I’m looking to purchase a house. However, the amount of cash I have with me will not suffice to completely fund the house. Given that I’m confident of earning that difference amount in the future means that some bank will give me a mortgage, and I will thus finance my house with debt. Question is why I can’t finance the house with equity instead.
Let’s say the house I want to buy costs Rs. 1 Crore and I have with me Rs. 50 lakh. Instead of taking a loan for the balance Rs. 50 lakh, why can’t I sell equity instead? A consortium of investors can be invited to invest the balance Rs. 50 lakh in exchange for a 50% stake in the house. Rather, we set up a company that owns my house of which I own 50%, and every month I pay a rent to this company. As and when I get additional funds I start buying up additional shares in the company that owns my home and soon I’ll own it completely.
So who will be these people that will invest the balance 50% in my house? They are going to be dedicated real estate investment funds and their business will be to invest in minority stakes in properties of different sizes and in different parts of the town and country. This they are going to fund via a bunch of funds that allow ordinary investors to take exposure to real estate.
Currently there is no way I can invest in real estate except for taking on a large mortgage and purchasing a whole house. If I’m saving up money to buy a house some day and want to invest it in a way that will help me partially hedge against increase in real estate prices (something that I’m unable to do today) I simply buy units in one of these real estate funds. On the other hand, if I sense there might be some problems with my property (let’s say it is ripe for acquisition by the government for some road widening purpose, let’s say) I can sell some part of it to some of these real estate firms, thus reducing my risk of ownership.
These real estate funds can offer a variety of funds that invest in different kinds of properties in different proportions (like you can have a fund that invests 50% of its money in housing, 30% in commercial real estate and 10% in farmland, say). This allows ordinary investors to get exposure to real estate without any large down payments or mortgages. And reduce the risk of owning property in a particular place (let’s say I’m concerned that property prices in Bangalore might fall while those in tier 2 cities might go up. I will simply sell stock in my Bangalore house and invest the money in a fund that invests in houses in tier 2 cities, thus hedging myself).
Why is such a structure not popular already? In fact, I don’t think you have such structures anywhere in the world. One problem in India is the massive transaction taxes on real estate which makes the market illiquid. If that goes, is there anything that prevents us into getting into a culture of home equity?
6 thoughts on “Home Equity”
Somewhere in some ibank, someone is reading this & plotting to create the next sub-prime crisis 😛
Just a few days ago, I too was thinking of a real estate exchange where property can be traded like stocks
Are you trying to figure out how to set up a REIT?…:)
On a separate note, how or why will “dedicated real estate investment funds …. This they are going to fund via a bunch of funds that allow ordinary investors to take exposure to real estate” be willing to accept relatively low returns?
Assuming liquidity, i think the model will face “operational issues” since you would be living in the house. Since you’re living there say after an year you might want to spend another 10 lakhs on doing up the kitchen and the bathroom as per your personal tastes- will your equal partner pitch in? Will the equal partner allow you to do that since your “taste” might reduce the salebility of the house. Also assuming you spent the 10 lakhs yourself, and when it comes to selling the house you will naturally want paid more than 50% since you spent the additional 10 lakhs.
I think REITS work only when the REIT owns the entire property, rents it out and pays the rent as dividend after maintenance expenses to its investors.
I would think of the following issues if I am managing a RE fund…
A) Too small for analyzing individually – The only way it would make sense would be if some bank/broker would bundle a few of them together and sell it as a unit with a fixed income stream and redemptions evry year (as you pay down) and this starts looking so much like a CDO that its scary…
B) Upside – How am I going to be get a share of upside if the prices rise in that area as its not a liquid exchange traded commodity and price rise would be a proxy
C) Credit Risk – Essentially I am taking a credit risk on you and your ability to pay down the remaining amount..so again
D) Most importantly if I like a property as an investment why should I not buy that myself and get full upside rather than go through this circuitous route and take credit risk