Assume Jean-Claude purchased real estate for $500,000 using $50,000 of which is his own money and $450,000 which he borrowed at an 8% interest rate. If the value increased by 10% in one year and he sold the property, what was Joe's rate of return on his investment? If the value of the property had declined by 2%, what would have been the rate of return on his investment?
The 10% appreciation implies an increase of $50,000 (10% × $500,000). The interest payment on the loan would be $36,000 (8% × $450,000). As such, he has an additional $14,000 ($50,000 ? $36,000 . with an original investment of $50,000 making his rate of return 28% ($14,000 ÷ $50,000).
The 2% decline in value implies a decrease of $10,000 (5% × $500,000). The interest payment on the loan would again be $36,000 (8% × $450,000). As such, he lost $46,000 (?$10,000 ? $36,000 . with an original investment of $50,000 making his rate of return ?92% ($46,000 ÷ $50,000).
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