What is Residual Value? Residual value is the entire worth of something, in the same time period. The thing we are talking about here is the residual value of an asset. So what is the residual value of an asset?
This concept was introduced by JK Galbraith and thereafter became popular as “Residual Trade Value”. Basically it involves figuring out the worth of an asset after a particular time, while keeping a constant rate of appreciation. This value is then discounted to the present day value. The concept works on a simple principle that once you sell an asset, you essentially “buy back” the value of that asset minus what you paid for it.
The concept of what is the residual value of an asset was made popular by Benjamin Graham. He made it big by investing in a lot of local businesses. Later on, these businesses were able to weather the storm of recession. The fact that these businesses were able to weather the storm meant that they had increased their worth significantly. Benjamin Graham then invested in other businesses. And these investments turned out fine as well.
Now, if you are thinking that you don’t have to sell your asset to get to its value, think again. Remember earlier when I told you that the price to earn a return is the amount you spend to buy the asset? Well, you will still have to pay this amount even after selling your asset. You will only get the value of the asset back, not the price you paid for it.
So what is the residual value of an asset if you don’t have to sell to get to its value? It means that when an asset is purchased and sold, you are essentially buying two things at the same time. First, you are buying the asset’s actual worth. And second, you are buying the potential residual value that the asset might have in the future because people will be willing to sell it for something higher than its current market value.
Think about assets like cars or houses. When a car is sold, you pay anywhere from one hundred to eight hundred thousand dollars for it. If you manage to sell it at the car’s actual value, you would walk away with around fifty or sixty percent of what you paid. The asset still exists after sale, but what is called its “present value” has already been determined. That is how much you would get from it if you sell it today.
With an asset like an apartment, the initial purchase price is often very high, and the asset will have little or no potential for appreciation in the future. However, you could find a buyer who really wants the apartment and will pay more than eight hundred thousand dollars for it. Would you be able to sell an asset like this for that amount? Most probably not, so what is the residual value of an asset?
Residual value refers to the amount an asset continues to have value even when no one is making any effort to make improvements to it. If you buy an apartment at an attractive price, but nobody is interested in living there, does it still have any value? The answer is no. Its residual value has been determined by how well you manage the building.
How can you make your asset more valuable? By adding the improvements that you make to it over time. This will increase its overall worth, as well as the amount it is worth to you immediately upon sale. In effect, it is like earning interest on your money! And what is the residual value of an asset?
Residual value is determined by the amount an asset would have if it were sold today, without making any changes. For example, if you were willing to give a business partner a twenty percent stake in the business and they agreed to hold onto the asset for twelve years, would you get back twice that amount as a profit? Obviously not, so the value of the asset is less than the amount you agree to sell it for. The point is that you should think about what you are willing to give up in return for what you gain from the deal. If the value of the asset goes up over time, then you can sell it for more than you originally invested.
So what is the residual value of an asset? It is what the asset would be worth in today’s market if it were sold without doing anything to it. Of course, you have to consider the maintenance costs associated with the asset. However, it is usually the case that once you spend a lot of time and effort working on improving your asset, its value increases significantly.