Mini-REIT or Fallacy?

[diymark]

Anybody heard of home equity sharing? Why haven’t we heard more about it?

In reviewing my own financial situation I came to realize that most of my net worth is tied up in my home. I suspect there are many people in the same boat. They have lived in their homes for a while paying down their mortgage while seeing market increases, which has netted them sizeable equity. But in many cases, such as my own, they are still paying off the mortgage. In my case my home is worth about $950K, judging from recent sales in my neighborhood. But I still owe about $350K. Meaning I have about $600K in home equity. After pondering this, I wondered if I could somehow free up some of that equity so I could use it to pay off the home. I thought what if I took on an investor in my property, sort of a mini-REIT.

An investor would supply a cash investment into my property which would be secured by adding him/her name to the property title. Both the investor and the occupier (me) would have a share of the increase in the property value. In my neighborhood property has increase better than 5% in the last 10 years or so (that’s including the 2008 downturn). If it continues to do so for the next 5 years the investor and occupier would share the increase of $175K. The risk for the investor is fairly low. The investment is secured by the home. And since I will use the investment to pay off the mortgage, only the investor and myself have any claims on the property. Of course the housing bubble could burst again and the value could go down. But that could happen with any investment. And the up side is real estate is appreciating far better than safer CD’s or and can be easier on the stomach than the up and down stock market. Plus there is a physical asset behind your money. Businesses sell portions of their balance sheet to investors all the time, so why not an individual? Seemed like a win-win to me.

So I did some searching on the internet found out that some call it “home equity sharing”. But the concept seems to primarily targeted at buyers that do not have enough money to qualify to buy a house on their own. In my case I would like to sell about 40% of my house to an investor and pay off my mortgage to lower my monthly expenditures significantly.

So what is wrong with this idea? How come there aren't more people pursuing this kind of creative financial concept. I must be missing something here?? Anyway I thought it would be a great discussion piece. Thoughts?
 

[matchewed]

Yeah you wouldn't be the one owning your home anymore. You'd be sharing ownership with someone. Why wouldn't they be allowed to just move into your kitchen?

If freeing up equity is the goal, how about offloading a nearly million dollar home and down scaling, rather than selling a percentage of your home to someone else?

Plus if you haven't thought this through you've already done what you said. You've borrowed money from an investor, the bank, in order to have the home in the first place. Now you want to get more money from a different investor for a maybe 5% return for them? What guarantees that return, a 10 year evaluation? What about if the house catches on fire? What if you undersell?

I think there are too many unknowns, it's got a questionable framework, there are far superior real estate investment options for a real estate investor that would guarantee more control, with better returns, and clearer guidelines. If there were literature and a good solid framework around this type of investment I'd probably be less critical.

But hey if you're swinging a million dollar home I'm kinda surprised that cash flow is your problem. Probably easier to save money to increase your cash position if you needed to rather than enter into complicated investor relationships.

[AssetGrinder]

Its all about numbers. What rate are you paying now? how much do you stand to make? Overall the concept you propose sounds complicated and not worth the complications especially with adding someone else to the title.

I am somewhat in a similar situation. I have a paid off  million+ home and I want to pull out about 35% equity from it. To me i only have 2 options.
1. Downsize - My first choice, I have been looking on the market but nothing I like popped up yet to downsize into fitting my criteria.
2. Refinance - You can refinance at a new rate and pull out more equity at new lower rates or in my case getting a new mortgage. All depends if rates are low enough. Looks like rates are at 2.25-2.75 for 5 year closed in my area which is some pretty cheap money. One could stick money into REITs and get 5%+ easily. But then again you assume more risk.

[Cyrano]

You form a partnership that owns the home. You get to live in the partnership's home. Your partner gets ??? No one takes that deal.

So let's try again. You form a partnership that owns the home. You rent the home from the partnership. Your partner gets an income stream in proportion to their equity in the home. Now you have a leaseback arrangement, and someone might take you up on it.

But gotcha: if and when you want to sell the place, you have to reach an agreement with the partner about when and for how much? Or if the partner wants out, you'll either buy them out or have an unhappy partner.

[NoraLenderbee]

You know, I thought about doing something like this . . . until I figured out that I would never take the other side of the deal. Basically, the partner gets the drawbacks of being a landlord and those of being a homeowner combined.

The partner has all the risk. If property values go down, you can still live in the house while you wait for them to recover. The partner gets nothing but a decline in value.
If you suddenly turned into a hoarder or a crazy cat lady, your actions could seriously lower the value of the house (through damage and lack of maintenance). The partner has no protection.
The partner has to count his share of the house as an asset if he goes into divorce proceedings or bankruptcy, or his children apply for college loans, or he has IRS problems.

If the partner wants out, you have to buy him out, which means taking on a mortgage all over again.

[dragoncar]

Reverse mortgage?

[diymark]

Definitely some interesting discussion. Some really good points. I'm not totally embracing to the concept, but found it an interesting limited explored venture, I just thought it seemed like a personal extension of what businesses do right now. Businesses sell a portion of their net worth to investors every day. Investors are betting that the business will be successful going forward. They get a proportional share of future prosperity. If a business decides to let themselves go (hoarder or crazy cat lady or any other bad business decision) they lose business and investors suffer. Just like a business a home owner typically does not want to do something that brings down the value. Both are pursuing increasing values.

For me the reason for pondering this is I'm about to start a new chapter of my life. Retirement. My plan includes a fixed pension, revenue from a rental that is located on the same property, and of course my savings. Downsizing is an option that I've been considering but it would grenade the rental revenue (at least in the short term). Plus expenses of selling are substantial on a house close to $1M. Plus I have spent the last 14 years making this place nice. Originally a fixer I have remodeled nearly every room + the rental apartment (I'm a licensed contractor). It soon will be more space than we need as my son will be off to college in a couple years. But it is less than a mile from the ocean (always temp comfortable and scenic), which is the primary reason for the steady property value increases. We will downsize but I would like to do it only once to limit costs.

As far as some of the issues brought up about partnerships going bad. I always thought that is what a contract is for. Well written contract would outline buyouts, term length, and fair value assessments at the end of the agreed term. Things like fires, floods, and quakes are what insurance is for and would be part of the contract. I've read about agreements that allow the occupier to make improvements to the property (with investor approval) that bolster value. The occupier continues to pay for maintenance, insurance and taxes. Investor does not.

I even pondered adding to the agreement that the property would be sold at the end of the term. Then also agree to let the investor use the property address for his principle residence for the last 2 years. In essence the occupier and investor switch. Both the original owner and the investor would get up to $250K gain without tax implications using (each living in the home for 2 of the last 5 years). That would be another nice investor perk. Try doing that with a REIT.

Do any of these make it more interesting? Again more food for discussion.

[frugalecon]

My intuition is that it would be very difficult to anticipate every contingency that could arise in this sort of relationship. The inherent risk would cause the partner to discount what he or she would pay, and there would surely be a chance of legal disputes.

[ampersand]

I don't think you'll find anyone interested in taking you up on this either way. I believe your aversion to your mortgage debt is irrational. A partner will expect cash flow as surely as your mortgage company and will in fact expect a higher return. You state that you think the house will appreciate. Why cut someone else in on a good investment when you already own it all. Right now you can keep ALL Capitol appreciation, for only paying tax deductible interest?
The mortgage also serves as a good method of hedging against inflation. IMHO you are seriously overthinking this.

I'd also like to mention that it's uncommon for companies to sell their stock of a healthy business. The stock market is simply owners trading prexisting shares. If a company is selling shares it dilutes everyone's ownership. It isn't commonly done unless A they have a specific planned use for the money that they otherwise couldn't afford through low interest bonds, or if they are hemorrhaging  and have to stop the bleeding (JC Penny). More and more companies are actually using share buy backs to decrease shares.

You may wish to think of your house right now as a business. It has cash flow from the renter (you), and has the potential for appreciation. It has taken a loam in order to finance the original purchase. If the rent is low, no buyer will be interested unless they are offered a discount ( that you don't want to give). If the rent is high, why would the business want to sell part ownership when cash flow will pay down the loan?