A new acronym to consider is HEI: home equity investment. The author, working in this space, argues that organizations such as family offices should take a look at the space.

The following article is from Jeffrey Glass, chief executive and founder of Hometap, a home equity investments business, which operates in Massachusetts, Michigan, Minnesota, Nevada, Ohio, South Carolina and Utah. The theme of the article is how such investments should be considered by family offices. Naturally enough, Glass is positive about the idea. Clearly, those with memories dating before the 2008 financial crash know that real estate investment and financing has had its fair share of problems. Bricks-and-mortar investments remain an important area for family offices, given their liking for real assets and those that appear to be an inflation hedge. 

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With a massive multigenerational wealth transfer set to occur over the next decade, the impetus to preserve and grow family wealth is all the more pressing. Another consideration is the varied interests and expertise of family members, including rising generations (ages 25 to 40), who may seek a greater emphasis on environmental, social, and governance opportunities. 

Moreover, concerns about lower returns on traditional investments underscore the need for new and innovative investment opportunities that offer both capital preservation and attractive risk-adjusted returns. These trends are critical to the overall growth in family offices, valued at almost $80 billion in 2020, with an estimated compound annual growth rate (CAGR) of over 9 per cent in the coming five years. 

For many family offices, real assets – including real estate – have become more attractive as an inflation hedge and source of enhanced returns. Real estate has long been considered one of the most established and valuable alternative asset classes. In exchange for illiquidity and longer investing time horizons, real estate offers inflation protection and risk-adjusted returns, as well as tax advantages and diversification with low correlation to public markets. Real estate holdings are already a fixture for family offices, making up approximately 12 per cent of family offices’ investment portfolios by some estimates (source: UBS Global Family Office Report 2022).

A fast-growing opportunity in residential real estate
Multi-family residential properties are popular for their strong cash flows and attractive risk-adjusted returns over the long term. They are typically less complex than office space, retail, or hotels. Like multi-family properties decades ago, residential homes have evolved into viable and profitable assets. Common routes to the residential home market include direct purchases, single-family rental vehicles (SFRs), and residential mortgage-backed securities (RMBS).

However, these strategies are subject to prevailing interest rates. In addition, direct purchases and SFRs require sizable capital outlays to acquire and maintain the properties, making them difficult to scale. 

Furthermore, none of these assets provide exposure to a relatively untapped asset class – residential home value growth in owner-occupied homes. Historical home values have proven resilient over the long term and even through decades of economic cycles, averaging 5.4 per cent growth annually since 1975. (Source: St Louis Fed.) Regarding tappable home equity – the amount homeowners can access while keeping at least 20 per cent equity in their homes – market value stood at approximately $10.3 trillion as of Q3 2022. (Source: Black Knight.) Even as that number fluctuates, this large pool of high-quality investible assets remains available.

Home equity investments (HEIs) represent an attractive alternative to traditional financing by enabling homeowners to share the gains in their home values with investors in exchange for upfront cash. HEIs should appeal to the large number of homeowners with good credit and quality homes who still may not meet the requirements for other financing options. With more flexible qualification criteria, HEIs enable more homeowners to tap into their equity. While homeowners do typically need significant home equity for an HEI – around 25 per cent – credit requirements for qualifying are usually less stringent. Although different HEI providers may vary, a typical investment amount is 30 per cent or less of the total home value.

And, as HEIs are not a loan, homeowners do not need to worry about monthly payments or interest. HEIs may empower some homeowners to get out of the debt cycle and put a portion of their home equity to work for themselves in other ways, such as paying off high-interest debt or renovating their home to increase its value.

A smart option for patient capital
HEIs offer an innovative investment vehicle to access residential home value growth, a relatively untapped multi-trillion-dollar asset class, over the long term. Many of the same benefits associated with investing in real estate assets apply to HEI investments: portfolio diversification with low correlation to public markets, inflation protection, enhanced risk-adjusted returns, capital preservation, and geographic diversification with investments across the US.
 
HEIs differ fundamentally from debt products, which pay a contractual interest payment or dividends like SFRs or RMBS. HEI companies raise capital from investors and deploy it by making minority investments in select homes and providing cash sums to homeowners in exchange for a percentage of the future value of the homes. Capital raised from family offices and institutional investors can be pooled into asset investment funds comprising HEIs. The HEI company manages fund portfolios in most cases. 

When investing in an HEI fund, investors do not directly own the HEIs but, instead, earn a return on HEIs as homeowners settle. Settlement may occur upon the sale of a home, refinancing, investment rollover, or buyout – whichever comes first – within an agreed-upon term, typically up to 10 years. However, many HEIs are settled in less time. Portfolio cash flow is generated on an ongoing basis when HEIs settle and is returned to investors annually.

And, while specific investments vary by HEI company, a typical HEI fund structure is designed to provide meaningful structured downside protection in periods of home price declines. This feature is specific to HEIs and is not typical of other real estate investments where lower property values typically result in losses for the investor.

A unique partnership between homeowners and investors
HEIs represent an innovative solution for both homeowners and family office investors. For homeowners, HEIs provide another option for tapping into their home equity in a way that allows them to avoid more debt and get closer to achieving their goals. 

For family offices, HEIs provide an entry point to trillions of dollars in untapped home equity assets and the opportunity for attractive returns, among other benefits.

And supporting HEI companies may indirectly provide a social benefit because they help American homeowners make renovations that will increase home value, pay off high-interest debt, cover emergency repairs, or address other financial concerns without adding to their household debt.