I’ve seen a number of companies who are trying to finance home equity. And it’s an interesting space.
The two most compelling reasons the space is interesting, from my perspective, are as follows:
(1) It’s odd that you can finance literally everything with both debt or equity, except your primary residence, of which you can only purchase it with debt (you have to contribute the equity).
(2) The space is massive (just like the home mortgage space is)
The primary reason these companies are hard to build, though, is that while there is real demand from people who would love to sell minority stakes in their homes to either purchase something they couldn’t otherwise afford, or to become less concentrated, there isn’t much appetite from capital markets to get exposure to the asset class as it currently stands.
Why? Well… for a few reasons:
· Interest rates are low/market doesn’t seem crazy under-valued; people think we’re going into a cycle soon, and more beta exposure to real estate in a subordinate structure seems like a bad idea
· Liquidity is hard to predict. Sure…. You can buy a big portfolio and use statistics to determine the rate of which re-financings, home sales etc. are likely to occur… but it’s far from clockwork. Plus, the only way to achieve statistical accuracy is to start with a big portfolio. And a big portfolio of real estate takes a lot of day 1 capital (tens of millions).
· The assets don’t produce income — and most early investors in unique asset classes value current income/yield.
· A minority stake in a home should be worth less than a majority stake. If you own the majority… you get the benefit of the investment + the utility of living in it. But if you own a minority, you only get the former benefit. Yet the minority stakes are often being priced at the same “valuation” as the majority stakes.
· The initial financing has to be large (homes, unlike smaller loans that a lot of online lenders focus on, are large, and require a big experimental balance sheet). On top of that, the feedback loops take a long time. If originating 60 day duration loans, you can see full cohort repayments shortly. But for home equity value appreciation it could take years to know how it’s actually going. Something startups cannot afford.
· The only bodies of capital who could deal with the illiquidity are pension funds, endowments etc. and they are unlikely to be “first capital in” to an experimental asset class. So there is a bit of a chicken and the egg. You need experimental bodies of capital to help jump start the product — yet they are afraid of the illiquidity. And you can’t get the people who don’t care about the illiquidity until the platform has been jump-started.
Ultimately, I have a few thoughts on how these companies can make the paper more attractive, and some circumstances in which a winning company will emerge:
(1) The home equity should be be given some beneficial governance/economic structure or offered at a discount to the closing price to make up for the fact that minority ownership comes w/o the utility
(2) Getting a market-maker backstop to the equity book would help (perhaps strike a deal where one hedge fund has a commitment/and the first right to buy any seller’s paper back for 80 cents on the dollar if they want to sell before the redemption period (defined in the Redemption Rights of the ownership agreement)
(3) It’s possible that a crypto exchange will immediately list the tokens — therefore giving utility to the access via speculators who are already the audience of an exchange such as Coinbase, Kraken, etc.
(4) A mortgage originator may make a strategic investment into a home-equity fund, realizing that if home-equity becomes an asset class, it’ll make the home loan origination maket easier to operate in (I think?). And therefore $20M to test out the fund, so that one day larger bodies of capital like insurance companies and pension funds could write larget checks into the vehicle, may make sense.
If we invested in the space, we’d probably be looking for a team that was able to make either #3 or #4 happen. They’d need to come up with an equity-like security that is senior to the common equity of the home, and if they could find a market-maker to help get more retail investors into the space, with the knowledge they could get out at some point if needed — all the better.
