Ellwood technique

[CANative]

aka Mortgage Equity Technique.

I understand the basics (The investment is typically not held forever - there is a "holding period" and that the investor receives the proceeds of the sale at the end of the holding period) but how does the "equity buildup" as the mortgage loan is paid down figure into the equations (models)?

 

[Pittsburgh Pete]

the computation (it is a deduction from the constructed rate) is the loan ratio X paid off loan ratio (over the holding period) X the SFF at the equity yield rate for the holding period. This factors in a return on the increased equity amassed over the holding period.

Does that answer your question?

 

[BRCJR]

the computation (it is a deduction from the constructed rate) is the loan ratio X paid off loan ratio (over the holding period) X the SFF at the equity yield rate for the holding period. This factors in a return on the increased equity amassed over the holding period.

Does that answer your question?

Is that also true if the property depreciates?

 

[CANative]

the computation (it is a deduction from the constructed rate) is the loan ratio X paid off loan ratio (over the holding period) X the SFF at the equity yield rate for the holding period. This factors in a return on the increased equity amassed over the holding period.

Does that answer your question?

RO = YE - M(YE + P 1/SN - RM) - DO 1/Sn

I feel like Abraham Lincoln trying to learn lawyer stuff by reading law books in front of the fireplace.

 

[Pittsburgh Pete]

Is that also true if the property depreciates?

Not in this particular computation. However, there are additional computations that address increases/decreases in both property value and income.

The formula I referenced only addressess increase in the equity and return on that increased equity--a situation that would happen even if the property's value is declining--at some point, however, the equity and the property value might cross paths.

 

[Ken B]

the computation (it is a deduction from the constructed rate) is the loan ratio X paid off loan ratio (over the holding period) X the SFF at the equity yield rate for the holding period. This factors in a return on the increased equity amassed over the holding period.

Does that answer your question?

I'm sorry, but could you put that in a bullet format?

 

[nstanbru]

This might be a duplicate post, I was somehow logged off the site. Try to find a copy of "The Instant Mortgage Equity Technique" by Irvine E. Johnson. It was published for the SREA by Lexington Books/D.C. Heath and Company, 1972. I don't know if Mr. Johnson is still around, but he was located in Ventura, CA.

 

[CANative]

I schlogging my way through this... (It's more than I need to do what I do, but I want to learn more as I go along)

Mortgage Equity Formula
Mortgage financing creates both a mortgage (i.e., debt) and an equity interest in the property, and
each of these interests can be analyzed and valued separately. The total value of a property is the
sum of the values of these two financial components. Mortgage-equity analysis, broadly defined,
refers to any income capitalization or investment analysis procedure that explicitly considers how
mortgage terms and equity yield requirements affect the value of a property. Mortgage-equity
analysis thus includes both the band of investment procedure for estimating a capitalization rate
and discounted cash flow analysis when that technique is used to separately value cashflows to
the equity interest.
A well-known application of mortgage equity analysis is the use of the mortgage-equity (or
Ellwood) formula for developing an overall capitalization rate. The Ellwood formula is similar in
kind to the basic yield capitalization formula discussed earlier, but is different in two ways: first,
it requires a given equity yield rate (YE) rather than an overall yield rate (YO); and second, it
incorporates assumptions regarding the terms of financing (interest rate, length of loan, loan-tovalue
ratio) in addition to those regarding an expected holding period and change in property
income and/or value. Similar to the basic yield capitalization formula, the mortgage equity
formula provides a direct method of solving for the present value of the property, given the set of
assumptions described above, even though both the future value of the property (i.e., the
property’s expected value at the end of the holding period) and the loan amount are based on the
property’s present value. The basic mortgage-equity formula is as follows:
RO = YE - M(YE + P 1/SN - RM) - DO 1/Sn
where
RO = overall capitalization rate
YE = equity yield rate
M = loan-to-value
P = percentage of loan paid off
1/Sn = sinking fund factor (SFF) at the equity yield rate
RM = mortgage capitalization rate (mortgage constant)
DO = percentage change in total property value over the holding period.
The basic mortgage-equity formula can be used only with a level income stream. However, it can
be modified to accommodate changes in income using income stabilization factors (so-called "J"
and "K" factors). A series of tables containing solutions for many of the variables needed to solve
the basic Ellwood formula and its refinements are also available, although these tables are now
largely obsolete given programmable financial calculators and spreadsheet software.69

 

[Michael S]

I came across this page a few months ago when I was looking into the mortgage equity technique. It includes some of the steps in the 12C.

http://www.commercialappraisalsoftware.dcfsoftware.com/mtgequity.htm

 

[CANative]

Thanks for that link.