Equity is a powerful tool in helping you build long-term wealth and add to your property investment portfolio. Here’s how to get started.
Put simply, equity is the difference between the current value of your investment property and how much you owe on it.
So, if your property is valued at $800,000 and you still owe $500,000 on your home loan, your equity is $300,000. You can leverage this equity by borrowing more money to help further your financial goals — like buying another property and building a portfolio.
“Your equity is the fuel that can help you build long-term wealth, or access liquidity when you need it, without having to sell,” says Founder and CEO of Futurerent, Godfrey Dinh.
“Traditionally, property investors leverage their equity instead of a cash deposit to borrow more funds.”
Although you may have a lot of equity in an existing property, banks won’t allow you to access it all. Picture: iStock
How to grow your equity
If you’re thinking about starting or growing your property portfolio, here are some top tips on how to grow and leverage your equity.
1. Understand the relationship between your equity and the property’s value
Few people really understand the impact that leverage has on magnifying your return on equity.
In simple terms (not accounting for income and expenses), if you own a property worth $1,000,000 and have borrowed 80% ($800,000) and the property increases in value by 3%, your equity has grown by 15% – which is $30,000 out of the original $200,000 deposit.
It’s useful taking a long-term view to ‘game out’ what this means over time.
Using the above example, over seven years the property would be worth $1,230,000, effectively more than doubling the equity based on borrowing 80% of the property value.
Obviously, leverage is a two-way street, so it’s worth considering downside scenarios as well, but understanding the relationship between equity and the property value is essential to any property investment strategy.
2. Renovate and maintain the property
One common way property investors increase the value of their property — and the equity at their disposal — is to renovate.
While renovating involves some upfront costs, it can also have additional benefits. Improving areas like the kitchen, bathroom, and the facade could help attract better tenants and deliver a greater rental return, Dinh says.
Renovating could be a great way to add value to your home. Picture: Getty
“Particularly under the strong rental market conditions we’re seeing now across the country, property investors can maximise their rental income with a well-renovated and maintained property,” he adds.
Even a cosmetic renovation every three-five years can make a big difference – a fresh coat of paint, polishing the floorboards or steam cleaning the carpets is all you need.
If you have no plans to sell, it’s still worthwhile keeping the property in good condition to maintain the quality of your tenants and maximise your yield, property valuation, and borrowing power.
3. Focus on value
Equity isn’t derived from how much you paid for a property, but the amount the bank appraises its current market value to be.
Ensuring constant and steady growth in your investment property is key to building the overall value of your portfolio — and the equity at your disposal.
You might have heard the expression that “life is a game of inches”. When it comes to property investment, it’s often the small things you do to improve value that can have a big impact on your equity position. This directly impacts your ability to get the most out of your property investments.
How to unlock equity and build your portfolio
Just because you own a property, it doesn’t mean banks will make it easy for you to access your equity. If you’re looking to build or grow your property portfolio, follow these tried and tested steps:
1. Get your investment property valued
First, you’ll need to get a valuation on your current property to see how much equity you have, as this will determine how much you can actually access.
“Over time, as the investment property increases in value, so does the usable equity available. This gives rise to more opportunities to invest and continues to compound wealth in a virtuous cycle”, Dinh says.
By maintaining your investment property, it may attract higher rental yield, but also increase the usable equity. Picture: Getty
2. Calculate your usable equity
Property investors will only be able to access usable equity, which is the equity in your property you can borrow against.
You can work out the usable equity available by calculating 80% of your property’s current value minus what is still owed on the mortgage.
So if, for example, your property is worth $800,000 and you owe $500,000, your equity is technically $300,000. The bank, however, will generally want to limit your borrowings to $640,000. This means that unless you take out lenders mortgage insurance, you will always need to keep $160,000 in equity in the property.
The other limit on how much the bank will lend you – and therefore how much equity you will be able to extract – is your borrowing power. This is based on your income and expenses, and how the bank assesses your ability to make principal and interest repayments after accounting for certain contingencies.
3. Maximise your borrowing power
There are many factors that impact your borrowing power, including whether you’re self-employed, earn investment income, or whether some of your income is subject to any variability due to scheduling or incentive structures.
And while it’s not always possible to change the type of income you earn, it’s worth being aware of this factor and any opportunities to optimise your income.
Your borrowing power is multi-factorial. It’s important to look at it from all angles. Picture: Getty
It’s also important to consider when the best time to apply for a loan is. If you have a partner, thinking about your household income collectively, seasonal expenses and family planning can make a big difference.
4. Consider looking beyond the big four banks to access more usable funds
There are ways to unlock more equity and investment capital by looking beyond the traditional banking system.
“Investing in property is generally very capital intensive and illiquid,” Dinh says.
Futurerent is giving property investors a simple, loan-free alternative to the banks, allowing you to access up to $100,000 of your rent, paid in advance.
“We make it easier for property investors to cash out on their investment property, and access funds that would’ve otherwise been locked away until they sell or refinance.”
“Unlocking up to $100,000 of rent in advance allows property investors to do more with their rental income.”