Wednesday, November 9, 2011

Moving Forward: A Third Way – Tenure Choices between Renting and Owning

by Jeffrey Lubell, Center for Housing Policy

I was discussing housing issues with members and staff of the Houston City Council when a council member asked, “Why isn’t there an option in between renting and owning?” Many of the council member’s constituents were renters who wanted the security of tenure, fixed monthly costs, control of their physical environment and ability to build equity offered by homeownership but couldn’t afford the costs of buying a home at market levels.

The answer, as some already know, is that there are forms of tenure that fall on the spectrum between owning and renting, but they are not well known to the general public and not as widely available as they should be. Investing in these strategies, which are sometimes grouped together under the label “shared equity homeownership,” would broaden the diversity of housing choices available to individual families and also represent a way to stretch scarce public subsidies further. Over a thirty-year period, we estimate that homeownership assistance provided through a shared equity model could serve two to three times as many families as comparable amounts of funding provided as down payment assistance.

The basic concept is fairly straightforward. A subsidy is used to reduce the price of a home to a level affordable to a low- or moderate-income family. The family purchases the home at an affordable level with a 30-year fixed rate mortgage. When the family sells the home, it does so at an affordable level to a qualifying buyer, ensuring that the initial investment in affordability is preserved over the long-term to help one generation of buyers after another. Well-designed resale formulas also provide an opportunity for buyers to share in any home price appreciation that may have occurred.

Here’s an example. Let’s say the price of a decent-quality market-rate home in a particular market is $250,000, but using appropriate underwriting criteria a buyer at the target income level can only afford a 30-year fixed-rate mortgage of $200,000 and a down payment of $10,000. Under this model, a $40,000 subsidy is provided, reducing the first mortgage amount to $200,000.

The family sells the home seven years later. Different programs have different resale formulas, but let’s say the program in our example calculates the resale price as the original price plus an increment tied to increases in the area median income. So if the area median income has gone up 20 percent in seven years, the family can sell the home for 20 percent more than the original $200,000, or $240,000. Because the increase in home price has tracked increases in income, the home remains roughly affordable to the next buyer at the same income level (subject only to fluctuations in interest rates), while the original buyer earns $40,000 on the sale, which is augmented by roughly $24,000 in paydown of principal (assuming a mortgage at 5-percent interest). While the buyer’s recovery is reduced by transaction costs, which will vary depending on the method of sale and the jurisdiction, the buyer nevertheless sees a very high rate of return on his/her initial $10,000 investment.

The next buyer follows the same rules, as does the buyer after that, and so on.

So here you have a single public or philanthropic investment that helps multiple families over time both achieve stable, affordable housing and build assets. Sound too good to be true? Take a look at a recent Urban Institute study of seven shared equity programs, which found that they did an excellent job of providing both long-term affordability and individual opportunities to build wealth, with returns on families’ down payment investment generally exceeding the returns available through the stock market. Many families who purchased and then sold shared equity homes also went on to purchase market-rate homes without restrictions.

There’s also evidence that shared equity homes have lower foreclosure rates than market-rate homes – due perhaps to a combination of families using safe and affordable mortgage products and the individual attention they receive from program sponsors. Another benefit is that homes are purchased well below market rates, so if the market stalls or even falls a bit, shared equity homeowners may still be able to realize a profit on sale or at least avoid a loss.

So there you have it – a tenure model well suited to today’s marketplace. It smooths out the excesses of the market – you won’t make a killing if prices spike, but you will also receive protection against modest market declines. Stability is further enhanced by ensuring that families purchase at an affordable price with a stable mortgage product. While useful in multiple contexts, the model is particularly important for preserving affordability in well-located areas near transit or job centers, where housing prices are expected to rise significantly over time.

There are several different forms of shared equity homeownership, including community land trusts, deed-restricted homeownership, and limited equity cooperatives and others. Here are some options for learning more. (There are also privately-funded loan products that use the term “shared equity” or “shared appreciation,” but they are not the subject of this column.)

Just to be clear – I’m not suggesting that we drop efforts to help families purchase through more conventional homeownership programs. But I do think a marketplace in which shared equity homes constitute a small but appreciable share of the stock – let’s say five percent or so – would provide families with more housing options than they have today and represent a smart long-term investment of housing funds.

Here are three things that could be done to promote greater use of this tool:
  1. Ensure continued strong funding for the HOME and CDBG programs that are the primary source of funding for these programs.
  2. Encourage communities that make large investments in affordable homeownership (say, $30,000 or more per-unit) to invest those funds in shared-equity models that preserve long-term affordability, rather than models that only help the initial buyer.
  3. Ensure that homeownership units made affordable through inclusionary housing strategies (whether voluntary or mandatory) remain affordable over the long-term through shared equity mechanisms.
In a world of limited government funding, it’s more important than ever to preserve scarce public subsidy. Shared equity homeownership represents a proven approach for helping more families without spending more, while expanding the housing options available to consumers.

Please join the conversation by commenting on this post.

Moving Forward is a monthly column about ideas for the future of U.S. housing policy by Jeffrey Lubell, Executive Director of the Center for Housing Policy. The column offers perspectives on the government role in housing and on broader housing market trends likely to shape future housing policy.

3 comments:

Dan_L said...

Shared equity, smequity. Has everybody forgotten about limited-equity cooperatives, (and its sister form Mutual Housing Associations) the most successful form of ownership housing the nation has ever known?

In the 1960s there were so few defaults (like none) among low-equity coops, that the feds refunded over $40 million in mortgage insurance premiums. The shared equity programs suggested fail to address the problem of low downpayments. Historically we know that the default rate with low downpayment mortgages is astronomically higher than with 20% downpayments. Low-equity coops avoid that problem. Converting market-rate apartments, public housing, and subsidized to low-equity coops has been amazingly successful for more than half a century. Why continue to ignore it, except that all the middlemen who profit from the sale of conventional home ownership are cut out with low-equity cooperatives and their much lower transaction costs.

Anonymous said...

Coops are a great idea, the only down fall is that their is no government regulation, unlike renting, to see what the owners of the coops are doing. A Coop board has free reign to do as they please, with little or no ramifications. They have the power to vote over sales of apartments, change fees, and force people out of their home.

I do not know if their is a difference between subsidized Coops, but I have run into regular Coops that put people in the building that they want, and run it with an iron fist.

Personally, someone close to me invested in a Coop, and the Coop board was constantly trying to buy them out at an unbelievable under market price; they did not sell. Unfortunately the person went bankrupt and the court took hold of the asset and sold it for six times the offer that was presented to the person. Just an example of a corrupt Coop Board.

JL Weybridge, VT said...

I consider limited equity cooperatives to be an example of shared equity homeownership. They are prominently covered in all of the materials I link to in the post. They have pluses and minuses, like all the other strategies, but certainly, they are one well-recognized approach for maintaining long-term affordability.

As for the issue of default risk tied to downpayment percentage, I'd urge you to look at the Center for Community Capital study on this question, which found that when well-underwritten, low-downpayment mortgages perform quite well. The doc is here: