Changing real estate through financing innovation

Real estate portals changed how people searched for homes. Tech-enabled and cloud brokerages changed the buy and sell experiences for agents and their clients. And iBuyers are changing the speed and ease at which you can buy and sell a home. But other companies are looking beyond the home sale itself and changing how consumers and agents access money for home purchases and sales.

Categories of traditional financing needs

First, it helps to provide a quick overview of the main categories of financial instruments that are central to residential transactions.

Mortgages

A mortgage is simply debt that secured by real estate. You borrow money, and if you don’t pay it back on the terms, the lender can sell your home to get paid. There are many forms of mortgages, but the two most common are 30-year fixed and 15-year fixed. The borrower pays back the principal (loan amount) and interest (premium bank charges) over the term of the loan. The interest will be lower the shorter the term because it’s less risky for the lender.

Mortgages are incredibly common. Over 85% of home buyers finance their home. And over 90% of first-time buyers finance their home. This means most home buyers are not saving up for the full price of the home. They are saving up so they can make a downpayment on their home and secure a mortgage. And with home prices climbing, the downpayment is getting more expensive. Some new entrants are helping buyers access capital or services so they can buy sooner.

As home prices have climbed, down payment requirements have as well. Source: FRED.

Bridge loans

Over 25% of sellers move because of a job or to be closer to friends and family. These sellers may want to move on a tight timeline but haven't been saving up for the transition. But they can use funds from their existing home to make a new purchase. Bridge loans exist to solve this problem.

A bridge loan allows the borrower to access the value of their current home and their future home. This means the buyer can purchase a more expensive home before selling their current one. 

But bridge loans have high interest rates and separate lending fees. They also result in an owner is paying off two mortgages and holding costs at the same time. But for a period under a year, this can be worthwhile if it allows the homeowner to buy the home they want quickly.

Home equity loans

A home equity loan is money borrowed based on the equity a homeowner has built up. The equity is simply the amount of the home owned based on the remaining mortgage amount. So if you have a $200K home and $100K left on the mortgage you have $100K in equity ($200K - $100K). And a home equity loan lets you borrow against that $100K in equity. Often home equity loans are used to help improve a home. There is even an associated tax deduction for these improvements. Like other loans, there will be interest rates and closing costs. And you put your home at risk f you don’t pay it back.

Home equity loans or lines of credit are sometimes used by sellers to improve their home to get it ready for sale. In many instances, sellers have substantial equity in their home. But they lack the cash they need to improve the home and sell it for the largest gain.

Sellers pay over $5,000 to get their home ready for sale. If they don’t have this cash available they can use their home equity to borrow at competitive rates for these funds. Source: Zillow.

New approaches to funding the buy and sell processes

Because of RESPA, real estate agent services and financial services are often separate. But new entrants have found interesting ways to simulate financial instruments. And they are compliant with RESPA. This has provided consumers with new opportunities on how they access money to buy and sell their home.

Rent-to-own and fractional home ownership paid by agent referral fees and home appreciation

Most home buyers are saving up for a downpayment. And they will get a mortgage to finance the home purchase. But homes have become more expensive, and many first-time buyers are waiting longer to buy. While they wait, they are paying rent. Many companies have come in to offer alternatives to this situation.

Companies such as Landis, Divvy Homes, and ZeroDown buy a home for the home buyer. They then and let the buyer rent it back from them. During the rental period, the homebuyer can save for the down payment or mortgage. They can then purchase the home from the company they rent from. These companies generate income from rent, home value appreciation, and agent referral fees. This process is called rent-to-own.

Some companies such as Unison offer fractional home ownership. This is where a company buys a percentage of the home for cash. In exchange the company gets to share in the appreciation of the home value. Agents often partner with these these services to help create new buyers. People who who couldn’t afford the home otherwise can quickly  make an offer and close. These services don’t replace mortgages. But they offer a first step to buying a home that previously didn’t exist.

Rent-to-own companies like ZeroDown fund their operations in a few ways. ZeroDown gets a real estate commission referral and charges an annual appreciation fee. Source: ZeroDown.

Buy-and-sell bridge loans paid for by real estate commissions

iBuyers help sellers get cash for their home quickly. But they charge service fees and offer a slight discount to the market price.  Many homeowners are simply moving quickly in their own state. They want access to the cash from the home they will be selling in the next few months to buy their new home. As a result, iBuyers feel like a bad deal for them. This is where buy-and-sell services come in. And traditionally this was solved by bridge loans.

Buy-and-sell services are offered by some modern brokerages. They act like a bridge loan. But they are simpler and rely on the brokerage taking commissions on the purchase and sale. Source: Flyhomes.

Many modern brokerages have bundled in buy-and-sell services. Some examples are Orchard, Flyhomes, and Knock. They provide the seller with the ability to pay for their new home. And this is based on the potential sale value of their old home. Once the brokerage has helped the seller buy the new home, they then work to sell the old one. If the original home doesn’t sell, the brokerage will usually buy it themselves. Bridge loans that provided access to this cash require interest. These services rely on the income the brokerage gets from commissions. In these deals, the brokerage gets both the buy and sell commissions. This doubles the potential commission per client a brokerage gets. But it means that the brokerage is on the hook if it can't sell the old home. In some cases, the brokerages will also offer mortgage and title services as well. This further increases the revenue per client. These services opens up a market of potential buyers. Many sellers would avoid bridge loans because of the cost and complexity. But buy-and-sell services can be easy and a good fit for the right sellers.

Some modern brokerages help home owners buy their new home with cash. And they will then help sell the client's old home. If the brokerage can't sell the home, they will buy it. But the brokerage is taking a commission on both the sale and the purchase. Source: Knock.

Home equity loans funded by agents business improvements

As I mentioned earlier, many sellers devote $5,000+ to home improvements to prepare a home for sale. But many don’t have the cash. And some sellers are hesitant to invest their cash into a home they're not keeping. But agents know that this helps homes sell faster and potentially for more. Because this is so critical for agents, a number of services have emerged to solve this. They allow agents to provide these improvements upfront for free. And then the service gets paid on the conclusion of the sale. This replaces a core function home equity loans and lines of credit play.

For example, Curbio specialized in $15,000+ improvement projects prior to home sales. Agents can offer it to help convince a seller to work with them. Curbio makes its money by performing the work. It also can expand its margins by getting discounts on the materials it uses. Curbio requires the seller to reduce the home price by 2% every 30 days. This ensures the home sells quickly. If the home doesn't sell, the owner still has to pay Curbio for the work. Realogy has partnered with HomeAdvisor to offer a similar program called RealVitalize. Sellers can hire HomeAdvisor pros upfront for free to help with seller prep work. Payments do not have to be made until the home is sold. The Realogy agent can pitch this as a unique reason to work with them instead of the competition. These services help agents market to clients. And service providers can capture more business from sellers.

Services like Curbio allow sellers to pay for renovations at closing. This means that sellers don't have to get a home equity loan if they don't have the cash. Source: Curbio.


This post was last updated on: 
April 3, 2020
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