The big, generous real estate depreciation write-offs provideed by Congress' 1981 tax cut are stimulating investment in a home-buying technique most law-makers had nevereven heard of: equity sharing.
Real estate brokers in cities across the country -- including one 3,500-office franchise chain--are attracting investors into "rich uncle" home buying mini-ventures with moderate-income purchasers.
The lure for the investors is tax shelter--hundreds of dollars a month--and the possibility of long-term capital gain. Unlike small-scale rental investments during the real estate go-go years of the 1970s, however, equity-sharing deals aren't pegged to high appreciation rates on the underlying property.
Equity-sharing joint ventures are commonly structured so that the investors receive a solid after-tax return even if the jointly owned condominium or house appreciates in value by as little as 3 or 4 percent a year. Promoters of the technique argue that this feature makes equity sharing a better bet for the 1980s than "straight" investments in small-scale rental real estate.
To get a feel for the concept, here's an example of a joint venture offered by a real estate firm active in Virginia, Maryland and the District.
The property involved is a new "luxury" town house with two bedrooms, 2 1/2 bathrooms, patio, yard, security system and numerous energy-conservation features. It's located in an upper-income neighborhood, but its builder hadn't been able to sell it for over six months because of high mortgage rates.
The builder cut the price by about $10,000 to $139,500 (a figure that's high by national standards, but about average for new town houses in metropolitan Washington).
The unit is for sale to a joint venture composed of two parties: a young professional couple with good-paying jobs but virtually no savings for a down payment, and an investor who's able to put up $7,000 in cash to purchase the townhouse. The investor, a high-income physician, will also contribute one-third of the monthly mortgage, tax and condo costs.
In exchange for these, the investor receives the right to one-half of the annual depreciation write-offs on the house, plus a one-half equity ownership share of the property.
The couple agrees to pay a relatively nominal "rent" to the investor, plus shoulder two-thirds of the mortgage, tax and condo charges.
Here's how the numbers work for the investor in the deal:
His monthly costs total $446 (principal, interest, taxes and condo fee). The $165 rent from the couple occupying the house reduces that out-of-pocket cost to $281.
The investor's monthly tax deductions--thanks to the accelerated depreciation features of the 1981 law--total $1,037. The $165 rental income cuts that back to $872.
Since the physician is in a 55 percent combined federal and state income-tax bracket, his net monthly tax shelter is $480 ($872 x .55). Those are dollars saved that would otherwise have been handed over to Uncle Sam. They are real dollars, not accounting mumbo-jumbo.
To get the investor's monthly after-tax profit on the joint venture, you have to subtract his out-of-pocket expenses ($446) from his earnings ($165 rent plus $480 = $645). The profit per month turns out to be $199, or $2,388 a year.
The joint venture agreement guarantees that the investor's $7,000 equity is repaid before any other split of proceeds occurs whenever the townhouse is sold. So even assuming levels of low single-digit appreciation typical of the 1950s or 1960s, the investor can look to full return of initial capital plus an annual after-tax yield of 30 percent or more on his money. (The $2,388 is about 34 percent of $7,000.)
If the property jumps in resale value by more than the low yearly rate anticipated, the investor's annualized after-tax profit (including capital gains) could easily run above 50 percent.
"The tax changes last year made equity sharing incredibly sweet for investors--much sweeter than I suspect anyone up on Capitol Hill could have envisioned," says Veronica Pickman, head of a Washington firm specializing in equity sharing.
"The combination of high leverage (low-dollar investment compared to the asset owned) and high monthly deductions can produce some really stunning returns," she says.
The equity-sharing "numbers" for the home purchasers aren't anywhere as attractive as for the investors, proponents of the concept concede. The home buyers give up half ownership rights, and as occupants, they can't take depreciation write-offs.
But they don't do badly, either, considering that they put up not a cent of the down payment. The young couple's monthly after-tax cost on the 2 1/2-bedroom condo is about $485 (assuming a 40 percent bracket for the couple).
Four or five years down the road, they can sell the property, split the proceeds, and probably net enough to finance a larger and better second home--one they fully own.
(For information on types of equity-sharing plans offered in selected cities around the country, send a stamped, self-addressed envelope to Kenneth Harney, The Nation's Housing, Box 4038, Chevy Chase, Md. 20815.)