Lord What Fools These Mortals Be (Real Estate Edition)

Apparently residential real estate speculation is not over. Or at least some parties are sufficiently confident that it isn’t over as to establish a business based on the premise that there are greater fools still out there.

The Springwise (“new business ideas for entrepreneurial minds”) newsletter leads with this choice item:

A new online marketplace with the descriptive name Home Equity Share matches home buyers with investors. To be exact: it brings together buyers who can afford monthly payments but not a 20% down payment, and investors who want to get into real estate but don’t want to become landlords or make monthly payments.

Potential home buyers post a profile listing their preferences, including the area they want to buy in, and the price range they’re looking for. They’re automatically matched with compatible investors, come to an agreement and sign a preliminary commitment. This allows the buyer to become pre-approved for a loan, and to start looking for a property. Once buyer and investor agree on a property, the investor provides the down payment, the buyer arranges a mortgage for his home and moves in. At the end of a specified agreement term—usually three to seven years—the buyer can purchase the investor’s interest in the property, or they can sell the house share its appreciation in value

Now Springwise can’t even characterize this lame-brained idea correctly (for a third party to lend an undisclosed down payment to a mortgage applicant would constitute fraud). The Home Equity Share site gives us the helicopter version of a deal:

Nancy provides Adam with most of the down payment.

Adam gets the mortgage, lives in and maintains the property.

At the end of the agreement term, Adam can buy Nancy’s interest in the property or they can sell and share the appreciation in value.

Another section of the site provides more detail:

For this example, suppose you have $85,000 in savings that you can invest.

You contribute $85,000 of the down payment, and your partner contributes $15,000. Together you have $100,000, so you can put 20% down and purchase a house worth $500,000.

Your partner borrows the remaining $400,000 and you buy the property, with both names on the title.

You and your partner split the equity 50/50.

Annual Depreciation $13,636
Your Depreciation Share $6,818
Total Deductions $34,090
Tax Savings $10,227

What Happens Next?

Over the next five years, your partner lives in the house and maintains it. Your partner makes all of the property payments while the property appreciates in value.

Each year, you are entitled to claim depreciation on your 50% of the value of the house itself. In this example, we’ll assume this comes to $6,818 per year that is probably deductible from income tax depending on your tax status.

This is so dumb-assed that it’s hard to know where to begin dissecting it, so I’ll just give you a couple of high points and leave the rest to your imagination, or better yet, to those willing to provide comments.

First, we’ve just learned from this subprime debacle that people who can’t put 20% down may not be the best credit risks. If you have your name on the deed, the bank can presumably seek payment from the investor if the co-owner defaults (the site creates the impression that that might be avoided, but that seems asking quite a lot of a lender). Yet one of the selling points of this scheme is that it is for people who want to invest in real estate but don’t want monthly payments, much the less possible damage to their credit records.

Second, the idea of getting into ambiguous, long-term agreements with unknown parties is a bad idea (it’s hard enough to do this sort of thing between parents and kids). And this deal IS ambiguous. The resident co-owner is supposed to maintain the property. What is an adequate degree of maintenance? That is a pretty subjective standard, and the resident and the investor clearly have opposing interests.

Third, if anything goes seriously wrong, it’s a complete mess. The investor at a minimum has to find a tenant to cover the mortgage payments, or pony up the dough himself (and don’t kid yourself, there will be legal costs too). And if the property has not been maintained well (likely in this scenario), he will probably have capital outlays to boot. Yet the site breezily assures investors:

The model Equity Sharing Agreement gives a significant financial benefit to the investor in the event of home buyer default. A performance deed of trust/mortgage or quitclaim deed signed by the home buyer in advance can and should be prepared (consult your attorney, or one from the home page) for better security.

If you’re up for this, I know someone who has $30 million in Nigeria who needs help getting it out of the country…..