It's in mute testimony to the dictum that "the family that pays together, stays together" that thousands of intrafamily real estate deals are struck every year: parents helping children buy their first home, and children helping parents get some liquidity out of their paid-for home.
Until relatively recently, however, such cross-pollination of funds was almost exclusively in the form of outright gifts and loans, with their limited tax advantages for either party.
Today, the shared-equity pros are moving into the field to let Uncle Sam pick up a part of the tab -- packaging the contractual arrangements between family members to satisfy stringent Internal Revenue Service requirements (the pitfalls, otherwise, can be sticky) and prearranging lines of credit among lenders, insurance companies (where applicable) and participants.
Few, if any, however, have gone into it as ambitiously as Family Backed Mortgage Association of Oakland, Calif. The association is active in all 50 states and is "working both sides of the street" -- parents helping children, and children helping parents. On the basis of a monthly loan volume that has doubled in recent weeks, the association is projecting $1 billion in closings this year.
For senior citizens with a hefty equity in their home but with a pressing need for more spendable income, the association's Kenneth T. Rosen has put together Grannie Mae, a sale-leaseback-annuity program (generically known as the "reverse annuity") involving parents, children and insurance carriers. And he has designed a shared-equity procedure called Daddy Mac for children needing parental support in the purchase of their first home.
Real estate economist Rosen is chairman of the Center for Real Estate and Urban Economics at the University of California, Berkeley. Ten years ago, he developed the graduated-payment mortgage (the GPM, or "jeep") program. Radical at the time ("It was four years before anyone took me seriously," Rosen commented), the GPM was devised for the first-time home buyer who couldn't qualify otherwise for conventional financing. It is a mortgage with monthly payments that are below-market during the early years but increase annually as the young buyer's income also rises, until they level off in about the seventh year.
Under Rosen's new venture, FBMA, the company's remuneration is exactly the same for the Grannie Mae and Daddy Mac program: a one-time $250 fee, essentially for the package, and a seven-year analysis of before-tax and after-tax cash flow for each participant, plus 1 1/2 percent of the 3 percent origination fee levied by the lender.
Under Rosen's Grannie Mae program, the children buy the parents' home, in which the parents have at least an 80 percent equity. The parents immediately use the proceeds from the sale to buy a life annuity (guaranteed for the lifetime of both parents) providing them with a monthly annuity, and simultaneously, they lease back their own home at a fair market rental price. The monthly annuity plus the property tax and insurance savings -- two responsibilities taken over by the child-buyer -- less the monthly rental, give the parents a net spendable income they otherwise would not have.
For the child-buyer, of course, the home that he or she has bought and leased back to his parents immediately becomes a piece of income-producing real estate with all of the attendant advantages -- depreciation and the tax deductibility of mortgage interest, taxes, insurance and maintenance and, ultimately, any appreciation in the value of the home. Rental income received from the parents is, of course, taxable.
The parent-child arrangement could be affected if President Reagan's proposal to eliminate the deductibility of local and state property taxes becomes law. And accountants still are divided on whether the proposed cap on interest deductibilty applies to such real estate investments.
The example cited by Rosen envisions a 76-year-old widow who owns, clear and free, a home appraised at $100,000. Selling the home to her child and applying the proceeds to the purchase of an annuity would give the widow about $12,600 a year from the annuity and would save $2,000 a year in property tax and insurance payments. She would pay roughly $6,000 a year in rent (based, depending on local conditions, on 4 to 9 percent of the market value of the house), which would leave her a net of $8,600 a year, or $715 a month, as spendable income.
To satisfy IRS requirements, the rent must increase at the rate of 3 percent a year, Rosen added. At the same time, however, the annuity payout also increases (from 1 to 3 percent a year) for the actual life of the seller or the surviving spouse, whichever comes last.
While this presumes that the widow applies the entire sales price of the home ($100,000) to the annuity, "There can be instances where the seller may need, or want, to spend part of the down payment for other things -- a vacation, needed repairs or what-have-you," Rosen continued.
"In this example, for instance, she might take $15,000 of the down payment in cash for other expenses, leaving $5,000 of it to apply to the annuity (with the $80,000 balance of the sales price, of course). This would reduce her monthly annuity about 15 percent -- from $715 a month to about $608. The only Grannie Mae requirement is that at least 80 percent of the sales price of the house must go toward the annuity."
To date, "We're using John Hancock Mutual Life Insurance Co. for our annuities east of the Mississippi and Transamerica Occidental for those in the West -- although the annuitant, of course, is free to choose his own life insurance company," Rosen said. "The rates are pretty comparable, and these two were picked simply because they're both licensed to write policies in all 50 states."
Family Backed Mortgage Association also has correspondent lenders on tap in all 50 states, such as United Jersey Bank (New Jersey's largest bank), First Chicago National Bank (Chicago's largest bank) and Phoenix's First Federal Savings and Loan Association (Arizona's largest S&L), Rosen continued.
"We felt that you can't really conduct programs like this on a state-by-state basis," he said.
In this respect, and another important one, FBMA differs sharply from Prudential-Bache Securities' recently announced entry into the reverse-annuity field. Instead of using the FBMA approach through conventional lenders and life insurance companies, Prudential-Bache, with assets of $76 billion, is financing its entire program itself and is going national with it state by state -- a process that, so far, has kept it unavailable except in a handful of states.
Additionally, FBMA's Grannie Mae and Daddy Mac programs have been approved by the Federal Home Loan Mortgage Corp. While this is unimportant to Prudential-Bache's reverse-annuity plan because the company has no intention of selling the mortgages it acquires, it gives FBMA's conventional lenders an essential ingredient: assurance that the mortgages they have underwritten can be sold easily in the secondary market.
Of the two FBMA programs, however, it is Daddy Mac, the shared-equity package, that brings Realtors into the picture in a critical role. As Jack Grigsby, president of Coldwell Banker Residential Marketing Services in Irvine, Calif., puts it: "Brokers aren't really involved in the Grannie Mae program, but we're quite enthusiastic about Daddy Mac -- it makes for extremely solid paper. If the son or daughter can't make it, there are always the parents to pick it up."
For years -- and especially since soaring house prices and high interest rates have left more and more first-time home buyers on the outside looking in -- Realtors have sensed the existence of a potentially rich market in shared equities, particularly among family members. The big bugaboo: the complexity of setting up such an arrangement to satisfy IRS conditions and the expense of hiring tax and legal experts.
What FBMA's Daddy Mac program provides, essentially, is such an arrangement, prepackaged, but with the added plus of at least two nationwide realty companies -- Century 21 and Coldwell Banker Residential Marketing Services -- actively promoting it.
To an even greater extent than in FBMA's Grannie Mae, the Daddy Mac program is as stylized as a Chinese fertility dance because of the IRS's no-nonsense insistence that, because Uncle Sam is picking up an appreciable part of the tab, all shared-equity arrangements between parents and children must be strictly business: no looking the other way if the child-occupant misses his rent . . . no unrealistically low rentals to favor the child . . . no inequitable division of expenses.