Why does equity matter?

[Scott Campbell]

I'm curious about wholesaling, and after listening to all of the podcasts about it, I still can't figure out why it would matter if a house has equity. We are just buying and selling the contract right? Plus, the buyer of the property will have his own financing in place too, so it seems like equity is irrelevant here?

[Dion DePaoli]

Oh boy.

Property is financed based on equity my friend.  Lenders do not lend on properties with no or negative equity.  Equity provides the potential for the lender (or other lien holders) to recover their dues from the property.   

The function of wholesaling simply buying and selling a contract is just the method of a transaction.  I am guessing, what you might have your eye on is some cash flow potential from the Subject Property, and that is what makes the Buyer of your wholesale deal attractive.  While that can be true, having negative equity or no equity means, someone else has all the equity.  Those parties with all the equity stand to recover or benefit from the equity.  Not having equity would mean that party is in a first loss.  Any money injected into the property can not be recovered from the property.

So for instance, say we take an investment property needing repairs of $24k.  If the property has zero equity, likely due to some senior lien holder like a mortgage, then putting the repairs into the property to only receive say $1,000 in rent each month is a pretty high gamble.  Rent cash flow would need to be collected for over 2 years in order to recoup the cost of the $24k in repairs.  In the event the folks who hold all the equity decide to enforce their ownership interests and use the property to recover their capital, the money put into the property can be lost in full.  

Equity is the value of an asset free of liability.  When the liability is equal to or greater than the asset value - there is no value in the asset.  It is all spoken for, if you will.  Sometimes equity positions can be improved or earned.  Like making repairs to a damaged property or by paying down the senior interests.

A Buyer can not finance a property with no equity.  A lender who provides the financing needs to be secured in most cases by the equity.  Again, where said equity represents all or a portion of the lender's capacity to recover the funds that are loaned out.  

It think the take away that you ended up with after listing to podcast on the matter is both interesting and ironic.  Some wholesale deals are self-serving for the whole-seller.  Others are mutually beneficial to all parties.  Take caution when you are the only winner in a deal.