Demystifying “Equity”, and how you can use that to boost your property portfolio!

In Property Investing world equity is the magic word that everyone is chasing! But what exactly is equity, and why is it so magical?

I remember I used to wonder about these questions as I start my journey, so today let’s uncover a bit about what Equity is and how you can use it against your next purchase.

For those of you that prefer video or visual format – I have done a YouTube video on this so you can see visually how it works! Check it out here, otherwise keep reading on:

What is Equity??

OK so in simple real estate terms “Equity” is the additional value a property contains. A simple example:
Current value of a property – $600,000
Loan on the property – $300,000
Equity of the property = current value minus loan – $300,000

Now, equity is usually realized in two common ways:
1. By selling down the property to obtain profit
2. By leveraging more with a lender as a standard loan

Selling down the property is quite straight forward – the net profit you get after factoring in all cost of sale is your equity. This approach the equity comes in as cash form.

But if you don’t want to sell down – think of it as taking the property up to a financial institution as a leverage to negotiate in order for you to lend more money from them. This is the more common approach for investors as they do not need to sell down the asset, but is able to “extract equity” of a property and use it towards the next purchase. The “extracted equity” can be in a form of a standard loan with surplus cash put into the associated offset.

How does extracted equity look like in my online banking?

When you have equity loan setup properly you’ll most likely see two lines in your bank account:
1. A loan account for the equity loan established (what you owe to the bank)
2. An offset account linked to the equity loan with the same value of cash deposited into it. This is the “equity” you can use to fund your new purchase.

One important clarification here – equity loan is a standard type of loan and is not free cash. If you draw down the amount in your offset account you’ll be charged with repayment. So it’s important to understand this concept – extracted equity is borrowed money, but it can be used as the stepping stone to propel and expand your property portfolio in a shorter timeframe.

Also, at time of writing most financial institutions are only willing to setup up to 80% of the property value. So, using the example we have above:
Current value of a property – $600,000
Loan on the property – $300,000
Available equity = 80% of property value minus existing loan – $180,000

Also note, because equity loan is one type of a loan, it’ll be subject to banks lending assessment to see if you can qualify for the additional amount.

How can I use equity as deposit to purchase the next IP?

Continuing on from the example above, the $180,000 sitting in the offset account associated with an equity loan is fund that can be used towards the next purchase in the form of a deposit. Let’s say Bob has extracted an equity of $180K from his PPOR and now wants to purchase his first IP, which we can call IP1.

IP1 sales price: $600,000
Loan required (assuming at 80% LVR): $480,000
20% deposit required: $120,000
Purchase cost (Stamp duty + conveyancing etc) = roughly 5% of sales price = $30,000

So in this case, instead of funding the deposit + purchase cost using his cash savings, he can fund it straight using the equity sitting in offset account. And Bob can use this equity for something else, or towards next purchase. There is also an additional benefit here – since equity is borrowed money and if used towards investing purposes it will be tax deductible.

I trust this now gives everyone a better idea on what Equity is in Property Investing terms! As usual, if you have any questions about any of the above content feel free to leave a comment or contact us directly.

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