Two policy changes in the nation's capital are likely to encourage a highly creative--and potentially risky--form of home buying known as "shared equity" financing.
Shared-equity mortgages involve mini-joint ventures between moderate-income home buyers and private investors. In exchange for a sizable piece of a home buyer's equity stake in the house or condominium, an investor puts up half or more of the down payment on a conventional mortgage obtained from a bank or savings and loan association.
The investor typically also agrees to pay up to half of the monthly mortgage, tax and insurance costs. When the property is sold or refinanced, the investor stands to reap significant capital gains--such as 50 percent of the profits plus all paid-in investment capital--provided the house has appreciated in value during the period of co-ownership.
Although shared-equity plans have been used sporadically by builders and realty brokers in major metropolitan markets, the technique could become far more commonplace in 1982 as a result of two recent developments.
Congress cleared away the key tax hurdle to equity sharing in legislation passed just prior to the holiday recess. Under the revised tax code, investors who co-own houses or condominiums will be able to take the full range of deductions--including depreciation--that they'd receive from any other commercial real estate investment.
Prior to this, co-purchasers were limited in their total deductions on the property and could not use their investment as a tax shelter.
The second recent change, detailed in last week's column, concerns mortgage money. The Federal Home Loan Mortgage Corp., a multi-billion-dollar source each year of home loans, announced that it will purchase "shared-equity" mortgages for the first time ever from local lenders, starting this month.
Savings and loan associations and banks, which traditionally have been unwilling to extend mortgage money to home-buyer joint ventures, will now be able to sell such loans at a profit to a congressionally chartered corporation in Washington.
As long as the home buyers and the investors have incomes sufficient to support their respective shares of the debt, according to officials at the corporation, shared-equity loans should be solid, safe investments.
But are shared-equity plans truly good deals for the consumer? And are they sure-fire bets for local, small-scale private investors--the doctors, dentists and other high-income individuals who often will part with cash in order to get a chunk of someone else's future equity growth?
Discussions with real estate professionals, accountants and lawyers suggest that equity sharing--like the proverbial lovemaking between porcupines--should be approached very carefully. The potential benefits to consumers and investors are substantial and obvious, but they can be outweighed by unseen risks and legal headaches.
On the plus side for the consumer, splitting the costs of a house with a silent, nonoccupant "rich uncle" can be a financial dream. For instance, the investor might put up 75 percent of a $20,000 down payment and pay half the monthly mortgage.
For a young couple with a rising income but little in the bank, such an arrangement may well be the only immediate route to homeownership.
On the plus side for the investor, equity sharing can mean not only long-term capital gains but also an attractive tax shelter (thanks to Congress' 1981 change). As long as the house keeps pace with inflation and the occupants keep making their monthly payments, the investor can hope for double-digit annual after-tax yields on his money.
But what are the risks?
For the consumer, they can be bone-chilling. What happens, for instance, if the "rich uncle" investor stops making his share of the contributions a year or so down the road? (The owner-occupants could face foreclosure, if they can't carry the full debt and can't find another investor.)
More common risks to the home buyers come in the fine print of the agreement they sign with the investor. Some equity-sharing contracts give virtually all the benefits to the investor: rent payments from the occupants, 100 percent of depreciation and insurance write-offs, guaranteed interest payments on the investor's capital, mandatory buy-out rights, and an effective 80 to 90 percent cut of the likely equity build-up over a seven-year period.
The "ballgame for the home buyer," says a Virginia realty broker experienced in equity sharing, "is in the contract. If the buyers' lawyer didn't draft the agreement, then they better make sure he goes over it with a fine-tooth comb."
The big risks for the investor? The first and least controllable is that the property won't rise much in resale value. (With interest rates at current levels, low appreciation is a distinct possibility for the next several years.) The second big risk is the reverse of the home buyers': The equity-sharing agreement may give away too much.
So whichever side of the equity-sharing equation you find yourself on, remember the porcupines. And get your lawyer into the act early.