The Best Ways to Build Equity for Rental Investors
What is equity?
In simple terms, equity is the difference between the value of a house and what you owe. Equity can grow by itself and increase your net worth, providing a source of funds for you to acquire more rental properties.
Keep in mind that equity is “invisible money” that only becomes cash when you sell your property or borrow against it.
In this article, we’ll tackle how you can build and manage equity as a rental investor.
How can you build equity in rental properties?
There are plenty of ways to build equity from investing in real estate, but there are additional perks that come with renting your property out, whether partially or as a whole.
Let’s say you acquired an SFH that’s worth $120,000 from a motivated seller who sold it to you for $110,000. You purchased it with a 30-year mortgage at 5% interest and put 20% down. You rent the SFH to a lovely couple who pays their rent consistently and on-time every month. The home then appreciates at a rate of 3% over the five years you’ve owned it. By the end of the five years, you stop renting out the house and sell it for the new market value of $139,113.
From this example, equity is created in a couple of ways:
a. $10,000 equity from buying under market value
b. $22,000 equity from down payment
c. $29,113 equity from appreciation
d. $7,190 equity from paying down your mortgage, compliments of the tenant.
Every month you pay the bank using rent payments, a part of it goes towards the interest and a part of it pays off the principal. That results in your equity gains accelerating every single month, boosting the investment value of your property simply by having paying tenants in the house.
How can you increase equity in your rental properties?
There are many ways to manage your equity in your properties, but here are several strategies that we believe every rental investor should know:
Acquire property with a low LTV (loan to value) by providing a bigger down payment. That way, it’s considered a lower risk loan and you get a lower interest rate. Plus, the increase in cash flow coming from a lower mortgage payment will help increase your overall ROI (return on investment).
Use net cash flow to pay off the mortgage faster, making extra payments toward the principal. Paying an extra $50-100 each month can already reduce the time it takes to pay off your mortgage by years, save you some money on interest, and grow equity faster. Just make sure that you can overpay by checking in with your lender, and verify that these payments will go towards the principal.
Consider getting a 15-year mortgage to build equity faster. You’ll pay a lower interest rate, have to make fewer payments, move along the amortization schedule faster, and spend less time in the high-interest phase. The payment is a significant increase, but you’ll also pay off your mortgage in half the time.
Avoid expensive risks, as home equity is not as liquid as some may think. You want to separate as much equity from your property as possible and maintain their liquidity for emergencies. Should you come across an opportunity to invest in more rental properties, you also want to be able to liquidate easily.
Make property updates to increase the value of the rental and eventually sell at a higher rental price. Curb appeal has one of the highest ROIs, so consider replacing the doors, windows, and adding premium touches. Inside the house, focus on cosmetic updating, as it tends to have a high rate of return, also. This will increase rental income over time and add to the overall value of your house when it comes time to sell.
Conclusion
Building equity is a long process. But it’s called “a gift that keeps on giving” for a reason, as it slowly makes you a little bit richer every day.
You can already build equity just by holding on to the property for a long time. However, you should also boost equity growth using any additional methods you can, because the quicker the equity grows, the faster you get the funds to buy more rental properties to add to your portfolio.
How do you plan to build equity in your properties? What other strategies do you recommend?
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