How to Invest in Real Estate Using Your Home Equity
I am sure that many investors read through real estate blogs and forums pertaining to real estate investing and wonder where the investment dollars will come from. They want to know how to invest in real estate, especially when they have no money. I know that many young professionals have stocked away savings accounts and retirement plans, but are uneasy about depleting these funds to buy investment property.
Down Payments Can Be Hard To Find
The mortgage environment simply isn’t what it was in 2005 when investors could get 100% financing on an investment property. These days, investors are typically putting 20%-25% down to obtain financing and this doesn’t even include closing costs, repairs, vacancy, leasing fees, etc. For many young investors, pulling this kind of money from their hard-earned nest egg is unsettling and often times a deterrent from investing in real estate at all.
While many people have seen the equity stripped out of their home over the last several years, there are still countless others who do have equity that can be borrowed. I realize the notion of borrowing against your home is taboo in certain circles, but I still adamantly believe in maximizing your dollars to achieve higher returns. This doesn’t mean that it makes sense to pull equity out of your house to redecorate or buy a new boat – I am talking about using your home equity as a vehicle for investment, not for consumption.
Why Borrowing From Your Equity Makes Financial Sense
If you look at it analytically, what is your home equity doing for you if it’s sitting untouched in your property? It’s not doing anything to help build your net worth and it’s not helping your property appreciate any faster. The question to ask yourself is what COULD this money be doing if it were invested elsewhere?
How to Invest in Real Estate with Your Home Equity
I would suggest that while the credit markets are tight right now and home values are down (meaning less available equity), there has never been a better time to borrow against home equity. This is because it’s never been cheaper to borrow mortgaged dollars and there have never been better real estate opportunities. With interest rates lower than 4% right now, it doesn’t take a mathematician to figure out that higher returns on leveraged real estate investments provide a very healthy net return.
As a very simple example, suppose you were able to pull $20,000 out of your home via an equity loan at 4% interest. You then took this $20,000 and used it as a down payment to buy a $100,000 property that was producing $300 a month in monthly cash flow. At $3600 a year in income on $20,000 of invested funds, you would be earning 18% interest. If you back out the 4% interest you are paying for the equity loan, you are still earning a 14% net return with your dollars.
Another Benefit Of Using Your Equity to Buy Real Estate
In addition to this, you now have another asset that has the potential to appreciate. This 14% net return doesn’t even include prospective gain from the investment property increasing in value. To take the example a step further, let’s say the market appreciates at 2% per year. In this example, the $100,000 property would gain $2,000 in value in the first year. If you add this to the $3,600 in rental income, you’ve got a first year return of 24%! ($5,600/$20,000=28% and then 28% – 4% for equity loan = 24%)
To me, the opportunity to earn 24% using some of my home equity versus doing nothing with it is a no brainer. I can understand an investor’s hesitation with risking a large portion of their savings (or liquidity) to invest in real estate … but I believe maximizing the availability of home equity and leverage to acquire real estate is an incredible way to build wealth.