What is Equity???

Question

Hey Everyone,

I know people might be thinking right now what a stupid question, this guy wants to be in real estate. Never gonna make it!

Anyways, I am confused about equity i have an idea but I keep hearing and reading different things. So I don't really know what it is and why i should be looking at this when i am wholesaling?

Thanks in advance.

Dion DePaoli · Answer

Equity is the term used to describe the junior interests of an asset.  Equity is junior to liabilities related to the asset.  So in real estate, you as an owner, would have a junior interest to any liabilities secured by the real property (if those exist).  In that, we get the layman explanation.  Equity is the net remaining interests after all superior liabilities.  Those liabilities are not limited to just mortgages.  They can include any liability such as other types of liens (tax, mechanic, etc).
	
	So, while the example above is not wrong, it is not fully inclusive of the idea.  If a homeowner has a home worth $100k with a mortgage of $50k, they may still have less than $50k in equity (or 50%) depending on the other liabilities, say mechanic lien for $10k, so they would have $40k or (or 40%).
	
	Most often, the quick and easy idea, like above, is used in conversation missing the details of the additional liabilities to establish a "true" defined amount of equity.
	
	Throw some examples out of confusing statements for some more commentary.

Jon Holdman · Answer

But...  There's paper equity and there's what you could put in your pocket.

Keep in mind that if you sell you will pay at least 8% of the sales price in commissions and closing costs.  More in some areas where seller concessions are still common.  So, if your property is worth $100K and you owe $80K, you cannot put $20K into your pocket by selling.  More like $9-12K.

Simliar for lending.  If that property was an investment property there's really no way to extract that $20 of paper equity because you won't be able to get a loan above 80% LTV.

Jean Bolger · Answer

I was just going to say "why don't you look it up?" Then I looked it up, and, hey! -- it is confusing.  There are many definitions for the word equity, but the one we talk about in real estate is  definition #3 in this link:

https://www.google.com/search?q=equity+&oq=equity+&aqs=chrome..69i57j0j69i61l2j0l2.6310j0j7&sourceid=chrome&es_sm=91&ie=UTF-8#q=equity+definition

Basically, it's the value of the property (what it would sell for today) minus any loans (mortgage, heloc, other liens) secured by the property. So if you own a property free and clear, with no loans, you have 100% equity. If you have a house that would sell for $100,000 but you have a mortgage of  $80,000 you have $20,000 in equity (20%).

Joseph Pytcher · Answer

Brianna answered it perfectly.

Bill Gulley · Answer

Assets-Liabilities=Owner's Equity

Both sides need to be examined depending on the purpose of the assessment of equity.

Assets; the value changes depending on the purpose of the evaluation of the asset, are we looking for market value, book value or for taxation purposes?

In RE we look generally to market value. You need to look up that definition has it carries legal weight. Value is applicable to the time it is assessed. Within one year from the time an asset is acquired the value is "book value" the cost of acquisition plus the costs of improvements. After one year market value will either be carried at the cost mentioned, less depreciation or it may be set at it's appraised value in the market applicable for the asset.

The guru talk of "I made 50K buying this property" is pure malarkey (I could have used other terms). Totally wrong and simply a basis to lie, hype and exaggerate what the investor did. Look to Enron Accounting. You can end up looking at fraud charges by overstating an assets value.

Book value was just mentioned, this is more to what you carry assets on with respect to financial statements and what you may turn over to a lender.

Taxation values or assessments use different approaches to valuation, estate taxes, transfer taxes and real estate taxes may be assessed differently.

Assessing values can become very complex, but for small RE, we are generally looking at the market value as described.

Liabilities also have variables as Jon and Dion pointed out. If equity is to be established from the disposition or sale of assets the costs of disposition will be included. If the asset is to be retained these costs may be ignored. Liabilities accrue or change daily, interest is charged, tax liabilities are assessed, other liens may increase daily such as special assessments, HOA fees or perhaps maintenance and management obligations. This is a primary reason you will see on any balance sheet (financial statement) being stated "As of a certain date". Such statements are the financial picture of the business or individual in and at a point in time as obligations change.

Now, you know more than you probably need to starting off. Look to both sides of the equity equation and understand what the purpose of the finding is to reflect. Having equity is usually, in almost all cases, a good thing. :)

Carlos Rosas · Answer

Thanks everyone. All these info really helped.

Dion DePaoli · Answer

Equity is not cash.  Equity is convertible into cash (or other assets) but is not cash in and of itself.
	
	To say it another way, equity is the net of the liabilities and assets.  The term gives an understanding of the priority of the interests held.  The definition works the same way in stocks as it does real property.  Quantifying the net interests of the holder from the asset's liabilities.

Brie Schmidt · Answer

@Carlos  Rosas Equity is what the homeowner has in the house.  So if the house is worth 100k and the loan is for 50k then he has 50k equity.

What is Equity???

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