How much equity is in my property and why is it so important? As an investor, one of the reasons you will have bought the property is for capital appreciation. But why is it important to work out not just your current surplus equity position, but also to try to forecast your equity position in the future?
It’s because, the surplus equity you have in the property is the capital you can use to either reinvest in new assets, or to pay down debt. If you are able to forecast your position you will be able to plan your strategy better and make better informed investment decisions.
How much equity is in my property?
Accurately work out the surplus equity
To accurately work out the surplus equity you need to prepare a balance sheet. You are investing in a long-term asset and long term debt, therefore for the purposes of the balance sheet, you will ignore your short term asset (rental income) and short term liabilities (creditors).
Your property is an appreciating asset, purchased as an investment strategy with the expectation that its value will increase over time.
Your furniture is a depreciating asset, which has a useful life, after which time it will have little or no value (in some countries, this can be depreciated from a taxation perspective).
Most property investors will therefore have two assets – the property and the furniture.
Typically this will be the mortgage.
In order to prepare the balance sheet so that it sets out a position in the future, you’ll need to make certain assumptions as to what will change over time and by how much. The best way explain this is by setting out an example.
Property: The property is bought for £400,000. Based on our research, we are anticipating annual growth of 2.5% in our given area.
Furniture: The furniture cost £10,000. The useful life is 7 years and after that it will have no value.
Mortgage: From the cashflow statement (read our article here as to how to prepare the cash flow statement) you can work out the remaining amount payable on your mortgage. In this example we have assumed you have a mortgage of £300,000. We have set out the balance at the beginning of each year.
|Assets||Year 1||Year 2||Year 3||Year 4||Year 5|
|Capital Appreciation Rate||2.50%||2.50%||2.50%||2.50%|
|Depreciated Value of Furniture||10,000||8,571||7,142||5,713||4,284|
|Total Value of Assets||410,000||418,571||427,392||436,469||445,809|
|Mortgage at Beginning of Year||300,000||295,160||290,098||284,804||279,266|
The difference in total assets and liabilities is your Investor Equity. As an investor, this is important because it has an impact your ability to raise debt and the equity to you have free for other investment.
Before you make an investment, you should play through different scenarios, by changing your growth assumptions, or changing the mortgage requirements. By comparing different scenarios against each other, you’ll be able to make better informed investment decisions.
We hope you have found this article useful, feel free to comment or ask any questions. For more information on about property investment check out our other articles and request your copy of our Buyers Guides from [email protected]
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