Housing Equity Finance: Housing Equity Finance: Creating a Stake for the PoorCreating a Stake for the Poor
Andrew Caplin, Amy Chua, Andrew Caplin, Amy Chua, Adam Gordon, and Johanna KalbAdam Gordon, and Johanna Kalb
World Bank PresentationWorld Bank PresentationMarch 2004March 2004
In almost all of the world, In almost all of the world, businesses use a mixture of debt businesses use a mixture of debt and equity to raise money, but and equity to raise money, but
households only use debt households only use debt to buy a house. to buy a house.
Why?Why?
Housing Equity FinanceHousing Equity Finance
How Does It Work?How Does It Work?
What we’ve learned from U.S., U.K., Australia What we’ve learned from U.S., U.K., Australia research and products:research and products:– Household interestHousehold interest– Investor interestInvestor interest
Developing World: Opportunities and ChallengesDeveloping World: Opportunities and Challenges
Questions and FeedbackQuestions and Feedback
How does it work?How does it work?
$200,000 house$200,000 house
Raise $50,000 (25%) with Proportional Equity Raise $50,000 (25%) with Proportional Equity Finance Mortgage (PEFM) - second to conventional Finance Mortgage (PEFM) - second to conventional first mortgagefirst mortgage
At time of sale, appreciation-sharing ratio A = 2, At time of sale, appreciation-sharing ratio A = 2, depreciation sharing D = 1depreciation sharing D = 1
– If sell for $160,000, forgiven $10,000If sell for $160,000, forgiven $10,000– If sell for $300,000, interest of $50,000If sell for $300,000, interest of $50,000
How Does It Work?How Does It Work?
Increases affordability by reducing down payment, Increases affordability by reducing down payment, monthly costs, or bothmonthly costs, or both
– Someone who could have only afforded $150,000 Someone who could have only afforded $150,000 house now can buy $200,000 househouse now can buy $200,000 house
Loss-sharing partial substitute for insuranceLoss-sharing partial substitute for insurance
– Valuable both to homeowner and lenderValuable both to homeowner and lender
Household InterestHousehold Interest Bank of Scotland zero-interest second, borrow up to 25%Bank of Scotland zero-interest second, borrow up to 25%
3% of appreciation for each 1% borrowed3% of appreciation for each 1% borrowed
Unfamiliar and expensive, yet over 15,000 issued in two Unfamiliar and expensive, yet over 15,000 issued in two yearsyears
Other small pilots in the U.S.; current private sector Other small pilots in the U.S.; current private sector efforts in Australia and U.K., public-private work in the efforts in Australia and U.K., public-private work in the U.S.U.S.
Household InterestHousehold Interest
““The SAM .. offered by the Bank of Scotland was The SAM .. offered by the Bank of Scotland was immensely popular. But … the Treasury prevented immensely popular. But … the Treasury prevented life insurers from buying the loans via life insurers from buying the loans via securitization. So the banks that offered it simply securitization. So the banks that offered it simply ran out of organizations that would finance the ran out of organizations that would finance the funds.” The Guardian, May 15 1999.funds.” The Guardian, May 15 1999.
One of many regulatory issues in U.S., U.K., and One of many regulatory issues in U.S., U.K., and Australia - rules designed for current systemAustralia - rules designed for current system
Household InterestHousehold Interest
Survey for Australian PM’s reportSurvey for Australian PM’s report
600 responses, widely representative, 600 responses, widely representative,
with 200 renterswith 200 renters
Even at highest cost (25% up front for 50% at time Even at highest cost (25% up front for 50% at time
of sale), 40% said “would increase the probability of sale), 40% said “would increase the probability of owning home” of owning home”
Investor Interest: Investor Interest: Incentive ChallengesIncentive Challenges
Incentive Problem 1: “Only use if housing is Incentive Problem 1: “Only use if housing is predicted to depreciate” predicted to depreciate”
– Why would a first-time buyer want depreciation?Why would a first-time buyer want depreciation?– Supplier of capital generally has superior informationSupplier of capital generally has superior information– Can vary price according to predicted appreciationCan vary price according to predicted appreciation– It takes two to tangoIt takes two to tango
Investor Interest: Investor Interest: Incentive ChallengesIncentive Challenges
Incentive Problem 2: “Few improvements, Incentive Problem 2: “Few improvements, poor maintenance, little sales effort” poor maintenance, little sales effort”
– Credit for value-enhancing improvementsCredit for value-enhancing improvements– As-is clause enforcedAs-is clause enforced– Appropriate use of indices for ex ante Appropriate use of indices for ex ante
incentives, ex post verificationincentives, ex post verification
Investor InterestInvestor Interest
PEFM-backed securities with ten-year PEFM-backed securities with ten-year horizon, full liquidity, idiosyncratic risk horizon, full liquidity, idiosyncratic risk diversifieddiversified
Table 1 provides data on returns and Table 1 provides data on returns and correlations among equities, bonds, bills, correlations among equities, bonds, bills, residential real estate, 1975-2002residential real estate, 1975-2002
Summary Statistics March 1975 to December 2002
Domestic Equities
10-year Bond
Cash Real
Estate
Real Geometric Return 5.46% 4.87% 1.67% 2.00%
Real Std Deviation 16.19% 11.57% 3.23% 1.47%
Sharpe Ratio 0.34 0.42 0.52 1.36
Kurtosis 0.66 3.55 1.01 0.38
Skewness -0.49 1.07 0.96 0.42
Correlation:
Domestic Equities 1.000 0.188 -0.074 -0.032
10-year Bond 0.188 1.000 -0.202 -0.083
Cash -0.074 -0.202 1.000 0.066
Real Estate -0.032 -0.083 0.066 1.000
Source: Global Financial Data and authors’ analysis
Investor InterestInvestor Interest
Investor InterestInvestor Interest
Decent expected returnsDecent expected returns
Wonderful correlation propertiesWonderful correlation properties
Recent years shows importance of Recent years shows importance of correlationcorrelation
Investor InterestInvestor Interest
Below, vary appreciation-sharing ratio Below, vary appreciation-sharing ratio AA in in PEFM, fix depreciation-sharing at 1.PEFM, fix depreciation-sharing at 1.
““Mean-variance” analysis Mean-variance” analysis – Bootstrap technique off monthly joint returnsBootstrap technique off monthly joint returns– No short salesNo short sales
Crude continuous 30% taxation assumptionCrude continuous 30% taxation assumption
Multi Asset-Class Efficient Frontier Using the Mean-Variance Approach
PEFM (various appreciation-sharing ratios), March 1975 to December 2002
2.0%
2.5%
3.0%
3.5%
4.0%
4.5%
5.0%
5.5%
0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0%
Standard Deviation
Expected Real Return
Par Price A=1.50 A=1.75 A=2.00 A=2.25 A=2.50
Large Risk Reduction
Investor InterestInvestor Interest
Investor InterestInvestor Interest
Renters saving to purchase a home have a Renters saving to purchase a home have a special interest in keeping pace with special interest in keeping pace with housing markethousing market
Australian survey scenario: Tax free saving Australian survey scenario: Tax free saving for home in one of three funds: savings for home in one of three funds: savings account, local housing market account, or account, local housing market account, or stocks and bondsstocks and bonds
Investor InterestInvestor Interest And the winner is …. real estateAnd the winner is …. real estate
– Nearly 40% of total funds if allowed to divideNearly 40% of total funds if allowed to divideNon-Owning Survey SampleHow would you allocate your money across the three investment alternatives?
31.4%
39.3%
29.6%
0.0%
10.0%
20.0%
30.0%
40.0%
Savings accountBalanced fundProperty accountInvestment Account
Percentage Allocated
Investor InterestInvestor Interest
New market: renters helping renters become New market: renters helping renters become owners in a virtuous circleowners in a virtuous circle
Not 0-1, but gentle graduation to ownershipNot 0-1, but gentle graduation to ownership
Could be used by parents on behalf of Could be used by parents on behalf of childrenchildren
Housing Equity Finance in the Housing Equity Finance in the Developing WorldDeveloping World
Opportunities and ChallengesOpportunities and Challenges
OpportunitiesOpportunities
Key Features of Housing Equity:Key Features of Housing Equity:
– Reduces monthly payments for homeownersReduces monthly payments for homeowners– Reduces financial risk for homeownersReduces financial risk for homeowners– Attracts new capital to finance homeownershipAttracts new capital to finance homeownership– Helps renters saving for a home to gain same financial returns Helps renters saving for a home to gain same financial returns
as homeownersas homeowners
Question: What pressing development problems do Question: What pressing development problems do you think that housing equity finance could help you think that housing equity finance could help address? address?
Opportunities: Our ListOpportunities: Our List
Turn the housing crisis in the developing world Turn the housing crisis in the developing world into an economic opportunity.into an economic opportunity.
Create a broader base of asset ownership, giving Create a broader base of asset ownership, giving more people a larger stake in economic growth. more people a larger stake in economic growth.
Provide a new, potentially lower-risk investment Provide a new, potentially lower-risk investment opportunity for domestic and international opportunity for domestic and international investors. investors.
Opportunities: Opportunities: Links to Links to World on FireWorld on Fire
Create a stake in economic system for poor Create a stake in economic system for poor majorities – first through investment, then through majorities – first through investment, then through homeownershiphomeownership
Align incentives for poor majorities and rich Align incentives for poor majorities and rich minoritiesminorities
Build consensus for economic reformsBuild consensus for economic reforms Create domestic investment opportunities for Create domestic investment opportunities for
wealthy minorities wealthy minorities
ChallengesChallenges
Our ListOur List
- Distortions in the Housing MarketDistortions in the Housing Market- Lack of Financial InfrastructureLack of Financial Infrastructure- Weakness in Legal InstitutionsWeakness in Legal Institutions- Weakness in Financial MarketsWeakness in Financial Markets- Getting the Incentives RightGetting the Incentives Right- Cultural BarriersCultural Barriers- Negative PerceptionsNegative Perceptions
Question: What do you see as the key challenges that Question: What do you see as the key challenges that implementing housing equity finance will face?implementing housing equity finance will face?
What Countries Are Best What Countries Are Best Candidates to Pilot HEF?Candidates to Pilot HEF?
Minimize challenges and maximize opportunities Minimize challenges and maximize opportunities
- Expected growth in housing marketExpected growth in housing market
- Political stabilityPolitical stability
- Developed financial and legal institutionsDeveloped financial and legal institutions
- Existing reform and development effortsExisting reform and development efforts
Thinking Creatively: BeijingThinking Creatively: Beijing
Challenge Challenge – Economic success creates pressure on urban housing Economic success creates pressure on urban housing
pricesprices
OpportunitiesOpportunities- Leverage the existing housing fund into a more Leverage the existing housing fund into a more
effective investment mechanism for low and middle effective investment mechanism for low and middle income home-buyersincome home-buyers
- Create a virtuous cycle: low-income homeowners Create a virtuous cycle: low-income homeowners helping each otherhelping each other
Thinking Creatively: EgyptThinking Creatively: Egypt
Challenge: Significant Market DistortionChallenge: Significant Market Distortion- 2 million units empty2 million units empty- Thousands of families priced out of the real estate marketThousands of families priced out of the real estate market- Explosive population growthExplosive population growth
OpportunitiesOpportunities- Help to correct market distortion by turning residents Help to correct market distortion by turning residents
into buyers into buyers - Maximize the assets of the new real estate finance Maximize the assets of the new real estate finance
companiescompanies
Why Housing Equity Finance?Why Housing Equity Finance?
Can be tried on a local level with a limited Can be tried on a local level with a limited pool of participantspool of participants
Can be integrated into existing housing Can be integrated into existing housing finance development and reform programsfinance development and reform programs
May mesh well with certain cultural valuesMay mesh well with certain cultural values
ConclusionConclusion
Starting a dialogueStarting a dialogue
– Opportunities/Challenges?Opportunities/Challenges?– Pilot Locations?Pilot Locations?
For more information: For more information: Adam Gordon, Adam Gordon, [email protected]@yale.edu
Special thanks to Yunlong Gao, Christopher Joye, Special thanks to Yunlong Gao, Christopher Joye, Martin Mayerchak, Russell Pittman, Nicholas Robinson, John Martin Mayerchak, Russell Pittman, Nicholas Robinson, John
Weiser, and the Yale Law SchoolWeiser, and the Yale Law School
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