Originally Posted by gwd
I don't see a consistant approach in your spreadsheet. Cell A2 is wrong. If you get a 7% discount your
initial cash outflow is .93 times the yearly rent so it would be 11160 not 12000 right? Then, it looks like
you are finding a monthly rate that makes cell E2 equal 0.07 right? I don't understand why you do that but when I rework your spreadsheet to make E2 0.07 look what happens, you get a 30% rate of return. With A2 at 11160, we agree on columns A and C because those columns represent cash flows. Columns D and E are mysterious to me.
My spreadsheet shows what would happen if instead of taking the $12000 (column A) and using it for prepayment, you put it in some kind of interest bearing fund. At the beginning of every month, you withdraw the rent from the fund (column C). At the end of every month you get interest deposited into the fund (column B). The balance of the account at the end of every month is shown in column D. If, at the end of the year, the money remaining in the fund is equal to about 7% then paying your rent monthly and investing in the fund is equivalent to taking the discount. It turns out that in order for this to happen (column E) the interest paid by the fund over the course of a month should be about 1.2% (column B). The annual return for such a fund is about 15% (column F), which corresponds to a before tax return of about 17% (column G).
...perhaps it would be more clear if I used 7/.85=8.2% as the target instead of 7%, since this reflects the actual (taxable) percentage return you'd have to obtain from your equivalent fund. Then you find that the APY of the fund must be about 17%, and the before tax equivalent (.17/.85) is meaningless since you wouldn't be paying tax on a 17% return. This is mathematically equivalent to what I did in my spreadsheet, but after typing the explaination above I like considering it this way better.
Originally Posted by gwd
The way I do it using the internal rate of return makes the result comparable to the statements that mutual funds put out when they say something like "You got x dollars this month and that translates into an annualized yield of y%." It is also comparable to present value methods because that is essentially what Excel's IRR function does. It finds the periodic rate that makes the present value of the cash flow series equal the initial cash outlay, or if you adopt a sign convention IRR finds the rate that makes the present value of all the cash flows zero. I learned this stuff with paper tables but OpenOffice and Excel and other products put the tables in functions. I would say that if one of the Excel or OpenOffice functions isn't doing the job for you, you are either making a mistake or getting too fancy for typical financial decision making.
The thing is, I'm not sure how you are trying to treat the equivalent mutual fund. Are you putting money into it every month? Are you taking money out of it every month? Which amounts are you paying tax on? I have computed it explicitly for the equivalent fund. However, as I already mentioned, either way I still don't think this is necessarily a fair comparison because, if I had access to a ~20% mutual fund with the same level of risk, then I wouldn't be withdrawing principal from it to pay my rent, I'd be adding to the principal. In my opinion, the very specific profile of the cash flow distorts the true worth of the deal. After all, in the end you're only saving around $1000 taxable dollars.
Originally Posted by gwd
When I approached landlords about prepayment discounts I did the "stupid renter" routine. Since they were both real estate professionals I knew they had a low opinion of renters. I mentioned that I had managed to save some money and was all confused about stocks bonds and CDs and mentioned the rates of return. They both in their ways began to give me the know it all talk about investments. So I'd say something like "Well I'm not ready for the stock market and real estate would you be interested in giving me a discount if I used my savings to pay the full year now?" Then the one said to me "Of course, years ago it was common to do that." At those times 7% was a lot less than the return on the stock market but a little higher than bonds, so that is what I suggested and they both went for it. The second one continued with the savvy invester act and pulled out his big real estate calculator, furrowed his brows and punched some numbers before he agreed to it. A third real estate agent who I didn' rent from but asked about prepay discounts advised me not to mention it until the landlord had agreed to rent to me because he thought it might make me seem like a person with a shady credit history.
Unfortunately, I've rarely had the opportunity to meet the actual property owner. Usually, I'm dealing with a management company which I'm guessing probably sits down with the property owner and a lawyer once a year to iron out what the lease should say (either that or the lease is just handed to them). They don't want to change one iota of the lease. It just makes more work for them since they would have to set up an extra meeting with the property owner.
Right now I'm pretty happy paying my rent via credit card. I get 3% cash back from the credit card company, two months interest on the payment (grace period), and not only do I control the money until the first of every month, but I have considerable leverage in getting back a payment (via a dispute to the credit card company). At the end of the year I end up being just a couple hundred short of your deal, but with probably less risk than an FDIC insured account. Now, if I could convince my landlord to give me a discount on a prepayment via credit card....
(thanks for the tip)