ShmoopTube

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principles of finance a la shmoop valuing an asset so how do you value a

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company let us count the ways starting with [Warren Buffet]

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thinking about a home even though that's kind of a different animal and you never [picture of house]

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owned a home it owns you well one way you could in theory value a

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home is to look at the replacement parts of it right you could buy a half acre

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somewhere nearby and simply replicate that same home buying your own timber

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pipes electric wire shingles etc and you'd add up all the costs and your time [building materials]

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labor in the land and all that stuff and say well that's what it cost me to build

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the home that's what it's worth ok that's one way to value it kind of

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the cost to build it alright well another way to value that home is to [construction workers working on a site]

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look at what it cost when it was built but if the home was built like 35 years

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ago is that still relevant like this home here in Palo Alto sells for four

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million dollars it was built 38 years ago and it cost a 200 grand back then so

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yeah a little different so not not that relevant that would be the book value of [very nice expensive home]

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the home sort of but at least the cost of it originally not all that relevant

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there's a third way to value a home it's whatever the market will pay for

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the home yeah good way to value it it's called Zillow just ask your friendly

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neighborhood realtor they know about it Zillow it's kind of an index of [Zillow robot in front of house]

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predictions of what Realtors think and it's adjusted on a per square foot basis

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to what your neighborhood sells for per foot and then acreage adjusted and all

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that crap so zilla's got a good algorithm that does all that and that's [green matrix numbers]

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just kind of what they think the market price will be there's a fourth way to

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value your home if this home will be worth a million dollars in ten years

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what is the most I can pay for it now so that I earn 7.2 percent return on my

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investment all right you're gonna discount that future million dollars ten

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years away to today that number then is the most the home can be worth to you

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the buyer well all of these are at least somewhat reasonable ways of thinking

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about valuing a home but a home doesn't produce cash in fact it consumes it just [water faucet working in reverse]

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wait till your bathtub pipes break when you're a homeowner and you'll feel us [bathtub pipe breaks and floods are]

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big on this one so what if instead of a home we had an apartment building

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aka a stream of cash flows okay that makes it

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a lot easier alright we have 20 apartments in the building which rent [writing on white board]

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for 2 grand a month each that means we're taking in four hundred eighty

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thousand dollars a year right twelve months times forty grand we have

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maintenance and power and water and insurance and other expenses the total

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80 grand a year so we make gross profit of four hundred thousand dollars a year

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from this apartment building well what would you pay to own a hundred percent

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of the equity in this place the it depends answer is always good with us

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here at schmuck can you raise rents over time hmm is the building sellable in ten

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years at a big profit a loss or about the same as where you'll have bought it

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are there regulatory issues like rent control and a bunch of Socialists in the

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government who won't let you do what you want to do with your own investment the

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building is fully rented now 100% will it always be that way or will it be more

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like eighty or seventy two point three all right and then you think about how

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much debt the building could hold so that you have an easier time paying [building turns into a pile of money]

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whatever the current owner dreams that it's worth like when you go to buy it if

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dead on the building is offered by your friendly local bank cost you ten percent [writing on white board]

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a year like they think you're really risky credit and if you paid four

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million dollars for that building well the four hundred grand a year you were

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collecting and operating profits would all go to the bank and just cover the

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interest payments you'd better hope you stay a hundred percent rented during

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this period and that nothing physically goes wrong with the building or well you [apartment building bursts into flames]

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go bankrupt fast but if you could slowly raise rent rates and make more profit [writing on white board]

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while you could eventually pay off that debt and the building then is a nice

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cash flow machine well what if interest rates were only

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five percent instead of ten could you pay eight million dollars and have the [writing on white board]

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same cash flow dynamics as you did in the other scenario well kind of pretty

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much at least from a structural perspective but think about that

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interest rates dropped in half and the notional value of the building just

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almost doubled isn't that crazy how can the building suddenly be worth twice as

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much when one little mothy nugget changes no because it does it is that's

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what happens welcome to the world of interest rates and how powerful they are

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in affecting things like real estate and there's a domino effect that comes with [fingers pushes dominos over]

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it most states tax real estate as a

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percentage of the purchase price so if interest rates

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to go up and real-estate values start to go down well then state taxes start to

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go down in a common ingredient that links all of these potential purchases [hand places cash into cooking pot]

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is the cash that's flowing in the various directions even if you're just

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buying it as an asset with no cash flow like a home eventually you'll want to

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sell it out of profits like buying a growth stock that pays no dividend

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you're gonna buy it hope the asset appreciates one day sell it and that's

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how you kind of do all your math then one day when you sell it in the buyer

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wires cash into your Wells Fargo escrow account well then cash has flowed and if [cash flowing down water slide]

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you want the fancy-schmancy mathy model check out our video on discounted cash

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flow analysis we've got like 18 of them and always remember the phrase cash is

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king because well yes it's good to be king [cash sitting on throne an wearing crown]

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