fbpx

HOW TO MAKE YOUR JOB OPTIONAL”

Masterclass on January 22!

 What if you could enjoy a doctor’s lifestyle without depending on your clinical paychecks?

HOW TO MAKE YOUR JOB OPTIONAL”

Masterclass on January 22!

 What if you could enjoy a doctor’s lifestyle without depending on your clinical paychecks?

Accelerating Wealth Is Now open!

Don’t miss out! Grab this golden opportunity to enroll in Accelerating Wealth.  Enrollment ends December 8th.

Days
Hours
Minutes
Seconds

Zero to Freedom is Now Open!

Don’t miss out! Grab this golden opportunity to enroll in Zero to Freedom. Enrollment ends January 30th. 

Days
Hours
Minutes
Seconds

Zero to Freedom Waitlist is Now Open!

Don’t miss out! Grab this golden opportunity to join the Spring 2024 Zero to Freedom waitlist. 

Do You Have Lazy Equity?

Summary: If you own rental properties, more likely than not, you have lazy equity in your properties. In this post, we define lazy equity, explain why you might not want lazy equity in your properties, and explore when and how you can address this issue of lazy equity.

 

What is lazy equity? And why are we always talking about it?

Lazy equity is the portion of a property you own (i.e., equity) that isn’t working for you or, in other words, generating a return.

Over time, the equity in your property generally goes up from a combination of appreciation, both market and forced (more on this later) and paying down a loan over time. As your equity grows, if your return doesn’t keep pace (it usually doesn’t), then your equity is just being lazy!

Lazy equity creates inefficiency in your portfolio. In some cases, you’ll want to get rid of it. In some cases, you may choose to keep it. Read on to determine if you have lazy equity and to decide if you want to do something about it. 

 

How do you track lazy equity?

The way to identify and quantify lazy equity is to look at your return on equity.

Return on equity is the annual return relative to the present value you have tied up in the property.

Return on Equity (ROE) = Total annual return/Equity in property

Let’s go through an example for clarity.

Say you buy a $100,000 property and put in 25% as a down payment. Then, say your property cashflows $4,000 a year after all expenses. At the time of purchase, your ROE = $4,000/$25,000 down payment or 16%. That’s pretty decent.

You then pay down your loan for 10 years, so now you have your down payment ($25,000) plus the amount of equity you’ve accumulated by paying the mortgage ($25,000). For the sake of simplicity, let’s say your cashflow remains the same. Now your ROE = $4,000/$50,000 = 8%.

Now let’s say your property has also appreciated by $50,000 in those 10 years. That means we add another $50,000 to the denominator, so your ROE is $4,000/$100,000 = 4%. 

You see how the return on equity of your property decreases over time? What this means is that your money is not working as hard for you as it used to. And you have a lot of lazy equity just sitting in your property, not generating the same level of return as you were when you first bought the property.

 

How can I get rid of lazy equity?

There are two main ways of getting rid of it.

One is to sell the property and move the equity into a more expensive property. This enables you to harvest the lazy equity and get it working harder for you again. If you go this route, be sure to use a 1031 exchange in order to exchange your property in the most tax efficient way. Selling has another benefit for those who have real estate professional tax status.  The replacement property you buy gives you another opportunity to use cost segregation and bonus depreciation to create a large tax deduction.

The second option is to do a cash-out-refinance. This will take some of that lazy equity out of the property and get it working for you again.

A third option, if your lazy equity is in your primary home, is to do a home equity line of credit (HELOC) and get that money working for you in a rental property.

It’s important to keep in mind that harvesting lazy equity does come at a price. Selling a property, getting a cash-out-refinance or HELOC, all cost money and take time. So you want to be sure that going through the work and spending the money is worth it.

 

How do I know when to get rid of my lazy equity?

If/when to get rid of it depends on your risk tolerance and goals.

Some people can’t stand the thought of being leveraged (being more in debt and having less equity) and want to pay them off their loans as quickly as possible. However, the cost is lower return on equity and slower growth.

If you goal is to achieve financial freedom as fast as possible, then you’ll want to be more leveraged and get rid of lazy equity as soon as possible. 

You may also want to get rid of it if your market has appreciated a lot or is in a bubble. If you are fortunate enough to be in this situation, you’ll want to act before the property goes down in value. As described above, you can either sell your property or tap into the equity with a cash-out refinance. In some ways, selling is better because you lock in the amount of equity you own rather than losing the equity gained when the property goes down in value. 

We had this happen to us with several of our properties in Seattle and Spokane. These properties appreciated between 25-50% in less than two years!  In these cases, we decided to sell these properties and shift them to properties in other markets, where they would cashflow more too!

As part of our decision-making, I asked myself whether these properties were going to increase by another 25-50% in the next two years. When I found my answer was no, the choice to sell them became even clearer.

 

Is there ever a time I could be okay with having lazy equity?

If your risk tolerance is low, you may want to keep a certain amount of lazy equity in your portfolio as insurance for when times get tough.

For example, you may want to pay off the loans of several of the properties in your portfolio in order to increase the cashflow from these properties. This would help you get through periods of prolonged vacancies or unexpected expenses. Another strategy is to pay down the loans (but don’t completely pay them off) and then recast them in order to lower your monthly mortgage payment and increase your cashflow.

Either way, the net effect is that you are increasing the lazy equity in your entire portfolio.

In the book Millionaire Real Estate Investor by Gary Keller, which is focused on studying what successful real estate investors have done, he found that on average, investors kept about 40% equity in their properties. 

In our portfolio, for example, we each favor having a different level of leverage. We’ve had to find a middle ground and the net result is that we keep a small amount of lazy equity in our properties.

 

What should I do differently?

We highly encourage you to assess if you have any lazy equity in your current rental properties or your primary home. Once you have this information, determine if the amount of lazy equity you have in your properties aligns with your risk tolerance and future goals. 

If the answer is no, you know what to do!

Harvest any of your lazy equity lately? Have a question about whether to hold or sell? Join our Facebook community and ask like-minded real estate investing friends for advice!

 

Action Steps:

  1. Calculate the ROE for each of your properties
  2. Determine if you want to sell or do a cash-out-refi (or take a HELOC on your primary residence) in order to harvest lazy equity
  3. Re-assess ROE every 6 months to year to ensure you are not letting your money sit around not working for you

Do you want to learn how to creatively fund your real estate portfolio and achieve financial freedom? Join the conversation! Follow our Semi-Retired MD  Facebook page and join our Doctors or Professionals  group!

Semi-Retired M.D. and its owners, presenters, and employees are not in the business of providing personal, financial, tax, legal or investment advice and specifically disclaims any liability, loss or risk, which is incurred as a consequence, either directly or indirectly, by the use of any of the information contained in this blog. Semi-Retired M.D., its website, this blog and any online tools, if any, do NOT provide ANY legal, accounting, securities, investment, tax or other professional services advice and are not intended to be a substitute for meeting with professional advisors. If legal advice or other expert assistance is required, the services of competent, licensed and certified professionals should be sought. In addition, Semi-Retired M.D. does not endorse ANY specific investments, investment strategies, advisors, or financial service firms.

Share

Hi, we’re Kenji and Leti

we provide coaching and mentorship for doctors and high-income earners

Several years ago, we were newlyweds working as full-time hospitalists. On paper, it looked like we had everything: the prestigious careers, the happy marriage, the luxurious rental home, the cars, etc.

But in reality? Despite having worked for several years, we had very little savings. Despite our high income, we had very little freedom in terms of time or money.

One thing was clear: we had to do something.

ready to see if
real estate is right
for you? Take The
free Quiz!

If you’re just getting started in your investing career, we have a free resource ready for you. Answer a few quick questions, and you’ll receive a FREE download to help get you results.

Search the Blog

view more posts

Explore

GET STARTED

search