Investing in a home equity agreement can be attractive for those looking for alternatives to the stock market or traditional real estate investments. Companies like Cityfunds offer a way to invest in home equity agreements, allowing anyone to tap into the home equity of owner-occupied homes, usually in bustling urban areas. But before diving in, asking the right questions is important. Let's walk you through 8 critical considerations before investing in home equity agreement companies.

1. What are the potential returns?

Home equity sharing companies often present an optimistic view of potential returns based on the appreciation of the home. The future value of your investment depends on how much the property's value increases over time. While historical data may suggest strong growth, it's important to remember that past performance doesn't guarantee future results. The actual cost of your investment should consider the risk-adjusted returns, considering fluctuations in the real estate market.

Cityfunds aims to achieve annual internal rates of return (IRR) ranging from 14% to 17% over a 7-year period, using historical home price appreciation as a basis. It's important to note that future returns are not guaranteed and will depend on the housing market in the cities where Cityfunds invests.

2. What are the risks?

While home equity investments are generally considered less volatile than stocks, they're not without risks. Your returns might suffer if the home's future appreciation stalls or the market dips. And unlike stocks, you can't sell off a portion if the market turns; your money is tied up until the home sale or the term ends. There's also the risk associated with the homeowner's ability to maintain property taxes and homeowners insurance, or even the risk of damage to the property itself.

Cityfunds aims to make safer investments by purchasing properties 10% to 15% below the appraised value, providing a cushion against risks. Investments are secured by a Deed of Trust, ensuring a payoff from sales, refinances, or homeowner's insurance claims, thus safeguarding your contribution.

3. How liquid is my investment?

Unlike stocks or bonds, which can be sold quickly, the liquidity of your investment in a home equity sharing agreement depends on the sale of the home or the end of the agreed-upon term. This may pose a challenge if you need quick access to funds or want to avoid the lengthy process of making monthly payments on a traditional loan. It's important to always consider liquidity, especially if you can't afford to wait until the end of the term.

If you're considering investing in Cityfunds, you should know we're working on a secondary marketplace to allow the trading of shares, but this is not available until 2025.

4. What are the fees?

Various fees are involved when entering a shared equity agreement, similar to those of home equity loans or cash-out refinances. In addition to the initial investment's potential origination and recording fees, the company's share in the property's appreciation and risk adjustment fees should be considered. It's wise to compare the costs of home equity investments with those of home equity lines or traditional loans.

For your Cityfunds investment, the shared equity agreement cost includes a modest management fee of 1.5% annually, billed quarterly at 0.375%. This fee is managed internally, preserving your initial investment and portfolio value while securing professional handling for optimal growth.

5. What are the tax implications?

One of the critical differences between a home equity sharing agreement and a home equity loan or cash-out refinance is how the IRS treats them. Unlike traditional loans, equity sharing agreements do not involve interest payments, which can impact the tax benefits. While the interest on a home equity loan may be tax-deductible depending on how the loan is used, the shared appreciation component of an equity agreement may not receive the same tax treatment. It's important to seek advice from a tax professional to understand how this may affect your tax situation.

With Cityfunds, keep your account contact details current, and we'll ensure you receive the necessary tax documents, such as 1099-DIV and 1099-INT.

6. What is the minimum investment and hold time?

Most shared equity agreements require a minimum investment, and the terms often encourage a longer hold time to reap the benefits of the home's future equity. However, if you prefer or require the option for a quicker exit or face temporary financial difficulties, the hold time can be a significant barrier. It's worth noting that each investment company offering a shared equity agreement may have different terms.

7. What happens if a homeowner defaults or the property is damaged?

If a homeowner falls into hardship, potentially facing a default situation, or the property suffers notable damage that affects its value, your equity investment may be affected. It’s essential to understand the protective measures the home equity sharing company or the equity sharing agreement has in place. Does an insurance policy exist? Will homeowners insurance address the damage, or is the investor partially accountable?

In our case, Cityfunds has processes to maintain the properties' condition and ensure homeowners meet their obligations.

8. What happens if I need to withdraw my money early?

Life can be unpredictable, and there may be times when you need to sell your assets earlier than planned. If you have invested in a home equity agreement, it's important to understand the rules for early withdrawal. Is there a penalty for withdrawing early? How much money can you get? Are there specific income requirements or other factors that could make it difficult for you to exit the investment early? Knowing these details in advance can help you avoid financial difficulties in the future.

Cityfunds has a redemption program slated before Q4 2024, which offers quarterly opportunities to redeem your shares.

The Takeaway

Investing in home equity sharing agreements presents a unique strategy to potentially benefit from a home's future appreciation, transforming the equity-sharing market into what many hope will be a win-win scenario for most homeowners and investors alike. However, finding this unfamiliar terrain requires diligence and careful consideration of the complex financial and contractual landscape. Aside from mainstream financial portals, exploring specialized resources or seeking expert consultation on evaluating a home's equity can help demystify the niche and guide you toward an informed decision related to home equity investments.