Final answer:
The financial analysis of purchasing an investment property involves calculating the monthly mortgage, PV of cash flows, total return, and annual compound rate of return, and comparing these with historical returns of the S&P 500 index, taking into account factors such as risk, liquidity, and costs.
Step-by-step explanation:
When considering the purchase of a house for investment, it is essential to calculate various financial metrics to determine the potential return on investment (ROI). For example, for a house in New Haven, CT, we can calculate the monthly mortgage, the present value (PV) of mortgage payments, the PV of monthly rent, and the PV of the property's resale value after 30 years, using a given mortgage rate of 7.5% and an annual property value increase of 5%. To get the total return, we compare the PV of cash flows to the initial investment.
To determine the annual compound rate of return, we use the formula for compound annual growth rate (CAGR). Additionally, one can compare this investment to investing in the S&P 500 index, which had a specific historical annualized return from 2008 to 2023, and decide which investment is preferable by considering factors beyond the return rate such as market risk, liquidity, and maintenance costs associated with property investment.
When comparing investment options, stocks historically offer higher average returns than bonds or savings accounts, albeit with higher risks. High-risk investments do not necessarily mean low returns; however, they are associated with greater volatility. The concept of opportunity cost and present discounted value play a critical role in these financial decisions. One must consider opportunity costs and interest rates when assessing potential investments.