When you go to fund an enterprise with outside money, you have two basic options, which you can mix and match: debt, where you have to pay your lenders spelled-out payments, or equity, where you pay your shareholders their share of profits — when you have profits. Debt is inflexible. Equity is forgiving.
When you go to buy a house, you typically borrow money — you take on debt — which means you win big if your house goes up in value, and you lose big if it goes down in value. If you put 10 percent down on a $400,000 house, that means you’re putting in just $40,000 of your own money and borrowing $360,000. If the house’s value goes down 10 percent, you lose 100 percent of your initial investment — it’s worth $360,000, and you owe $360,000. If, on the other hand, it goes up 10 percent, you double your initial investment — it’s now worth $440,000, and you owe just $360,000. That’s why debt is called leverage.
Leverage is great on the upside, but most people are risk-averse, which is why I was surprised that something like a Real Estate Equity Exchange agreement wasn’t already popular:
Now a San Francisco firm called Rex & Co. (the name stands for “real estate equity exchange”) is offering a new option, known as a Rex agreement, that can be used both to draw on a home’s equity and to hedge against declining property values.Rex gives homeowners, interest-free, a portion of their house’s market price in cash — up to 15 percent of the appraised value of the home, topping out at $300,000. In exchange, Rex gets the right to share in up to half of the future increase in the home’s value. The more homeowners are willing to let Rex cash in on future profit, the more money they get up front. If a home declines in value — and many homeowners nowadays are worried about just that — Rex shares in the loss. “It’s a way to make the equity you’ve earned more liquid,” says Rex CEO Thomas Sponholtz.
A homeowner and Rex agree on how much money the property owner is to receive, as well as the percentage of the future change in the value of the home he or she is willing to share. (The homeowner also pays back the cash advance when the property is sold.) The home’s value is assessed by a third-party appraiser.
The fact that they pay “up to 15 percent of the appraised value of the home,” but get the right to share in “up to half of the future increase in the home’s value” implies that they’re not just buying equity in the house though. It implies they’ve set up some kind of derivative that their customers won’t understand.