What Is Compound Interest?
Compound interest is "interest on interest." $100,000 at 7% simple interest for 10 years = $170,000. Same amount at 7% compounded annually = $196,715. The difference compounds. In real estate, equity growth from appreciation and principal paydown compounds—your equity earns more equity as the property appreciates. Time value of money and wealth building both rely on compounding. The longer you hold, the more it works for you.
Compound interest is interest earned on both the principal and previously earned interest—so your money grows faster over time as each period's gains generate their own gains.
At a Glance
- What it is: Interest earned on principal plus prior interest—exponential growth
- Why it matters: Drives wealth building; time is the multiplier
- Formula: A = P(1 + r)^t (future value = principal × (1 + rate)^time)
- Real estate link: Equity growth, appreciation, principal paydown all compound
- Rule of 72: 72 ÷ rate = years to double (7% ≈ 10 years)
A = P(1 + r/n)^(nt)
How It Works
The math. Year 1: $100,000 × 1.07 = $107,000. Year 2: $107,000 × 1.07 = $114,490. Year 3: $114,490 × 1.07 = $122,504. Each year you earn interest on a larger base. After 20 years at 7%, $100,000 becomes $386,968. Simple interest would give $240,000. The gap widens with time.
In real estate. Appreciation compounds—3% annual growth on a $300,000 property means year 1 gain $9,000, year 2 gain $9,270 (on $309,000), year 3 gain $9,548. Principal paydown compounds too—early payments are mostly interest; later payments pay down more principal, so equity accelerates. Leverage amplifies the effect—you're compounding on the full property value, not just your down payment.
Rule of 72. Divide 72 by your annual return to get years to double. 7% return = 72 ÷ 7 ≈ 10 years. 10% = 7.2 years. It's a quick mental check for holding period and exit strategy.
Real-World Example
Martin's duplex in Memphis. Bought for $245,000 in 2019, 25% down ($61,250). Five years: appreciation 4% annually → property worth $298,000. Principal paydown: $12,400. Equity = $298,000 − $171,350 (loan balance) = $126,650. His $61,250 grew to $126,650—107% return in 5 years. Compound interest on appreciation and paydown did the work. Another 10 years at similar rates and equity could triple again.
Pros & Cons
- Exponential growth—the longer you hold, the steeper the curve
- Leverage amplifies compounding on equity
- Appreciation and principal paydown both compound
- Reinvesting cash flow accelerates wealth building
- Time value of money favors long holding periods
- Works against you when you borrow—mortgage interest compounds on the loan
- Requires patience; early years show modest gains
- Inflation erodes real returns—7% nominal might be 4% real
- Selling early cuts off compounding
Watch Out
- Debt compounding: Mortgage interest compounds against you—paying extra principal early saves more than paying late
- Inflation adjustment: Nominal appreciation isn't real wealth if inflation matches it
- Sequence risk: A crash early in your holding period can reset compounding—cash reserves matter
Ask an Investor
The Takeaway
Compound interest is your ally in wealth building. Equity growth from appreciation and principal paydown compounds over time. The longer you hold, the more it works. Don't sell too early—let it run.