It's fairly common for new real estate investors to focus on finding and analyzing investment opportunities as they get started investing. Doing due diligence on an asset is a huge part of successful investing, but many don't realize how important it is to get their financial house, including their net worth, in order. Without knowing, tracking, and improving your net worth, you are limiting your access to financing and even an entire pool of investment opportunities. In this article we will not only show you why net worth is a critical factor but how to calculate your net worth as well.
What is net worth?
Net worth, in its most basic form, is your monetary value. Essentially it is the sum of all of your assets minus all of your liabilities. Individuals, businesses, and even big corporations can use net worth to derive their overall value as a company or person. If an entity has more assets than liabilities, it will result in a positive net worth; conversely, if you have more debt obligations than assets, you can have a negative net worth.
Why is net worth important to investors?
Net worth is an important calculation to understand and work toward improving because it is an element lenders consider when approving a real estate or commercial loan. In commercial real estate, net worth is a large determinant in your ability to get approved for a loan. If you have bought a home or a car, even a personal residence, you have perhaps unknowingly already calculated your net worth, or at least allowed the lending institution to calculate it for you. If you have high liabilities and minimal assets, they are less likely to lend to you or they may charge a higher interest rate since the risk of default is higher for them.
How to calculate your net worth
If you're working directly with a lender in an effort to get a loan, the lender will likely have a specific net worth form for you to complete and provide to them. If you're trying to track and stay on top of increasing your net worth over time, you can grab a free form from online or use a net worth template provided for free in Excel or a similar program. Regardless of the net worth tracking method you decide to use, you're simply going to add up all assets and subtract all liabilities.
Assets - Liabilities = Net worth
Assets can include:
- Real estate (primary residence and investment properties or vacation homes).
- Art or collectibles of value.
- Investments like stocks, real estate investment trusts (REITs), or retirement accounts.
- Cash (checking, savings, and cash reserves outside of banks).
- Other items of value that you own such as furniture, antiques, jewelry, etc.
Liabilities include any debt obligations including:
- Mortgages (from formal lending institutions, equity lines of credit, or private loans).
- Car loans.
- Credit card debt.
- Medical debt.
- Student loans.
- Other payments you may be obligated to, like alimony.
How can high net worth create opportunity?
With a high positive net worth, at minimum $1 million or more without considering your personal residence, you are considered an accredited investor. This high net worth valuation allows you to sidestep the annual income requirement of earning $200,000 as a single filer or $300,000 jointly for the past two consecutive years with reasonable expectations of the same income for the following year.
Being an accredited investor allows you to access institutional quality investments through crowdfunding opportunities or private hedge fund investments. According to the U.S. Securities and Exchange Commission, less than 10% of the population can access these types of investments even though they hold 76% of total household wealth in the United States. The higher your net worth, the better terms for financing you can receive, higher lines of credit you can get approved for, and higher quality investments you can gain access to.
Net worth is the most precise way to measure wealth, and it should be measured frequently so you can work toward improving it. What gets measured gets managed -- and this metric is one investors should manage continuously.