Equity is one of the most misunderstood components in real estate. In our experience, it’s also one of the major reasons that investors stall, rather than creating a meaningful portfolio. The reason for this is a lack of understanding with regards to the nature of equity, what it can do and its shortcomings.
Here are our five steps to understanding equity.
- Equity is Earned
Equity at its most basic is the difference between the amount of money you owe on your property and the value of that property. It is the amount of earned capital that exists in your home. There is no difference between profit derived from investing in the stock market and the equity you have created in your home.
- Equity Is Latent
Meaning, equity in your property is only accessible through leverage. This means using a loan, or the sale of the property to take a theoretical value – the equity – and turn it into a usable and investable resource. This process of leveraging equity is the reason that many people consider using equity as an investment vehicle to be no different than taking out a loan from the bank. However, when looked at in reverse it becomes obvious that due to its nature, possessing equity without leverage is fiscally irresponsible.
You see, equity earns no interest and does not increase in value. Sure, your property may continue to be worth more, but the equity itself will remain entirely static as if you had invested in a bank account that yielded no interest at all.
- The Value of Your Equity Is Far More Than You Think
While equity in its latent form is worthless, once it is leveraged to form part of an investment strategy, its value becomes extraordinary.
For example, if you have $50,000 worth of equity in your current property, and you leverage that into an investment property, you now own a house worth far more than the original value of the equity. In addition, both of your properties are now increasing in value, and creating equity of their own. Now, consider how much that original $50,000 will be worth when you repeat this process five or six times, and each property continues to increase in value. Best of all, the equity has done all the heavy lifting, and you haven’t spent any physical currency.
- You Don’t Lose or Keep Equity
Spending equity doesn’t remove the value of the equity in your property; it only changes its nature. Your property is still worth more than it was, and the equity is now tangible, and useful.
- Equity Is Not a Useful Fall-back Position
Many people consider equity to be a “safety blanket,” that will rescue them in times of financial uncertainty. However, as already discussed, to leverage equity you need to borrow against it or sell the property. In times of financial upheaval, banks and lending institutions are far less likely to approve loans, regardless of the amount of equity you have available. The ideal time to leverage equity, and gain access to increased investment power, is when your finances are strong, your income is stable, and your state of mind is positive.
Equity isn’t your entire investment strategy, but it is a straightforward pathway to increasing wealth and doing so without having to drain your savings or sacrifice your lifestyle.
Zaki Ameer | Founder | DDP Property