Real Estate Investing

Navigating Equity in Real Estate Investments

May 16, 2024

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Equity in Real Estate Investments   

What is real estate equity? If you’re delving into real estate, understanding equity is crucial. This article breaks down the core concepts, helping you calculate home equity, grasp influencing factors, and leverage it strategically. 

By mastering the role of home equity in property ownership and learning how to leverage it through home equity loan options, you can confidently navigate the market. Whether you’re a seasoned pro or a newbie, this knowledge empowers you to make informed investment decisions and tap into real estate’s wealth-building potential. 

What is Real Estate Equity? 

Real estate equity or home equity is the investment a homeowner has in their property. In other words, it’s the value the homeowner has paid into their home and owns, either in cash or by making mortgage loan payments over time. 

The equity in your home grows as you make more monthly mortgage payments and as a higher percentage of the home’s cost has been paid off. Equity can also grow when homes appreciate and gain value. 

Home equity is important as homeowners can leverage it to obtain loans, finance home repairs, or pay off higher interest debt. You can “borrow against” your home’s equity built through an existing mortgage via a home equity loan to pursue other financial goals.  

How Do You Calculate Home Equity? 

Home equity is calculated by taking the current market value of a home and subtracting any mortgages or liens against it. The amount leftover represents how much equity you have in the home. 

For example, let’s say you purchased a $330,000 home with a 20% down payment. Your loan is a 30-year fixed-rate mortgage at a 7.91% interest rate. Just after you submit the down payment, the amount of equity you have in your home is $66,000. After a year of making payments, your equity will have grown by about $28,800. 

As an investor, understanding the importance of equity in real estate investments is important for maximizing returns and financial growth. Calculating home equity and tracking your property’s amortization allows you to gauge the value of your investment beyond the initial purchase price. 

How Can I Increase Equity? 

There are several ways homeowners and investors build equity:  

  • Paying off the mortgage slowly over time 
  • Paying more than the minimum monthly mortgage payment each month 
  • Making a large down payment 
  • Securing low rates so that a higher percentage of each monthly payment goes to principal balance rather than interest (as well as eliminating other fees once you have enough equity, such as private mortgage insurance) 
  • Buying-and-holding until the property appreciates 
  • Forcing appreciation through strategic additions/improvements. 

Although cash flow is important, appreciation is the underlying mechanism that builds wealth and helps many investors capitalize on holding real estate for long periods of time. Simply buying, holding, and renting out property over the years will usually lead to appreciation if your property is in an attractive location. 

However, some investors choose to achieve appreciation on a faster timeline. Forced appreciation through renovations, updates, and strategic improvements can significantly increase equity, leading to higher returns upon resale. For example, adding an extra bedroom and bathroom, installing a new roof, or converting unused areas (such as a basement or attic) to livable spaces can substantially increase a home’s value.  

Investors looking to force appreciation aim to monitor local real estate trends and economic factors that impact property values to make informed decisions about what to add or improve. By making these changes, they can increase rents in the short term and eventually sell the home for more in the long term. However, this must be done while avoiding excessive debt that could diminish equity growth potential. 

Evaluating Property Equity Value 

While homeowners can always know how much they’ve paid into their home equity, they may not know how that equity transfers into value in the current market they’re in. This is especially relevant for those looking to sell their properties. 

Professional property appraisals can estimate a home’s current market value. Appraisals consider factors like location, property condition, and recent sales of comparable properties to provide an approximation of the home’s value. While online valuation tools can do this, professional appraisers can generally do it better. 

Note that appraisal values are not the same as equity. Equity is the investment you’ve made in a home, while appraised values are the professional assessment of what your home is worth. It is possible to pay very little for a distressed or below-market value home, improve it drastically, and then get it appraised for much more. This is the central component of both house flippers and the BRRRR method of real estate investing, which involve investors profiting from below-market value homes after making improvements. 

The best way to track your home’s value is to pay attention to market trends and economic indicators. Remember that both equity and appraised values are dynamic and can fluctuate based on numerous factors. 

Leveraging Equity for Investment Growth 

Although home equity isn’t considered a liquid asset, you can tap into it. Your home equity is a powerful tool for maximizing investment growth in real estate. By leveraging the equity you have built in your property, you can access funds to expand your real estate portfolio or undertake new investment opportunities. 

What Can Home Equity Loans Be Used For? 

Home equity loans (“second mortgage”) or home equity lines of credit (HELOCs) allow you to borrow against the value of your property, providing the financial flexibility needed to grow your investments. Whether you aim to renovate existing properties, purchase additional real estate assets, or diversify your investment portfolio, leveraging your home equity through a home equity loan or line of credit can propel your investment growth. A cash out refinance option or reverse mortgage might also be viable if you want to access your equity and/or refinance your original mortgage. 

One benefit of home equity loans is that their interest rates tend to be lower. This is because the loan is secured by the equity you’ve already built in your home, which is used as collateral. However, home equity generally cannot be quickly converted into cash, as equity is based on not only how much you’ve paid into it but also a current appraisal of your property. 

Risks of Equity Investments 

Equity investments (like homes) offer the potential for higher returns compared to other investment types. By owning a property, you benefit from property value appreciation in all types of markets.  

However, equity investments, like any investments, do come with risks. For instance, market fluctuations constantly influence property values. In case of a market downturn, your equity could decrease. Local factors can also cause economic obsolescence, negatively influence property values. Think of unfavorable changes in local legislation, zoning, industry economics, crime rates, or even environmental hazards. 

Diversifying your portfolio across multiple types of assets (single-family, multi-family, storage units, etc.) and markets (different cities, urban vs. suburban, etc.) can mitigate risks associated with equity investments. Understanding the market, property trends, and financial implications is crucial for making informed decisions when considering equity investments in real estate. 

Conclusion 

By evaluating property equity value and weighing the risks and benefits of equity investments, you’re well-equipped to navigate the real estate market with confidence. Levering your equity is key to unlocking the wealth-building potential of real estate and achieving your investment goals. 

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