUCE/DEFER TAXES:

1. Boost compounded returns
2. Pay taxes in inflated dollars
3. Wait for more favorable tax laws
4. Perhaps put it off completely

WAYS TO REDUCE/DEFER TAXES

• 1031 Exchange
• Hold for a Minimum of One Year (and a Day!)
• Invest from a Self-Directed IRA
• Sell When Your Income Is Low
• Installment Sales
• Qualified Opportunity Zones

Chapter 14 – ASKING THE RIGHT QUESTIONS

Q1. How much money will I make from this investment?
Q2. What percentage of my initial investment will this investment return?
Q3. What percentage of my initial investment will this investment return per year?
Q4. What is the compounded return of this investment over time?

Q1: Profit, Net Operating Income (NOI), Cash Flow (CF)
Q2: Return on Investment (ROI), Equity Multiplier (EM)
Q3: Capitalization Rate (Cap Rate), Cash-on-Cash Return (COC), Average Annual Return (AAR)
Q4: Compound Annual Growth Rate (CAGR)