Owning a home is the American Dream. It represents a path to financial freedom and is typically the largest single asset an individual owns. More specifically, home ownership offers many benefits. First, home equity grows over time as the owner pays down debt over the course of a lifetime. Second, capital appreciation can lead to meaningful passive value creation over the long term. Often times much more so than the value created by and saved from a single traditional salary. Third, home ownership provides access to debt capital in the form of refinancing and home equity loans which can prove helpful when purchasing additional assets or covering unforeseen costs in the future. Yet, the American Dream feels out of reach for so many. Interest rates are rising, making the cost of capital more expensive and inflation is increasing disproportionately to lower and middle-class incomes. Everyone, but particularly Millennials, are feeling the crunch to not only 1) purchase a home but also 2) access the equity accrued over the lifetime of home ownership. Fortunately, technology startups have recognized those pain points and are developing creative solutions to provide an easier path to not only equity ownership but also equity release.
Let’s start by discussing creative solutions offering a path to home ownership. The most common paradigm is a rent to own solution. Surprisingly, rent to own options benefit not only low FICO score candidates but also high-income earners. For example, low FICO score candidates with credit in the high 400 to low-mid 500 range may not have access to traditional mortgages to help finance a home purchase. In addition, high-income earners may also need assistance because they do not have the savings necessary for a down payment, given they are young, just transitioning from being low to high income earners or have other significant costs (ie student, medical, dependent debt). Companies such as Divvy Homes based in San Francisco and Unmortgage based in London provide down payments for those individuals. Subsequently a portion of the monthly rent pays back the down payment simultaneously.
Next, let’s discuss the options releasing home equity. For those property owners that need access to cash immediately but have a FICO score less than 580, traditional refinancing might not be a possibility. As a result, those owners have to explore other novel, creative alternatives many times provided by tech startups, such as, Easyknock, Hometap and Point to gain access to the equity in their home. For example, Easyknock provides a sale lease back option where Easyknock will purchase a home and rent it back to the seller. The seller receives cash immediately, saves on fees (brokerage, moving, etc), does not have to relocate his or her family and receives the right of first refusal to repurchase the home at another time in the future. Hometap and Point provide cash immediately in the form of no interest loans in exchange for equity in the home. When the house is sold in the future, Hometap and Point will share in the profits from capital appreciation. Some may view those options as expensive given equity is more costly than debt. However, if the alternative is default or bankruptcy and if a home owner needs a little extra cash to fund a small business, the opportunity cost is high and these solutions may actually look cheap depending on the context.
With all that said, there is one major risk: market exposure. The US economy has experienced an unprecedented bull market run since the 2008 financial crisis. As a result, many believe the United States real estate market could potentially be at a tipping point. Thus, it can be considered risky to purchase homes at the top of the cycle because the market can turn quickly and new buyers can be left with a property worth only 70% of what they originally paid for it. Further, home prices in some US geographies dropped by as much as 30% during the 2008 mortgage crisis. That is an important data point because it sets a scary precedent: what happened before can certainly happen again, and potentially be worse.
So, the question becomes, what can be done to mitigate this market risk?
Three major assumptions need to be considered: duration, geography, and the purchase discount to fair market value. First, duration is an important consideration because the shorter the hold time the less likely a significant downturn will occur during the investment period. However, an extra-long hold period, for example, in perpetuity, could potentially be just as effective as, if not more so than, the shortest hold time. More specifically, in theory if investors hold in perpetuity, they will be able to hold through “down” business cycles, weather a storm and reap the benefits of capital appreciation over the long term. Second, geography is meaningful because certain areas are more resistant to recessions while others are more susceptible to pullbacks. For example, Texas could represent an attractive geography for these creative solutions because home prices decreased no more than 10%, which is 20% less than some of the hardest hit geographies in the United States during the 2008 financial crisis. The Bay Area could represent another attractive area to explore because the local market is supply constrained and could help insulate home prices from a broader market downturn. However, just because those areas have not been hit hard in the past, does not mean they cannot be hit hard in the future. Lastly and most importantly creating the ability to purchase homes at a discount to fair market value could prove critical. For example, if an acquirer can purchase a home for 70% of the fair market value, it offers a 30% “buffer” in the event the real estate market experiences a significant correction during the hold period.
In conclusion, it is encouraging to see so many startups building creative solutions for home equity ownership and release enabling more Americans to realize the American Dream and access the equity in their existing homes. However, it will be absolutely critical to address and mitigate the inherent volatile market risk these models are exposed to. The current bull market will eventually end and when it does the companies with the most downside protection built into their business model will be able to weather the storm and come out the other side successfully. If you are a founder building the future of home ownership, please reach out. It would be a privilege to learn about your business and explore how we can work together.
In partnership with Laramar Group, Nine Four Ventures has access to 15k tenants around the country who will eventually want to own a home of their own. As a result, we can help with targeted customer acquisition. In addition, we have strong relationships with creative lenders that can help provide the debt funding you need to help finance property acquisitions.
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