Chuck Jaffe's Stupid Investment of the Week: REX Agreements
The sales pitch is simple: Tap into your home equity without taking on more debt, without paying any interest and without having to worry about additional monthly payments, ever.
It’s getting thousands of people each week to look into something called a “REX Agreement,” which might best be described as a home-equity-risk/return-sharing arrangement, a phrase so mind-numbingly complex that it makes it clear this deal is anything but simple.
While there is some truth to the hype, there’s also no denying that REX agreements — and similar “alternative-to-mortgage” deals popping up around the country — have real potential to turn into a Stupid Investment of the Week of the worst kind, one with long-lasting, expensive side effects.
Stupid Investment of the Week highlights the concerns and characteristics that make an investment less than ideal for the average consumer, and is written in the hope that spotlighting trouble spots in one situation will make it easier to root them out elsewhere. Because REX agreements do not involve the outlay of cash with an expected return, they don’t meet the classic definition of an investment. That said, they involve the way an average investor manages the family’s largest investment — their home — and, as such, qualify for the column.
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The one thing that is most clear about a REX agreement is that it’s a huge bet on the appreciation of your home, and that it looks like a sweet deal, but it has a lot of sour potential. Worse yet, it’s almost impossible to tell who these deals will actually work out for, and who is finding a new way to mortgage their financial future.
But because they appeal to the consumer’s most basic desires — cash now, no payments, no interest rate to worry about — REX agreements are something that a consumer can easily bungle, even under the best of market conditions.
How it’s supposed to work
To see why that is, let’s dive into the workings of a REX agreement.
REX stands for Real Estate Equity Exchange, and the deals are marketed by REX & Co., a San Francisco-based company currently offering its agreements in 11 states (Washington is one of those, and more are added seemingly every few weeks). REX has been advertising heavily on television and the Internet.
The agreement involves selling an option lasting five to 50 years, where you get cash now and REX shares in the future sale price of your home. If the home increases in value before the deal terminates, REX gets a chunk of the gain; in 9 out of 10 deals, homeowners take the maximum upfront cash and give up a 50 percent share of the home’s value, according to Tjarko Leifer, managing partner for REX.
You read that right. If your home is valued at $500,000 today — and you have at least 20 percent equity in your home — you can get $75,000 today and $175,000 when the home eventually is sold. REX, however, will get half of your home’s value at closing time, or when the deal is terminated.
“About 60 percent of Americans have more than 80 percent of their net worth tied up in their home,” says Leifer. “The mantra for investing has been to diversify, and yet people aren’t diversified because of their home. … Our product offers people a way to access some of their equity, and to do it in a way that decreases their risk. By comparison, a home-equity loan increases your leverage and maintains the exposure to real estate.”
To truly diversify risk, the homeowner should invest the proceeds into other asset classes and securities. That same kind of thinking spurred many people to take option ARMs, adjustable mortgages with low payments where the best way to come out ahead was to invest the savings; it sounded great, except almost no one actually invested the savings from lower payments.
With a REX agreement, rates are a nonissue, but the diversification advantage evaporates if the money is plowed back into the house, and is minimized if the cash is used to pay off other debts.
A key sales point is that the “sharing” works in both directions, a particularly attractive feature given the current housing meltdown. If a home’s price falls while the agreement is in place, REX shares in the loss at closing time. (One other key point: Home improvements are credited to the owner, so that if the REX money is used on an addition, the value of the home would be adjusted upward before REX’s share of final appreciation is calculated.)
“With home prices sliding in so many markets, consumers may assume they can get a partner to share the pain, but if you end the agreement in the first five years, REX doesn’t share in any home-value decline,” says Greg McBride, senior financial analyst for BankRate.com. “They take their share of the home’s value at the time the agreement was signed, plus an exit fee.”
That fee starts at 25 percent of the original cash advance and drops by five percentage points per year until it is phased out after five years. In the meantime, it’s a nasty penalty for the homeowner who needs to make a change. After the penalty phase, you can end the agreement by selling the home or refinancing the deal, keeping the property but getting a new appraisal and paying off REX’s share in any appreciation.
The longer the homeowner is in the agreement, the better the chance that the real-estate market will make the deal work out in REX’s favor. Technically speaking, the deal is not a loan, but that hardly makes the money free, not when REX could walk away from the sale of your home with a six-figure payday.
A REX example
Let’s run an example:
Say your home goes through the appraisal process and is valued at $500,000. That independent appraisal is crucial, since it determines the basis for the future sharing; if you dislike the appraisal number after starting in the deal, you’ll pay $500 for walking away from the application process.
Now you decide how much of the home’s future value you want to share; the more you give REX in the future, the more money REX gives you today. In exchange for a 50 percent stake in the future value of the home, the homeowner can access from 12.5 percent to 15 percent of current value; we’ll say $75,000.
This is your “advance payment” from REX, and you’ll get it immediately, with no interest and no taxes due and no payments to make.
When the agreement is terminated by the sale of your home or by a refinancing, REX will owe you a “remaining payment,” which in this case would be $175,000. That’s the difference between the “option exercise price” — the current value of the home multiplied by the percentage of future value being shared with REX; in short, you sold a $250,000 option on your home, based on its current value, for $75,000 today and $175,000 at closing. You get your $75,000 immediately, with no interest, no taxes due and nothing to repay (although homeowners do pay some fees on the deal).
A decade later, let’s say the home is sold for $700,000. REX gets half of that money, or $350,000, and it pays you the remaining payment of $175,000. It walks away from the deal with $175,000, which equals the advance you got, plus half of the home’s appreciation from where the deal got done.
Effectively, that means the homeowner actually spent $100,000 to borrow 75 grand for a decade. By comparison, a $75,000 interest-only second mortgage or home-equity deal at 7 percent interest would have meant 120 payments of $437.50, so that when the house sold and the loan was repaid from the proceeds, the consumer would have paid $52,500 in borrowing costs. And unlike the $100,000 in appreciation that goes to REX, the mortgage interest is tax deductible.
That’s how REX’s easy money can become expensive, although it is important to recognize that terms and conditions can go in almost any direction, which is part of the problem in sizing up whether a REX is right for you.
Where it works best
Clearly, it’s not right for everyone who sees the ads on television.
REX only works with owners of single-family homes who are taking the agreement on their primary residence and who have at least 25 percent equity in that home. Credit scores need to be high — the average REX client is 56 years old, has a 50 percent loan-to-value ratio on their home and has a FICO score of 723, according to Leifer — so it’s the upper echelon of “average consumer” who is actually interested and able to qualify.
These deals won’t work for someone who put no money down and bought at the height of the market, or who is now underwater or in danger of foreclosure.
Leifer concedes that the deal also is not right for two groups of people, those who are bullish on real estate and expect a market bounce and seniors who have no interest in leaving remaining home equity to their heirs, as those homeowners can typically access more cash through a reverse-mortgage arrangement. He acknowledges the danger of people using their home as a piggy bank.
“This is not quick money, it’s a major part of your net worth,” Leifer says. “You’re re-allocating your assets, making major investments in the home, alternative investments or in paying off debt. If you go spend this on a new Escalade and the car is gone in five years and you’re sharing in the upside of your home for years, you’ve made a bad deal.”
McBride noted that the deals may be best for homeowners who expect to move in five to 10 years, and whose local market looks like it will remain sluggish for the foreseeable future.
“Selling a small share of your home today may sound like a good deal, but it could cost you a lot more than traditional borrowing,” says McBride.
“It’s hard to tell, but since a home isn’t just the biggest investment most people make but the best one they make, I think you have to think pretty hard before you jump at this.”
Chuck Jaffe is senior columnist for MarketWatch. He does not own or hold short positions in any securities covered by Stupid Investment of the Week. If you have a suggestion for Chuck Jaffe’s Stupid Investment of the Week or a comment about this week’s column, you can reach him at firstname.lastname@example.org or Box 70, Cohasset, MA 02025-0070.