A New Way to Speculate? How Home Equity Sharing Agreements Are Going Mainstream

Home equity sharing agreements allow property owners to receive a lump sum of cash in exchange for a portion of the future appreciation or value of their home, allowing them to finance a variety of needs from niche products. are moving towards more popular options.

In July, DBRS Morningstar, the world’s fourth-largest credit rating agency, developed the first methodology to evaluate securitizations of home equity investments. This will likely make securitized bonds backed by home equity sharing arrangements more mainstream.

About two years ago, financial company Redwood Trust announced a deal with fintech company Point. first securitization Backed solely by a home equity sharing agreement.but First-rated securitization Among the bonds backed by home equity investments, $224 million in bonds backed by home equity contracts originated by Unlock Technologies and issued by Saluda Grade were issued this fall. The transaction demonstrates growing confidence in the asset class as an option for investors.

A home equity sharing agreement is a way for homeowners to access a portion of their home equity. capital You can live in your home without taking on debt or making monthly payments. But are they a good option for investors looking to leverage existing assets to expand their real estate portfolio? And do these speculative investments pose a threat to the market in the long term?

What is home equity investing?

Home equity investments, better known as shared equity or shared valuation agreements, provide homeowners with access to cash in exchange for a portion of their home’s future value or a future valuation above their starting point. Masu. These contracts are not loans. This means that if there are any credit or income requirements, they often come with more lenient terms and are not affected by today’s high interest rate environment.Homeowners can use that cash to make money Refurbishmentpay off high-interest debt, or buy a second homeall without monthly loan payments.

However, the contract is secured by your property and typically comes with a repayment period of 10 to 30 years. During that time, you can choose to either buy back the company’s shares in the home equity, usually for more money than you originally received, or pay the company the shares when you refinance or sell the home.

At the end of the term, if you don’t have the money to pay it back, your contract may force you to sell. Unlike mortgages, home equity contracts are also non-standard contracts and may have burdensome provisions regarding renovations and other terms that are difficult to understand.

Additionally, most contracts come with: closing costs In addition to the establishment fee, there is a portion of the home’s future appraised value or value that equates to a higher annual interest rate. for example, unlock you can access 10% of your home’s current value in exchange for 20% of your home’s future value.

Some companies, such as Unlock and Splitero, offer caps to help homeowners avoid taking on too much debt in the event of rapid appreciation. Spritero uses a shared evaluation model. This means that the company also shares in the loss if depreciation occurs.

“If the value of your home or property declines significantly, your Splitero investment could be repurchased for less than your initial investment,” he says. michael gifford, CEO and co-founder of Splitero, said in a conversation with BiggerPockets. However, in consideration of risks, the valuation is calculated from a starting point lower than the valuation.

Is home equity investing a good option for real estate investors?

To ensure that a home equity sharing arrangement is a profitable way to finance an investment property, you need to ensure that the property generates a return that exceeds the cost of accessing the equity. You can also compare your net income for the period to the expected net income you would receive if you financed the property using traditional methods. mortgage, Home Equity Loan or HELOC, hard money loanor alternative financing Placement.

However, entering into a home equity investment agreement is not the same as borrowing money and comes with other benefits, making it difficult to compare apples-to-apples with traditional financing options.

Gifford explains: “Because this is not a loan, there are no additional monthly payments that will be affected by interest rate increases or new debt associated with Splitero HEI. Splitero HEI also has no income requirements to qualify, meaning you can access a property even if your wealth or income is tied up in it.”

Splitero works with both owner-occupied and non-owner-occupied properties.

In other words, it’s an option for investors who don’t qualify for other types of loans. And if you can use cash flow to increase your revenue by not having monthly payments, Rental property portfolio It’s faster, and you can potentially earn far more than you owe the contract creator. However, you’ll need to crunch numbers, and given the complexity of these non-standard contracts, you’ll likely need input from experts. lawyer.

Also, while most companies offer calculators that you can use to estimate the price of a share repurchase, understand that these tools are based on assumptions about the market that may not be true. is also important.

Risks of home equity investment securities as a mainstream asset class

Securitization of housing loans began when 1970s. Most mortgage-backed securities have been around for a long time because the mortgage is backed by real estate and government-backed mortgage companies such as Fannie Mae and Freddie Mac guarantee payments in much of the secondary mortgage market. It has been considered a relatively safe investment.

However, home equity investment agreements are typically secondary liens. If the homeowner defaults on the mortgage and the home is sold in foreclosure, the home equity sharing company will collect only after the primary mortgage lender is paid.

Therefore, equity stocks can be a high-risk, high-return investment. Real estate tends to rise over the long term, but the 2007-2008 housing boom and subsequent crash revealed how typical trends can be derailed.the study suggest Part of the cause of the economic downturn was housing speculation, and it is thought that there was also the packaging of low-quality housing loans as shown below. subprime loanto securities.

DBRS Morningstar has rated the Class A and Class B bonds included in Unlocked HEA Trust 2023-1 as BBB (low) and BB (low). This means that analysis has shown that the bonds are of “adequate credit quality” and “speculative and non-creditworthy.” “Investment Grade Quality”, respectively.

The DBRS Morningstar rating system could help institutional investors view the asset class as reliable, and government-backed mortgage companies could become players themselves. Under current regulations, Fannie Mae and Freddie Mac cannot purchase mortgages that are subject to private transfer fee provisions used to enforce home equity investment agreements, but Fannie Mae and Freddie Mac cannot )teeth, under consideration Permanently remove restrictions on shared stock loans.

The move aims to support affordable housing by allowing the securitization of shared equity loans managed by land trusts, governments and nonprofit organizations. These programs typically provide down payment assistance to low-income homebuyers in exchange for a portion of the home’s future appraised value or value.

FHFA not only exempted Fannie Mae and Freddie Mac from purchasing stock loans until 2024, but also eliminated income limits. The agency is seeking comment on whether to make the exemption permanent for regulated banks and whether income limits should be reinstated.Relaxed standards could increase the popularity of home equity investment contractsBut it can also mean speculative risks.

But the average homeowner in the United States is currently sitting on more than that. $274,000 Regarding housing equity, Gifford doesn’t expect Spritero to have problems, even in a recession, adding: During the global financial crisis. After such modifications, most homeowners still have equity in their homes and are unlikely to sell their properties at that time. There is a much better chance that they will hold out and bring home values ​​back up to higher price levels. ”

conclusion

Home equity investing may be evolving from a niche product to a mainstream financial tool for property owners. For some, this arrangement may be a better option than taking on new debt. First-class securitization of share-share agreements can increase confidence in the validity of the asset class, foster growth for home equity investment providers, and lead to competitive new product options for homeowners.

Be careful, however, as home equity sharing agreements are often an expensive option for property owners who want to leverage their home equity. Additionally, the economic impact of low-quality securities should not be ignored.

Note by BiggerPockets: These are the opinions expressed by the author and do not necessarily represent the opinions of BiggerPockets.