Hey guys, I’m having trouble understanding equity and its importance in a deal. Can someone share with me what equity is and why it is a strong factor in determining how the amount of equity can bring a greater ROI in a deal. Greatly appreciated!
Equity can have different meanings depending on the context of its use.
Equity is generally understood as the unencumbered value of an asset.
For example, if a property is worth $100,000 and there is a lien against the property for $70,000, then the remaining equity is $30,000.
That would refer to “gross equity.”
Equity can also mean the equivalent amount of money/cash you put into a property, including the down payment, and total dollar costs of rehab.
If you put too much ‘equity’ into a property, or buy at too high a price, you could end up with less equity than you started with. This is called being in a negative equity position, or being “upside down.”
Bottom line is that the equity equals the difference between what the property is actually worth today, less any 3rd party liens/loans (in the form of trust deeds, mortgages, etc.).
$100,000 Retail Value
-$70,000 Total Lien(s)
=$30,000 (Gross) Equity
Then there’s potential equity; dead equity; buried equity; and imaginary equity (which is 99% of the seller’s opinion of their homes values, but I digress…). :biggrin :biggrin :biggrin
Is that any help?
Gross equity is not necessarily the “effective equity.”
After you back out costs of selling, carrying costs, insurance fees, loan fees, etc, you have the “net equity” or “effective equity.” This can be substantially less than the “gross equity.”
So, when you figure “gross equity” remember there are additional costs and overhead that will reveal the “effective/net equity” remaining.
Hope that makes sense.
Thanks Javi…so equity is loosely defined as the amount of money put into the payment of a property. So based on your example if an owner of a house worth $100,000 can no longer make the payments for whatever reason and has $70,000 left to pay, the equity in is $30,000.
As an investor looking to purchase, the equity is valuable to me because I’ll only need to purchase this house at $70,000 since there’s $30,000 of equity already in the property. Correct???
To your first question… Yes, the [gross] equity is $30,000.
To your second question…
Let’s back up. The spread between what is owed on the property and what the property is worth in it’s present condition is known as the “current equity,” “gross equity,” or perhaps “actual equity”
“I only need to purchase this house at $70,000 since there’s $30,000 of equity already in the property. Correct???”
No. You may only ‘want’ to purchase this house for $70,000, but what you pay is whatever you can negotiate. Or rather, this just means that $70,000 is the ‘least amount’ you could pay, unless the seller agreed to reduce the loan balance out of pocket.
Otherwise, the $70,000 loan balance AND the remaining gross equity would be part of your purchase price, if you paid full retail for this house.
Okay. It’s better! Thank you for sharing!