Coming Soon: Fractional Home Shares?
Wall Street’s fling with the housing market didn’t go so well (see, “2008 Financial Crash”).
Will Silicon Valley’s housing-related ideas fare better?
Consider this one, recently floated by a Silicon Valley venture capitalist:
“Why not sell a portion of your home? With the right financial vehicle, a sovereign wealth fund could invest to co-own houses in, say, pricey Palo Alto, Calif., making it easier for prospective home buyers to make down payments and reduce their mortgage burden.
Investors could own 10 percent or 15 percent of your house, so you don’t have to borrow as much.”
–Alex Rampell, Andreesen Horowitz; “With an Eye on Fintech, Andreeson Horovitz Adds a New General Partner”; The NYT (8/19/2015)
That DejÃ¡ Vu feeling
If that idea sounds familiar, it should: it’s the same securitization idea pioneered by Wall Street, just this time on the equity instead of debt side.
If you’re rusty on the details, here’s a quick recap: housing prices galloped to the moon more than a decade ago because Wall Street figured out how to unleash a tidal wave of capital on the housing market (the Fed gets, umm . . credit for creating all that cheap money).
It worked as follows: 1) Wall Street lends capital to mortgage lenders (and also frequently takes an equity stake); 2) the lenders use the money to originate mortgages (with little or no underwriting scrutiny); 3) the lenders sell the mortgages to Wall Street; then 4) Wall Street “bundles” (packages) them into securities, and sells them to investors worldwide.
By the trillions.
All with the blessing (“Triple A” rating) of the credit rating agencies (Standard & Poor’s, Moody’s, etc.; guess who paid for their ratings?).
Of course, then there was step #5: “wash, rinse, repeat.”
That is, recycle the proceeds back into housing — and specifically, mortgages — to repeat the process again (and again), until the music finally stopped.**
Thus was the biggest housing bubble of all time inflated.
“Fractional Equity Shares?” “Residential Equity Slices?”
For Rampell’s idea to work, Silicon Valley needs to find a way to make such fractional equity interests liquid.
Otherwise, how do investors ever get their money out?
Whereas debt holders are entitled to a stream of payments that can be sliced and diced (“tranches,” anyone?), equity investors have a claim on a non-income producing, illiquid asset: a house.
To get their money back (and presumably a profit), they either need to: a) sell it; or b) sell their interest to another investor.
Which leads to bugaboo #2: determining fair market value.
A stock is worth whatever it just traded for a nanosecond ago; houses are worth what they fetch on the open market, after weeks (months) of market exposure. See, “Bubble-Resistant, Not Bubble-Proof: Why the Housing Market is More Stable Than the Stock Market.”
An investment fund comprised of illiquid, fractional home ownership shares sounds a lot like exterminator Raid’s one-time pitch for its “Black Flag Roach Motels”: ‘roaches check in, but they don’t check out.’
The Stanford Quid Pro Quo (“Strings Attached Financing”)
With all these negatives, how it is possible for Stanford University to effectively make a (very) successful, long-term bet on Silicon Valley housing?
I haven’t lived on the campus for decades, but at least once upon a time, Stanford was supposed to have extended (very) cheap mortgage financing to faculty in exchange for a share of their home’s future appreciation.
Faculty loved it, because such a quid pro quo made the area’s stratospheric housing prices affordable; the costs (profit-sharing, actually) were all prospective and not out-of-pocket; and the deal came with no downside risk.
Meanwhile, Stanford loved it because Silicon Valley home prices have been appreciating, strongly, for decades.
The catch(es): 1) Stanford owns the underlying land, at very low cost (the homeowners actually enter into a long-term ground lease); 2) Stanford is a very patient, long-term investor; and 3) the University realizes other, non-financial benefits from the deal(s) — like attracting and keeping stellar faculty in the high-priced Bay Area.
Investors who lack one or more of those attributes should think twice about signing up for any forthcoming “residential equity slices,” courtesy of Silicon Valley.
**Near the end, there was actually Step #6: Wall Street players like Goldman Sachs created and sold billions in synthetic securities (“derivatives”) tied to the real ones, and bet against them as the bubble popped.