I have a reputation for beginning most conversations about real estate with an easy to remember acronym that describes the many benefits of investing: IDEAL.

Each letter in IDEAL stands for a one of the advantages of investing in real estate: income, depreciation, equity buildup, appreciation and leverage. Actually, I usually add in control as another benefit, but I digress.

While most investors really emphasize income, leverage and appreciation, today I wanted to narrow in and focus on equity buildup.

If you have seen any of my very detailed, deal analysis blog posts (and it is hard to miss them because I’ve analyze deals for over 280 US markets and marketed the heck out of them), you know that I actually calculate and include the financial benefit of equity buildup.

So, what is equity buildup? Simply, it is paying down the loan on your property. The less you owe the more equity you have (assuming the property value stays the same). So, as you pay down more and more of your loan over time, you build up more and more equity because you have decreased what you owe.

One great thing about the equity that accumulates from paying down your loan is that it is a guaranteed return: if you pay your mortgage payments, you get the return. Plus, your return increases over time. Why? Because you are actually paying down your loan faster and faster with each passing year.

Let me explain: in the first year of a 30 year amortized loan, your payment is mostly interest. In fact, from all of your payments for the entire first year you end up paying off about .9% (less than 1%) of the total loan balance. In the second year, your principal pay-down grows slightly so that you pay off about 1%. In the third year, you end up paying off 1.1% of the loan and each year it increases until, in the last year, you end up paying off about 8% of the original loan amount.

Here’s another way of looking at equity buildup that I personally use. I have a spreadsheet with all my rental properties listed down one side and columns that match each of the benefits from IDEAL listed across the top. I look at the column for equity buildup like I am actually putting that money into a savings account (called equity in my house). With one or two houses it may not seem like that much… a hundred dollars here, a hundred dollars there per month, but get a portfolio of investment property like I have and you’re putting away serious money each and every month. For example, if you had $1,000,000 worth of real estate loans (whether that’s five $200,000 houses or ten $100,000 houses), you could be gaining over $800 per month from equity buildup.

What’s great about this is that, as I mentioned above, this amount grows each year since you end up paying more and more toward principal with each payment. So, the next year you might be saving $850 per month.

It’s kind of like a forced savings plan, because it happens automatically every month that you pay your mortgage, whether you intend to save money or not.

So, when you do your own real estate investing analysis don’t overlook the powerful benefit of equity buildup in your calculations.

Until my next post,

James

P.S. If you want access to my Housing Analysis Spreadsheet and to be able to download over 100 of our real estate investing courses plus get free consulting for your business, I encourage you to upgrade to our Real Estate Investor Bronze Membership now.