Many of us have heard the question, “What is the rate of return on the equity in your properties?”
Of course, the answer is usually zero, as most people aren’t investing it. However, the question we should really be asking ourselves is, “How can I safely utilize the equity in my properties, combined with other investing strategies, to build wealth without taking on any unnecessary risks?”
Let me start by saying that this is a widely debated topic that many people have strong feelings about. Its ability to stir up emotion makes it akin to subjects like the desire for wealth, debt, and the charging of interest.
Investing by tapping into your equity isn’t a one-size-fits-all strategy. It’s not for everyone. But if you’re going to do it, you need to be disciplined and strategic in your approach.
First, let’s be honest with ourselves. If we’re not disciplined with things like time and money, most creative real-estate or wealth-building strategies will not work. If you’re not organized and you don’t use a budget to track your income and expenses, these creative ideas won’t benefit you much (until you get your own house in order).
But let’s assume you have it all together. Why would you consider tapping into the equity that you’ve been building up through your properties? More importantly, how can you do so safely?
How to Purchase Real Estate With No (or Low) Money!
One of the biggest struggles that many new investors have is in coming up with the money to purchase their first real estate properties. Well, BiggerPockets can help with that too. The Book on Investing in Real Estate with No (and Low) Money Down can give you the tools you need to get started in real estate, even if you don’t have tons of cash lying around.
5 Reasons to Invest Your Equity
Personally, I decided to do it, not only because it made financial sense, but also because it gave me more asset protection and an opportunity to leverage my assets in a smart, strategic way.
1. Asset protection through debt
Years ago, I heard an attorney speak at a real estate convention. She spoke about two concepts that I’m a firm believer in: asset protection through debt and liquidity. When I first started investing, many of my initial properties were held in my own name, largely due to more favorable mortgage terms.The idea of using debt as a form of asset protection (beyond just using more liability insurance) made a lot of sense. At the time, I didn’t want to transfer these properties to an entity or trust, because transfer tax is expensive in my state of Pennsylvania. I also didn’t want to trigger the due-on-sale clause, which would have given the bank the option to call my mortgage due in full should I transfer the deed. So, when I was ready, I was able to visit the well of equity via a home equity line of credit (HELOC).
The value of liquidity was the second take away from the asset-protection attorney’s speech. She said that if I had an equity loan or credit line attached to my properties for the majority of the equity, even if I had a zero balance on the line, it acted as a form of asset protection through debt: The county courthouse’s public records would show that I owed a lot of money against the property. In the case of the line of credit, not only did it give me access to money to do more deals, it also gave me a safety net should something happen to me personally (such as an illness or job loss) since banks would no longer see me as a favorable borrower.
Other reasons to utilize equity come from financial planning concepts that are frequently referenced from authors like Doug Andrew of Missed Fortune 101 fame.
3. Home equity is already at risk
Many people believe that equity that is left in the property is, in some way, safe. I think this is a myth. I’ve purchased multiple properties that depreciated shortly after, often for long periods of time. I actually believe it’s safer to separate the equity when possible, thus reducing the likelihood of foreclosure. If you think about it, equity has no true rate of return: It just grows as a function of real estate appreciation and mortgage reduction.
Home equity, in my opinion, is not liquid. If I can separate as much as possible, as frequently as possible, I’ll have reserves for emergencies and other conservative investment opportunities. For example, having a more liquid, safe, side fund can give you more flexibility in using your capital (whether you decide to pay off your mortgage or not), while still maximizing your tax advantages.
However, eliminating your mortgage interest deduction is not necessarily a good thing. Personally, I prefer to use the difference between preferred interest and non-preferred interest to invest.
Another myth I hear quite often is that all debt is bad. Managing equity properly can be a very positive lever, especially if utilized to compound wealth rather than for consumption purposes. Having equity in your property doesn’t necessarily enhance net worth the way that accessing the equity can, especially if used to accelerate your other resources to cover your debts.
5. More opportunities
Many folks think if they put more money down on a property they’ll get better rates and terms with lower fees. This is true. But I put little-to-no money down on properties these days, thus enabling me to take advantage of more opportunities with the same capital. Translation: Closing more deals. In fact, generally speaking, in the years that I worked as a real estate agent, it seemed that retail sellers with higher mortgage balances seemed to get fewer low ball offers.
Risk and Safety
Another controversial question is this: “Is investing your money in real estate really the safest place to invest your money?” For me, the answer was a flat, “NO,” as there were safer places to park my money. Two examples that come to mind are IRA types of custodial accounts and insurance contracts. Anytime I can sweep money from my business or properties and move it to safer vehicles, I do so. Especially with real estate.
Over the years, not only have I seen prices fluctuate dramatically in up-and-down markets, but I’ve also seen dramatic changes in financing, which is crucial in a finance-driven business like real estate. So for me, tying up capital in real estate was risky, and my money was better utilized elsewhere. For me, the best aspects of owning real estate over the last 30 years have been cash flow, appreciation, and tax advantages. Notice I didn’t say using my real estate as a savings account.
Thinking Bigger but Doing it Safely
Over the years, I was able to make twice as many investments using my equity than if I hadn’t. This enabled more tenants to buy me more properties and more borrowers to pay me interest. All kidding aside, if I can invest in what I know — what I’m good at — and it’s a high-yielding vehicle with collateral, then why not use equity to do more deals? When buying real estate, my strategy was to use little (or none of) my own cash. With notes, I do use my money, but I don’t mind since notes are not only an asset backed by real estate, but they’re also much more liquid in the event that I need to access the cash.
So, if you want to think bigger and leverage your equity safely, perhaps using notes and hard money, along with more real estate deals, will make sense for you, too.
What are some of the ways you safely work the equity in your property? Tell me in the comments section below!