Let me say from the start, that what I am about to say is not to encourage you into debt, at least not recklessly taking on debt. I would not expect anyone to adopt the principles I am about to outline unless they were absolutely sure of what they are doing and the possible consequences.
So with all that said, here’s a general principle I want to talk about: if you have any equity, anywhere, that you are not using, then you are wasting money.
I realise that might sound like a very bold statement but I believe it to be true. Before I explain why, let’s first define equity. For our purposes equity is the value of an asset (whether it be your home, another property investment or some other type of asset altogether) less the amount of any loan outstanding and secured against it.
Something I’ve noticed and which I think is a bit strange is that people tend to be somewhat dismissive of the value of equity, especially equity in property. People often say, somewhat philosophically, “well, it’s only on paper” but that doesn’t make any sense. If you were able to realise the value of that equity, perhaps through sale, or to withdraw part of the value, perhaps through a loan, you would see that it is actually very real.
Perhaps the reason behind this is that most people’s experience of having equity is equity in their own home and they see it as being locked-up and untouchable, and so perhaps a little hypothetical.
However, it is only of worth to you if you use it and use it properly, so let’s explore why I think having unused equity is a waste.
I’ll start with the negative consequences of not using equity, and then move on to the positive reasons for using equity.
Although there may be no obvious cost involved in having equity and not using it, there are a couple of costs.
The first is, because of inflation, the value of your equity is being eroded every day, month and year. For example, suppose you have £50,000 equity in your own home. If you just leave it there what happens? Inflation reduces the real value of every pound you have tucked away in your equity. Even at the Bank of England’s target rate of 2%, in twenty years time the real value of your £50,000 of equity will be reduced to £42,600 in today’s terms.
But, you might argue, if I leave well alone, and if property prices increase, won’t the value of my equity increase? It will in absolute terms but every pound of existing equity will still be devaluing. Your most recent pounds of equity won’t have devalued as much as those that you’ve had for longer, but every pound in equity will still be devaluing. At the moment it is devaluing in real terms, minute by minute and, for want of a better description, it is giving you a negative return.
The second cost of unused equity is ‘opportunity cost’, the opportunity cost of not investing that wealth elsewhere. If you were to release your equity, it could be invested to give you a positive return instead of no return or even a negative return in real terms.
It’s true that there are costs involved with releasing equity such as lenders fees and valuation fees, and you will have to pay interest on any equity you do take out. But even with these costs, reinvesting this money and perhaps even using it as geared funds, the returns you can achieve can be significantly more than the costs involved.
We’ll look at this in more detail in the next few posts
Here’s to successful property investing.
Peter Jones B.Sc FRICS
Chartered Surveyor, Author & Property Investor