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Tom Kelly
Tom Kelly
The Real Estate Adviser

January 24, 1997

EQUITY SHARING CAN WORK FOR SOME DEALS

BY TOM KELLY
The Real Estate Advisor

Talk about a blast from the past . . . One reader, a Joe Lucero of Seattle, sent me a newspaper clipping I had written Feb. 10, 1985. The subject of his inquiry was a topic I probably hadn't even considered since I wrote the article nearly 12 years ago.

"I recently had occasion to dust off your article on equity sharing."

The concept was definitely from a different time, when interest rates on home loans rates were high and going higher. Conventional lenders had not generally taken the time to explore unconventional options, and adjustable-rate mortgages were unrefined and unacceptable.

Some potential home buyers, seeking all possible methods of getting in the door, found private investors willing to share the cost of the home in return for future appreciation. This concept, known as equity sharing or shared equity, has slowed for two basic reasons: Lenders are now readily making low-down-payment mortgages and homes are not appreciating like they were seven years ago; therefore, potential investors invest elsewhere.

"With all of the liberal loan programs around today, we haven't heard much about the need for equity sharing," said Darrell Devine, former president of the Seattle Mortgage Bankers Association. "Consumers are able to borrow so much more today then they were a few years ago. There's rarely any real need for a partner. "

That's true. Why share the pie when a lender is willing to let you borrow 97 percent of the purchase price on owner-occupied houses?

The need for equity sharing was originally shaped by credit. Under the guidelines that govern most lending institutions, persons who have either cash but no credit or credit but no cash do not qualify for home mortgages at affordable rates. The lender's position is understandable -- they are using money from their depositors and must exercise caution when granting a loan.

An investor, however, is usually using his own funds and can be more tolerant of money and credit problems. A popular example of this practice is seller-financing. The seller may "carry the contract" for a buyer instead of the buyer obtaining financing from a lending institution.

The concept of equity sharing, an often misunderstood and confusing vehicle of financing, was too complicated for the average first-time home buyer. However, it is still sometimes used in a rental property arrangement. When obtained through the assistance of a reputable investor, equity sharing could be a profitable venture for both parties.

In investment (rental) property, a cash-poor buyer who knows of a good investment often seeks a partner to "front" the down payment. The two form a partnership to share the profits of the sale.

Generally, there are three principals involved in an equity-sharing agreement in an "owner occupied" situation -- a lender, investor and purchaser. The investor negotiates and secures a loan from the lender and buys the property. The purchaser (with little up-front cash) then buys the property from the investor.

Those two parties then share in the profits from the increase in equity over a predetermined period of time, normally five to seven years. The investor puts up the money for the down payment while the purchaser lives on the property, maintains it and makes the monthly payments. Both investor and purchaser share major repair bills, depending upon the agreement and who is occupying (purchaser or renter) the home.

The investor often makes about 50 percent on his initial investment, plus tax deductions on interest taxes and depreciation. The buyer gets into a home for little up-front cash, while enjoying part of those tax benefits and the chance to establish credit.

The part of the deal that's probably the most misunderstood is the ownership split. The purchaser does not automatically get a 50 percent stake in the property. Typically, the purchaser gets 50 percent of the increase in equity over a specified period of time.

Equity sharing differs from a lease-option in two key ways. First, if the prospective lease-option buyer does not exercise the option to buy, all of the payments made have secured no equity -- similar to renting. Second, all payments made in a lease-option are not necessarily subtracted from the purchase price.

In an equity share, the investor usually requires the buyer to pay the equivalent of three monthly payments in advance. These three payments are subtracted from the last three months of the 30-year term schedule. The payments provide the investor with a little operating cash and are credited to the buyer at the time of sale.

If you are considering equity sharing, ask a lot of questions and have an attorney review all documents. The concept is a legitimate way of buying and selling real estate, but be sure all terms are explained.

Investors can be found in the "Money to Lend" and "Real Estate Loans" section of the newspaper. Check into investor's background and don't be pressured into signing an agreement until you clearly understand the process.



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