The Home Equity Opportunity

The topic of high rent costs has dominated every discussion forum imaginable, not just in NYC but nationally, over the past 2 years. From expert panels to first dates, everyone seems to be equally bewildered at how home prices continue to rise in the face of rising interest rates and migration trends towards less populous areas.

Prospective renters and home buyers alike are facing the same issues nationwide - a historical underinvestment in housing supply has resulted in sustained price increases not seen since 2008. The tribulations of prospective buyers are music to the ears of homeowners, who have enjoyed unprecedented asset appreciation over the past handful of years. While there are certainly similarities to draw between the bubble-like run up in prices of the two eras, there is one key factor that could prevent a similar collapse from taking place - the health of the homeowner’s capital stack.

At the trough of the recession in 2009, owners’ equity in their homes as a percentage of home value was at 46%, the lowest level observed in the US since federal reserve data became available in 1945. The result was a large portion of homeowners who were underwater on their mortgages as soon as home prices stopped appreciating, which drove forced selling and downward pricing pressure. 

The story is the complete opposite today. The federal reserve reported in Q1 of this year that owners’ equity was ~70% of home values, near the top of observed values in the last 60 years. Combine that statistic with the fact that the market value of owner-occupied real estate is around $40 trillion as of Q1 2023 and it’s not hard to come to the conclusion that US homeowners have a substantial financial cushion in the form of home equity value. 

Additionally, the rapid rise in interest rates has spurred what is known as a “Lock-In-Effect”, where existing homeowners who have taken out a mortgage at a significantly lower rate than the current market would allow are less inclined to sell their home. At the end of 2022, 62 percent of mortgage holders had a rate below 4 percent, and 82 percent had a rate below 5 percent, according to Redfin data. A whopping 92 percent had a rate below 6 percent, the highest ever. This effect, led to the decline in home sales volume and deterioration of public Proptech names (Opendoor, Redfin to name a few), has driven an even greater need for liquidity event alternatives to access home equity. 

Historically there have been a number of financing products available to homeowners that can help them unlock this equity value. The largest asset class addressing this need in the US today is home equity lines of credit (HELOCs), which provide consumers with a revolving credit facility secured by a lien on their property. This added security increases their credit profile and allows lenders to provide credit at more attractive rates than comparable unsecured options (i.e. credit cards). Interestingly enough, despite the recent run up in home equity values, the total volume of revolving home equity loans held at commercial banks has decreased by 58% since 2009. At ~$250bn of value, HELOCs represent <1% of the total value of homeowner equity in the US. Clunky application processes, large origination fees and long closing times have impacted consumer demand. While a portion of that decline can be attributed to non-bank lenders entering the space, there is clear white space for addressing the large untapped value from homeowner equity. 

This phenomenon has not gone unnoticed in the private markets. Private equity and venture capital money has long flooded into large, antiquated sectors ripe for disruption via technological advances, and real estate has been no exception. The last decade or so has given rise to a variety of products geared towards tapping into home equity wealth, while detaching at a low enough loan to value on the underlying home to give investors some cushion in the event of a pullback (think 60% - 75% on the upper end). Below I will explore some of the most popular products, and their relative attractiveness from an investment risk perspective.

1. Home Equity Investments (HEIs)

Key Players - HomeTap, Unison, EquiFi

Home equity contracts allow homeowners to receive a lump sum payment upfront, typically anywhere from 5% - 25% of the property value, in exchange for a share in the home’s value at the term of the contract, typically after 5-10 years or upon the sale of the home. Unlike traditional lending products, there is no interest payment due from the consumer, which may be particularly attractive for more liquidity strapped homeowners. From the investors perspective, success is based on a myriad of factors including resolutions times and home price appreciation over the term of the investment. While the upside can yield daunting IRRs to investors (often times 20%+), this only occurs should the home experience significant price appreciation, which the owner also shares in. 

2. Sale Leaseback

Key Players - EasyKnock, Truehold, Sell2Rent

Leaseback agreements allow homeowners to access significantly more of their home’s equity value without taking out a loan or line of credit. Owners will sell their home to these companies, oftentimes at a discount, and remain a tenant for some period of time. While investor returns are generally more predictable than HEIs, there is still a considerable amount of risk in continuing to collect rent payments from the current tenant, or finding a new one / selling the home in the event of a default. 

3. Buy / Borrow Before You Sell

Key Players - Knock, Homeward

One of the more innovative products in the proptech lending landscape is the Buy / Borrow Before You Sell offering. Equity-rich but cash poor existing homeowners often struggle to come up with the liquidity for a down payment / other expenses associated with buying a home, and need to make “contingent offers” on their new prospective homes (e.g., that their offer on a new home is contingent upon the sale of their current home). The product is simple - either sell or take out a subordinated lien against the existing property in a structure that repays the liability upon the sale of the home. This product also has a significantly shorter expected term than some of the others mentioned above, which helps investors achieve an outsized risk adjusted return by mitigating long exposure to home prices.

4. Home Equity Backed Credit Card

Key Players: Aven, Chloe

A similar yet more consumer friendly alternative to regular way HELOCs, home equity backed credit cards allow consumers to enjoy all the functionality of a regular credit card product at significantly lower APR rates than unsecured competitors. Unlike HELOCs, there are no large origination fees or minimum credit balances, and take significantly less time to close. From a credit perspective, the relatively small outstanding balances compared to the value of the collateralized home create increased incentive for customers to pay off their bills higher in their waterfall of payments than other unsecured products would be. 

5. UoP Specific Financing

Key Players: TBD

Another proprietary way to tap into home owner equity is to provide homeowners with a value proposition that either increases their property value or allows them to generate additional monetary or intrinsic value to their home. One interesting opportunity in that vein is providing financing for equity rich homeowners to build accessory dwelling units (“ADU”s) on their property. ADUs are standalone structures, in the form of either a converted garage or new build, that provide additional single family housing opportunities in geographies struggling with affordability like California. The addition of an ADU can (a) increase the livable square footage of a property and therefore the total value, (b) create additional separate living space for family members, (c) create passive income opportunities for homeowners by renting out the space to tenants, and more. The big limiting factor for this product taking off has been getting homeowners the financing they need to complete the project, which could present an interesting opportunity for a specialty finance company to address. It will be exciting to see other use cases in this sector play out over time.

While the residential housing market remains in flux, the undeniable fact is that homeowners have never had more wealth tied up in their home at any point in history. This massive TAM, coupled with the strong PE/VC investment, is creating opportunities to deploy private credit capital into innovative products that help homeowners access this liquidity in different ways. We believe this whitespace presents a unique opportunity for investors to deploy meaningful capital into a largely untapped and growing market.

For any questions or thoughts related to this piece, please don’t hesitate to contact josh@coventure.vc for more information. 

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