Is Equity necessary?

Question

I am VERY new, which will likely be obvious by my question :). I am looking to "buy and hold", and am reading that you "make your money when you buy" a home, i.e. buy a home that is a deal because it will come with equity in it.  But let's say I instead overpay by $10k for a home, but through deal analysis even with overpaying it is still going to net me a 15% annual return on my investment after all expenses.  Other than if I needed to sell in the first few years, my brain still wants to think this is a good investment because of the good ROI.  Can someone point out the error in my thinking?  Thanks in advance, and take it easy on the new guy!

Tony Szymczak · Answer

Ok so if I am not purchasing and then flipping, how do I know I am purchasing a house with equity in it if I am not going off of the Zestimate?   What is the best way to determine equity in the home when doing the preliminary numbers?

Aaron K. · Answer

@Tony Szymczak the Zestimate isn't worth much, when just starting there isn't a quick way to filter, once you get in the habit of analyzing things for a few weeks you'll be able to tell by looking at house if it is worth analyzing or if it isn't worth your time because it is so far off.

Joe Villeneuve · Answer

Throw out anything where you're evaluating a property based on a percentage...they lie.  As far as comparing asking price to Zillow's Zestimate...throw out the Zestimate.  You can buy a property for over the AP and make have a higher profit, and pay less for it, than another REI paying 20% less than the AP.  Understand what your actual cost is versus the total cost of a property.  The total cost doesn't matter if it's covered, because you're not the one paying it.  The terms are what makes a deal profitable, and you cost...the only cost that matters...is what comes directly out of your pocket, as in cash, as long as you have positive cash flow.

Tony Szymczak · Answer

Thanks @Joe Villeneuve and Aaron! That does make sense, especially in terms of the equity being 5x it's worth when it is a DP on a home.  So when I am analyzing potential deals, if I am understanding correctly, likely my very first way of filtering out ones NOT worth investigating would be to compare the asking price to what the approximate value is on Zillow?  Or am I over simplifying, i.e. not accounting for upgrades etc?  Or is that a pretty quick and dirty way of filtering, along with the 1% rule I have been reading about?

With so many options to buy out there, and me being a newbie, I am trying to determine my fastest way to weed out as many non deals as possible before having to run all of the numbers, which takes time.  Thanks again for your help guys!

Joe Villeneuve · Answer

There's a lot more to it than that when it comes to REI though.  When you buy that car for $60k, it's worth less with every mile you drive it.  There isn't any equity in it...and all equity is not equal.  With RE, the equity "you buy" is represented by the DP...which is the total cost of the property to you. Whether you left it in the bank, or moved it to the DP, it has the exact same face value.  However, when it's in the property as "paid equity", it has a real value of 5 times that (assuming the DP was for 20%).

The equity that is "gifted" to you (principal pay down from the tenant, and appreciation from the economy), has the same face value, but it also has the same real value.  In order to get the real value of the gifted equity to be the same 5 times as the paid equity, you have to get all that equity out...and into the next REI...as your new paid equity, where the entire amount has a real value of 5 times its face value.

Equity has a lot of value...as long as it's moving.  Equity that builds in the same spot, is not taking advantage of its potential...and is in fact losing you money.  Equity is a very good thing...as a verb...not as a noun.

Aaron K. · Answer

@Tony Szymczak it isn't a good investment simply because you overpaid.  Take a car for example that brand new Truck, Tesla etc. you buy for $60k and you are happy with it it is a great car, but you find out the dealer down the street was selling it for $50k the exact same car just a lower price.  You were happy to pay $60 but still a financial misstep because you didn't have to.