Many Americans own a home and have equity locked in it for the long term. To be precise, Americans hold nearly $20 trillion worth of home equity, and, of that amount, $6.6 trillion is tappable. Before discussing the options available to cash out on this equity via an equity sharing agreement, it is essential to define what tappable means.
Tappable equity is “the amount of equity homeowners can borrow against before hitting the 80% loan-to-value limit imposed by most lenders.” Tappable equity hit an all-time high as recently as 2019. Lenders will allow homebuyers and homeowners to borrow up to 97% of their home value with a mortgage. So, by definition, most homeowners own a minimum of 3% of their homes. But borrowing more than 80% of a home’s value requires private mortgage insurance (PMI), which insures the lender against default. The evidence shows that when homeowners, particularly first-time buyers, own less than 20% of their homes, they are more likely to default. After all, they have less skin in the game.
Trillions of Dollars of Locked Up Value
In aggregate, homeowners in the US own $6.6 trillion of this type of home equity. This home equity is mostly an untradable asset that is locked up in a home and can only turn into cash upon a sale. Of course, if the homeowner has good credit and income, they can borrow against their equity by doing a cash-out refinance or taking out a home equity loan or line of credit (HELOC). Loans and HELOCs use home equity as a security for the loan and require regular payments plus interest.
Housing Partnerships and Equity Sharing Agreement
Over the last couple of decades, another method of liquidating home equity has emerged. It is called equity sharing agreements or equity sharing programs. The 1997 book entitled Housing Partnerships: A New Approach to a Market at a Crossroads (Andrew Caplin, Sewin Chan, Charles Freeman, and Joseph Tracy) inspired many of these programs. The book’s proposition is simple: allow the homeowner to share or sell part of their home equity to an outside institutional investor (a bank or an investment company). In return for the equity share, the homeowner gets cash. Upon the sale of the home, the institutional investor earns the proceeds equal to the percentage of equity they purchased.
So What Are the Benefits of an Equity Sharing Agreement?
Equity sharing offers several benefits that other types of financing do not. In a market like the one we have in 2020, these benefits are beginning to look mighty attractive. Let’s go through them briefly, starting with the homeowner’s benefits and then the investors’.
Benefits of Equity Sharing Agreement #1: Homeowners have no monthly payments
A few companies have tried to implement versions of this shared equity model. They all offer lump sum cash in return for an equity interest in the homeowner’s home. To put it plainly, you trade future appreciation for cash in hand and doesn’t require any monthly payments. Wow! What a relief.
Benefits of Equity Sharing Agreement #2: Homeowners don’t incur any debt
Because equity sharing is not a loan that has to be paid back over time, homeowners do not incur any long-term debt. Unlike banks that offer credit cards, home equity loans, or home equity lines of credit (HELOCs), an equity share doesn’t require payments over a specified amount of time. There is no anticipated term for the return of capital. As co-owners, or co-investors, of appreciation of the property, the two parties are not pitted against each other but rather have the same real estate appreciation goal.
Benefits of Equity Sharing Agreement #3: Investors unlock new opportunities
An equity share of real estate allows investors to have their own slice of a real estate investment, also called an ownership share. Typical real estate investment has a very high entry barrier: 20% of the fair market purchase price or sale price. Not many investors interested in diversifying their portfolio would be able to swing that type of cash, particularly ones just starting, those without an ideal credit score, or those in cities with high home value like San Francisco or Washington DC.
Benefits of Equity Sharing Agreement #4: Investors improved their ROI
Most investors interested in an equity share are real estate investors. Most have a lot of operating expenses for rental properties or to renovate and flip. With an equity share, none of that exists because the property is usually an owner-occupied principal residence. There are no closing costs, significant repairs, housing associations, or real estate agents to pay.
But there are also some critical risks in the following categories:
- Term of investment.
- Cost to the homeowner.
Disadvantages of Current Equity Sharing Programs Currently Offered
Let’s start by talking about the term of the investment. All current companies that offer cash in return for an equity interest do so for a limited-term between 10 and 30 years. The homeowner is obligated to pay the investor their equity interest in the home at the end of its term. The homeowner must either take out a new loan against the house or sell it. If not, the investor can force the sale of the home, leaving the homeowner potentially homeless.
No Monthly Payments but High Cost to Homeowner
If the investor buys an equity stake in the home, they should get a fair return on that equity stake. If the home appreciates, they get a greater return than the original investment but in proportion to that investment. In reality, however, the companies that currently offer equity sharing programs invest in the home and demand a disproportionately greater return than their original investment.
Outsized Returns to Institutional Investors
Taken together—the limited term of investment and the outsized and disproportionate returns demanded—these factors make the shared equity program offered by these companies untenable for the average homeowner in terms of cost of capital and risk to their home. Two things are clear to me: first, there is massive potential in the shared equity program, and, second, for it to become widely adopted, the price point and the terms need to be more favorable to the homeowner.
Invown’s New Inexpensive Equity Sharing Program on the Homeowner’s Terms
Invown is an attractive new solution to this problem. With our product, homeowners will receive shared equity financing to sell their home equity to investors on their terms and not the bank’s. This could include a long-term or unlimited investment timeframe and an equitable split of any home appreciation.
Get in touch with us if you would like to be an early adopter or learn more.