(10/28/2011) Erate Exclusive - Savings poor, but income rich?
Buy a home with a partner who has some money to burn.
It won't be easy in today's tight money mortgage market, but equity
sharing is an option you should at least explore.
Equity sharing is a symbiotic relationship -- as well as a legal
agreement -- between two or more parties holding title to one home. Two or
more parties share title in order to share the risk, thereby reducing the
risk for both parties. Inevitably, however, home price appreciation is the
bottom line. The property must grow in value over the term of the deal for
it to really pay off.
That's no easy feat these days.
"The concept of equity sharing is a far easier sell during times of rapid
real estate appreciation, but without that rise in property values as a
catalyst, the short term horizon of these arrangements renders them less
useful in today's slow growth to declining market because of the difficulty
for either party to be able to make an exit," said Nancy Osborne, Chief
Operating Officer of Erate.com, a Santa Clara, CA-based financial information
publisher and interest rate tracker.
Equity-sharing partners
• The seller. The seller can use equity sharing as a way to
quickly sell in a slow market. The seller can also become the investor and
retain a stake in the property.
• The investor. Typically a non-resident owner, the investor
provides the initial leverage in the form of a down payment or larger stake.
He or she can be a family member of the occupying home owner, a trusted
friend of the occupying home owner or some private entity, say a
professional investor. The investor gets tax deductions for his or her
prorated share of the deal. With time, provided equity grows, the investor enjoys a joint venture-like
return on the investment.
• The occupying home owner. Often savings-poor, but
income-rich, one person, with little or no money down, becomes the occupying
home owner. He or she pays the mortgage and other costs associated with
owning and occupying a home -- including taxes, insurance, maintenance and
the like.
The occupying home owner gets to deduct a prorated share of the mortgage
interest and property taxes, along with other tax breaks that come with home
ownership. With enough equity growth, the occupant can eventually cash out,
buy out the investor, keep the home or use the equity gain to buy
another.
• Title to the home can be held in a variety of ways -- joint
tenancy with right of survivorship, tenancy in common, partnership or as a
living trust.
Variations on equity sharing
Like its creative financing cousins -- seller financing and lease
options -- equity sharing often makes the news as an alternative
financing tool buyers and sellers turn to in tough, cash- or credit-tight
markets. That's because equity sharing lessens the upfront costs buyers face
in any market. If buyers can manage to buy, sellers can sell.
However, a tight market isn't mandatory.
• Equity sharing also can be strictly business -- an investment
purely for financial gain, provided the investor and buyer are willing to
risk they'll realize enough appreciation to make the deal pay off.
• Equity sharing can be a tool to help stave off foreclosure. A
defaulting homeowner can privately bring in an equity share investor to buy
a lump sum stake in the property or subsidize monthly payments over time,
that is, pay some or all of the monthly mortgage for some period. Again, for
the effort, the investor gets an equity stake.
• Equity sharing can also be used by a financially secure seller who
doesn't need to drop his or her home price, but wants to move. With an
investor buying an 80 percent stake, the seller could retain 20 percent
ownership, and get another home. Then, say five years down the road, the
seller and investor sell the home, each taking an appropriate share of the
equity. Again, and always, appreciation must be sufficient for the deal to
pay off.
• From time to time, local governments offer equity sharing deals
typically for first-time buyers, low- and moderate-income households and
crucial community workers like police, firefighters and teachers.
The devil's in the details
Equity sharing is never a silver bullet.
They are most often short term contracts of five, seven, ten years or so
-- to make sure the period of risk exposure is short. At the end of the
term, the net proceeds from the sale are split, doled out according to
contract.
Because the deal relies upon appreciation within a short term, equity
sharing can be a tough sell in a depreciating market. They are
perhaps better suited for a bottom market or a market already on the
rise.
Equity sharing is also a two-sided coin when it comes to the lender.
Risk averse lenders have put a squeeze on all credit and may not look
favorably on all but the most "plain vanilla" mortgages.
On the other hand, if the investors has cash for his, say, 80 percent
stake, and the buyer-occupant needs a mortgage of only 20 percent of the
value of the home, the lender might bite a well-documented offer.
Equity sharing is relatively obscure because the deals can be
complicated.
The deals must be legal and binding contracts designed to provide an
equitable means to an end. The contract must include provisions for any
disputes or disagreements that might arise during the term. The contracts
typically don't allow extracting any returns until the term is up, unless
there's an escape clause. Escape clauses come with provisions that include
stiff cash penalties for early outs and other resolutions.
Finally, even if the equity sharing deal is designed to ultimately create
a homeowner, its underlying investment approach triggers a different set of
underwriting and tax rules, compared to a conventional home buy.
Buyers will almost always need an equity sharing-experienced team -- real
estate agent, attorney and tax professional -- to set up the transaction's
contract.
