Start-Up Seeks to Reinvent Home Equity Sector
As positive equity returns in greater volume to the housing market, many originators forecast that home equity-related products will be among the mortgage world’s most popular offerings in 2015. However, a San Francisco-headquartered start-up is offering a boldly different approach to the home equity, brushing aside the traditional HELOCs in favor an intriguing new idea: The world's first residential real-estate equity exchange.
The company in question is Primarq, and its mission is to launch a crowd-sourcing inspired Internet platform where homebuyers can supplement their down payments and homeowners can access home equity without additional borrowing. This is achieved through the input of third party investors that will co-invest equity alongside homebuyers and homeowners, thus reducing the amount of mortgage debt that would be carried for either property purchasing or equity access.
The Primarq system works this way: A residential property for purchase or refinance is submitted to the Primarq exchange, where its projected performance is reviewed using third-party data, along with assessments on the mortgage level and credit quality of the homebuyer. If it is approved for the exchange, it is posted as an offering and investors can submit bids—designated as a "Q" position—to participate in the investment. In this set-up, 1Q would equal a $10,000 purchase equity holding. Investors would submit funds to escrow upon acceptance of their bids.
As funds are collected and the financial contingencies associated with the exchange are met, other elements related to the transaction—the buyer’s downpayment and the loan—are simultaneously coordinated. Because of the incremental investor equity, mortgages are approved based on lower loan-to-value and debt-to-income ratios.
The homeowner has full occupancy and improvement rights to the property, and investors can monetize their positions through access to the secondary market for Q trading.
In an exclusive interview with National Mortgage Professional Magazine, Primarq President Richard Zahm explained how his company’s approach to the home equity market can impact the depth and scope of the housing finance space.
What is the inspiration for Primarq’s unique approach to equity financing?
Richard Zahm: The starting point is basic finance. If you look at other capital markets where third party funding is required—such as corporate or commercial real estate—there is always an equity component and an equity market. But it’s not there in the housing space. Why is this?
And why is it that credit principles are thrown out when it comes to housing? Banks are lending 80 to 90 percent (or more) against assets that are illiquid and volatile. Margins on loans are under 100 bps, so this means that on a $500,000 loan, they stand to make $5,000 if everything goes right. When a lender has to take a write down, it has to replace the loan with many more successful loans. The point is this: Lenders are not paid for their risk.
They can correct this by decreasing the advance rate—making safer loans by lending a lower amount on an asset.
Equity sharing has been taking place for years. In the academic world, Stanford (my alma mater), UC Berkeley, USC and the Ivies co-invest with incoming professors when they move from less expensive housing markets. The universities win: They participate in the appreciation, and it allows them to continue to pay university-level salaries. And hundreds of home equity sharing deals have already been done in the Bay Area.
For a homebuyer, affordability equates to debt capability. It all comes down to the monthly payment, and this reflects the size of the loan. It also involves the 20 percent minimum downpayment requirement. Put down less than this amount, and mortgage insurance kicks in. For houses in expensive areas, this alone is sizable—easily the amount of a car payment or two.
When you look at the math, for the homebuyer, the IRR on appreciation is the same whether they own all of the equity, or only a proportion of it.
Finally, from an investor’s perspective, equity sharing provides a means of direct investing in residential real estate in a more efficient fashion. Right now, investments are limited to REITs, CREFs or becoming a landlord. These all involve tenants. Equity sharing is co-investing with someone that has very personal skin the game—a homeowner, who is paying for maintenance and leverage (debt), with no management fees or carried interest.
What are the benefits to lenders and borrowers in using this approach to equity, versus the traditional HELOC or other equity-related products like reverse mortgages?
Zahm: Equity withdrawal doesn’t impact a loan the way that borrowing additional amounts does. If it’s applied to paying down the loan amount, it can actually create a more secure loan. HELOCs ramp up the amount owed, monthly payments, and risk.
Lenders get a fixed return and mitigate their risk lending a lower amount. The loan amount is less, and because mortgage payments are lower, there is better loan service coverage. The loan is stronger.
Reverse mortgages are not equity products—they’re debt. They accrete in value independent of home price movement. So in a down market, interest accruing at say, five percent on a reverse mortgage as a fixed return to the lender wipes out the equity. The lender can’t kick out the senior, and if the senior lives a long time, the equity can be wiped out (bad estate planning for the senior) and the lender will end up being exposed to seeing the collateral value (advance rate) being reduced with the accrual.
Who are the investors participating in this? And is this open to individual investors or institutional investors?
Zahm: Investors include HNW (High Net Worth) individuals, institutions and others, seeking to gain exposure on a huge asset class (single family residential real estate) but with less expense, risk, and on a leveraged basis. Investments in REITs, CREFs, etc., are typically yield driven. Sponsors (such as Colony, Blackstone, Starwood Waypoint) have purchased SFR (typically low end) and converted them to rental properties.
Equity sharing provides a means of gaining investment exposure across price points and geographies in a different manner, investing side-by-side with highly motivated homeowners, not renters. The investment is passive, informed (through quarterly mark-to-market reports and forecasts), and liquid (investors can sell their positions back into the market without the property being sold).
Not to be rude, but it seems almost too good to be true. What are the potential downsides of the Primarq model?
Zahm: The market could collapse and the homeowner could default. For investors, this risk can be mitigated through various insurance programs. There might be a psychological issue, of splitting appreciation gains sometime in the future—even though the math disproves this.
But homebuyers are also sharing downside risk with the investor, and they’re either paying less each month in mortgage expense or they’re enjoying living in a home that could be better than the one they could have bought on their own—together with the better neighborhoods and better schools.
While using equity requires the homeowner to give up some of the appreciation, compare the monthly cost savings of a higher mortgage payment over the life of homeownership. Equity sharing allows a homeowner not to borrow. At certain interest rates, and at certain appreciation rates, it’s very possible that a house will not appreciate sufficient to pay for the cost of the money borrowed.
The focus needs to be on the optimal blend of debt versus equity, which can be different in each market.
What timeline are you working on to get this platform up and running?
Zahm: We should be live in 60 to 90 days. We believe we will be providing a fundamental change to the industry—and we want to put the American Dream into the hands of the next generation.