As tight lending standards continue to lock many would-be buyers out of the market, one company plans to crack open the door to homeownership by providing crowdfunded down payment assistance from investors in exchange for a slice of a buyer’s home equity.
PRIMARQ tells real estate agents that its “equity participation” service can empower their clients to “buy the house they really want, not just the one they can afford.”
The “shared equity” service may face regulatory hurdles and resistance from mortgage lenders. But if it overcomes these obstacles, PRIMARQ’s model could enable some borrowers who currently can’t qualify to buy a home to purchase one, and help qualified borrowers set their sights on bigger homes.
At the same time, borrowers purchasing homes using PRIMARQ would have less skin in the game, potentially making it more likely that they would walk away from their mortgages if they fell on hard times or if the market tanked.
Critics are quick to point out that offering borrowers lower down payments, which PRIMARQ does by obtaining down payment assistance from investors, has helped trip up the housing market in the past. (The Federal Housing Administration has estimated that losses on mortgages that relied on seller-funded down payment assistance programs funded by homebuilders may end up costing FHA more than $15 billion).
With recently enacted crowdfunding legislation poised to open up alternative investments to more of the public, PRIMARQ is one company, many of which are considered “crowdfunders,” that could enable everyday investors to take stakes in individual properties.
Bringing shared equity to buyers
But PRIMARQ stands out because it appears to offer the only service that enables not just property owners, but also property buyers, to tap investor capital.
PRIMARQ, which aims to go live with its first deal in two to three weeks, accomplishes this by enabling a buyer to obtain down payment assistance from an investor. In return, an investor who uses PRIMARQ earns an equity stake in the buyer’s property, and then shares in gains or losses in the property’s value.
The investor may cash out a stake either by selling it to another investor or accepting a portion of the gain or loss when the property sells. Buyers who participate in PRIMARQ-brokered deals enjoy full occupancy and improvement rights.
Steven Cinelli, founder and CEO at PRIMARQ, offered an example of how a PRIMARQ deal could play out:
John and Mary want to buy a $500,000 home, but can muster only a 10 percent down payment, or $50,000. That would normally require them to pay private mortgage insurance, which Cinelli said would raise their monthly payment from about $2,700 to $3,100.
If the couple turned to PRIMARQ, however, they could obtain $50,000 from an investor, allowing them to make a 20 percent down payment and forgo mortgage insurance. Their loan amount would also be lower at $400,000, instead of $450,000. That would slash their monthly payment by 23 percent, to $2,400 a month, he said.
So, assuming John and Mary purchase the home using shared equity, what happens when they sell it?
Well, for the $50,000 the investor provided for John and Mary’s down payment, the investor might obtain a 40 percent stake in John and Mary’s equity, thereby committing to share in 40 percent of value appreciation or depreciation in the home.
So let’s say the value of John and Mary’s home appreciates by 5 percent a year, reaching a value of $578,812.50 after three years.
If John and Mary sell at that price, the investor would earn 40 percent of the $78,812.50 in appreciation, or $31,525. John and Mary would pocket the remaining 60 percent in appreciation, or $47,287.50.
Slicing and dicing
If the investor in John and Mary’s home wanted to cash out before the couple was willing to sell, that investor could also sell his stake to another investor.
Designed to support a secondary market for home equity, PRIMARQ’s service carves equity stakes into $10,000 positions. Each is known as a “Q,” and in crowdfunding fashion may be traded separately from other Q’s that were part of the same original slice of equity.
Multiple investors may also purchase Q’s that comprise part of a single down payment, meaning that, from the get-go, not just one, but several investors could own equity in a property that is purchased with the help of PRIMARQ.
“So a $50,000 investment could be split into five individual interests, each trading separately,” Cinelli said. “Our goal is to create the framework for proper trading and optimal pricing.”
An ‘awful idea’?
While PRIMARQ’s service seems to unlock doors for buyers and investors, Dr. Michael J. Seiler, professor of real estate at the College of William and Mary, says that, “If you peel back the first layer, it’s an awful idea.”
Providing a way for borrowers to lower their down payments is sometimes a recipe for disaster, he said, because it enables some borrowers to buy homes that they can’t afford and ditch their mortgages without losing as much money as they might otherwise.
Seiler also worries that many borrowers using PRIMARQ aren’t likely to realize just how much value appreciation they may end up forking over to an investor. And he argues that many investors probably won’t appreciate the full risks that come with such a deal — like the possibility of foreclosure, a buyer’s failure to properly maintain a home, or a market downturn.
There’s “an incredible amount of snares and pitfalls … along this path to homeownership,” Seiler said.
PRIMARQ says that its clients may protect their investments by buying out a homeowner’s equity stake if that homeowner defaults. They also can safeguard their investments from a variety of scenarios by purchasing several types of insurance that PRIMARQ has designed.
Cinelli said that the policies are underwritten by “a couple of the largest insurers and re-insurers,” but did not name them due to the proprietary nature of the structures.
Tracing shared equity’s roots
Though PRIMARQ may leverage cutting-edge technology to provide it, down payment assistance provided through equity-share arrangements is not a new concept, said Lou Barnes, a mortgage broker and Inman News columnist.
In the 1980s, as interest rates soared in the 14 to 18 percent range, loans that allowed borrowers to obtain down payment assistance from investors crept into the market, Barnes said.
But those loans performed dismally, helping to generate what were at the time the highest default rates in history, he said.
“Embedded in the ‘80s shared-equity disaster is a lesson,” Barnes said, adding that the only form of down payment assistance that has a decent track record is assistance offered by a family member.
“Families will defend the funds even if the borrower gets in trouble, and families tend not to provide down payments to kids who don’t look ready,” Barnes said. “Outside providers are unwilling to do the former, and do not have knowledge of the latter — the most important piece.”
Other crowdfunders steering clear
Such risks may explain in part why other real estate crowdfunders like Equidy, RealtyMogul, RealtyShares and PassiveFlow.com don’t appear interested in involving owner-occupants in their equity-share schemes.
RealtyShares CEO Nav Athwal said his company has also shied away from engineering equity-share deals that involve owner-occupants and mortgages because of regulatory hurdles.
RealtyShares has crowdfunded three debt-free home purchases so far, according to Athwal.
“If you’re trying to get those loans involved … there’s going to be a lot of regulatory scrutiny,” he said.
Another firm — Weiss Residential Real Estate, which intends to launch next year — is developing what may be the only other service that is designed to convert shared equity into a resource for owner-occupants.
But it’s purposely stopping short of helping buyers. Instead, Weiss Residential caters only to current homeowners, allowing them to sell stakes in their properties to investors.
“There’s a reason that we’re starting at the opposite side of the risk spectrum,” Weiss said, in explaining his decision not to have his service, at least initially, broker down payment assistance for buyers.
To qualify for Weiss’s “Passive Indexed Equity” program, homeowners must already have at least 50 percent equity in their home, and they must use cash from selling a stake of their home to pay off the balance of their loan, thereby removing mortgage debt from the equation.
“The optimal solution to start with is to create an equity financing structure that replaces debt,” he said.
Still, Weiss and others who are trying to enable more investors to tap real estate equity said that they are certainly not ruling out working with owner-occupant buyers with or without mortgages after their initial services have time to mature.
“We will explore this option in the future,” said Kenson Goo, founder of PassiveFlow.com. The site currently enables investors to buy stakes in income-generating properties, like rentals.
Who you calling nonprime?
Despite its poor track record, some believe that, if executed responsibly, investor-provided down payment assistance could have a positive impact on the housing market.
Cinelli says the mortgages that PRIMARQ aims to help borrowers obtain are a far cry from the toxic loans that helped spark the financial crisis.
The company works only with buyers who can put up a 10 percent down payment — much higher than FHA’s minimum down payment of 3.5 percent, have a minimum credit score of 680 and a maximum debt-to-income ratio of 38 percent, he said.
Cinelli also argues that PRIMARQ helps buyers reduce their total loan amounts and avoid private mortgage insurance, resulting in substantial savings.
That claim, however, is premised on the idea that a buyer who uses PRIMARQ would have purchased the same home without PRIMARQ, and not have opted for a less expensive home, on which they could more easily afford to make a down payment.
PRIMARQ Chief Marketing Officer Sara Batterby said that the only reason that the loans that the company aims to help incubate may appear unsafe to some is because current lending standards are too strict.
“So many people who would be considered very conservative homebuyers with a 10 percent down payment are locked out of the marketplace,” Batterby said.
Added Cinelli: “What we’re proposing is not suggesting someone put less than what they can down. But let’s supplement that … reduce the overall borrowing level and in so doing reduce the payment, thereby improving affordability.”
Paul Diggle, property economist at Capital Economics, said that PRIMARQ’s scheme seems to represent a “great investment” and is similar to one engineered by the United Kingdom that has helped support growth. The U.K.’s “Help to Buy” program offers up to 20 percent in down payment assistance in the form of a home equity loan whose interest rate doesn’t kick in for five years.
“The scheme will certainly be helpful for would-be buyers who find themselves unable to raise the sort of deposit lenders want nowadays,” he said of PRIMARQ’s model. “That said, they need to be aware that a chunk of any price gains will be accruing to the co-investor.”
Not approved, but not disapproved
But even if shared-equity down payment assistance could buoy housing demand, it’s unclear if it would also gain acceptance from lenders and regulators.
Lenders aren’t likely to originate mortgages that rely on PRIMARQ-supplemented down payments unless they can sell them to Fannie Mae and Freddie Mac.
It’s also unclear if loans with a PRIMARQ component meet the definitions of a ”qualified mortgage” (QM) and “qualified residential mortgage” (QRM), which release lenders from certain liabilities.
A Freddie Mac spokesman said that, with shared-equity plans, it can purchase loans in which the owner-occupant and owner-investor make a down payment of at least 5 percent. A loan with a 20 percent down payment split 50-50 between an owner-occupant and an investor would not require private mortgage insurance to meet its underwriting guidelines, he said.
But the Freddie Mac spokesman said the loans would also have to comply with a number of other stipulations, including a requirement that both the owner-occupant and owner-investor be individuals, not partnerships or other legal entities. That last stipulation could prove an obstacle for PRIMARQ, since, according to Cinelli, it’s primarily targeting institutional investors.
Even if the loans do technically comply with key requirements like QM and QRM, many lenders are likely to be wary of them.
“Lenders like loans that don’t require a lot of work, that don’t require scrutiny, that are plain vanilla if at all possible,” said Guy Cecala, publisher of Inside Mortgage Finance. “And this is not plain vanilla.”
Nonetheless, Cinelli expressed confidence that agencies and institutions will ultimately embrace loans that rely on down payments supplemented by PRIMARQ investors.
“So while we are not ‘promulgated as approved,’ we are similarly not disapproved. We have not been addressed is the simple answer,” he said. “ My discussions with the agencies will lay the groundwork which will ultimately have the Hill both support us and endorse us.”
Regardless of whether PRIMARQ struggles to carve out a foothold in the market, its pool of potential clients may soon expand.
Here comes Joe Six-Pack
If the Securities Exchange Commission implements the crowdfunding exemption of the Jumpstart Our Business Startups Act (JOBS Act), which it may by early next year, average-joe investors, not just well-heeled ones, will be able to participate in investments like those brokered by PRIMARQ.
The exemption is what many say has spurred the sprouting of crowdfunders in a multitude of industries, including real estate.
“That’s an idea we’ve kicked around quite a bit,” Athwal said when asked if RealtyShares would accept cash from non-accredited investors if the exemption is approved. “We want to, but we’ll be careful about our approach to it.”
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