Using equity to build a property portfolio is one of the most powerful strategies property investors use to accumulate wealth faster. The equity will allow you to grow your investments without having to work harder and save more money yourself.
In this strategy, the first property is critical because there must be some growth that you can pull out from your first property that will allow you to purchase sooner your second property investment with zero or less money coming out from your savings.
First, let’s talk about equity.
When we talk about home equity, it refers to the difference between the market value of the home and the balance of unpaid mortgage of the home. To put it in another sense, it is the value of your ownership of the asset.
Equity on Property
Your house is technically an asset. House value increases over time and the land your house is on.
*An asset is anything you own that has value. *
Houses are usually bought using mortgages – loans from a bank. The bank owns your house unless you pay down your mortgage.
*Equity is the amount of an asset that you already own. *
When you pay down your mortgage, you increase your ownership share of the house and decrease the portion that the bank possesses. Equity is also the cash used to pay for the mortgage or the property.
Every successful upgrade and renovation naturally intensify the value of the property. Like mentioned at the start, the value of house and property increases; thus, equity also increases.
Note: Equity as Security
You can borrow using equity as security with the banks to fund other big purchases. Big purchases may be but are not limited to home renovations/extensions/upgrades, business start-ups, and vacation trips.
Property Portfolio
Like an art portfolio consisting of either the best or all the works done by an artist, a property portfolio is the range of the owner’s best or all the invested properties.
Property owned includes the land, the building, and both qualities. The more valuable the lot of land and the better the architectural and structural condition of the building, the better for the property portfolio.
“Get your Access to our Fully Customisable Investment Property Research and Analytics Tool Now!”
Equity is the edge needed to strengthen a property portfolio.
Real estate investors use property portfolios to initiate and accumulate a source of income. The key to getting ahead of all the other portfolios is to show that you are a competent owner with an incredible amount of equity.
Building a Property Portfolio by Utilizing Equity
There aren’t any complications when creating a property portfolio. Typically, first-time investors use their family home to calculate equity on their property. That’s how easy it is to start up a portfolio.
However, the “performance” of a property portfolio would require a strategy that depends on the first property. The first property is critical because its growth and equity can be used to develop your second property and any sequential properties. The growth value from the first property qualifies you to buy the second property with no money down. If your cash savings are insufficient, utilizing equity can be the solution to grow your property portfolio substantially.
Formulating the Equity:
In the organization of a property portfolio, the equity needed is:
Equity = (Property’s Market Value) – (Amount of Money in Debit)
Amount of money in debit = mortgage
Take note that the equity as a whole can’t be utilized because banks only lend a portion of your equity. It is also a safety precaution in case house prices dip since this could lead to an unsettled loan that is worth more than your property. The general rule of thumb is that you’re able to use 80% of the equity uplift in your property.
The portion of the equity that can be used shall be known as “useable equity”.
Formulating the useable equity:
Useable Equity = ( 80% x (Property’s Market Value) – (Amount of Money in Debit)
When you apply for a loan in a bank, you would be able to use up to 80% of your home’s current value when using equity as the deposit.
To put into perspective how to use these formulas:
Situational Example:
You’re a first-time investor, and you would like to use your house worth $650,000 in today’s market, and you still have $275,000 as the mortgage.
Thus, it would look like this
- Your home’s value = $650,000
- Amount of outstanding loans = $275,000
- Portioned home’s value = $650,000 x 80% = $520,000
- Your home’s potential useable equity = $520,000 – $275,000 = $245,000
After computing, you have $245,000 of useable equity towards purchasing an investment property.
This is the reason why you have to be in a strong financial situation from the usual get-go, so that you will not be compelled to sell your property in case of any future adversities.
Check out “Crunching the Numbers: Positive Cash Flow vs. Negative Gearing“
Tips to Increase the Equity in your Property
The main points of increasing equity were already mentioned at the start, but here’s a list for you to consider.
1. Choose shorter loan terms
Short-term loans typically have lower interest rates compared to long-term loans. This allows you to pay for the principal without getting burdened too much by the interest. Once your mortgage principal increase, it will be converted to equity.
2. Start with a bigger deposit
Other than choosing a short loan term, it would also be best for you to start the loan with a bigger deposit. With this initial deposit, you would receive more equity for your property upon purchase.
3. Paying down mortgage loans
The faster the loan is paid off, the quicker you can build the property equity. If you can pay in advance, consider pacing yourself to finish the loan promptly.
4. Invest in property improvementsying down mortgage loans
Property improvements include extensions, upgrades as well as structural and non-structural renovations. It is usual for buyers to get properties at a lower price then invest in renovations to increase property value.
5. Wait for the property to appreciate in value
Property value may depreciate and appreciate depending on the capital growth over time. When the property increases in value, then your equity will increase as well.
Assessment of benefits and risks of using equity for property portfolios.
| BENEFITS | RISKS | TIP TO MINIMIZE RISK |
|---|---|---|
| 1. It’s manageable to accumulate wealth this way, and it may prove to be effective than just simply saving up additional cash. Property portfolios can amass equity and set aside extra money if appropriately calculated. | 1. Investing in the right properties is risky since there can be unpredictable accidents and incidents where the market could force the property’s value to depreciate. | 1. Plan your budgeting wisely. Equity must be used for multiple investments, not just one property. It’s also best to have a stable cash flow and a finance framework if the current equity could not handle the property’s costs. |
| 2. There is a sense of rhythm in using equity to build property portfolios. Growing the number of properties for the portfolio generates a lot of equity that can avail new investments. | 2. A well-balanced property should have inclined equity and a positive rental yield. Equity may be able to cover any future renovations. However, it may not be able to help with mortgages or loans. | 2. Focus on quality before quantity when it comes to portfolio development, but also take note that acquired properties must be well-balanced to sustain themselves. This risk can relate to the first tip: to ready backup cash should an unfavorable circumstance arise. |
| 3. Increasing equity takes time, and as mentioned earlier, most properties can be bought at a low price to conduct renovation investments. This is one of the easiest ways to expand property portfolios. | 3. Relying on cheaper properties is a risk in itself. Before any construction work is done, a mandatory inspection of the building and the property. This could lead to more problems to the structure than what was first depicted. Plans could be pushed back until the established complication has been solved. | 3. Consider all potential advantages and disadvantages when committing to a new investment with an old property. When in doubt, always consult with a professional. Make sure that there is a backup plan to counter any possible misfortune and still pay back the loan. Like the first and second tips, keep backup cash ready. |
“Get your Access to our Fully Customisable Investment Property Research and Analytics Tool Now!”
Consultations! Who do you need to contact?
- Mortgage Brokers – they’re intermediaries between the borrower and possible lenders. Mortgage brokers specialize in home loans. Unless you focus on multiple residential property portfolios, consider finding a particular broker that can connect you to multifunctional property investors.
- Accountants – they help in keeping, inspecting, and analysing financial accounts. Accountants are who you most definitely approach if you are unsure of your financial standing. Qualified accountants can also offer guidance when you’re starting on a property portfolio.
