One recent model may be in trouble; the other has endured for more than four decades.
In simple terms, equity sharing is shared ownership or co-ownership. There are two kinds of shared equity models currently in use. The first is referred to as an equity sharing company. The second model involves a potential homeowner and a private investor.
Letās take a closer look at each model.
Model #1: Equity Sharing Company
The first is often called an āequity sharing companyā because it involves an institutional investor.
Homebuyers and homeowners have four options for raising cash:
- Home equity loans
- Cash-out refinancing
- Home equity lines of credit (HELOC)
- Home equity sharing
In option #4, the institutional investor obtains an appraisal on the property and then offers up to 20% cash for part ownership in the home. It is not a loan, so there is no interest and there are no payments. When the home sells or is refinanced, the investor is paid their part of the appreciation plus their initial investment.
Here are five companies with location and year they were founded.
- Unison, San Francisco, 2013
- EquiFi, San Jose, 2015
- Hometap, Boston, 2019
- Point, Palo Alto, 2015
- Unlock, San Jose, year not found
This form of equity sharing is not a debt for the homeowner, and some of these companies will invest even if the homeowners have credit scores as low as 500. The company simply adjusts the amount they offer to compensate for lower credit scores.
One drawback, however, is that currently these companies do not operate in every state. Another consideration is that only principal single-family residences are eligible.
There could be a problem developing with this business model, however. These companies designed their business models to prosper in an appreciating market; however, prices are declining 10%-30% across the country now. As a result, these institutions will not last in their present form.
Model #2: Equity Sharing
Equity sharing is a situation in which a private investor (investor co-owner; ICO) and a potential homeowner (resident co-owner; RCO) buy a single-family residence together and the aspiring homeowner occupies it. This shared equity model has lasted more than 45 years.
Percentage shares are negotiable. Generally, the RCO pays the property taxes, insurance, loan payments, and routine repairs. The ICO puts up the down payment and pays closing costs. There is a shared equity agreement or joint ownership agreement, which sets the term, allocates the income tax benefits, discusses possible events like divorce, and specifies how the venture is to be wound up.
The benefits to the RCO include:
- Home ownership
- No down payment or closing costs
- No landlord or rent receipts
- Appreciation potential
- Income tax benefits
- Inflation hedge
Likewise, benefits accrue to the ICO:
- Low-risk investment
- High return potential
- No negative cash flow
- One-time investment
- Income tax benefits
- Inflation hedge
- No management or maintenance problems
Applications
Here are three applications of equity sharing to show how it can be used.
- A bachelor used his pension account to set up seven equity shares for his young relatives to achieve homeownership while growing his retirement fund.
- A psychiatrist purchased a house near the college where his nephew was a student. The nephew rented out bedrooms to other students. They had an equity share. After the nephew graduated, they sold the house. The nephew got married and used his share to buy a home for his wife and future family.
- A broker and an attorney made a business of equity sharing. They formed limited partnerships to raise money and then create equity shares with investors and homebuyers. They wrote articles and gave public and industry seminars. Together, they did about 300 equity shares. They earned an āorganization fee,ā a āmanagement fee,ā and the broker earned real estate commissions. It was a profitable venture helping future homeowners get started.
Exit Strategies
Equity sharing arrangements typically wind up with the property being sold, or one party buying out the other. Either party can buy out the other based on an appraisal. Usually, the RCO cashes out, often to acquire a whole property rather than share the next time. The ICO, being an investor, will cash out and pay taxes on their gain, or conduct an IRC 1031 Tax-Deferred Exchange into another investment property to save taxes. Both parties come out ahead in their chosen direction.
Risks and Precautions
The only risk potential is the RCO defaulting by not paying their obligations, maintaining the property, dying, getting divorced, or filing bankruptcy. These are covered in the equity-sharing agreement, but an attorney will be needed to deal with them.
If the parties are intelligent, good-natured, and fully informed, all usually goes well. The agreement is complicated, exceeding 20 pages, including addenda. Meeting with a knowledgeable attorney for explanations is essential.
Additionally, when buying the property, it is important for the parties to receive the set of disclosures that brokers or agents usually provide. Obtain physical inspections (e.g., pest control, roof, and property). If a broker or agent is not involved, it would be wise to hire one for an hourly fee to process the disclosures and arrange for inspections. The parties can split the cost.
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