Equity is defined as the total market value of a property less the outstanding mortgage balance. Equity of a property is computed by subtracting from the property’s fair market value the total unpaid mortgage debt and any other outstanding liens or debts incurred against the property. Equity increases as the owner pays off the mortgage or the property appreciates in value.
Home equity is wealth on paper not accessible unless you remove it and utilize it for some investment purpose. For eg. Your home is worth $900,000 and outstanding mortgage on the house is $500,000, then the equity on your house is $400,000. If property prices drop, then you lose your equity, but instead if you remove the $400,000, then you can invest the money in income producing funds.
Hence in real estate, trading on the equity represents the amount of additional financing that can be obtained from the increased equity value of a real estate property minus any remaining mortgage. Trading on the equity is a form of real estate financing that is generally used to acquire a second mortgage or investing in other real estate.
Trading on equity = (new equity) – (original equity – existing mortgage) * amount eligible to be borrowed on new equity
Assume that a home purchased in the year 1998 for $200,000. In 2008 it has a 20 year mortgage remaining on a $130,000, 30 year mortgage. Now the appraised value of the property is $350,000. How much loan the new net equity will qualify assuming that the bank will lend 80% of the new equity. The computing reveals that the bank lends $240,000 on a home equity loan or a second mortgage. In real estate trading on equity is used for secondary investment reasons.
A real estate equity investment represents a residual interest in the property. A real estate equity investor is essentially the owner of the property, who gains if the property appreciates in value or the rentals increase. The risk taken by a real estate equity investor is much like that of owning stocks. Investment in real estate equity depends on equity investor risk tolerance and return expectations.
Commercial properties like office property, retail property, and industrial property are the best sources of income producing investment. Returns from office property are higher as the market tends to be sensitive to economic performance. As the economy progresses, the demand for office space and white collar jobs also increases leading to higher rents and increased income for theequity investor.
Retail properties include large enclosed shopping malls to single tenant buildings. Returns from retail commercial real estate tend to be more stable and since retail leases are generally larger and retailers’ are less inclined to relocate, so the equity investor tends to get a long and stable source of income.
Industrial properties are considered the staple of commercial real estate investments, since they require smaller average investments, less management and less operating costs. Most commercial property tenant leases are net or partially net, meaning that operating costs are passed along to the tenants, thereby benefiting the equity investor.
Multi family residential properties and rental properties deliver always an income to the equity investor as whatever the economic conditions people require a place to live.
Real estate equity funds seek to invest in property for development purpose. They invest in ground-up development of commercial, office, industrial and retail properties. Real estate equity fund also focus on repositioning well located under performingproperties through renovation, expansion, management and branding.
Real estate equity fund play a role in creating a developed market for real estate investors looking for equity capital. These funds raise money from institutional and high net worth individuals and provide equity for leveraged buy-out of companies with potential for growth. Real estate equity funds usually offer high returns since risks undertaken are also high.
The Metropolitan Real Estate Equity Management is a leading investment management firm founded by a group of investment professionals that creates and manages real estate private equity, equity funds of funds for endowments, foundations and high net worth investors. The Metropolitan Real Estate Equity management is on its way to raising $100 million. This vehicle will invest in a mix of opportunistic, value-added and core plus funds. The unleveraged fund targets an internal rate of return of 13% to 15% to its investors.