Sep202013

Equity share: a good option for true housing bears

Strong arguments can be made for a ten to twenty year bear market in real estate. We are at the bottom of the interest rate cycle, and for the next thirty years, we may face an environment of slowly but steadily increasing interest rates similar to what we saw between 1950 and 1980. If that comes to pass, borrowing power will be steadily eroded just as it was steadily increased over the last 30 years. Combine this with the likelihood of a decade or more of underemployment and stagnant wages, and you have a recipe for house prices to go nowhere for a very long time.

If you believe this bearish scenario will come to pass, and if you want to own a house anyway for a place your family can live, there is a new option you should consider. An investment group is willing to subsidize your down payment (and thereby free up your capital to invest in other things), and all they want is a portion of the equity in your house. If you are bearish and don’t believe this equity is likely to materialize through price appreciation, why wouldn’t you take this money to avoid tying up your own?

Wealthy Borrowers Sacrifice Upside for Down Payment Aid

By Jody Shenn and Heather Perlberg September 18, 2013

Jeff Uter would have needed to sell stocks or pull cash out of his consulting business to afford the down payment on a $780,000 home in Orange County, California.

Instead, he paid half of the 20 percent required and got the other $78,000 from San Francisco-based FirstRex. In exchange, the real estate investment firm will get 40 percent of any gains in the value of Uter’s 4-bedroom condo in a golf course community.

As with any deal, the devil is in the details. If the firm wanted 40% of all equity at sale, it would be a ripoff because they would be taking 40% of your amortized savings. However, if they are only taking 40% of the upside, then it comes down to your opinion on future home price appreciation.

If prices go up, then you don’t make as much as you hoped. If prices are stagnant or go down, then you didn’t tie up your money to get no return.

“I have stocks and my own business,” said Uter. “I’d rather invest in that than put it in a personal residence.” …

I think he is making a wise decision.

With the recovery underway, FirstRex started offering the down payment assistance this year using money from pension funds and endowments to fill a need otherwise served by wealthy relatives, according to co-Chief Executive Officer Jim Riccitelli.

“Houses are really affordable right now because interest rates are low, even after the recent run-up, but housing is not that accessible,” Riccitelli said. “If you can’t get the house, affordability doesn’t really matter.”

If you don’t have wealthy relatives who will either give you or loan you the money, then this is a good option. It levels the playing field for those not born with silver spoons.

Borrowers also benefit because the equity investment lowers monthly payments by shrinking their debt or helping them avoid mortgage insurance, Hirt said. That may become even more important to lenders with the industry facing new government rules next year, which will expose them to greater legal risk when consumers’ borrowing costs exceed 43 percent of their incomes, he said. …

The increased down payment will allow people to bid more which will push up prices, but since this is equity rather than debt, it’s unlikely to create a bubble.

Debt known as shared-appreciation mortgages were available in the U.S. starting in the 1970s, according to a 2007 paper for the Fannie Mae Foundation by researchers including New York University professor Andrew Caplin. Such loans can cause problems for investors because evidence suggests “the incentive to use these mortgages is highest among those expecting no price appreciation and those intent on holding the loans for as long as possible.

I guess I’m not the first housing bear to figure this out.

Homeowners can get a maximum of half of their down payment from FirstRex, though they also may choose to give up less of an ownership stake, and have the option to buy equity back before selling in up to 30 years. It also shares in any losses. …

This seems like a good program to me. I haven’t researched their entire agreement, but based on the terms stated in this article, there is little that would turn me off to the idea.

Uter, who bought his California home in March, said he had enough money for a down payment after selling his previous property. By giving up some home equity now, he said he can later tap other investments that he expects to return more in retirement.

“We’re going to stay for a while,” he said.

I like this guy’s thinking.

So what do you think? Would you give up 40% of the upside on a house purchase for 10% in an up-front down payment?

With what I believe will unfold over the next decade or more in Coastal California, I would.

A late Option ARM implosion

I haven’t seen too many Option ARM implosions lately. I assumed all of them already blew up, but apparently, there are a few hardy survivors out there. The owners of today’s featured property got a $340,000 Option ARM with a 1.25% teaser rate back in 2006. Apparently, they are still paying on it today.

It what can only be described as careless and stupid underwriting, Washington Mutual (now Chase) allowed these borrowers to obtain a $185,000 HELOC on top of an Option ARM. How stupid is that? No wonder WAMU bit the dust.

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[idx-listing mlsnumber=”PW13186654″ showpricehistory=”true”]

13342 IOWA St Westminster, CA 92683

$350,000 …….. Asking Price
$213,000 ………. Purchase Price
11/29/1999 ………. Purchase Date

$137,000 ………. Gross Gain (Loss)
($28,000) ………… Commissions and Costs at 8%
============================================
$109,000 ………. Net Gain (Loss)
============================================
64.3% ………. Gross Percent Change
51.2% ………. Net Percent Change
3.6% ………… Annual Appreciation

Cost of Home Ownership
——————————————————————————
$350,000 …….. Asking Price
$12,250 ………… 3.5% Down FHA Financing
4.55% …………. Mortgage Interest Rate
30 ……………… Number of Years
$337,750 …….. Mortgage
$95,907 ………. Income Requirement

$1,721 ………… Monthly Mortgage Payment
$303 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$73 ………… Homeowners Insurance at 0.25%
$380 ………… Private Mortgage Insurance
$0 ………… Homeowners Association Fees
============================================
$2,478 ………. Monthly Cash Outlays

($360) ………. Tax Savings
($441) ………. Principal Amortization
$21 ………….. Opportunity Cost of Down Payment
$108 ………….. Maintenance and Replacement Reserves
============================================
$1,805 ………. Monthly Cost of Ownership

Cash Acquisition Demands
——————————————————————————
$5,000 ………… Furnishing and Move-In Costs at 1% + $1,500
$5,000 ………… Closing Costs at 1% + $1,500
$3,378 ………… Interest Points at 1%
$12,250 ………… Down Payment
============================================
$25,628 ………. Total Cash Costs
$27,600 ………. Emergency Cash Reserves
============================================
$53,228 ………. Total Savings Needed
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