I'm far far from being a financial genius. i try to get partners who run the numbers and deal with details. My business strength is in understanding where technology is going (in the areas I pay attention to), what the business applications of that technology are and most importantly, how to sell them.
Thats a polite way of saying that I'm not a details guy.
I mention this because as they say, "The Devil is in the Details", and I have no idea how to make happen what I'm about to propose. Nor do I know if there are specific laws or common sense "rules of the marketplace" that make this idea just plain stupid. Who knows. What I do know is that I'm curious about whether this would work and there is no better way to open an idea to criticism or support than by posting it on my blog. So here goes.
In the residential real estate world, the concept of buying a house is simple. You pick the house, negotiate a price, then agree to a payment arrangement.
The payment arrangement options are pretty straightforward.
You can pay for it with cash.
You can borrow money to pay for whatever amount that you cant or choose not to pay on the house. The payment terms are then set between you and the lender
This has worked well for a long time. A successful purchase of the house can be quickly defined as being able to make the payments you have committed to make, under the terms you have agreed to, until the house is paid off, all while gaining the utility of living in the house.
The problem with this approach is that when things go wrong and you can't make the payments the "solutions" are very binary.
1. You find a way to make your lender happy.
2. Your house is sold in an effort to satisfy your debt to the lender.
The binary nature of residential real estate financing also lends itself to being an attractive market for "sharks". We dont call the houses we live in "assets", we call them homes. They are very personal and important to us. Which in turn clouds our judgement. People who are at risk of losing their homes get desperate and take measures that aren't necessarily in their best interests just to save their homes and their families from grief.
There has to be a better way to protect homebuyers on the downside.
Lets contrast the financing process of individual homebuyers with funding in the business world. Businesses have any number of ways of raising capital for corporate purposes but they basically can be boiled down to two:
They can raise money via debt.
They can raise money via equity sale.
Debt resolution in the business world is just as binary as it is in residential real estate. If you can't pay the debt, you get foreclosed on and everyone probably goes home unhappy.
Which is exactly why , rather than borrowing money, most startups and growing businesses turn to the equity sale of some percentage of their company to raise capital. Need confirmation of this ? Look at the number of bonds available on national exchanges vs the number of stocks for sale on exchanges . The number of stocks is far greater than bonds and thats on the listed exchanges. Throw in the OTC and Pink Sheet markets and the numbers dwarf debt offerings even more dramatically.
Which leads to the question of...
Why can't home owners sell some percentage of equity in their homes on a listed exchange ? Why can't I
"Take My House Public ?"
Why not create a market or exchange where homeowners can sell equity in their homes ?
The rules could be very eimple
1. The house is appraised by a company approved by the exchange that lists the houses.
2. "Shares" are set with a Par Value of 10pct of the appraised value. For a 100k dollar house, there are 10 shares potentially available. However at no point in time can more than 40pct of the "shares" in a home be sold. We dont want the opportunity for "hostile takeovers"
3. The price of the shares will of course be set by the market. In a hot market it will be set above par, in a tough market like today, it will sell below Par.
4. All Proceeds from the sale of shares MUST be used to pay down any debt on the home.
This is the key element of this approach. By selling equity in a home, the buyer gets an asset based security that will move up and down with the market. If this market is big enough, there should be enough liquidity to move in and out of positions.
The seller receives cash that can be used to pay down the debt and thereby reduce his/her monthly payments. The seller loses a part of the upside if the market for the home improves and prices go up, but thats a small price to pay for not going into foreclosure.
Beyond creating liquidity options for individuals in the housing market, which i think is a good thing, I think this will also reduce the volatility in the market. Despite the best efforts of the residential Real Estate industry, no one ever really knows what their house is worth until you try to sell it. This exchange listing approach will certainly make for better information available for the market, which in turn will also reduce the volatility.
It will also increase the options of homeowners who have paid off their homes to acquire capital for personal uses. If a homeowner has completely paid off his/her home and wants to raise money for whatever purpose, a vacation, a car, education, whatever, rather than taking on debt , they could get their home appraised, have the
option of selling equity in my home that I would not be obligated to pay back. An option that would create a significant flow of capital back into the hands of consumers
How can this actually come together ?
It wouldn't be easy. It would probably take the country's biggest banks working together to create an exchange that develops the public market for home equity one city or region at a time. They would have to identify a means to safely set values so that Post IPO price the share pricing was stable. There would have to be provisions set for what happened when a home was sold. Shareholders would have to be paid their share of the salesprice upon closing.
There are thousands of things that i haven't thought of that would make or break this idea, but I think at its most basic, the concept is sound. However one thing I am sure of, this approach would reduce the Boom Bust cycles of residential real estate and the dramatic impact they have on our economy
Solution for the Real Estate Market ? Take Your House Public ?
Reader Comments
(Page 1)2. Novel idea, but the main problem I forsee is the liquidity aspect of equities; to create such an exchange would take too much unwarranted funds.
Posted at 2:34PM on Aug 13th 2007 by Ed
3. We can make it happen. Solid idea, outside the box thinking, but resolving a pressing issue in a simple way. That's the roots of a successful business plan and it takes an open mind to give it away to the public. The means to entry are high, but the market might be willing to take something like this in if the situation is right. Email me if you'd like to move on it.
-steve
Posted at 2:35PM on Aug 13th 2007 by Steve
4. Fairly similar to this idea, but with shares + real money:
http://www.zillowblog.com/virtual-housing-stock-market-zillow-api-idea-1/2007/03/
Posted at 2:39PM on Aug 13th 2007 by Jeff Lewis
5. This is a GREAT idea that I think would be a revolution in an industry that is in need of a revolution. One issue that I see would be when it comes time to sell the property, who gets to determine when it's ready to sell. Think of it this way: if TLC and HGTV have taught us anything, its that a fresh coat of paint and drapes can add thousands to the value of a home. If a homeowner sells a house for X amount, when one of his investors says he should have painted more and sold it for Y amount, you have a lawsuit waiting to happen. Unfortunately, the real estate industry is full of lawsuits, so something would need to be put in place to prevent this type of thing from happening.
Posted at 2:59PM on Aug 13th 2007 by Jarrod
6. Bloody brilliant! If you want to fund it, I will help build it :)
You need an exchange, an set of standard contracts, and probably a way to package similar "home equities" into REITs so you can get some economy of scale.
Another way of looking at this is that you don't need to get the homeowner involved at all - the banks could do this directly, since via the debt, they could be considered owners of much of the equity. I dunno - just a thought.
Posted at 3:04PM on Aug 13th 2007 by Aaron Erickson
7. If corporations are the legal equivalent of people (can own assets), a shell corporation could own the house, and one could sell shares of the corporation.
This is what Real Estate Investment Trusts are, no?
The cost of the legal process probably makes this impractical for a single piece of real estate, though.
Posted at 3:06PM on Aug 13th 2007 by Andrew GJ Fung
8. Interesting concept, I've had a few thoughts on this myself over the years. Three basic problems to start with, however.
1) Liquidity. The most basic problem is liquidity, manifested as the "uniqueness" of each individual property. Publicly traded companies are large enough to create a critical mass of shares against value that attracts investors in identical shares of the company (each share of stock in a one-class company is identical). In residential real estate, each house isn't large enough to create a critical mass of shares against value, so you're left trying to either group similar properties or have an illiquid security that doesn't really help the basic problem you're trying to solve. Groups of houses are necessarily subject to various unique features that change the value of each house and things get messy from there.
2) Moral Hazard. A homeowner who doesn't own a home has much less incentive to keep it repaired, maintained or improved over time. The limitation of only 40% of asset being owned by non-primary shareholders would reduce this issue, but it certainly exists regardless. If you consider for a minute the issue of repairs, maintenance and insurance costs, it leads to the next issue...
3) Separation of occupancy benefit from asset ownership. The occupier of the property has a separate benefit from the equity holders in an asset, namely they get to live in the house. Some split of these two must therefore be made in order to equitably account for responsibility for repairs, maintenance, improvement, etc. Expense choices in this area certainly affect the value of both occupier and asset owners, but in many cases in significantly different respects (polarity and magnitude). For example, a principal owner who also resides in the home could desire a pool that increases his benefit of occupancy but reduces the market value of the house.
All that being said, I agree with you that there has to be a way through the thicket into a better option for home ownership and all its associated issues.
Posted at 3:08PM on Aug 13th 2007 by John K. Lunde
9. "A successful purchase of the house can be quickly defined as being able to make the payments you have committed to make, under the terms you have agreed to..."
The sales of many houses with subprime loans cannot be called successful. I think the buyers and sellers of homes that are in trouble knew at the time of sale that the payments could not be made.
The issuer of the loan figured they could sell the debt before it went bad, and the buyer figured that they could refinance before the payments became impossible to make.
How do you fix seller and loan issuer both trying to get something for nothing?
Posted at 3:35PM on Aug 13th 2007 by Bruce McL
10. Mark: Now you got may you know what in a major knot! The fact that the feds went into bail out the hedge fund billionaires at the cost of the americans who are losing their homes. Look at the tax rate these criminals pay? Its LTCM all over again, How many people that work for you are losing homes? You'd be surprised! Its the lenders,yes, but who turned their profits and paper into derivitives? Is bad enough we are in a war costing us billions and lives and we still have to pay $4.00 for gas. Should we not get it for free? Having a very bad Day!
Posted at 4:01PM on Aug 13th 2007 by Mary Clemente
11. The idea is intriguing, but I have a question/problem:
1) To what extent of say would shareholder have? If the person living in the house is a bum, and he/she does not maintain the house at all and lets it deteriorate over time—to the point that the house is worth far less than comparable houses—at what point can shareholder step in? When someone invests in public companies and is a minority shareholder, usually there is nothing they can do if the front office is clearly running the company into the ground right in front of the public eye. But, if they were 40% shareholders, wouldn’t they have votes/right?
Posted at 4:05PM on Aug 13th 2007 by Colin
12. Mark,
This is a good idea and it does already exist, albeit, I know of only one company that does it (You can read more about it at http://www.therobboreport.com/article/?q=rex+agreement). Also, another form of equity sharing that is becoming more common, especially as first time home ownership is becoming more difficult these days is essentailly sharing a mortgage (http://www.therobboreport.com/article/?q=mixing+a+mortgage).
Granted I am more of a fan of the Equity Sharing agreement with a company than with friens but both are options.
I scour the real estate news everyday for my user community and have been directly and indirectly involved with mortgage industry for 10 years, and I will have to say that I was very impressed by the paradigm shift that the equity sharing partnership agreement. It does offer a lot of optioins. I was also a bit surprised that a company had such faith in the appreciating asset values in this market where real estate is considered to have fallen into the burning ring of fire as an investment class.
Finally, another version of your proposal could be construed as similar to a Reverse Mortgage which will we will be hearing a lot about in the next 20 years as they grow in understanding and popularity for baby boomers as a way to access their equity.
Please take a look at the articles and I hope you and your readers find them useful.
Also,here is to the hope that the MLB Old Boys Club gives you a fair shake at becoming the new owner of my summer office...Section 528, Row 1, Seats 108 & 109 at Wrigley Field...Go Cubs!!!!!
Rob "Robbo" Burke
www.TheRobboReport.com
Posted at 4:34PM on Aug 13th 2007 by Rob "Robbo" Burke
13. I thought about the ability to essentially take yourself public. People could invest in me (buy a portion of my salary) and I would have a board that would help guide my choices. The board may advise me to get my MBA, work for a certain company, take a certain job, dress a certain way...etc. and then guide me to a high paying position in corporate america and I would pay the board a percentage of my salary. I can buy back shares my shares except they will get more expensive the more my value increases. Is it possible, I don't know. I would love to try it for a year or two to see what the possiblities would be. How about it Mark? Want to buy some shares?
Posted at 5:46PM on Aug 13th 2007 by Brandon
14. Solid Idea. That is why I just bought the domain: www.takemyhousepublic.com
Posted at 6:00PM on Aug 13th 2007 by Joe McMackin
15. Great idea, but there is too much built in risk for the non-occupant shareholders. Why not just buy a 30yr bond? The return will be higher and the risk will be significantly lower. If this is some kind of charitable or non-profit investment (see Kiva.org non-profit microloans), then I can understand doing it, but it is not a worthy investment vehicle.
Just my two cents,
Todd
Posted at 6:34PM on Aug 13th 2007 by Todd Thompson
16. Isn't zillow setting itself up to be at the center of such a marketplace?
Posted at 6:46PM on Aug 13th 2007 by Mike Alfred
17. Interesting idea, but it is missing a mechanism for the equity holder to realize the value of their investment. In other words, let's say the value of the house rises, how does the equity holder capture the value of that rise? There are no dividends in this model so capital gains is the only mechanism but if you allow the shareholder to force a sale, then you defeat the social objectives of this idea.
Stockholders (at least in majority public companies) have the right to and, in theory, can change the board, force a dividend or force a sale. Even if they don't go through with these actions, the fact that they can gives the shares value in the secondary market because if they drop below liquidation value, someone will swoop in and do these things.
Antonis
Posted at 7:31PM on Aug 13th 2007 by Antonis Polemitis
18. Does a simple house fire cause your price/share dropping to nothing?
Isn't this what home equity loans are? Just instead of selling shares of stock, the banks are 1, selling the loans, and 2 the banks are buying other assets with the future money?
Is another way of looking at this, instead of buying debt, you are selling ownership of your house? That implies that upon your debt being paid, you are not the full owner.
Would be good as an alternative to reverse mortgages. Except you are getting the full value of the % of ownership you sell.
A company that could facilitate this is Clear Capital. www.clearcapital.com
Posted at 7:38PM on Aug 13th 2007 by Total Sports Direct
20. One way to avoid some of the problems mentioned is to scale it back and make it less universal. Hearthstone Homes is a builder in Omaha that buys up an entire neighborhood. There are no other builders in this neighborhood and all the houses look very similar. There's at least one builder like this in every city in America.
The builder establishes an LLC that owns the deeds to every house in the neighborhood. Not more than 40% of the shares of the LLC will be sold publicly. The other 60% is sold to the 'homeowner' who never gets his name on a deed, but rather gets his name on an LLC membership certificate and gets the right to occupy a certain piece of real property. There are restrictions that he can't sell his ownership except to vacate the real property and sell it whomever occupies it. Or maybe he can only sell it to the LLC who would essentially broker the sale to the next occupant.
The bank will happily lend him 100% of his purchase price, because the LLC will put up 100% of the deed against what will essentially be a 60% loan. Perhaps the LLC will require 10% cash. In that case, the homeowner puts up $10k to live in a $170k house, the bank funds $90k, and the LLC funds $70k. This gives average homebuyer $70k more house than he *should* otherwise buy.
Buying shares in an LLC that owns 200 houses of consistent quality, all in the same neighborhood, and all under similar covenants will mitigate some the risk associates with the 'uniqueness' of residential real estate.
Buyers get more house than they could otherwise afford. Bankers get an outstanding 60% loan-to-value ratio on an assets that almost never depreciates. Hearthstone Homes just increased their customer base from all the people in the $150-$200k range to all the people in the $50-$200k range. The only loser in the deal is the 40% shareholder who's getting residential-real-estate level returns when he could have put his money into an index fund and made more.
We might need some tweaks to the tax law for this to work. What other holes are there?
Posted at 8:19PM on Aug 13th 2007 by Dick Kusleika
1. Interesting. I actually thought of doing this when the Interstate was move 40 yards closer to my home. Now I have >200,000 cars traveling 40 feet from me every day. I thought, "I'll never be able to sell this house to another homeowner now, but maybe I can turn it commercial".
Freeway access on and off, high visibility, large lot (1 acre).
The problem is it takes thousands of dollars in legal fees, and a number of years to get the zoning changed. Time and money I didn't have. So I looked into selling "shares" of my house. It's 250K worth of property with less than 70K owed. Commercial value is about 800K.
Should be easy to get people to invest, right? Nope - I couldn't even find an attorney willing to consider putting together the required legal documentation - they just said, "It can't be one", or, "it can be done, but you home cannot be "split" into seperate ownerships - so he investors would have no recourse to take "my" property back if I falted on my side of the deal"
In the end I decided to go it alone, and have slowly been working the system. At this rate it'll take six years to get the property re-zoned.
The problem isn't with the courts - and not even the lender. The problem is with the lawyers. Imagine that :)
Posted at 2:33PM on Aug 13th 2007 by Rob La Gesse