Shared Appreciation Notes - Any Experience?

Question

Greetings!

Just joined a few minutes ago, so thought I would start off with a topic that is somewhat uncommon. I apologize in advance for the long preamble but this is a rather unique and somewhat complicated topic.

Many years ago Robert Allen's first edition of No Money Down (early 1980's ?) discussed a concept called a SAM (Shared Appreciation Mortgage) whereby the seller would agree to sell their property at a price (usually lower than FMV), and then would participate in the future appreciation of the property. The benefit to the seller is that s/he sells his property quickly, gets enough cash to provide for his/her current needs, and doesn't allow the buyer to in their mind "steal" the property and in fact benefits as the property appreciates (but obviously not as much as if the property were still held). The buyer gets a "deal", and the only downside is that s/he doesn't get all of the appreciation and also runs the risk that the new owner doesn't take care of the property such that it doesn't appreciate as much as it should.

The amount that is "shared" would typically depend on how much of a discount is offered - a large discount might find the seller hypothetically getting the first $50K of appreciation, then the next $100K is split 50/50, and anything over $150K is split 85/15, etc.

This works potentially well in the case of an owner who has a primary residence and finds themselves still holding another home from a previous move, and their tenant leaves on short notice and the owner in unable or unwilling to carry two mortgages at the same time - a situation I found myself in recently.

I had a property I owned out of state that was independently appraised at $700K but the market was saturated with similar homes (only 8 weeks earlier there were no other similar homes on the market) and thus buyers were playing all of the sellers against each other and bombing prices because they could. I needed to either rent it out again or sell it fast. I thought about offering a special deal - I would sell the property at any amount equal to or higher than my mortgage plus commissions and fees - around $535K - with the caveat that I would have a note that would be filed as a lien on the property for the "shared appreciation" that would be due to me when the property was eventually resold again. I was thinking about a 90/10 split for any sale less than $700K (any discounted sale price less than FMV would come from the 10% the person who bought the house from me controlled; we would split the next $100K (from $700K to $800K) 50/50, and for anything over $800K we would split it 10/90 where I get 10% of the appreciation above $800K.

The nice thing about this type of deal is that the lender who loaned the person the money to buy the house from me shouldn't care because the lien doesn't represent a current financial obligation to the loan holder - the note only becomes due when the property is sold, and there will always be enough money to repay the loan (unless the property were sold for some amount below $535K, which could be dealt with by saying there is no appreciation split at all (actually depreciation split) below $535K).

So why didn't I do this? Several reasons, the best being I ended up leasing the house rather quickly again. But if I didn't lease it, I saw several obstacles and I was wondering how these could have been dealt with, if at all.

1. How would one write up such an offer in the MLS? Presumably I could have used Prudential, which still uses range pricing in our area (and my realtor happened to be a Prudential agent). I could have set the lower limit as my minimum "walk away" number, and the high price limit as the FMV, and waited for an offer to come in and explain it at that time. Any other thoughts/ideas?

2. How would I have structured the lien so that while it was subordinate to the original mortgage, it would take precedent over any other type of loan or lien placed on the property?

3. Would there have been any way to structure the note so that if I didn't want to wait until the property was resold, it would be possible to force the buyer to refinance or take out a home equity loan or use a LOC in such a manner within a pre-defined time period (say five years) that wouldn't require the lender's approval? I couldn't think of any way to do this, and I wasn't sure I wanted to wait for some of my money until the property was sold again.

4. Last but not least, I couldn't find any attorney anywhere who had any idea how to structure the sales agreement to have it say what I wanted to see happen.

It seems to me that this would be a great way to buy homes from homeowners that can still remember where their homes were worth 30-40% more than they might be worth today but need to sell, and don't want to give up all of what they are sure will be a goldmine of future appreciation to someone who they bellieve would be "stealing" their home, even if they bought it a FMV.

Any thoughts or ideas/answers to the above questions would be appreciated, as I'm still convinced that this is a great potential way to buy a home..

Dion DePaoli · Answer

Rick,

Shared Appreciation loans for residential property is not uncommon but tends to be found in more of a public finance or non-profit finance situation. Some Neighborhood Rehabilitation loans or alike will take back a second lien, which usually ends up being 'silent' and then upon the liquidation of the asset, the lien is paid off and equity is calculated and shared or simple interest applied and paid.

The ones I have seen in the past prorata the debt/equity percent into the net proceeds. So if the silent second was 10%, they would realize 10% from the net proceeds.

I am not sure these types of loan arrangements are allowable under the new rules in 2014 unless you are a government agency or non-profit. For primary residential real property anyway.

Structuring the subordination is simply either recording the lien in second position or executing a subornation agreement in favor of the first lien holder or both.

In terms of creating and enforcing a maturity date. That will function just like any other secured loan. I have seen some that have a interest deferment maturity date, where the interest is deferred for 5 years and then an interest charge applies unless the loan is paid in full. Enforcement would be foreclosure. No real way around that. I have seen too many foreclosures from these types of structures i am sure there are/were some but in general the ones I have seen seem to be patient when it comes to repayment.

The elephant in the room is I suspect you really can't do this type of deal any more once the new rules come into play. @Bill Gulley what do you think on that? It seems to me this is now sort of looked at like equity stripping and is essentially forbidden on owner occupied property.

Bill Gulley · Answer

That is much along the same thinking as a reverse mortgage, but special exemptions prevail. My question is are those owner occupied loans, if so any amount made is a finance charge, how do you know what that charge might be with a sale in the future? The APR is required on owner occupied loans.

Another aspect to check on are the exemptions, seems to me out guru is applying what has been done for decades in commercial with institutions and suggesting that the same or similar deal be done as an individual or private party. That's not the same playground. An individual can't do a reveres mortgage for example, lenders can do many things an individual can't, including "sky is the limit" interest rates .

Owner occupied is the key here, I'll stick to my original opinion, especially in view of the SAFE Act issues and more kicking in in 40 some days.

BTW, I have had such commercial arrangements myself, I didn't scalp anyone, but I've had it in theory with RE, inventory and accounts receivables, taking a portion of the maturity in lieu of higher interest, a deferred interest charge.

I have no issue with it, I have an issue with individuals entering into such arrangements as a lender on an owner occupied SFD, or even on a SFD as they may not be able to determine future occupancy issues, just to be on the safe side. :)

Dion DePaoli · Answer

I like this idea as a solution.

However, SAM's are in practice today Bill and are not illegal through TILA (Reg Z) proper disclosure is required and guided by state law but no prohibited that I have seen. It's not just guru stuff either.

Ocwen has been doing SAM's on their modifications. Essentially their program forgives in stages over 3 years and equitable gain is shared upon liquidation of the asset. In addition, I have seen many public programs which offer a structure which I mentioned. How then are those programs present if it violates Reg Z? What is the Reg Z violation they violate?

They [Ocwen] have done over 200,000 of these deals with the blessing of the regulators as they are a HAMP servicer. They are a $7.53 Billion company, I would think they did a little homework before rolling this program out which they have openly preached about all over the place.

Alternative Mortgage Transaction Parity Act of 1982 gave permission to create SAM's provided disclosure is proper in accordance with OCC and as I understand it they treat SAM's similar to ARM's.

I also took a glance at DF and they call for a study to be conducted on SAM's for regulatory oversight: "Study of Shared Appreciation Mortgages (Section 1406) – Requires HUD to conduct comprehensive study to determine prudent statutory and regulatory requirements for wide-spread use of shared appreciation mortgages and report to Congress within 6 months after date of enactment."

State law may prevail over a SAM but it doesn't seem to simply label them all as a violation of Reg Z or Reg D for that matter seems a bit overstated unless I am missing something.

Bill Gulley · Answer

That SAM is a violation of TILA 20 + years ago and still is along with the new regs on owner occupied homes. Profit made in connection with a mortgage is a finance charge, you have no idea what that is until it sells, then your APR sky rockets, you missed the loan costs on the HUD-1 and interest disclosures.

Commercial loans can be made, but subject to usury rates if applicable.

I'm not surprised you couldn't find an attorney to write that up, I bet they weren't sure of the legality and gave a simple answer to avoid the issue. Wise choice on their part.

I suggest you take that guru book out, set it on fire and roast a hot dog over it, that way it would be a cooking fire and would probably be allowed by your fire department.

I'm beginning to add solutions rather than just slapping down guru junk. Don't make a loan, buy an interest in the property, go on title with a special warranty deed, then split up what ever you want. You can lease your interest back to the other party (seller) equal to interest and you can reduce any foggy principal in the split arrangement. Don't do that as a mortgage. :)

Shared Appreciation Notes - Any Experience?

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