The burden of buying an apartment caused by skyrocketing house prices after 2015 has continued to trouble young people in Beijing, Shanghai and Guangzhou. However, people in all the global metropolises are facing the same problem. In Silicon Valley, young people also face the difficulty of buying houses, while companies also face high rents and a brain drain caused by the inability of many people to afford high housing prices. The traditional way of buying a house is to apply for a loan with a certain percentage of the down payment to the bank. However, the rapid development of housing prices makes the loan become an increasing burden on the middle classes as well as on traditional workers.
Ordinary Mortgage Model is Hiding Troubles
The traditional mortgage financing model, as the only way to purchase housing through loans has also brought problems. For example, the subprime mortgage crisis in the US was caused by a chain reaction of falling house prices, which ultimately overwhelmed those people with high leverage and repayment pressure. Unlike previous views that the subprime mortgage crisis was caused by problems in the balance sheet of large financial institutions including banks, the "House of Debt" by Professor Atif Mian from MIT and Professor Amir Sufi from the University of Chicago proposed another viewpoint. They believe that American households were burdened with high leverage, which leads to a serious decline in the family's net worth at the time of the crisis, so they were forced to reduce consumer spending, which leads to a deeper economic crisis. More particularly, when a poor household's net assets in their house is negative, they are more likely to choose to default, which leads to a larger number of bad debts in banks and other financial institutions. Moreover, the volatility of poor households' net assets increases with leverage.
After criticizing the existing real estate debt contract, Mian and Sufi have proposed a feasible financing solution, which allows a change of creditor's rights, such that loan principal changes with the change in housing prices. This provides an innovative solution for real estate financing.
After the financial crisis, academics and policy makers are studying and hoping to formulate policies that will stabilize the economy when house prices fall, but their debate has focused on whether to reduce the debtor's principal or to reduce the debtor's monthly mortgage payment, to avoid greater losses in the financial system. Regardless of the current state of the debate, at least a corresponding solution has been proposed - that is to set more flexibility in the original contract. Companies can also take an innovative step in the real estate financing business model.
Crowdfunding in Real Estate
Real estate crowdfunding has arisen in recent years as a means of real estate financing. However, this form of crowdfunding is often equal to the expected future income. Generally restricted to real estate companies, financiers often purchase commercial real estate in the form of financing, or purchase a house and then obtain stable cash flow returns by renting it out. There are fewer ways of financing in the form of self-help for personal housing.
We compiled a list of U.S. real estate crowdfunding providers from The Crowdfunding Review, which evaluates 100+ real estate crowdfunding platforms in the US, evaluates them by investment assets, laws and investment contracts, and selects 25 platforms that are worthy to invest. Most of the 25 platforms are commercial real estate platforms, so just a few platforms are involved in personal house purchase financing and all of these are financed in the form of creditor's rights - this is because most of individual investors need stable returns. If they invest in owner-occupied houses in equity form, they can only withdraw after the homeowner sells the property. This type of investment is not popular with investors because it's lack of liquidity.
Innovation Practices in Silicon Valley
In Silicon Valley, we found two companies that use equity investment to provide financing for homeowners - Landed and Patch Homes.
Founded in 2015, Landed is helping to provide housing down payment loans for educational workers in the U.S. The company's vision is to support basic professional teachers to settle in the local community easily, and to reduce American educators' barriers of purchasing houses through a well-designed model of loan and risk sharing.
Also established in 2015, Patch Homes mainly provides new equity-based interest-free home loan products. Unlike traditional home equity loans or HELOCs, applicants do not need to pay monthly installment payment and interest. Instead, applicants share the rights and interests of the houses with the company to realize a real reduction in the burden for homebuyers.
The similarity between the two platforms' business models is sharing premium returns and downside risks of real estate value with homebuyers. In simple terms, the platform and the homebuyers jointly share the home equity. When the house is sold in the future, if the price is higher than the original price, the platform will receive a premium for the house selling in proportion, and if the price falls, the platform and the homeowner will share the loss.
The difference between the two lies in the fact that Patch Homes targets customers who already own a house and helps them better repay the loan. In contrast, Landed mainly targets school staff that need to purchase a home but have not yet purchased. In addition, Patch Homes' ratio of shares is calculated based on the current equity value of the house. However, Landed's ratio of shares is calculated based on the total value of the house plus the leverage, and the construction methods of the two are different.
Business Model of Landed
Landed provides housing down payment loan to the borrower and adopts a risk sharing mechanism. When the home owner sells the house, if the house price rises, the investor can also receive a portion of the premium while obtaining the principal; if the house price falls, the investor suffers a loss.
Landed is currently conducting business in schools to help educators get loans. In fact, schools are a good entry point. In the past, many universities could provide staffing and housing-related policies for teaching staff, but not all schools are able to afford this expenditure. Therefore, cooperation with Landed is a feasible model for schools. At present, some schools have invited the founders of Landed to provide lectures for school employees and encourage them to apply for home loans in this way.
The business model of the platform is similar to the crowdfunding down payment. The homeowner needs to pay a down payment to obtain a loan from the bank, which can be partially raised by platform investors. For example, the house price is US$800,000, and the bank asked the homeowner to pay US$160,000, so homeowners can raise US$80,000 from the platform without having to pay the interest. When the house is sold, the homeowner shares the profit with investor, and then the amount that the investor can recover is equal to the profit or loss portion of the house selling (in proportion to the principal) plus the crowdfunding principal.
Landed is actually a traditional community land trust. The homeowner must pay at least 10% of the down payment and buy it in a specific area. If the homeowner does not sell the property for 10 years, he will repay the loan in 10-30 years. At present, the platform has not disclosed its business scale.
Business Model of Patch Homes
Patch Homes provides property owners with ten years of financing through equity investment, and shares property ownership, housing appreciation and housing devaluation with applicants. Unlike home mortgages, Patch Homes does not charge the borrower for any monthly payments, interest or fees. Patch Homes is committed to turning a large amount of real estate into more liquid cash for home owners, helping them make up for the fact that they have a large amount of real estate rights, but they have low deposits.
The types of homes that Patch Homes supports in financing include single-family homes, apartments and townhouses, as well as common rental units or cooperative houses (cooperatives). In the home equity market with nearly US$4.5 trillion of net worth in total in the U.S., Patch Homes has its own valuation model targeting only specific communities and specific types of homeowners. It is estimated that the market scale is about US$11,000. Patch Homes' potential customers are people with credit scores between 600 and 720. According to Patch Homes, these people account for about 40% of the US population, but they are unable to get the most generous home loan interests. Compared to other financial products of HELOC, the equity financing plan with zero interest is very competitive for them.
Typically, the platform will provide funding that is equivalent to 10% to 15% of the house value for applicants who already have houses, requiring that the loan-to-value ratio of the house be no more than 80% (including all loans related to the house), and the absolute amount not exceed US$150,000. The specific amount of funds provided and proportion share will be determined by the information provided by users and the platform's own underwriting and risk analysis model.
The initial housing valuation is conducted by Zillow - a free real estate appraisal service and from its own property valuation method. Users can also value the houses by their own for reference, but the final financing amount is subject to a third-party professional appraisal agency. The platform does not limit the use of funds, so the homebuyers can use the funds to repay home loans, decorate homes, or pay for children's education. When the platform releases funds, Patch Homes charges a one-time 3% fee, and the platform does not bear the evaluation fee and the third-party equity custody fees (about US$400 each).
As with financing-related taxes, customers only have to bear the taxes associated with the valuation of the selling price - no tax is required when obtaining the funds. If the client wants to quit early, he can withdraw at any time by means of cash repayment or selling the house. The platform will not charge a fine. Property-related asset taxes and insurance are undertaken by the financiers themselves.
The Essence of Equity Sharing: Investment in Lands
Both platforms' funds are raised from investment companies, family offices and other funds. In terms of fees, Landed collects management fees from institutional investors, which is usually 3%. At the same time, it also charges the real estate agency for fees, to require the borrower to use its designated real estate agency. Patch Homes charges a one-time 3% loan service fee from customers, and charges a 1% asset management fee annually from investors.
According to statistics, homeowners will sell or refinance their homes every seven years on average. When the platform's funding comes from individual investors, the platform will sign a ten-year contract with the homeowner. But now the funds of these platforms are basically derived from institutional investors, including pensions, family funds, and similar funds. These institutions do not need liquidity so much, nor do they have a requirement for a fixed return.
This form of investment, which is equivalent to holding equity, is actually a leveraged investment in land rather than housing. Silicon Valley is facing the same problem as many other cosmopolitan cities - there is not so much available land that can be sold again. Therefore, the flowing properties in the real estate market are mainly second-hand properties. If institutional investors without good assets want to invest in land, they can choose to invest in the form of equity as an alternative method. Institutional investors who invest in this way can hold the land for a long time and share the risk without having to consider renting, maintenance, operations and other ongoing costs. Of course, there are also risks in this form of equity financing. If house prices can't continue to grow, the related businesses will not be able to guarantee the profitability for investors.
