Mike’s Real Estate Show

The following article is printed with permission of Brad Bolinger, Editor, NorthBay Business Journal

Equity share can help close gap for homebuyers
PROCESS BRINGS TOGETHER INVESTORS, HOMEOWNERS TO OVERCOME LENDING LIMITS
Monday, February 18, 2008
BY HARRY COFFEY

People still want to buy homes, but the subprime mortgage meltdown, tighter credit rules and rising ARM rates are keeping many buyers out of the market. Stringent borrowing criteria are preventing many would-be homeowners from qualifying for fixed-rate loans.Previously, a buyer would get a first mortgage for 80 percent of the purchase price and a second mortgage for the remaining 20 percent to put down on the house. However, the days of 100 percent financing are gone. Now the ability of a prospective buyer to raise one-fifth of the purchase price as a down payment is the key obstacle.

Last November, this scenario contributed to a glut of about 3,900 homes on the market in Sonoma County alone. Only 512 homes sold, or just 13 percent of properties listed.

The buy side has not dried up, it is just dormant. The current situation is less a failure of demand as it is a failure to find workable financing. Thirty years ago the real estate market faced a similar dilemma, and a safe and effective solution emerged.

This solution is called “equity sharing.” It involves finding a mortgage broker who is able to match a willing buyer with a willing investor when both are willing to agree to a formula for sharing future potential appreciation through mutual ownership. Over the years, this process has enabled literally thousands of Californians to become homeowners without taking second mortgages or having to wait years to save for a down payment.

In a nutshell, equity sharing is a co-ownership agreement between an investor-owner and an owner-occupier. The investor puts up some or all of the cash or equity for the down payment – usually 20 percent – and the occupier obtains a mortgage on the remaining 80 percent of the purchase price of the home.

The occupier agrees to pay principal and interest, property taxes and hazard insurance and is responsible for repairs and maintenance. The investor is not a co-signer on the mortgage but may take over the home and mortgage if the occupier defaults. The term of such agreements is typically five years, but they can range from three to five, seven or 10 years.

At the end of the agreement, the house can be sold, with each party receiving 50 percent of the profit on the home – after subtracting the original down payment, which is returned to the investor.

The occupier can choose to refinance the property and has first right to buy out the investor prior to termination of the co-ownership agreement. If the occupier does not wish to exercise this option, the investor can refinance the property and buy out the occupier. Other alternatives include extending the agreement to wait for a higher market valuation or selling the home to a third party.

While equity sharing may seem complicated, it really isn’t, and there are many benefits to be derived for both sides.

For the investor, IRS tax benefits include a write off of any closing costs and could involve deductions for depreciation – if the investor charges the occupier a fair rent for the right to occupy the property. In this scenario, along with paying the rent portion, the occupier also pays the balance of the total payment.

If payments are not made, the investor uses the occupier’s original deposit that is held in escrow. This deposit is returned when the agreement expires, if all payments have been made as agreed. As far as the investor is concerned, this is a management-free investment. For tax purposes, proceeds to the investor from such an agreement are treated as long-term capital gains.

Owner-occupiers can deduct mortgage interest and property taxes and – when the property is sold – they can qualify for exemption from capital gains. Closing costs to acquire the home are not reimbursable and are typically paid by the occupier. The closing costs and sales commissions are split 50/50 when they decide to sell the home.

Risks associated with equity sharing are few. The occupier could default on the mortgage or have to relocate prior to the end of the term. In such an event, the property could be rented. In addition, housing values could decline or a spouse could die during the term, thus delaying a final transaction. Still, in a recent analysis of about 600 equity-sharing agreements in California, only 2 percent had any problems.

Independent investors and builders can use this process to more easily sell their properties. In a tough real estate market, buyers with fully documented credit, good incomes and steady jobs can still qualify for an 80 percent mortgage. Equity sharing is a time-tested way to close the remaining 20 percent down-payment gap with relatively low risk.

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Harry Coffey, a broker with Investors Trust Mortgage Corp., can be contacted at 707-547-2716 or by e-mail at hcoffey@investorstrust.com. For more information about equity sharing, call 877-506-6162.

 
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