Real Estate Finance Basics

Dr. Arthur C. Nelson, FAICP

January 2009

Not Rocket Science

• Future Value

• Present Value

• Future Value of an Annuity– Future value of cash flow stream

• Present Value of an Annuity– Present value of cash flow stream

• Mortgage Constant

• Loan Amortization

Future & Present Value• i = annual interest rate

• n = number of years

• FVi,n = PV(1+i)n

$1,000,000 today @ 2% interest, 10 years =

• PVi,n = FV / (1+i)n

$1,000,000 in 10 years @ 2% discountdiscount =

Trust Fund Proceeds

• $100,000 received at end of each year for being “good.” How much is it worth after 20 years @ 5% interest?

• “Future Value of Regular Annuity”

• FVAi,n = ANN x {[ (1+i)n – 1] / i} =

Lottery Winnings

• You win $1,000,000 annually for 20 years, what is the present worth @ 5% discount rate?

• Present Value of Annuity

• PVAi,n = ANN x {1- [1 / (1+i)n ] / I } =

The Hairy Monster

• $1,000,000 mortgage (first house after graduate school). What are the monthly payments @ 6% interest (jumbo loanjumbo loan) 30 years?

• Mortgage Constant, Monthly

• MCi,n = PV x { i/12 / 1- [(1/1 + i/12)n x 12]}

Loan Amortization ScheduleVinnie lends you $1,000,000 @ 12%, 5 years.

What are your annual payments?EOY

Amount Annual

Year Outstanding DS Interest Principal

0 $1,000,000

1 $ 842,590 $277,410 $120,000 $157,410

2 $ 666,291 $277,410 $101,111 $176,299

3 $ 468,837 $277,410 $ 79,955 $197,455

4 $ 247,687 $277,410 $ 56,260 $221,149

5 $ 0 $277,410 $ 29,722 $247,687