A penny saved is a penny worth more today than ever again.
We’re willing to bet you haven’t heard it that way before. Not during Nana’s lessons on frugality. In fact, concluding the lesson with a penny earned is not only incorrect, but plainly poor advice.
Try instead, a penny invested, is a penny kept. We know you’re not walking around with pennies in your pockets, so assume from here forward we’re discussing value, and the only way to keep value is to invest your money at (minimum) the inflationary rate.
Future Value is the numerical value of an asset at a specific date. The logic says that at a certain point, one penny will become one hundred pennies, one thousand pennies, or any infinite numerical representation of currency. This does not mean that one day a penny will make you wealthy, but rather that it’s a good time to do away with the penny, as it’s probably worthless (Canada did…).
Returning to the REsheets fundamentals of Financial Analysis, specifically REsheets U: Finance 301, we call upon the legendary Sir Walter Capital to provide a Commercial Real Estate example:
Consider the simplified example of a four unit Apartment Complex purchased by Sir Walter Capital today for a cool $1 million. Assume the previous owner was a generous landlord with four very happy, very long term tenants. In his generosity, the previous owner has allowed each tenant to pay the entire year’s rent in one lump sum at year’s end. In return, the tenants treat each Apartment Complex as home, maintaining, repairing, and paying all utilities on their own.
At the end of the year, each tenant cuts a check for $18,000.
Sir Walter Capital believes the Apartment Market is steadily increasing by 2% each year.
To determine Future Value using simple interest, the formula looks like this:
FV = PV * (1 + rt)
FV = $1,000,000 * (1 + .02) = $1,020,000
but don’t forget to add the (4) one year ($18,000) tenant checks already in Future Value,
One year Future Value = $1,092,000
Congratulations, Sir Walter Capital has increased his numerical wealth by $92,000! So why doesn’t that mean anything?
Because Future Value must be made relative to Present Value. We have to know how much a penny will be worth, in terms of its purchasing capacity, tomorrow as compared to today. If it costs $1 to a buy a pack of gum today, and $1.10 next year, then Sir Walter Capital will have essentially lost wealth (only increasing his own by 9.2%). 10% inflation is generally unlikely, but it is very possible that the opportunity cost of this investment was a shopping center paying 12% per year.
Of course Future Value is rarely so simple as the above example, but beginning simply allows us to comprehend the effect. Money in the future is worth less than money today, so we better make a lot more of it! Also, payment structures (and expenses, taxes, fees, etc.) are rarely so straightforward, including compound methods of calculating interest.
But essentially remember, Future Value is entirely relative to today, other opportunities, and risk. And Future Value is always subject to risk as forecasting the future is always an assumption. The goal is to best prepare your assumptions.
At REsheets, we offer a variety of products capturing the Real Value of Commercial Property today and in the future. If you have any questions about today’s lesson, or beginning your own confident analysis, never hesitate to contact us!