Use your property equity to build your investment property portfolio
If you have one investment property or a multi-million-dollar portfolio, the chances are you have been using equity to increase your property asset acquisition. What is equity and how can we use it to accelerate our property investment portfolio?
What is equity?
- Equity is almost as good as cash in the bank and can be used in almost the same way as cash in building an investment property portfolio. Equity refers to the difference between a property’s market value and the amount of money owing on it. So let’s say your current property (investment property or home) is worth $800,000 and you only owe $200,000 on your mortgage, then you have $800,000 – $200,000 = $600,000 in equity. You can then use most of this $600,000 equity in the same way you would use cash to purchase more investment properties. There are many property investment stories that make equity sound like something magical:
- tapping into the equity in your property
- using equity
- extracting equity
- maximising equity
- accessing equity’
These are all phrases you may read in any investment property article but it’s not terribly difficult to understand and it’s not something that only experienced investors with large established portfolios use.
Equity can be used on any property you own, including the family home, and in fact this is probably by far the most common way for first-time property investor will structure to enter the property investment market.
Equity is created in two main ways, either by paying down your mortgage or investment loan or, more usually, benefiting from the increased value of your property during a growth cycle in your geographic region.
Generally not all of your equity in one property can be used. If you are taking out an equity-based loans, your lender would prefer you to ‘keep’ at least 20% of the property’s worth in the loan so that you are normally not borrowing more than 80 per cent of the available equity.
Most lenders will allow you to borrow against this equity to fund additional asset purchase. The equity can be taken out by re-financing the existing loan(s) to reflect your property’s increased value, which frees up the capital you may require to purchase your next property investment. Usually this is done by just taking out a new loan against the equity in order to fund deposits on a further investment property.
These types of loans are sometimes called home equity loans. They can be a flexible lending solution for property investors to borrow against the equity in their existing property(s). The big issue to avoid is making sure your sub-account is ‘for purpose’. Keep any single home equity loan that is being used for investment property separate to all other loans as the interest accrued on the sub loan will be 100% tax deductible but interest accrued on all or part of say, your home loan, is not tax deductible. Take advice from your tax advisor on the structure of these loans and do not depend on your lender knowing about tax!
This method of extracting equity from property is often used to fund upgrades and/or renovations to a property also. Again, if it is an investment property, interest paid is usually tax deductible.
Lime Property Solutions can organise excellent brokers who understand tax matters and will only structure your investment loans AFTER a full discussion with your tax adviser.
Risks and benefits of using equity?
The obvious principle benefit of using equity to build your portfolio is that you are able to use equity to accumulate wealth quicker than if you were simply trying to save the additional cash you may require for another property investment.
Through the use of equity, properties can be added to your portfolio at a faster rate, and the more properties you have in your portfolio, the more equity you are likely to generate.
To make the most of the equity in your portfolio you must structure your finances correctly and be aware of your cash flow and budget. In our experience the average young bank lender can easily assess an application on aspects such as your current income, dependents and outstanding debts but is unlikely to have the property investment skills or tax knowledge to properly structure your investment loans. Give Lime a call to discuss this.
In looking at risk and return in property, it is very common to find that equity growth does not necessarily translate to high rental yields, meaning that a property may generate enough equity to fund further purchases but not enough cash flow to cover current loan commitments. The opposite is commonly true also, a property with a very high yield may not achieve the equity growth require to purchase another property investment. Lime Property Solutions will constantly look for investment property which will give a fair ‘balance’ between yield and future equity growth.
Property investment that has the highest probable short-term growth, appreciating in value, is our key strategy. If you invest in a property that goes backwards in value, you may find yourself struggling to service all of your investment loans.
The simplest solution to avoid losing equity is to ensure you include a ‘safety net’ and/or a buffer in your repayment calculations before taking on a new investment loan using your existing equity. Ensure you can afford to repay all loans in the ‘worst scenario”, and also ensure that you use diversification in building your property portfolio and don’t just purchase your property investments in one location and/or in a single type of property.
Often, experienced property investors will spread their investment loans between different lenders and only ever tap into a finite amount of funds avoiding overextending themselves.
How can I maximise equity?
Maximising equity can really only occur in a few ways: pay off some of the loan; ensure you buy in an area where prices are currently rising or by undertaking value-adding projects on an investment property. This might be just cosmetic renovations such as re-painting and re-carpeting, or full-blown renovations involving new kitchen and bathrooms.
Adding on to or extending an investment property or adding a granny-flat can simultaneously add equity and increase cash-flow. However, never lose site of an exit strategy. A Granny flat in the garden may not be an addition a future owner/occupier wants or is willing to pay for!
It’s also very important to ensure you do not overcapitalise in trying to increase equity. An increased valuation achieves nothing if you have spent the same money on renovation works as the increase!
The simplest method to add equity quickly is to ensure that you purchase in the market with the highest possibility of short-term growth as well as long-term sustainable growth. This is where the research provided by Lime so important.
We have read that buying a property under market value is another way to maximise equity. This, of course, is Real Estate Agent nonsense. The price you pay for a property is the market value! No-one in their right mind is going to sell you a property worth $600,000 for $570,000.
Creating instant equity can sometime be possible in buying and building a duplex-type house and land. Otherwise you will pay market value!
