Are you putting your equity to good use?

One of the most common mistakes that you can make when trying to grow your investment property portfolio is to be sitting on “lazy equity”. The problem arises because most people don’t understand what it means to have lazy equity and how they can avoid it.

Lazy equity is the term given to equity that you have accumulated in your property portfolio but which, for some reason, you are not putting to its most appropriate use (ie to invest in more appreciating assets). The two main reasons why investors accumulate lazy equity are:

1. Not being aware of the current value of a property; and
2. Not having the most suitable loan structure.

Smart investors should always be aware of changes in the median house value of suburbs where they hold investment property. While the median house value is not an indication of the value of their property, it can be used as a “marker” to prompt you to undertake a more detailed study of local property prices. You should then get a printout of the 50 to 100 most recent sales in the suburb (visit www.propertydata.com.au) and look through this to find at least 5 properties of a similar size/type to yours. These properties will give you a good indication of the value of your property if an independent bank panel valuer was to assess your property. If you believe that the value has increased by more than 5 per cent since your last valuation then you should be speaking to your finance broker to find out if your borrowing capacity will increase (remember, borrowing capacity is determined by income and equity so an increase in equity doesn’t always lead to an increased borrowing capacity).

The reason that the correct loan structure is essential for putting your equity to use is that different banks have different standards for lending money against property. Some banks won’t lend more than 80 per cent of the value of the property. Others will happily lend up to 95 per cent against the value of a property, but they won’t increase your line of credit unless you agree to borrow through them for the next property (they call this a “contingent liability” – as the increased loan is contingent on them agreeing to what you want to use the funds for). The problem with a contingent liability is that the bank may decline your next investment even though it meets all of their usual criteria. Why would they do this? Because the more properties that you have mortgaged with a single bank, the greater the “concentration risk” for that bank. Concentration risk is the risk created by a concentrated investment in a single entity (or associated group of entities). In other words, the more property you hold with one bank the riskier you are to that bank. So, mortgaging all of your property to one bank is akin to holding all of your eggs in one basket.

An increase in your portfolio’s value is only beneficial if you have access to your money. Therefore, it is absolutely critical that your team of advisers (particularly your finance broker) has a thorough understanding of the loan structures on the market to ensure that you do not get hamstrung by a single bank controlling all of your assets, or by a bank that has outdated and overly conservative loan products. Smart investors get ahead by using the system to access equity generated by increases in their properties' value in order to invest in additional properties.

NOTE: While a 5 per cent increase in the value of one property might not give you enough equity to duplicate, the more property you hold the more benefit you receive from a 5 per cent increase in the portfolio’s value. For instance, a 5 per cent increase on a $500,000 portfolio will only give you $25,000 (not enough for a deposit on a new home) but an increase of 5 per cent on four properties worth $2 million would give you $100,000 to put towards a fifth property. That is the power of duplication and the reason why each subsequent property gets easier and easier if you’re structured correctly.