As the name suggests, sweat equity refers to a person’s contribution toward a particular project. In most cases, sweat equity is not monetary but rather comes in the form of physical labor, time, and mental effort. Sweat equity applies to different sectors, including business, startup, and property investment. If you’re a real estate investor, you might have heard this term before. So, how does sweat equity play its role in real estate?
A real estate market value is determined by countless variables. Among those variables are location, size, features, amenities, age, and more. While some variables are fixed, there are several ways you can increase the value of your home. With sufficient funds, you can easily invest in upgrades and improvements. But for someone who doesn’t have easy access to a large sum of money, sweat equity is the way to go.
This article explains everything you need to know about sweat equity in real estate investing. This includes sweat equity definition, its calculation, and the pros and cons of sweat equity. So, without further ado, here’s everything you need to know about sweat equity real estate.
What Is Sweat Equity In Real Estate?
As stated by Freddie Mac, equity is the difference between how much your home is worth and how much you own in your mortgage. In other words, it is the value of homeowners’ financial interest in their homes. Equity is the actual market value of a property without any liens that are attached to it. If that’s the basic equity real estate definition, then what is sweat equity?
David McMillin on Bankrate on April 13, 2022, defines sweat equity as an effort homeowners put into their home improvement. As you know, most homeowners put a lot of effort into making their homes more comfortable, which often translates into home improvements and upgrades. While most of them do this using certified builders and home improvement services, it is not common for a homeowner to improve their homes by themselves.
In fact, an August 22, 2022 report by Angi shows that 81 percent of homeowners completed different do-it-yourself (DIY) projects during the pandemic. In addition, 77 percent of them confessed that their projects were rooted in increasing the future sale value of their properties. Based on those reports, it is clear that the sweat equity definition involves non-monetary effort that homeowners make to improve their homes’ market value.
How Does Sweat Equity Influence Property Value?
Sweat equity plays an important role in increasing property value. For instance, your current home doesn’t have a backyard patio. But you have the sufficient skills to construct a backyard patio on your own, and put in the effort to build it. When you’re ready to sell the improved sweat equity homes, the buyer may want to pay more based on your addition to the backyard. In other words, you’ve successfully increased your home’s value.
Despite sounding fairly simple, it is essential to note that sweat equity still requires spending money on supplies and raw materials. Still, you’ll be able to save a lot of money by not hiring someone to do the improvement for you. In the end, sweat equity is a great solution for home improvements if you don’t have or don’t want to spend a large amount of money on improvements.
How To Determine Sweat Equity In Real Estate Investing?
As previously mentioned, sweat equity can be an amazing opportunity for real estate investors to make a fortune. So, if you have the necessary skills in plumbing, landscaping, or electrical, you may find your way to be a successful real estate investor. But what if you haven’t been involved in any kind of investment venture before? Do not worry. Here’s how you can turn sweat equity into sweet equity.
- Identify your skill
If you want to offer your skill to build sweat equity, you must identify the skill you can offer. After all, the skill that you possess is the reason for starting this investment venture. So, make sure that you have the necessary skill to improve property value.
- Find potential investors
If you want to use your DIY skills in real estate investing, you have to find someone with sufficient funds to purchase the property. You can start by offering your real estate investment partnership to your friends and family. In doing so, you have to make sure that they’re savvy enough and understand all the risks involved in sweat equity real estate investment. Most importantly, you also need to discuss the value that this partnership would offer.
- Make an agreement
Once you find an investing partner, continue your step by making a detailed agreement with them. You can start by specifying the value of your non-monetary contribution. In addition, you may want to structure it as a percentage of return on investment if you intend to flip and sell the property. Lastly, be sure to calculate any hard costs you might encounter as a part of the improvement process.
- Find the right property
Once you made a solid and formal agreement, it is time to find the right property. You can find properties in various ways, including auctions and online listings. In doing so, make sure that you find a property with the biggest upside potential and good bargains. Also, make sure that the property condition is aligned with your skill.
- Put the effort into the property
Once you find the right property, work with your business partner to create a solid financing plan, which may include how you and your business partner handle the mortgage. In addition, work together to complete the necessary paperwork for closing. Lastly, you can start your improvement effort by creating a timetable for renovation.
How To Calculate Sweat Equity
It is impossible to calculate the value of the hard work that you’ve put into your home until you’ve sold your home and calculated the proceeds. As stated by Rocket Homes on August 31, 2022. The simplest method of how calculating sweat equity is by subtracting the final selling price of the home from the home’s original price, the percentage of market value fluctuation, and the material cost for the project.
For example, you purchase a housing unit for $350,000 in 2019. Over the next three years, you’ve spent a lot of work remodeling the kitchen, adding an outdoor fireplace, and installing a basement wet bar. After an appraisal, it is revealed that the home is now worth $500,000, an increase of $150,000. However, remember that amount is not all sweet equity since you haven’t considered the percentage of market value fluctuation and the material cost for the project.
So, let’s say that the housing market value in your neighborhood has increased by 15% since you bought the home. Therefore, $52,500 of the total appreciation comes from the market. In addition, you paid a total of $45,000 for home improvement materials. So, by subtracting the total appreciation ($150,000) from the market value fluctuation ($52,500) and the material cost for the improvement ($45,000), your sweat equity has yielded a return of $53,000.
Examples Of Sweat Equity Real Estate
Besides home renovations and real estate investing, there are other ways to involve sweat equity in real estate. Some of those examples are:
- Tenant-landlord agreement
In some cases, landlords offer sweat equity to earn an equity stake in their property or to lower housing costs. For instance, you can offer your landlord the service of regular maintenance in exchange for equity or money. As a result, you’re essentially working to earn the equity or pay your housing cost.
- Startup real estate business
If you run a real estate business, such as a real estate agent or an investor, sweat equity can help your business grow. By doing the repair and improvement yourself, you can increase the home value without spending a large amount of money on labor and services. With more money to save, you can grow your real estate portfolio faster.
Pros and Cons of Sweat Equity Homes
As with other things in life, sweat equity has its advantages and disadvantages. Below are the full breakdowns of the pros and cons of sweat equity.
Pros
- Lower upfront cost
In most cases, houses that require more work are priced lower than houses in good condition. In addition, most people tend to shy away from housing units that need repairs and renovation, increasing your chance of getting a suitable property. All of those factors resulted in the minimum amount of capital you need to get started on the investment.
- Personal satisfaction
If you love DIY projects, sweat equity real estate can be the best way to release your creativity and skill. All the effort you put into renovation and improvement will add value to the monetary sense and overall quality of life. Lastly, if you live in a home that you’re renovating on your own, you’ll be able to enjoy all improvements before anybody else.
- More income from guests
If you rent out the housing unit that you’re improving, you might be able to charge more for the upgrades. Charging additional costs for newly added amenities is a common practice in short-term rental businesses, such as Airbnb and Vrbo. So, if you want to have extra income from your rental business, improve the unit by yourself.
Cons
- The rapid change in trends and demands
Housing trends are rapidly changing. So, if you don’t work quick enough, you might miss certain housing trends at their peak. All the energy and time you spent on building that outdoor fireplace might not turn a profit if the trend of outdoor relaxation is no longer at its peak. Trends influence paint colors and interior layout as well. So, unless you work fast, you may end up putting a lot of effort into something with limited return.
- Living with constant renovation
Of course, while you’ll be able to enjoy the renovated house before anyone else, you need to live in a constant period of renovation and construction. If you choose to live in your house while it is being renovated, you may consider the sweat equity no longer worth the effort. In addition, if you choose interim housing, you need to cope with paying the rent and other expenses of renting a house.
Frequently Asked Questions About Sweat Equity
What is the difference between equity and sweat equity?
In real estate, equity is the value of homeowners’ financial interest in their homes. It is always measured using monetary value. On the other hand, sweat equity is the effort homeowners put into improving their homes’ market value. In most cases, sweat equity is not monetary, but rather comes in the form of physical labor, time, and mental effort.
How to measure sweat equity?
As stated by Bankrate on April 13, 2022, swat equity is calculated by subtracting the final selling price of a home with the home’s original price, the percentage of market value fluctuation, and the material cost for the project. It is essential to note that you can never calculate the exact value of sweat equity before you sell the house in question.
What is a sweat equity example?
One of the most commonly found examples of sweat equity in real estate is home flipping, which involves improving a purchased housing unit to sell it at a higher price. You can also find some examples of sweat equity in tenant-landlord agreements and startup real estate business.
Is sweat equity a good idea?
Sweat equity can be the best way to improve your home’s market value. However, you must possess the necessary skill to improve and renovate a house. It is also essential to know the different risks of sweat equity, including the rapid change in trends and the chaos of living in constant renovation and construction.
Final Words
As long as you possess the necessary skill in home improvements, sweat equity can be your best way to increase your home’s market value. Sweat equity is also useful to grow your real estate business quickly and increase your return on investment real estate investing. However, you must know the risk sweat equity has. So, if you decide to improve your home to increase its market value, be prepared for the unwanted outcome.
