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American Housing investment opportunity featured in Financial Investigator

Graceful Finance is excited to share its work and research with Roland van den Brink, who educates Dutch institutional investors in Financial Investigator on the American market and impact investing to help older American homeowners age in place gracefully.

This is Chat GPT translation of the original article:

"American home equity mortgages: high spread, limited risk, large market

Many American people over 60 face a retirement dilemma: they...

Own a valuable home, but expect a limited monthly income. Home equity mortgages offer a popular solution.

By Roland van den Brink

Despite the small premium above the euro swap curve, investing in Dutch mortgages has become popular with pension funds. They invest approximately 5% of their assets in this. This is mainly due to the limited risk and usability of mortgages for interest rate hedging (LDI). There are various providers on the market, such as Achmea, Aegon, ASR, Dynamic Credit and Vista/Rabo. Since 2014 we have also known DMFCO/MUNT, founded by pension funds, which mainly collects mortgages for clients through mandates. With such a mandate, you indicate the conditions, for example only NHG mortgages with a minimum energy label, and the amount to be invested. The portfolio is built up in accordance with the conditions.

New market segment

In the United States there are similar organizations with a slightly different, but equally interesting, mortgage product. Basically, the investment involves long-term loans to seniors at a spread of currently 3%, with a maximum of 49% of the home value being financed. The initial loan-to-value (LTV) ratio is therefore better than with Dutch mortgages (often 100%), while the surcharge is twice as high. It is an emerging market segment that is not yet well known in the Netherlands. The credit crisis in 2008 gave American mortgages a bad name, but this concerned loans to people with low incomes for often poor-quality homes.

Furthermore, in many cases there was non-recourse, whereby mortgagees were not liable for any residual debt. Banks had to take massive losses when mortgage holders simply handed them the keys to their flooded homes. However, home equity mortgages involve an affluent target group, limited financing and valuable properties.

Home Equity Mortgages in the US

In America, people over 62 can get a reverse mortgage with government support. This is called a home equity conversion mortgage (HECM). This mortgage is only available through a Federal Housing Administration (FHA) approved lender. HECM borrowers can remain in their homes indefinitely, as long as property taxes and insurance are paid. If a borrower defaults, the FHA lender can foreclose on the home. Such a HECM is attractive for the elderly, because there are no repayments or interest payments. The mortgage amount is increased monthly by the interest costs. In this way, seniors can supplement their pension by slowly 'eating' their equity in their home.

However, research shows that only 1 in 10 seniors who need additional financing submits a HECM application that is approved, while demand for this type of loan is particularly high among baby boomers. The size is approximately €90 billion per year. The FHA lenders are making about 8 to 12% returns in a growing market, and therefore spend little time on this large residual demand.

Providing mortgages is labor intensive. Only through automation can costs be controlled. In the Netherlands this is relatively simple, because there is only one set of regulations and housing credit data can be easily and reliably retrieved. In addition, the intermediaries are often well organized. In addition, there are good estimates of the home value via the WOZ and providers such as Calcasa and ORTEC.

In the US, several states have their own rules. In addition, there are many local influences on the assessment of valuations. Furthermore, mediators are often one or two people and therefore more difficult to reach. Only after the rise of big data and AI has it been possible to collect mortgage needs from all over the US in an affordable manner since 2023. This is relevant because institutional investors often want to exclude certain areas, for example due to the risk of forest fires, earthquake hazard, water or storm damage. It is now possible to impose detailed preconditions on a mandate and still have insight into sufficient volume.

What is the basic investment proposal? 

The financial behavior of Americans is different from that of Europeans. One of the most striking differences is that people in the US have various types of financing, for example for the car and the credit card. This type of product usually costs 12% interest. By pledging the home as collateral, elderly people can pay off current debts and pay 8% interest. This results in substantial monthly savings, while the mortgage provider, in addition to a high return, is offered a lot of security.

Why is the investment risk limited?

These are well-maintained homes that are each worth more than $1 million. The investment is a maximum of 49% of the conservatively estimated market value. The loan conditions state that the residents must properly maintain the home and pay housing taxes.

Even though certain areas are excluded, generic risks remain. For example, the estimated life expectancy may be different in practice, which affects the duration of the product. For seniors who live partly on their investment income, a stock market crash may force them to sell their home, shortening the lifespan. Just like in the Netherlands, there is a shortage of housing in the US, which supports value retention, but in the long term the value may be negatively affected by political influences. Furthermore, the storage offered will probably gradually decrease as more providers become available.

How does it work in practice?

Two solutions for American seniors. One is the home equity product and the other is known in the Netherlands as the eat-up or cash-in mortgage. The legal structure is different in the US than in the Netherlands to ensure that the mortgage provider has first rights if the situation changes due to death or relocation and in the event of payment problems.

The legal effect of the equity product is a sale-and-lease-back construction. The house is sold by the owner up to 49% of the value and in return they pay monthly rent. This corresponds to an interest-only mortgage where (due to the partial sale) the investor is the primary creditor. The resident has the right to repay the sales amount (in installments) and thus, for example, retain the house for heirs.

With the alternative variant of the cash-in mortgage, the home is sold at a discount, a so-called forward sale, whereby the residents can continue to live in it. In exchange, they receive a lump sum (maximum 40% of the conservatively estimated value) and also a monthly amount of money, depending on age.

These are a long-term investment. This means that careful preliminary research is important. The recommended first step is to talk to intermediaries and seniors on site, followed by thorough operational due diligence.

There are policy questions, such as how to deal with currency risk. But even if the US dollar is completely hedged, a higher spread remains than is the case with Dutch mortgages (mid-2024), while the initial LTV is much lower. Furthermore, sustainability criteria can be imposed on the loans, which has a major impact, given the often careless energy consumption for heating and air conditioning in the US.

In brief

Home equity products are a new investment segment that offers an attractive surcharge of 3% with a low LTV ratio of less than 50%.

Smart digitalization makes housing and credit data more readily available across the U.S., lowering costs and risk.

Investing in American home equity products can be done via a mandate construction at relatively low costs.

The demand for these types of products is enormous, approximately €90 billion per year, allowing investors to easily invest in larger amounts.

Even if the US dollar is completely hedged, the return and risk profile are more interesting than that of Dutch mortgages."

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