Sweat Equity: What It Means And How It Works
Sweat equity is a creative way to increase your profits on your own home or investment property by doing the work yourself. While the idea of renovating you own home can seem daunting at first, the payoff in money saved by can be extremely appealing.
Below we’ll explore what sweat equity is and how to make it work for you.
What Is Sweat Equity In Real Estate?
Sweat equity real estate refers to the time and DIY labor you commit to renovations or upgrades that increase the value of your home or investment property. We might know it as ‘hard work,’ but sweat equity meaning a non-monetary investment that turns into true profit when you sell your home.
Don’t confuse sweat equity with home equity, though. While they are similar, both refer to the profits you earn when you sell your home, they have differences. Sweat equity is the equity you don’t have to pay for because you trade your time and expertise for money. In other words, you didn’t have to make payments or pay someone to improve your home’s value – you did it yourself.
Home equity refers to the equity you earn either by hard work, paying down your mortgage, or your home naturally appreciating because the area’s market appreciated. Home equity is the money you receive in hand when you sell your home after paying off your mortgage.
Think of home equity as the total amount you earn when you sell your home after paying off all expenses, such as your mortgage, any supplies you purchased to renovate the home, and any liens you might have on the property.
How Does Sweat Equity Work?
The concept of sweat equity is simple. You’re trading hard work and the sweat off your back for increased property value.
Let’s say, you renovated a bathroom and kitchen in your home. You put in your time and effort and appreciated the home’s value by $20,000. You can now take that $20,000 and deduct the cost of any materials you purchased to find your sweat equity.
Both homeowners and real estate investors can take advantage of sweat equity.
Homeowners can use it to increase their home’s value, giving them more equity in the home when they sell it. They can also refinance the home, take some of the equity out, and use the cash to consolidate debt, buy another property, or pay for other home renovations.
You can also use the equity earned to refinance your mortgage, lowering the mortgage payment and, therefore, the cost of homeownership.
Real estate investors can use sweat equity to increase their profits.
For example, let’s say you bought a fixer-upper home. You plan to fix it up and sell it for a profit. However, before you put in your own sweat, you decide where it’s best spent. Where will you get the best return for your time? Once you determine what you’ll do and what you’ll hire out, you renovate the home and sell it for a profit.
By doing some of the hard work yourself, you save money, leaving more money in your pocket when you sell the home. As a real estate investor, this can be a great way to increase your portfolio by giving you more money to invest in other properties.
Either way, when you use sweat equity, you walk away with a larger profit since you didn’t have to spend money to earn some or all of the home’s equity.
How Do You Calculate Sweat Equity In A Home?
To calculate the sweat equity you earned in a real estate investment, you’ll need a few numbers:
- The home’s sales price (the price you paid)
- The cost of any supplies you purchased to fix up the home
- The percentage of appreciation the neighborhood experienced
- The home’s after-repaired value, aka the home’s current sales price
For example, you bought a home for $150,000. You purchased $40,000 worth of supplies, the neighborhood homes appreciated by 20%, and the home today could sell for $350,000, according to your local real estate agent.
At first glance, you’d think you have $200,000 in sweat equity, but there’s more to it. That’s the total equity in the home, but that’s not how much you earned with your hard work. First, $22,500 (20%) is due to the market’s performance because the home naturally appreciated that amount. Next, you must deduct the $40,000 you spent on supplies. This leaves you with $137,500 in sweat equity, or the equity you earned by putting in your own work into the home.
What Are Examples Of Sweat Equity In Real Estate?
There are many ways to earn sweat equity in a property. Here are a few examples to get you started.
Habitat For Humanity
Habitat for Humanity builds and renovates homes for those less fortunate. They rely on their extensive volunteer network to provide their sweat equity to make the homes habitable. Not all sweat equity involves people physically working on the houses, either. They also have volunteers who help with housing education.
Without these volunteers, homeownership wouldn’t be possible for many. In addition, the volunteers' hours save the organization hundreds of thousands of dollars and allow them to continue their mission.
Home Renovations Or Repairs
You can earn sweat equity on your own home to remodel it, or on a fixer-upper you purchase. Whether you plan to keep the home or fix it up and sell it, the work you do yourself saves you money upfront and puts more money in your pocket when you sell the home.
You can use sweat equity to save money on tasks you can handle yourself while hiring out for the larger tasks that are outside your abilities. For example, if the home needs major electrical work, that might be outside your area of expertise, but you might be able to handle installing new cabinets or new flooring.
Some landlords offer the option to use sweat equity to either earn an equity stake in the property or to lower their overall housing costs. For example, you can offer your services for regular maintenance or renovations/repairs in exchange for equity versus cash. This way, you’re working to earn the equity or to pay your housing costs.
There is no right or wrong way to have a tenant-landlord agreement. It’s a good idea, however, to have your attorney review the agreement before signing it. You want to make sure you are protected in the contract.
Real Estate Investing
Real estate investors often flip homes or buy rundown homes, fix them up and sell them within 6 – 12 months. To do this, you’ll need someone to renovate the home and increase its value. Most investors pay contractors to do the work, but this costs money.
If you are able to do the work, though, there’s a chance you’ll earn a lot more equity in the home. You won’t have to pay for the labor, just the supplies needed. You could even partner up with someone who is also handy and possibly cut down further on the costs incurred in renovating the fix and flip home.
Startup Real Estate Business
If you’re a real estate investor, real estate agent, or any other business person interested in investing in real estate, sweat equity can help your business grow. By doing the repairs yourself, you increase the home’s value without spending any money on labor. This leaves more money in your pocket, which allows you to grow your real estate portfolio faster.
You never know, you might even learn new skills as you come across renovations or repairs the homes need that you aren’t familiar with but are willing to learn.
The Bottom Line
Earning sweat equity is one of the smartest ways to increase your profits on a real estate investment or even your own home. All it takes is a little time and effort to save thousands of dollars. So whether you’re building a real estate portfolio or just want to maximize your capital gains on your home, it’s a great way to invest in real estate.
If you’re ready to buy an investment property and use your sweat equity to increase your profits, start the mortgage process now.