If you are new to the real estate investing world, then you might have heard of real estate equity. Together with other real estate financial terms like cash flow and appreciation, home equity plays an important role in your real estate investing career. To learn more about real estate equity and how you can use it to build your real estate investment portfolio, read this guide on how to calculate equity in real estate.
Real Estate Equity Definition
Before we show you how to calculate equity in real estate, let us first define what real estate equity really means. In accounting terms, equity is defined as the difference between the value of assets owned and the value of liabilities owed. In real estate, the same definition can be applied. Home equity is the difference between the market value of your investment property and the total amount of debt registered against it, which includes mostly the mortgage you still owe the bank. In other words, the equity you own in your investment property is the part of the property that you really own.
Why Is It Important to Calculate Equity?
The reason why you should learn how to calculate equity in real estate is that it could be useful when buying another investment property, whether you’ll be asking for a home equity loan or selling an investment property you currently own.
A home equity loan is a type of mortgage in which the real estate equity is used as collateral to finance another investment property. Using home equity loans to buy a rental property can be a good idea if you have built enough equity in your first property.
It is important to point out that banks ask for a professional real estate appraisal to determine the value of your property before approving a home equity loan, but that shouldn’t stop you from learning how to calculate equity in real estate by yourself.
Related: Weighing Your Investment Options: Rely on Equity or Take Out a New Mortgage?
How to Calculate Equity in Real Estate
Real Estate Equity = Assets – Liabilities
To calculate the current equity you own in a real estate property, you need two things:
1- Assets: This is the market value of your investment property. The price that you have paid for your real estate property may be different than its current value due to real estate appreciation or depreciation.
To find out how much your real estate property is worth, you need to conduct a real estate market analysis. Mashvisor provides real estate investment tools that will help you valuate your real estate property based on recently sold real estate comps. The rental property and Airbnb calculator from Mashvisor will provide you with a list of properties similar to yours with their selling prices. Click here to learn more about our tools.
Related: Mashvisor: The Best Rental Property Calculator You Could Ask For
2- Liabilities: This is the outstanding balance of your mortgage plus other debts related to the real estate property. You can estimate how much you still owe on your mortgage by asking your lender or by using an online mortgage balance calculator.
Example on how to calculate equity in real estate:
Assuming you bought a real estate property 15 years ago for $250,000 with a 15% down payment ($37,500), you financed the rest ($212,500) with a mortgage loan at 3% and $1200 monthly payments for 30 years. How much equity do you own now?
1- Estimate market value: After conducting a real estate market analysis, you find that your investment property is worth around $370,000 in today’s real estate market.
2- Estimate liabilities using a mortgage balance calculator: You still owe the bank $61,000.
3- Calculate real estate equity: $370,000 – $61,000 = $309,000 If you were to sell the investment property today, this is how much the gross equity of your property would be.
Gross Equity vs. Net Equity
The net equity of a real estate property is slightly different from the gross equity. Net equity is gross equity minus the costs of selling the property, which include the real estate agent commission, remaining property taxes, title changes, and other closing costs that are paid by the property seller. The net equity is what you would actually walk away with after selling the investment property.
Related: Investing in Real Estate: What Are Closing Costs?
How to Build Equity in Real Estate
1- Mortgage Payments
The higher the down payment you put, the higher your initial equity in the investment property will be. After that, every mortgage payment you make helps build up your real estate equity as the principal balance you owe decreases.
2- Real Estate Appreciation
The market value of your real estate property normally appreciates over time, unless there’s a market crisis or the property deteriorates. When comparable listings in your area are selling for more than you originally bought the investment property, this would reflect positively on your equity.
3- Home Improvements
When you make home improvements that increase the market value of your investment property, your home equity increases as well. For example, spending $20,000 on remodeling your kitchen can increase the market value of the property by $10,000. This way you have increased your equity by $10,000.
How Is Equity Reduced?
In some cases, real estate equity can also fall. When the financial crisis hit the housing market in 2006, property values fell taking down equity along with them. If you bought an investment property for $150,000 and similar properties are selling for $120,000 now, your equity has dropped by $30,000.
Home equity can also decrease if you refinance your mortgage or take a home equity loan, and of course from physical deterioration due to age and other factors.
The Bottom Line
Learning how to calculate equity in real estate is important to keep track of your real estate wealth or when selling an investment property. Moreover, equity can be used to launch your real estate investing career by using home equity loans to finance a rental property.
To learn more about how we will help you make faster and smarter real estate investment decisions, click here.