Jan102017

Would you surrender future equity gains for a lower house payment?

Investors will supplement down payments in exchange for a share of future profits. Would you make a deal like that?

Are there any circumstances under which homebuyers would be willing to share in the upside of home price appreciation? Would you sell an option worth 35% of the upside in exchange for half (10%) of your down payment? You wouldn’t have any payments like a second mortgage, and if you sell for a loss, the investor shares in the losses with you.

When you reflect on it, the main reason you wouldn’t participate is because you believed you will make a fortune on appreciation, and you don’t want to share it.

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 steadily erode just as it steadily increased over the last 30 years.

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 35% of the profit at resale. 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?

Of course, then the property is burdened by a third-party equity claim, which most people don’t find appealing, but this isn’t an ownership claim. The entire deal is structured as an option contract, so it places few restrictions on your ability to use the property.

This company will help with a down payment, but it wants a stake in your new home

James Rufus Koren, January 6, 2016

When Ricardo and Catherine Soto were looking to buy a home in Chula Vista, they knew that even after selling their old house in El Cajon they would be able to afford a down payment of only about 10%.

But when buying a home, 20% is the magic number. It means not only borrowing less but also avoiding mortgage insurance, which can cost hundreds of dollars a month.

Some cash-strapped home buyers might have opted to tap a relative or retirement savings, but the Sotos tried something new. When they bought their home for $650,000 in September, the couple came up with the 20% after all — thanks to an unusual arrangement with a newcomer to the mass mortgage market.

Unison, a 12-year-old San Francisco company, offered to match the $65,000 that the Sotos brought to the table in exchange for what amounts to an ownership stake in their house.

The Sotos don’t have to pay anything back — not for a while, at least. But when the couple sell their house they will owe Unison the $65,000 it invested, plus 35% of the value their home gains. Should the market suffer a setback, Unison will share in the loss. …

The details matter here. Is the repayment calculated on a gross or net basis? Remember the post How to sell a house for $100,000 profit and still lose money? One a gross basis, it’s possible to sell for a profit and still lose money on the net due to sales costs.

In a typical move-up sale, a seller has about 30% equity. The 6% commission is nearly 20% of the gain, and if the investor takes another 35%, the equity check gets pretty small, probably not enough to make a move-up. If this program became widespread, the move-up market would suffer.

For the last few years, Unison has offered its down-payment product to buyers of pricey homes who need so-called jumbo mortgages. Now the company is going mass market.

It’s working directly with mortgage lenders to offers its down-payment program to buyers looking for ordinary home loans. Government-backed mortgage agency Freddie Mac will purchase loans made to Unison customers through what the agency described as a “very limited pilot.”

Unison’s program could help some buyers get into homes they otherwise could not afford.

This will serve to inflate prices further and potentially destabilize the market just like affordability products did.

But housing finance watchers don’t see this as a return to the kind of high-risk lending that sparked last decade’s financial crisis. Unison customers must have good credit, qualify for a standard mortgage and make at least a 10% down payment — much more than what’s required for loans insured by the Federal Housing Administration, for instance.

New programs always start off with prudent standards, but if investors want to funnel money into real estate this way, standards will fall as the program expands.

Still, deals with Unison and other firms are novel and come with a big tradeoff: In exchange for a smaller mortgage, buyers give up a big chunk of the value their homes might gain.

Laurie Goodman, co-director of the housing policy finance center at research group Urban Institute, said it’s important for home buyers to know what they’re getting into.

“Saving money up front in exchange for a share of the upside is a legitimate decision, but it’s one the buyer needs to fully understand,” she said.

The first buyers will understand, but later buyers will not.

For the Sotos, the decision came down not to how much value their home might gain or lose, but the size of the monthly payment.

“For our personal situation, what was most critical was having access to discretionary income because our kids will be going on to college,” said Ricardo Soto, 50, a father of three teenagers. “Having that lower payment and knowing I can count on that was really important.”

Eliminating mortgage insurance is a big deal. Reducing the payment by reducing the mortgage balance is a nice bonus.

This transaction is potentially a win-win, mostly because it eliminates the mortgage insurance. When you compound the savings on the mortgage and insurance, both the buyer and the investor make a good return on their money because the unnecessary mortgage insurance leak is plugged.

With tighter mortgage-lending standards, home prices near pre-recession highs and expensive rents making it difficult for would-be home buyers to save for a down payment, Unison co-Chief Executives Jim Riccitelli and Thomas Sponholtz say they think that there will be healthy demand for their down-payment program. …

I think they’re right. Potential homebuyers can’t save for down payments with high rents, making a formidable down payment barrier at the conforming loan limit. This program could potentially overcome part of the resistance at the down payment barrier.

down-payment-barrier-2016

Here’s how it works: Buyers have to qualify for a mortgage and be able to make a down payment of at least 10% on their own.

In a typical deal, Unison will match that 10% down payment, but the company will do smaller and larger deals. For example, it might match a 12.5% down payment, or put up as little as 5% if the buyer can put up more. Unison gets that money back, plus gains or losses, when the home is resold.

If homeowners haven’t sold or don’t want to sell after 30 years, they’re obligated to get an appraisal of the house’s value and cash Unison out, which could require taking out a home equity loan.

This probably isn’t the way buyers should acquire their “forever” home, but if their worst-case scenario is that after 30 years they must take out a HELOC for 35% of the gain on their house, that isn’t too bad.

After the deal closes, the buyer takes possession of the house and is responsible for monthly mortgage payments, taxes, insurance and maintenance.

Unison’s deals are structured as an option — that is, in exchange for help with the down payment, the company is buying the right to acquire a set percentage of the home at a later date.
We don’t technically own a piece of the house while the homeowner lives there — that’s really important for the home buyer,” Sponholtz said. “The home buyer maintains control of their home.

That means that, while Unison won’t help pay property taxes, it also can’t tell homeowners what kind of landscaping to put in or whether they should choose hardwood or carpet.

While it’s great that this deal doesn’t encumber the property, it does create a disincentive to improve it. Why would anyone make any significant improvements when 35% of the added value goes to an investor? Many long-term owners make improvements when they go to sell their property, but owners in this program will not. 

Most of the equity we realized in our last home had to do with paying down the mortgage, not with appreciation,” he said. “And I get to keep all the value I get by paying off the mortgage.”

He also liked that Unison will share in the downside if home prices should fall — 35% of the decrease in value will be subtracted from what the couple owes the company.

This is why the program should really appeal to housing bears who want to keep the amortization but won’t mind surrendering appreciation they don’t believe will materialize.

And regardless of the ups and downs of the housing market, the Sotos are saving about $300 a month on their mortgage payment and an additional $400 because they don’t need mortgage insurance.

An extra $700 a month is a big deal, he said, as his kids all start college over the next four years.

The lure of free, or nearly free money is appealing.

So would you do this?