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How to Use Equity in Real Estate for Success

Real estate equity is a powerful tool that top investors use to build wealth and expand their property portfolios. Understanding how to effectively leverage equity is a key to unlocking cash flow and passive income in the real estate market.

This comprehensive guide will explore the concept of real estate equity, strategies for putting it to work, and important considerations for investors looking to maximize their success.

Understanding Real Estate Equity

To successfully leverage equity in real estate, investors must understand what it is. Here are the basics about investment property equity.

What is Equity in Real Estate?

Equity represents the portion of a property's value that an investor truly owns. It's the difference between the current market value of a property and the outstanding balance on the mortgage. Note that equity is calculated based on the current-day value of the property, not the cost that the investor paid. This includes the after-repair value of a property that an investor has rehabbed.

For example, if a single-family home is worth $300,000 today, and an investor currently owes $200,000 on the loan, the equity in the property would be $100,000.

How Real Estate Equity is Built

Investors can benefit from growing property equity in three major ways:

1. Mortgage Payments: As an investor makes regular monthly payments on the investment property loan, he or she gradually increases their ownership stake in the property.
2. Property Appreciation: When the market value of a property increases over time, the investor’s equity grows on top of the equity from mortgage payments. This means that investors in markets with strong home price appreciation (HPA) can create equity more quickly.
3. Value-Add Rehab: When an investor rehabs a property, the property appreciates in value. Experienced investors can create equity via rehab. For example, an investor who spends $35,000 in rehab costs to increase a property value by $50,000 creates $15,000 in equity.

Importance of Building Equity

Building equity is crucial for several reasons:

• It increases an investor’s net worth.
• It provides financial security because the investor owns assets that are growing in value.
• It can be leveraged for future real estate investments through cash-out refinances.
• It offers flexibility in future investments through cross-collateralization.

Using Equity in Real Estate Strategies

Real estate investors quickly discover the power of leveraging equity in their properties to grow their portfolios.

Cash-Out Refinancing

Cash-out refinancing allows investors to borrow against their equity by refinancing their current mortgage into a new investment property loan. By leveraging a certain percentage of the value of the property—at Lima One, this can be up to 75%—the investor can pay off the first loan and still have enough money to get cash out at closing. This cash can be used for future real estate investments.

Scaling Your Real Estate Investments

After getting cash out by refinancing a property, investors can then scale their investment property portfolios by purchasing new single-family homes. In essence, the investor uses the equity from one property to finance the down payment on additional properties, effectively scaling the investments without bringing additional cash to the table.

While a cash-out refinance is the most common way to do this, it can also happen through cross-collateralization on a single loan. In this way, the investor creates a portfolio that includes properties with equity and new purchases and uses the equity in the existing portfolio to cover the down payment for the new ones.

BRRRR Method

Investors who seek to leverage equity in their properties often create this equity using the BRRRR method.

The BRRRR method (Buy, Rehab, Rent, Refinance, Repeat) is a popular strategy among real estate investors. This approach involves purchasing a distressed property, renovating it, renting it out, and then refinancing it to pull out the built-up equity so it can be invested in the next property. This allows the investor to keep a property in his or her portfolio and to get cash out for future purchases based on the equity created during rehab.

Here's a simplified example of the BRRRR method:

1. Buy a distressed property for $180,000.
2. Invest $20,000 in repairs.
3. Rent the property for $1,700 per month.
4. Refinance based on the new value of $300,000 at 75% LTV, covering the costs of the original loan ($200,000) and getting an additional $25,000 of cash out.
5. Use the cash from refinancing (in this case, $25,000) to purchase another property.

Lima One’s Fix2Rent^® loan program is ideal for financing BRRRR properties. Investors can use one appraisal for both the initial flip loan and the takeout DSCR loan for the rental property, and they also receive discounts on fees when they refinance.

Steps to Leverage Real Estate Equity

Here are the tactical steps an investor can use to leverage the equity in a real estate investment property or portfolio.

Assessing Your Equity Position

Before leveraging equity, it's crucial for an investor to accurately assess his or her current equity position. This involves:

1. Getting a professional appraisal of your property's current market value. The lender will require an independent appraiser, but it’s wise for an investor to have a solid idea of the value of the property before going to a lender.
2. Calculating the outstanding balance on the investment property loan.
3. Subtracting the mortgage balance from the appraised value to determine your equity.

Remember, a private money lender like Lima One will only lend up to a certain loan-to-value percentage on a property to make sure investors maintain a healthy portfolio. For example, a property worth $400,000 may have $150,000 in equity, but a 75% loan-to-value cash-out-refinance loan will yield $50,000 in actual cash out for future investments.

Choosing the Right Financing Option

Investors with equity in properties can look at different options for cash-out refinances. A traditional bank may offer a HELOC (home equity line of credit) that acts as a second mortgage above the existing mortgage, but a private lender like Lima One will refinance the original loan so that the investor has only one payment while maintaining a healthy loan-to-value ratio.

Identifying Investment Opportunities

Once you've accessed your equity, investors can look at different types of investments, including:

• Rent-ready single-family homes.
• Distressed properties that can be flips or BRRR investments.
• New construction.

Potential Risks and Considerations

Investors who leverage their equity are taking on some additional risk, because they are borrowing additional money to scale their portfolios. This risk is manageable, but investing wisely requires a clear-eyed view of the situation.

Market Fluctuations

Investors should ensure that rent rates will cover the cost of any new rental financing on properties. The debt service coverage ratio (DSCR) of each property should remain strong at 1.2 or more, which means that the rents cover 120% of the standard monthly expenses, including loan principal and interest, taxes, insurance, and association fees. This percentage gives investors cash flow margin in case of short periods of vacancy or necessary capital expenditures like HVAC systems or new roofs.

In addition, investors need to watch home price appreciation trends in their markets to make sure home prices continue to grow. This ensures that their loan-to-value percentages remain healthy.

Loan Terms and Interest Rates

Investors need to watch for loan terms and interest rates to ensure cash flow now and the appropriate amount of certainty and flexibility later. This means that investors need to know the prepayment penalty terms of their existing loans to ensure the most advantageous refinancing timing. They also need to choose wisely when it comes to fixed-rate rental loans versus adjustable-rate mortgages (ARMs) versus interest-only terms. Lima One offers investors flexibility in cash-out refinances, and a loan consultant can provide options to help investors choose their preferred terms.

Long-Term Financing Planning

Leveraging equity involves taking on additional debt, with the benefit of additional cash flow from additional properties. Investors need to assess their own risk tolerance and their ultimate cash-flow goals so they can build toward the right- size portfolio for their goals. This is an individual decision each investor needs to make, but the bottom line is that it’s essential to have a solid plan for repaying loans and managing cash flow from investments.

Conclusion

Real estate equity is a powerful tool that, when used wisely, can significantly accelerate an investor’s wealth-building journey in real estate. By understanding how equity works, implementing strategic investment approaches, and carefully considering the risks involved, investors can leverage their equity to expand their real estate portfolios and achieve long-term financial success.

Remember, successful real estate investing requires careful planning, thorough research, and a willingness to adapt to changing market conditions. While leveraging equity can provide exciting opportunities, it's crucial to approach each investment decision with appropriate caution or aggressiveness.

By mastering the art of using equity in real estate, investors will be well-positioned to take advantage of opportunities in the market and build a robust, profitable real estate investment portfolio. Lima One helps investors leverage their portfolios with a full suite of cash-out- refinance rental loan options. Talk to a loan consultant today to discover the options that best fit your investment thesis.