Thesis Driven dives deep into emerging themes and real estate operating models. This week’s letter explores the companies that are building products to help homeowners unlock their home equity—and renters buy their first home.
Homeowners and renters alike are stuck. With interest rates at decade-plus highs, Americans across the wealth spectrum are finding it impossible to move.
Homeowners lucky enough to have locked in low-rate mortgages over the past 15 years face a conundrum: while they have significant home equity value, selling their current home and buying a new one would mean paying a much higher rate for a similar property. This means either sticking with a property that isn’t meeting their needs or facing a meaningful downgrade in location or quality.
But aspiring homeowners are in an even tougher position, staring down dizzying mortgage payments driven by a double-whammy of rate increases and rapid home price increases over the past three years.
The end result is a nation stuck in place. Families can’t buy their first home or upgrade to a larger one with more bedrooms. On the flip side, aging empty nesters can’t downgrade from too-big suburban homes. And working professionals just looking to move from one city to another are forced to choose between eye-watering mortgage payments and a downgrade in home size & quality.
But a new wave of companies are aiming to come to the rescue with a raft of novel products for homeowners and renters alike. Today we will separate the signal from the noise, analyzing the world of companies building products to help single-family homeowners buy, sell, or move. Specifically, we’ll look at:
Products to Unstick Homeowners, including:
SFR-oriented property management
Products to Unstick Renters, including:
Upside sharing arrangements
Each concept has its own pros and cons, drawbacks and opportunities for the company, real estate investors, and the homeowner themselves.
Let’s dig in.
First, it’s important to note that the universe of novel financial products for homeowners can be painfully challenging to navigate even for real estate veterans. Translating flowery marketing language into concrete real estate terms is always tricky, but the single-family home financing space seems particularly challenging—perhaps by design. Regardless, we’ll look to separate the signal from the noise and piece together the underlying business models.
— Unsticking Homeowners —
While people who bought a home in a lower-rate (and likely lower-cost) environment are generally better-off than first-time homebuyers, they still face challenges. The recent rapid increase in interest rates has made it difficult for homeowners to move, as selling their current home and buying a new one would require getting a new mortgage at a much higher interest rate—which likely means sacrificing location, quality, or disposable income. This is increasingly leaving homeowners stuck in a home they don’t want: perhaps it’s too big, too small, or just in the wrong location.
Fortunately, there are a variety of solutions to help single-family homeowners unlock the value of their existing home.
SFR Property Management
Rising rates have led to a dramatic increase in the number of ‘accidental landlords’—property owners who become landlords out of circumstance rather than intent. With a low interest rate mortgage in place, many homeowners who need to move decide they are better off renting out their home rather than attempting to sell into a tough housing market.
Without much experience managing rental properties themselves, these accidental landlords are prime customers for single-family rental property management firms like Mynd or Bungalow. In many cases, single-family rental property managers will even offer revenue guarantees to owners in exchange for a longer management contract, appealing to owners who value a reliable property income stream over revenue maximization. Short-term stay managers like AvantStay and Vacasa also serve this market, although they’re a bit more selective with the properties they manage given their focus on vacation rentals.
Mynd offers several guarantees to single-family owners looking to rent out their house; these consumer-style guarantee products are helpful to small owners who are willing to pay higher management fees but couldn’t stomach the losses from a blue state eviction process.
Property tax policies like California’s Prop 13—which freeze property taxes in place for homeowners—reinforce this ‘accidental landlord’ phenomenon by penalizing property sales with dramatic increases in property taxes.
While the current mortgage rate environment is a tailwind for single-family management firms, residential property management is a notoriously tough business, and managing a diverse and geographically distributed portfolio of single-family homes for unsophisticated clients is makes it even tougher. Operations—including maintenance and leasing—marketing, financial reporting, and compliance all have to work, and property management companies typically don’t have the margins to pay for top talent. And management firms tend to trade for low multiples of EBITDA even when they do reach scale.
Sale Leasebacks are among the most straightforward products designed to unstick homeowners and are particularly relevant in today’s tight rental market. In a sale leaseback, a homeowner sells their home to a company which then leases the home back to the former owner. For a homeowner, a sale leaseback is a way to unlock home equity without being forced to move.
Sale leasebacks are particularly relevant for (a) seniors who want to free up cash and are willing to sacrifice some long-term certainty and (b) homeowners with a fixed future move date—e.g., a homeowner is building a new home that will be complete in two years but wants to free up cash today to pay for the renovation. The homeowner unlocks their home equity without having to move, and the sale leaseback company acquires an asset off-market with an in-place lease.
TrueHold and EasyKnock are two companies popularizing the sale leaseback model, and both have raised substantial venture dollars: EasyKnock raised a $57 million Series C in early 2022 while TrueHold raised an undisclosed Series B late last year. While the companies have similar offerings, TrueHold provides the seller with all their equity upon sale whereas EasyKnock remits 75% up-front and the remainder over time.
One challenge of sale leasebacks is that the underlying attractive mortgage disappears in the sale, replaced by the companies’ own financing vehicles. Ultimately, that needs to be reflected in the seller’s rent to make the math work for the home purchaser—usually a vehicle controlled by the sale leaseback company. Of course, the fact that sale leasebacks are not simply beneficiaries of the rapid run-up in rates is probably a good sign for the long-term health of the model.
While this letter is focused on the financing costs that homeowners face, people who own multiple homes face an additional challenge: a hefty capital gains tax bill driven by the recent run-up in home prices. While there are a number of ways that property sellers can defer these taxes—such as the popular 1031 exchange—the lesser-known 721 exchange has advantages that make it attractive for small, mom-and-pop landlords who own a few homes.
In a 721 exchange (or "UPREIT"), a property owner contributes their property to a REIT in exchange for shares in that REIT. Unlike a 1031 exchange, the 721 exchange enables a property owner to receive shares in a basket of cash-flowing properties rather than a stake in a single property, making it a preferred route for small, conservative owners.
Flock Homesis likely the leader in the 721 exchange market, appealing to landlords with small portfolios of single family homes. Today, Flock has approximately $100 million worth of homes in their portfolio; new products enabling homeowners to exchange into other funds are also in the works.
Co-investments help homeowners unlock their home equity by purchasing a piece of that equity. Unison, for example, will purchase up to 15% of a homeowner’s equity, paying cash now for the opportunity to share in any appreciation (or the lack thereof) down the road.
These co-investments have the benefit of maintaining the homeowner’s current mortgage terms. They also aren’t debt, and they generally aren’t preferential to the homeowner’s equity in the capital stack, making them less risky for a homeowner than second mortgage or HELOC. These products are also available for homeowners with weaker credit, as the investment is in the home and isn’t dependent on the owner’s ability to repay. Point, for example, has a credit score requirement of 500 and no income requirement.
In addition to Unison and Point, a number of companies have sprung up to offer a variety of co-investment products. HomeTap and Balance Homes are two examples; Balance is somewhat unique is that they appear to be combining a home equity purchase with a debt refinancing product specifically targeting homeowners with poor credit. (Their website boasts that their average customer starts with a credit score of only 538.) By using home equity to pay down debt, Balance customers can improve their credit and be in a better position to qualify for lower-interest financing.
Unfortunately, these co-investment products often layer on the fees; Unison applies a 5% "risk adjustment" to the third-party appraisal that determines the home’s value; they also take a 3.9% transaction fee on any equity they purchase, putting them well into the money by the time any equity purchase closes. While most of the firms discussed here focus on purchasing equity from existing homeowners, some also help prospective homeowners buy homes by co-investing alongside them. We’ll discuss that strategy in the next section.
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— Unsticking Renters —
While the prior section covered companies helping existing homeowners unlock equity value trapped in their homes, current renters aspiring to buy face an even steeper challenge without appreciated home equity to leverage. This section will cover a handful of concepts looking to help renters make the transition into homeownership in a difficult market.
Rent-to-own is not a new concept—Home Partners of America (now owned by Blackstone) has been offering rent-to-own for over a decade—but the post-pandemic run-up in home prices has brought renewed attention to the space.
In a typical rent-to-own model, a prospective buyer will sign a lease and a forward purchase agreement (at a locked-in price) for a specific home. The prospective buyer will pay above-market rent for some period of time—often 2 to 5 years—with the additional rent accruing toward a down payment on the home they’re renting. Rent-to-own is appealing to aspiring homeowners who can’t afford to purchase a home due to poor credit or the lack of money for a down payment.
Landis and Divvy are two examples of companies modernizing the rent-to-own model, and the concept has attracted considerable venture interest. Tiger Global valued Divvy at $2 billion in 2021, although the company is likely worth substantially less today. Rent-to-own companies are often good fits for OpCo-PropCo models, as they need substantial capital to purchase all their rent-to-own homes.
Rent-to-own businesses are often breakage models, with a significant percentage of renters failing to purchase the home upon the completion of their lease. When a renter fails to purchase their home—whether due to changes in circumstance or because they fail to qualify for a mortgage—he or she typically forfeits some or all of their accumulated deposit to the rent-to-own company, making it a risky path to saving for homeownership. The rent-to-own company is then free to sell the house on the market or rent it to another tenant.
We covered structured co-investments for existing homeowners in the prior section, but many co-investment companies also partner with aspiring homeowners to help them purchase their first home. This can be a great option for buyers with good credit but insufficient cash to afford a down payment.
Landed is an example of a company offering structured co-investments to help buyers purchase homes. Rather than working with buyers directly, Landed partners with third parties—employers, community organizations, and financial institutions, for example—to help them structure co-investment or down payment assistance products for their communities.
Many of Landed’s partners have motivations beyond pure financial returns; for example, they helped Denver Public Schools structure a co-investment product to help teachers buy homes. (Notably, teachers tend to have good credit but struggle to save enough money for a down payment, making them a good fit for this kind of co-investment product).
Rather than attempting to foster outright ownership, upside sharing arrangements offer renters a slice of their home’s appreciation—effectively, a synthetic ownership vehicle that sits on top of a rental arrangement.
One upside sharing company, Up and Up, creates a "wallet" in lieu of a security deposit. The wallet changes in value depending on what is going on in the home: it goes up if rent is paid on time and there are fewer maintenance calls; it also tracks the underlying home’s appreciation (or, I assume, depreciation).
Acreappears to be a similar concept. While Acre is positioned to be more like homeownership, Acre customers rent their homes and can receive up to 50% of their home’s appreciation through a value share agreement, a wallet-like structure that tracks to their home’s price. Unlike in rent-to-own concepts, Acre residents can receive the money accrued in their wallet even if they don’t ultimately purchase their home. In fact, Acre is explicitly marketed to renters seeking "shorter" stays with an eye toward "3 to 5 year" durations.
As novel financial structures, these are not the easiest products to understand or communicate. As I mentioned earlier, this is a bit of a recurring problem in this space; there are a lot of companies attempting to explain complex and new financial concepts to (often) unsophisticated customers using powerful and inspirational marketing language. It’s a recipe for messiness and confusion all around.
Many of these companies are providing useful services to homeowners and renters alike today. But becoming enduring, profitable companies once the macroeconomic climate changes is a different—and harder—challenge.
Interest rates may rise further in the back half of 2023, but they’re not going to climb forever. And while it’s not clear today what might push them lower—or when—they will likely fall again at some point: maybe a year from now, maybe three, maybe ten. So it’s worth evaluating what these businesses may become in a declining rate environment when credit is easier to come by and mortgage payments are becoming more affordable, and innovative home financing solutions are a vitamin rather than a painkiller.
Put another way, how are these companies positioning themselves to create enduring value when the home financing market inevitably shifts once again?
I can’t speak for all these startups, but I’ll share one example of a company that seems to be thinking about it the right way. I spoke with Ari Rubin at Flock Homes last month about his plans to expand beyond facilitating 721 exchanges to create a broader set of products for small-time landlords. By using his initial wedge to become a go-to stop for mom and pop owners to access other products and services, Rubin could insulate Flock from inevitable swings in the housing market and build an enduring business.
— Brad Hargreaves
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