## What is Time Value of Money?

You have probably heard the term “time value of money.” But do you know what it is?

For example, if you put $100 under your mattress today and then took it out 10 years later, you still have $100, but the TVM has likely decreased as it would not buy you as much in 10 years as it would have bought you today. In essence, the money that was worth $100 of buying power today, may only be worth $92 of buying power 10 years from now. That is the time value of money.

## The Importance of Time Value of Money in Real Estate Investing

Understanding the time value of money is important to real estate investors as a financial planning tool to determine whether you are better off using your cash now for a rehab, or borrowing money and conserving your cash for a future project or another purpose.

It can also help formulate a savings plan for how much would you need to invest in today’s dollars to have a specific higher amount in the future.

## The Time Value of Money Formula

## Time Value of Money Example

Madeline is a real estate investor.

Madeline has **$1,000** that she can invest at **5%** for **10 years**.

The time value of money equation would look like this:

**FV = 1000(1 + .05) ^{10}**

Using this equation, **FV = 1,628.89**.

What we have learned is that **the $1,000 that Madeline invests today under the terms set above would be worth $1,628.89**.

As a real estate investor, Madeline has to decide if she wants to hold onto her $1,000 today and borrow the funds for her rehab project by figuring out the costs she will have to pay for the loan, versus the amount of money she will have at the end of the time period.

By using the time value of money equation, she knows that by holding onto the money for 10 years at 5% interest she will have an additional $628.89 at the end of the time period (if successfully invested at a 5% return).

In most cases, this gain will be subject to income tax. If she puts her money into the project rather than holding on to it, she will likely pay more in interest than she could have earned if she had the funds invested (as that is the underlying principal of capital markets).

But there is more to be taken into account…

## Inflation and Real Estate Values

Furthermore, because Madeline is rehabbing as a business endeavor, she can deduct the costs of the loan from any profits she makes from her income tax, which has a huge effect on increasing her actual gain at the end of the project.

The difference between the increase of value of the $1,000 if saved and the amount paid for investing that money is now $384. While there is still a difference in gain/cost for borrower funds, she has retained the use of the $1,000 for other investments and opportunities to realize the $628.89 gain, reducing the cost of borrowing funds even more.

Time value of money is a helpful tool in evaluating whether you borrow funds for your rehab project, use your own funds, or do both. It is vital to understand the mechanics of investment and debt in order to determine the most effective tools for your rehab business.