Poker, Real Estate, and Cheese

Life is much easier when you know math and follow its path than if you don’t know math or ignore its absolutes… Today we’ll look at 2 simple math problems involving selling a house and buying some cheese…

Poker Night

I was playing poker with some friends recently and a buddy was going on and on about his recent house sale. He’d bought a house 15 years ago for $150,000 and recently sold it for $450,000. He was ecstatic – though I did notice he brought cheap beer to the game despite this sudden windfall…

As he talked he was exclaiming that he had “tripled his money” in just 15 years – a curious claim right off the bat as I quickly calculated some simple percentages… He was also talking about his home increasing by 300% in value. As several folks chimed in with this 300% “triple up”, I started thinking that if these guys were as bad at poker as they were at math they were about to leave the game a lot lighter in their wallets…

Math is (not) Hard

I hate to break it to you my friends, but going from $150k to $450k is a 200% gain, not a 300% gain. Yes you “tripled” your money, but that does not equate to a 300% return on your investment. Oy vey…

Ok, we’re off by a factor of 100% on the appreciation calculation, but something else didn’t ring true about my buddy’s profit margin. Had he even doubled his money, let alone tripled it? As the cards were dealt I began to probe…

My friend had put down $25,000 and financed $125,000 at 4% on a 30 year mortgage to buy his $150,000 house. After 15 years he had sold it for $450,000, claiming a 300% gain that was really a 200% gain. Is his calculator low on batteries or is he just pushing the wrong buttons?

Figuring Your Net Gain

  • First off, upon the sale of his home @ $450,000 he paid a 6% real estate commission, so let’s take $27,000 in transaction costs off the table right away.
  • Aside from that, a simple amortization table will show he also paid $66,000 in interest in those 15 years – that’s the cost of renting cash from the bank to finance your housing investment.
  • He also paid property taxes on this investment that ran him $36,000 over 15 years @ $2,400/year.
  • Using a conservative average of around 1% of his home value we can figure he also saw “operating costs” in the form of maintenance totaling $45,000 in the time he lived there @ $3,000/year
  • In addition, his bank required him to insure his home as a condition of his mortgage and that totaled $18,000 @ $1,200/year.
  • Finally, he paid about $3,000 in closing costs across the buy and the sale.

So his payout after 15 years ended up being $255,000 net of operating and transaction costs.

Next let’s look at invested capital. He put $25,000 down and paid $107,460 in payments toward the principal on the house, using the same mortgage amortization table. Therefore, across 15 years his investment of capital totaled $132,460 toward the “hard capital asset” – the structure and the property it sits on.

Swig the beer, eat the Doritos, and play your next hand at the poker table. After it was all said and done my buddy turned $132,460 into $255,000 across 15 years. That’s gain of $122,540, or 92%. And here my poor friend with a busted flush draw thought he’d seen a 300% return on his money in real estate… He didn’t even double up…

Now… a 92% gain is obviously nothing to sneeze at. Across 15 years that means he saw an average annualized return of around 4.5% per year – about the same as a good safe bond fund, but not the high-flying profit he had maybe anticipated.

Realtor Math

My buddy fell victim to what I call “realtor math”. Realtors want you to think folks all over town are doubling and tripling their money in real estate with ease, but those numbers seldom represent reality.

This story would emphasize the importance of math, specifically working with percentages, knowing how to calculate ROI, and knowing how to read an amortization schedule. If you passed 8th grade it should come to you easily – you just have to do the math and adhere to its absolutes…

Say Cheese…

How about something more practical? How about cheese? Let’s say you really like cheese and you go through a pound per week (I hope you have good plumbing…)

Your local store usually sells cheese for $3/pound. Though you never keep it that long, you know it would last 3 months in your refrigerator if you had to store it.

One day you walk into the store and they have cheese on sale at $1/pound. “Oh man, cheese is on sale! Nice!!!” So what do you do? You get edgy, you go wild, you go cheese-crazy and you buy not one, but THREE  pounds of cheese this week! Whoo-hoo! What a deal!

Three pounds? You’ve just short changed yourself in a huge way! The correct amount to buy is not 3 pounds but 12 pounds! That’s 3 months worth, the amount of time the last remaining block will stay fresh in your fridge. In buying only 3 pounds on sale you’ve lost out on a savings of $18 that is being offered to you with zero downside. You’ll be paying $2 more per pound than you should the next 9 times you buy cheese!

Frugality…

Frugality always had a 100% chance of working and it is taxed at 0%. Look for these deals and be prepared to do math as you shop… And know how to tabulate your ROI on your non-consumables.  Cheers – thanks for reading!

Disclaimer – the cheese narrative contains an “Uncle Buck” quip and the scenario is cheesily borrowed from a Mr. Money Mustache story. The poker game described was for amusement only and the poker chips held no monetary value. All participants were of legal drinking age and were home in bed by 9pm…

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