Monday, July 16, 2007

Equity sharing - Prosper for real estate

SFgate.com published an interesting article today about how home buyers are using equity sharing to purchase homes. The model has been compared to Prosper - borrowing and lending among people to meet financial goals. In fact, Prosper CTO John Witchel is quoted extensively in the article.

First, what is equity sharing? Home ownership is split between the resident of the house and an investor. The investor typically makes all or part of the down payment and the resident makes the mortgage payments. By some pre-determined termination date (usually 3-10 years) the parties sell the house and split the profits or the resident refinances the property and buys out the investor's portion. This helps potential home buyers purchase a home even when they do not have the money to make a large down payment.

Jeff Langholz created a site, homeequityshare.com, to match buyers and investors. According to the article, "Langholz compares his Web site to Prosper, the person-to-person lending Web site that started in February 2006. It allows people, regardless of credit rating, to post the amount they'd like to borrow so lenders can bid on it, eBay-style."


The article goes on to compare home equity sharing with Prosper:

Prosper co-founder and Chief Technical Officer John Witchel says these community-based models of doing business have important implications for the economy.

"The thing we talk about internally, it's kind of schlocky, but we talk about that great scene in "It's a Wonderful Life" where Jimmy Stewart is at the teller window and there's a run on the bank, and he's saying, 'The money's not in a safe or in a vault or in the basement, it's in your neighbor's house, it's in the farm down the road, and we all have to work together to make it work. And if not, Mr. Potter's coming to town.'

"We'd like to see a return to a way of life where people are standing up for each other," Witchel says, "and they're not naïve about it and they're not idealistic about it. We believe people are good."

Are there any readers who have invested money in borrowers on homeequityshare.com or otherwise participated in equity sharing programs?

12 comments:

Mike said...

I'd be much more apprehensive of the residential investment model that you outlined. The 20% down payment was an indicator of financial stability for the borrower. Not having it is a clear sign that the borrower was a much bigger risk. The current sub-prime real-estate meltdown should indicate that there are dangers playing in this space.

Mike

Tom said...

Mike - very good point. Another thing that I would be concerned about is the time required to make worthwhile investments. Not only do you need to vett a borrower you need to take a look at the house and see what kind of deal they are getting. Prosper is time intensive as is.

I'm also not sure if you can diversify your portfolio. It looks like one investor per home.

In addition, would it be better for the investor if he just bought the house and rented it to the person who wanted to live there? What is the advantage of the equity share model to the investor?

Tom said...

So, I did a little more research. It looks like you can diversify. From the FAQ:

Q: I’d like to invest with other investors? How does that work?

A: We call this a joint venture where all owners are investors. Just sign up as an investor seeking another investor. When you come together with more than one, you can buy more and have help with management. It makes it all much easier.

However, it sounds like this is the exception rather than the norm. It seems like this could complicate matters making the equity share tough to work.

Matt said...

There are tons of mortgage loans that allow for no down payment. I would think that the home buyer would be better off with the $0 down payment mortgage loan rather than an investor that is basically an absentee landlord. I wonder how they handle things like repairs and maintenance. Would that be the investor's responsibility?

Mike said...

Tom - What is the advantage of the equity share model to the investor?

Leverage. I have some in-laws who explained this idea to me a few years ago. Assume you buy half of a $500k house and only pay the 20% down payment ($100k). If the house appreciates at 5% per year, that's 25k / year, you get your half of 12.5k. I just made $12.5k/year on the $100k I put up. That's 12.5%. Woohoo!

Matt - I would think that the home buyer would be better off with the $0 down payment mortgage loan rather than an investor that is basically an absentee landlord.

They're saving on their mortgage. I ran the numbers. Borrowing 400k with a 5% down payment gives an APY of 6.35% in my local market (so sayith Bankrate) while a 400k with a 20% down payment gives an APY of 6.11%, and you ditch mortgage insurance (~0.5% of the loan amount) because the house has 20%. My math puts that at $2385/mo @ 20% versus $2442/mo + $167/mo PMI @ 5%, or a $225 savings/mo.

Or, to be fair, the same house price with and without the investor covering the down payment (same loan rates, I'm tired of Bankrate): $2900/mo plus $198/mo for a 475k loan and 5% down. That's 30% higher than the 20% down scenario.

I'd certainly entertain that idea if I was cash strapped in California. That's assuming I'd entertain the idea of buying a house in Ca, but to each their own.

Mike

Matt said...

Mike, I can see how this would work from your example. If it were me personally, if I was going to pay the $2400 per month for the mortgage anyway, I would want to go ahead and pay the extra $200-$300 and actually own the house and be able to keep any equity that builds in the house.

Mike said...

matt -

I have to agree, but I know that there are some people who intend to move into an area for <5 years for work (or whatever random fancy crosses their minds) and it would be a good deal all around in those cases.

Mike

thisguy said...

this is scary
home prices have risen to the point the average person cannot afford it in some areas of the country, i.e. SF so now after no money down loans failed to get people into housing, after interest only loans failed, after option interest only failed, now we have this? And its a good thing?

Maybe prices should come down to an area where demand = supply. This is creating artificial demand by bringing in new buyers that otherwise could not afford the prices.

What happens in this scenario if prices fall for an extended period of time? CA went through a tough recession in part of the 90s and housing prices dropped 20% in some areas over a 3-4 year period. What happens then to all these rosy outcomes? Its just another way to get people into homes they cannot afford.

Portland Real Estate said...

Looks like the prices will be coming down. On top of that financing is much harder to get now.

Bill McKee said...

A more sophisticated version of "equity sharing" reduces risks for both investor and occupant. It provides for a contengency fund held in escrow to cover payments should the occupant be late. It also provides an eviction process that is fair and even handed (rather than foreclosure). I have used the system several times and worked as designed everytime. Most often I use it to "match up" owners who have vacant homes who "Stay in" the deal for 3-5 years while another party occupies the home and makes the PITI. At termination, the property is sold and proceeds of sale distributed as agreed in advance.

Equity sharing does work- but some agreements have considerably better built in advantages than others.

Anonymous said...

The Freedom Fund (the, “Fund”), is a private fund of money allocated to co-invest with individuals in real estate. The Fund allows both first-time homebuyers and seasoned investors to convert the equity in the property they purchase into immediate cash with n monthly payments ever. In exchange for the cash today, the homeowner or investor agrees to share up to 50 percent of the future equity growth of the specific property with the fund

After entering g into the agreement with the Fund pays you an amount predetermined by the Fund and you depend on the amount of the share in future equity. Additionally, this amount is dependent on the type of property, geographic location and occupancy type.

For more information e-mail

Jtaylor@woodsatcountryside.com

Or visit

www.freedomfundaccess.com

Anonymous said...

The Buyers Equity fund (the, “Fund”), is a private fund of money allocated to co-invest with individuals in real estate. The Fund allows both first-time homebuyers and seasoned investors to convert the equity in the property they purchase into immediate cash with n monthly payments ever. In exchange for the cash today, the homeowner or investor agrees to share up to 50 percent of the future equity growth of the specific property with the fund

After entering g into the agreement with the Fund pays you an amount predetermined by the Fund and you depend on the amount of the share in future equity. Additionally, this amount is dependent on the type of property, geographic location and occupancy type.

For more information e-mail

Jtaylor@woodsatcountryside.com

Or visit

www.Buyersequityfund.com