Simple Interest and Compound Interest in Real Estate Investing

Book: Real Estate by the Numbers | Authors: J Scott and Dave Meyer | Chapters: 5-6

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Interest is everywhere. You see it on your credit card bill, in your savings account, and on your mortgage statement. Most of us have a rough idea what it means. But if you want to understand your investments on a deep level, you need more than a rough idea.

That’s what Chapters 5 and 6 of Real Estate by the Numbers are about. The authors walk through how interest works from the ground up, and then show how reinvesting your profits can completely change your outcomes over time.

What Is Interest, Really?

Here’s the definition the book gives: interest is the periodic payment against money that is borrowed or lent.

When you borrow money from a bank, you pay interest. That interest is the bank’s profit for lending to you. When you deposit money in a savings account, you earn interest. That interest is your profit for letting the bank use your money.

Three things determine how much interest gets paid:

1. Principal - the amount of money borrowed or lent
2. Interest rate - the percentage return, usually expressed per year
3. Time - how long the money is out

Simple Interest

The most basic form is simple interest. Here’s the formula:

Interest = Principal × Interest rate

Say you borrow $10,000 at 2% per year. Each year you owe:

$10,000 × 2% = $200 per year

Over five years, that’s $200 × 5 = $1,000 in total interest.

To get total interest over multiple years:

Total interest = Principal × Interest rate × Number of years

You can also flip this formula to figure out the interest rate you’re getting. If a friend offers you $350 to loan them $5,000 for a year:

Interest rate = $350 ÷ $5,000 = 7%

Simple enough.

Applying This to Real Estate

Here’s where it gets interesting for investors. You don’t have to be making a loan to think about your returns in terms of interest.

Imagine you buy a rental property for $60,000 cash. In the first year, you earn $3,000 in profit. Your return looks just like an interest calculation:

Return = $3,000 ÷ $60,000 = 5%

You are earning 5% on your invested capital. When we apply this concept to investments that aren’t loans, we usually call it “rate of return” instead of “interest rate.” Same math, different name.

Here’s the thing: once you earn that $3,000, you have a choice. You can spend it, or you can reinvest it. That decision matters a lot, and it’s what Chapter 6 is all about.

Compound Interest: Where Things Get Interesting

Simple interest assumes you pull your profits out each time. You earn the same return every year on the same principal.

Compound interest is what happens when you reinvest your profits. Your profits start earning profits of their own.

The book uses a clean example. Say you put $10,000 in a savings account at 5% annual interest.

With simple interest (spending the profits each year):

Total earned: $2,500

With compound interest (reinvesting the profits each year):

Total earned: about $2,763

The extra $263 doesn’t look huge here. But scale this up to larger amounts, higher returns, and longer time periods and the gap becomes enormous.

The Long Game

The authors use a memorable example. Put $1,000 in an investment on your 25th birthday at 10% annual returns. Reinvest everything.

• Age 35: ~$2,593
• Age 45: ~$6,727
• Age 55: ~$17,449
• Age 65: ~$45,259

Without compounding (spending profits each year), you’d have about $5,000 at 65 ($100/year × 40 years, plus your $1,000 back). With compounding, you’d have over $45,000. That’s the difference.

As Benjamin Franklin put it: “Money makes money. And the money that money makes makes more money.”

Albert Einstein is credited with calling compounding “the eighth wonder of the world.” Whether he actually said that is debated, but the math backs it up.

The Rule of 72

Want a quick way to estimate how fast an investment doubles? Divide 72 by your rate of return.

Years to double = 72 ÷ Rate of return

At 8% returns: 72 ÷ 8 = 9 years. At 15%: 72 ÷ 15 = 4.8 years.

This is a rough estimate, not a precise formula. But it’s handy for quick mental math when you’re comparing deals.

Compounding Periods

Here’s a detail that matters more than most people think. The compounding period is how often profits get reinvested.

Compounding monthly gives better results than compounding yearly, because you’re reinvesting sooner. More reinvestment intervals means faster growth.

Going back to the 10% annual return example with $1,000 invested at age 25:

• Compounding annually: $45,259 at age 65
• Compounding monthly: $53,700 at age 65

Monthly compounding adds more than 15% to your total lifetime return just by reinvesting more frequently. That’s a meaningful difference from a small change in how often you reinvest.

What This Means for Real Estate Investors

This is why the authors push the idea of reinvesting rental income as quickly as possible. Letting cash pile up under the mattress while you wait to save enough for your next property slows your compounding. Every month your rental income isn’t working, you’re giving up growth.

The strategy the book recommends is simple: reinvest your profits as quickly as possible, at the highest rate of return you can find. Time in the market beats timing the market, and compounding rewards patience and early reinvestment.

The Formulas

Simple interest:

Interest = Principal × Interest rate
Total interest = Principal × Interest rate × Years
Interest rate = Interest ÷ Principal

Compound interest:

Compound interest = (Principal × (1 + Interest rate)^Periods) - Principal

Rule of 72:

Years to double = 72 ÷ Rate of return

These formulas are building blocks. The next chapters use them to do much more powerful analysis of real estate investments.

← Examining a Cash-Flowing Property | Expected Value and Time Value of Money →