Ownership interest in the assets of an
entity after deducting its liabilities. The
balance sheet contains an owner’s equity or
shareholder’s equity section that includes,
in the case of the latter, types of share
capital, contributed surplus, and retained
earnings.
For real estate purposes, equity
typically refers to the difference between
the market value of the property and the
mortgages, and liens, against the property.
A capitalization rate expressing the
relationship between cash flow and the
equity invested in a property, that is
usually obtained from research involving the
sale of comparable properties.
Mortgages given based primarily on the
equity of the property with secondary
consideration for the covenant of the
borrower.
Example of
Equity Financing
A Buyer is
acquiring a fully occupied 96-unit apartment
complex that provided the previous owner a
consistent net annual operating income
(before debt service), of $350,000 over each
of the past seven years.
The Buyer, having a substantial
downpayment, requires a first mortgage of
$2,000,000. The purchase price is
$4,900,000.
The lender is prepared to advance funds
by way of a first mortgage at 8% amortized
over 20 years and due in five years. The
annual mortgage payments are $198,805.80.
The debt service represents approximately
57% of anticipated net annual operating
income. Given the sizeable downpayment and
the past financial performance of the
building, the lender is not focused on
Jones’ personal covenant, but rather on the
significant equity position in the property
and the resulting high cash flows to address
annual debt service.
The right of the mortgagor to reclaim
clear title to the property upon full
repayment of the debt. This right is granted
to mortgagors but is extinguishable under
foreclosure.
Example of Equity of Redemption
A Buyeracquires a property at a purchase
price of $150,000. For ten years, he makes
regular payments of $1,206.41, principal and
interest, on an 8% mortgage in the amount of
$100,000 amortized over ten years. Upon
completion of 120 payments,
the Buyer has
retired the debt. A discharge of the
mortgage is prepared and registered on the
title to the property and Jones, as
mortgagor, exercises his equity of
redemption and reclaims clear title to the
property.
A term generally referring to the
mortgaging of equity in property for a
variety of reasons. Individuals may borrow
money from their equity through arranging
new financing or renegotiating existing
mortgage(s).
Equity takeout loans rely more on the
equity position of the owner and the actual
security, with GDS and TDS considerations
often taking a more secondary position in
the qualifying process. A basic guideline
for lenders is maximum equity takeout of 70%
(loan to value ratio) for any property under
consideration.
An appraisal term relating to the rate
of return applicable on the equity portion
of a real estate investment over a specified
holding period.
For real estate investment analysis, the
equity portion refers to the capital
provided by an investor in acquiring
property, as distinct from the debt
component. The equity yield rate is a
measure of return based on initial capital
invested in relation to projected operations
and sale proceeds cash flow over a specified
holding period. The mortgage yield rate is
the comparable rate of return for the debt
portion of the investment.
Equity yield rates are typically
calculated on a before tax basis, but
nothing prevents analysis based on cash flow
after tax. Most appraisal activity involves
the former, with commercial practitioners
often comparing after tax positions for
specific clients (referred to as after tax
equity yield). Equity yield rate should be
clearly distinguished from the equity
capitalization rate which expresses the
relationship between a single year’s
operating income and expenses and capital
invested. Similarly, the mortgage yield rate
(interest rate on the mortgage), should be
differentiated from the mortgage
capitalization rate.
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