Equity, why does it matter?

9 Replies

Hi Everyone,

This will be my first post and I was wondering if all the veterans could help this newbie out. I'm currently reading J Scott's book on flipping homes and I came across a section where it recommends looking at more "established" neighborhoods because homeowners tend to have more equity in there home. Why would it matter if a home has equity? I understand that equity is the difference between the market price and the amount owed on the mortgage but it is not connecting in my brain why that would help me as a buyer. Thanks again for your help.

-Tim

I would need to understand the context a little more from J's book and I am sure he will find this post to comment, but my assumption is that this would present a better farm area for deals.  Your job if you're trying to "flip" is to:

1.  Identify Equity

2.  Purchase Said Equity At A Discount To Intrinsic Value

Item 1 is tough to do in areas where there is no equity.  You fish where there are fish in the pond and not where the lake is empty.  

Originally posted by @Tim Hsu:
I understand that equity is the difference between the market price and the amount owed on the mortgage -Tim

 This is correct. It is hard for someone to sell there house for less than they owe on the mortgage. If the mortgage is as much as the house is worth then how are you going to buy at a below market price?

Equity is money sellers can't spend.  One reason to sell a house is because you want or need the money.  I am not sure about the context here but that is just what came to my mind. Also if they have deferred maintenance they may be willing to deal on equity  rather then do the rehab themselves.

Guessing at the context and how it may help you...

If a house is being sold for what it is worth, $100k and has a mortgage of $100k, then there is nothing for seller to receive at closing and nothing for you to gain vs any house down the street.

However, if a owner has been in the house 20 years, and its worth $100k and only owes $25k, then there is a lot of spread to negotiate, if you can get to $70k, owner may feel thrilled to walk with $45k and you get $30k in equity so how is this important?  Now you have $30k you can pull from, sell quick and make $30k, etc.  You would have a potential $30k gain.  And if you decide to rent, it should easily cash-flow since it was purchased a bit under market.

Bottom line, you can't get anything out of a property if there is nothing, zero equity, in it.

Yep, I'll expand a little. I used to buy exclusively from homeowners, usually in foreclosure. Ill simplify the

Yep, I'll expand a little. I used to buy exclusively from homeowners, usually in foreclosure. Nowadays I'm usually buying from banks because nobody has any equity around here. Ill simplify the typical deal for instruction:

Guy owes $100k on a $150k house, we'd give him $3k and pay his house off. Put $5k into fixing it up and sell it for $150k, netting about $25k after expenses (very random numbers, but you get the idea)
---(more like pay him $3k, reinstate his loan, take it sub2, then fix it and sell it, but that's a lot if you're just getting started.)

That was pretty common around here before the crash when people generally had equity because values had been increasing regularly for over a decade.

Nowadays you get a lot of calls from people that have little or no equity and the approach to dealing with them is completely different.

Keep in mind, people generally don't just give money away, they need a reason to do it. Sometimes they dont count equity as money, but usually they need a reason to walk away from that equity, whether its a foreclosure (they're gonna lose it anyway), they can't get to it (house needs repairs they can't afford), they don't realize they have it, or any one of a number of other things. When looking to rehab, you are looking for a situation you can fix more than a house.

I still market to individuals, but not aggressively because we values down considerably here and I get a lot of calls where someone owes $130k on a $150k house. Lets say it just needs paint and carpet, you're still gonna spend $7k on it.

So using the formula of 70% of after repaired value minus repairs, your offer should be no more than $98k. (Very rough, fake numbers, btw). If you offer someone $98k that owes $130k on a house, they have to write a check for $32,000 to sell it to you. How often do you think that will happen?

Like was said, that conversation is completely different if they owe $25k on a $100k house that needs $15k in work. Your offer is $60k, they get a check for $30k at closing. MUCH easier sale.

My first questions when someone calls me:

Tell me about the situation.
Then:
What do you think the house would appraise for in perfect condition?
What would it need to get it in perfect condition?
What do you owe on it?
Would you take that for it? (No matter what they say, unless its paid for)

I'm just weeding out the ones that can't sell it to me at a price I can make money on. I never trust their numbers, but it gives you a place to start.

Keep in mind, if you are marketing to individuals you talk to a lot of people to get a real deal. I probably talk to 100 people to look at 10 houses to buy 1.

Hope that helps!

Thanks for everyone's advice, it finally clicked in my head why equity is important when buying a home with intentions to flip it. I am sure I will have more questions in the future and am looking forward to all your inputs.

you absolutely can make bucketloads of money flipping houses with no equity as well.  

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