Equity Sharing

By Steve Gillman - 2005

With equity sharing, you get to make profits without being a landlord. The downside? You will tie up some money and depend on others to protect your investment.

I haven't seen much about equity sharing since it was promoted and hyped by late-night TV real estate marketers twenty years ago. It was often presented as a way for the buyer to get into a house with no down payment. But from the other side, as the investor putting up the cash, it might still be a decent investment.

How Equity Sharing Works

Suppose a young couple has the opportunity to buy a house for $106,000, and the seller will finance the deal if they can pay just $6,000 down. They have less than half of that in the bank, so they can't do it. Then they hear that you might be able to help.

After talking to them, and looking at their credit report and their situation, you decide that they are responsible enough, so you agree to put up the $6,000. However, you don't charge interest. Instead you will take a half of the equity build-up in the home in six years. In other words, they make all, the payments, but you get half of the equity.

Why would they do this? Because they haven't found another way to buy a house with no money for a down payment. In any case their payments, with taxes and insurance, will be close to what they would pay in rent if they didn't buy. Half of the equity in something is better than none.

If they sell, you get your $6,000 back, plus half of any equity left after closing costs. If they want to keep the home beyond five years, you will get an appraisal, and they will need to refinance to pay you your $6,000 and equity share. How much might that be?

Suppose that the original financing from the seller was at 8%, with payments of $955.66 (15-year amortization). After five years, the balance will still be almost $79,000. That means they have built $21,000 in equity from paying down the loan. If home prices have appreciated at 4% annually, The house will now be worth about $129,000.

The home is worth $129,000 and there is 79,000 owed on it. You are entitled to the return of your $6,000, plus half of the $44,000 remaining equity, or $22,000. They either refinance and pay you $28,000, or the home is sold. In the latter case, if the costs of selling are $8,000, you would get $24,000 (your $6,000 plus half of the other $36,000 in equity), and they would get $18,000.

Whether you get $28,000 back or $24,000, that's not a bad return on your investment. Meanwhile, the young couple has $18,000 cash they probably wouldn't have had otherwise. Alternately, they refinance to pay you, and owe $107,000 on a home worth $129,000. You can see that equity sharing can be a win-win proposition.

One cost you will have is for an attorney to draw up an agreement for an arrangement like this. You have to anticipate all possible outcomes (what if they want to sell after a year?), and account for them in the contract. Remember also that if they just never made a payment and lost the house, you will likely lose everything. That risk is why you get paid such a high return on your investment with equity sharing.

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