What is the Time Value for Money Concept?
Imagine the following, if you were to hold on to €100 for the next 10 years, it would most likely be valued at more or less, €92 in 2030. Perhaps mostly due to inflation, but this is what the concept of Time Value of Money (TVM) looks to determine - How much could the value of your money today be worth over time, or in the future?
Investments When Using the TVM Concept?
Determining the future cash flow of a real estate investment made in today’s money is essential, and therefore the importance in understanding the Time Value for Money Concept. As an example, we could imagine we take a mortgage to buy a residential or investment property, and use the TVM formula to determine the present value of the money you will need to make over the term of the mortgage, in order to pay it back.
Using the TVM formula is a great financial planning tool in analysing whether it is wiser to use the capital now for a refurbish, or retain the cash for a future project.
The Time Value of Money Formula
Let’s use an example to understand how the formula works:
Timothy is a real estate investor who has €5,000 euros, he would like to invest at a rate of 4% for the next 10 years. With this in mind and the formula given above, we know the following:
PV = 5,000
r = 4%
n = 10 years
FV = 5000 ( 1 + 0.04 )10
FV = €7,401
We now determine that given the terms above, set during 10 years, after the end of this period the initial €5,000 Timothy decided to invest will be worth €7,401. With this in mind, Timothy can now best decide whether he would prefer to hold on to the capital he has today and borrow funds for his investment, understanding the cost he will have with the loan versus the money he will have at the end of the time period.
Given the result of the values worked out above, Timothy now knows that at the end of the 10 year period he will have an additional €2,401, given it is invested successfully at a 4% return rate. As we know and in most cases, this income is subject to tax dependent on the investor’s residence.
The TVM Concept in Relation to Real Estate
Capital which is invested in real estate more often that not, can be used as a “buffer” against inflation. Therefore, seeing as the concept of TVM, often takes inflation into account, an individual’s personal industry experience helps to account for this slight setback.
In the example above, most likely the investment taken on by Timothy, being real estate, over the years will appreciate more than the money invested, which resulted in €2,401 returned at the end of a decade. Furthermore, if this invested money was to be used to refurbish a real estate asset, confirms that capital in real estate is sure to both value the property as well as the funds invested.
Using the Time Value for Money formula allows for an investor to understand whether it is best to borrow funds, use your own or perhaps apply both. This is one of the vital tools to any investor or fund, who wish to in detail analyse and evaluate a real estate investment in the future.