When to Sell Equity or Borrow: A Guide for Homeowners, Students, and Artists
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Locking the money for the rest of us. This is a personal finance show on money how IT works, how to invest IT and how to live without worrying about IT. I'm your host David's stein.

Today is episode four twenty four. It's title when to sell equity and when to borrow to guide for homeowners, students and artist. After last week's episodes and three on affordable housing crisis, I received an email from A P.

R. agency. And I get dozens of emails from P. R. agencies. But this one I looked at and IT mentioned that home owners were waiting for interest rates to fob low six percent before they they move, and there is a backlog of people that haven't moved. The P, R, company was representing a company named unlock, which provides home equity investments, sometimes known as home equity share agreement, essentially said a borrowing money, a homeowner could receive a payment in exchange for the future upside or appreciation in the home. The equity.

This got me thinking over the past week, I wasn't that familiar with home equity share agreements, but considering other situations where we have to decide should we borrow money or should we give up quality, we discuss this five years ago in an episode that i'll link to in the show, notes on income share agreements where a student could borrow money, take out alone to pay tuition for some training, a college degree p or they could give up some of the future earnings potential, and the payback of that tuition assistance would be based on the future share of income. It's it's a way of selling equity in yourself. And another option that will explore in this episode relates to artist.

Artist, i'd have written a song or performed the song and have a copyright to IT intellectual property. They have the option of a selling the upside in that song in terms of future income streams from royalties. And it's like selling equity, but in this case, it's equity and a future income stream for a copyright ded asset.

Let's go here and take a look at those examples and then we'll step back and derive some principles for deciding when we should potentially equity or when that would be more advantages to borrow money. There are a number of companies. They're new the fin tax startups in the home equity share agreement space.

One is unlock, another is point. I think point is interesting because they recently, last may, packaged up some of the these home equity share agreements into securities and sold them on wall street. Institutional investors were willing to buy a security that was tied to the home appreciation of residential homes, and this was the second security zone that has been done in.

And that's good news for this brand new market because now there's a source of capital to fund these home equity share agreements. I went through a number of examples that I could find. And let's say you have a house that's worth a half a million dollars. This is an exercise that unlocked, did on there's site. And you wanted borrow ten percent of that home value.

So to be about fifty thousand dollars now, perhaps you have two hundred thousand dollars in equity in this home because you have a three hundred thousand dollar mortgage and you just don't want to go out and take out a home equity line because it's variable rate debt and the interest rates higher than you would like. And you have a thirty year mortgage at three percent. And so you don't want to do a cash out refinances, which basically means to you, you're getting a brand new mortgage at a higher interest rates and the U.

S. Mortgage rates are just over six percent right now. And so you think, okay, i'm going to do a home equity investment with the firm like unlock the way the day is set at that up is so you borrow ten percent of the home value and then they have afternoon as an exchange way, which is basically a multiple of the appreciation that they will receive in the home.

So if you borrow ten percent of your home value, fifty thousand dollars, in this case, the exchange rates two, which means unlock would receive twenty percent of your homes value when the agreement end. That agreement can end when you sell the house or up to ten years. In the case of point, their home market investments can go as long as thirty years.

And so conceptually, it's it's more chAllenging to think about as opposed to I take out a mortgage, here's my monthly payment because with home equity investments, there is no a month monthly payment. You just receive the amount you're willing to take of your home equity and you're giving up a future appreciation. Now if you have a lower credit score or if the home is dem, more risky a risk y your neighborhood, in the sense that maybe the potato appreciation isn't as high that exchange traded, the multiple could be potentially two point one five if you wanted to take out twenty percent of your home value.

Then again, with a multiple of two and luck, we get forty percent of the home value when the agreement ends. And potentially, you can take thirty five percent your home value as an equity payment. It's almost like selling part of your home up front.

You get IT. But then if the house appreciates further, you're paying much of that appreciation to unlock your point or one of these other providers. Before we continue, let me post and share some words from one of this week. Sponsors net sweet.

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Now, if the house goes down and value, you still have to pay a percent of your home equity to unlock these other companies. So you had a six hundred thousand dollar house. That's what IT was worth when you took out ten percent of that.

So sixty thousand dollars in the equity payment, but then home Prices fall ten percent. So now your house is worth only five hundred forty thousand. And luck with to get twenty percent of that to one hundred and eight thousand ours, they get a portion equity.

So there needs to be some buffer there, some equity in order for these things to work. There is a cost. If you take out one of these home equity investments, the origination for payment can be four percent, five percent painting on the provider and and that's meaningful.

I'm not sure whether that I point that origination fee can be rolled in to the homework quid agreement. I think this is cash you might have to come up with yourself, have to see the fine print of that. But just as with a mortgage and lock your point, they will place a lean on your property and and this is a legal agreement, there is a settlement, believe they use a title company, there is an a praise al.

I mean, it's it's a serious as taking out a mortgage is just that instead of making monthly payments, you basically resolved your house and are giving up some of the appreciation. Now there's definitely flexibility in doing that. But because of the flexibility, often the cost can be higher.

Now we can look at this home appreciation while it's settled at the end, that can be converted into an analyze cost. And so in their example that they gave where unlocked at the home appreciated three percent a year for ten years. In their example, the analyze cost of taking that settlement payment of the equally going to unlock was ten point four percent.

If the house lost money, the analyzed cost was closer to six percent, which would be similar to current mortgage rates. And then if the home value was unchanged, they developed analyst costs to seven point two percent. These aren't easy to understand, and most of them, they have a cap to what that analyzed costs can be.

If the home just skyrocket in Price and you ended the agreement after two years, the analyst cost cap is typically twenty percent. So there there is some cat to the upside. This is one example of a newer product bed is available, provide a little more flexibility.

You don't have to make payments, but you are giving up upside and the cost are typically high because the the the equity you give up, you're not getting, for example, the tax deduction that you would in the U. S. And interest experience on a mortgage debt.

But it's an option and that out there in a new option that one could consider if they don't want to make regular payments and debt and want to basically keep their low interest rate mortgage but access some equity in their house without having to make ongoing payments income share agreements when they came out. This is for students to pay for schooling. These were initially thought of as as sort of like equity.

There is a commitment to pay back the tuition, but there was flexibility in terms of what the payment would be. And if you didn't have a job, you didn't have to make the payment. And if your income fell below a certain levels, such as thirty thousand dollars, you didn't have to make the payment.

And then your payment that you did make was a function of your income, your revenue as an individual, which is kind of how equity works. When you have equity company, you say it's a publicly traded company, you get to share the profit in the form of dividends. The income share agreement, the investor would get a share of the income that the student generates once they enter the job market.

These really came out inside. And twenty sixteen, I think puri university was one of the first to use income share agreements. Lot of a trade schools or coding schools had used them and continue to use them.

Again, newer product, more complicated. And at one point, the this was in twenty twenty one, twenty twenty two, the consumer finances protection bureau issued a consent order against some of these student loan originators using income share agreements. The C, F, P, B made the determination that these are loans.

This is not an equity investment. This is a loan, and often times the providers weren't providing the appropriate information that this was like alone. In fact, the U.

S. Consumer financial protection bureau settled with the bankrupcy core related to premiere, which was another company participating in the income share agreement space. And and they felt president had engaged in deceptive acts.

Such as misrepresenting to consumers that these income sure agreements were not loans or credit and did not create debt when in fact, they consider the type of loan is, is that the repayment was more flexible because I was a percentage of incoming. And that's where it's not always straightforward. The difference between equity and debt, I think it's more straight forward with a homey share agreement.

But even then, they're calculating specially an annual cost like a financially even though it's equity. And so income share agreements have have fAllen out of favor a number of universities that allowed them have stopped their programme, including purdue ticula ly after the c fp b came out and and said, there they are a type of loan. There are still some startups in this space.

Leaf is one. L I F. Egli is. Seems like they're still involved there. When I tried to hook g in to get information on investing, IT wouldn't let me create a new account. I don't know they're taking on new investors or not, but this this is a space that struggle, but it's an example of A A type of equity investment in yourself before we continue limit POS and share some words from this week sponsors.

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Some musicians, though do, especially with streaming on spotify. Another platforms, a song that's been copyright, either the actual performance or one copyright available is on the performance itself. There's another copyright on the composition who wrote the song. When a song is streamed on a platform, there's income generated that flows to the copyright holders as royalties.

If a song is modified in in some way and used in A A production or maybe the original is used in a car advertisement, any use of that song in any form, even if it's modified, can generate realty. And so the first time there was an investment tied to realty was back in ninety ninety seven, when investment banker David polman developed boy bonds, which essentially took the royalties, and David boys catalogue e of songs, twenty five albums recorded before one thousand nine hundred ninety. And those were actually packaged into bonds.

There were ten year bonds face five, fifty five million dollars. IT had a fixed interest rate of seven point nine percent. This was an acid backboned. Instead of the bonds being backed by mortgages like a more respect, security or back by credit card receivables or back by home equity investment, IT was backed by the fees they were generated for royalties for David boys back catalog, and they were known as boye bonds.

And I think this one instruction investor, basically, we bought the entire amount, but there's been other sense now the market changed even more to where we, as individual investors could invest in the royalties and receive royalties for a song. There's A A new platform called J, K, B, X, and they sell royalty shares. They use regulation a of the security exchange commission to issue securities that the income is tied to the future royalties on a song, and you you can buy, for example, royalties on the song.

Happier by adhering the world to right to do buying is on the composition. So if that song is played on spotify, if IT is used in a movie, is using a commercial, it's, it's used in a variety ways and generates a royalty. You would get a percentage of that.

I think I looked on J, K, B, X. And IT was thirteen dollars. So for thirteen dollars, you could buy a slice of the royalties of this song.

I when I see something like this, I I first do as I wanted to understand the platform risk, as we've talked about in a number of episodes, is this really a security? Or is that a promise by J, K, B, X. To pay the royalty is IT unsecure debt in J, K, B, X, and it's not IT is a register security.

There is a trust put in place to receive the royalty payments and pay them to the security holders. The only way to value these things. So and and that's the risk of a link to the offering circular.

But they can set any Price they want. So they might do a million dollar offering and sells individual shares for these these royalty shares on a specific song. But they said the Price, the only way you can really judge in my overpaying in my business attractive is to look at the yield.

They provide a yield estimate, but just based on the royalty's per share for twenty twenty three. So the yield on this etern song was two and a half percent. Some of the yields for three and a half percent.

This is A A low yielding asset at this point. Now when you're buying and what your hoping is for some reason, maybe the song over vial again or be used in a mega black buster movie and generate higher realty. But it's uncertain and they only provide realities for the past couple years and potentially the order, the song, the lower the royalties.

The other chAllenge with this branding investment is there. There isn't a secondary market. There isn't.

Once you buy, there isn't. You want to sell IT your royalty share at this point. Now hopefully, that will develop over time. But that is one of the the platform risk is in that yeah that the the security itself is secure in terms of the royalties are put in a trust. It's pass through, but there isn't really way to get out of IT and which is one of the chAllenges with royalties.

I remember back when I was an institutional investment adviser and IT was a manager that was buying up royalties in the natural gas space. And remember talking to the founder about what's the exit strategy. And there there wasn't necessarily there is super long term investments.

Eventually, there was some exit, but that really wasn't the point. The point was to buy a very long term security that would generate some income. The chAllenge is with music rights IT seems like the productivity of that that music, Michael, over time. And so you you sort of left figure out of which which song should I invest. But from an artist perspective, this this is potentially very attractive.

Your song writer, you can basically sell the upside in your song that you've copy writ and get the income up front and diversifying incomes stream because you can receive that payment and invest ted and something else rather than having written song, not knowing what the future income will be in terms of royalties for that song. And so this can be attractive for artist. That isn't the only option though they could also, instead of selling the entire catalogue in, many musicians have sold their catalogues for hundreds of millions of dollars, giving up the upside.

But basically taking the cash up front, they could also borrows money, structural separate note based on the potential future incomes dreamer securitized by that. But IT could be a straight up debt with an interest payment at seven. And so even an artist has that option, assuming ing an artist has written songs that are being played.

Now the vast fast majority of the artists aren't in that position. And that we talked about that earlier this year on positive skies and parallels how a few artists make most of the money. A do authors make most of money. But if you happen to one of those artists, you have more opportunities now. Or if if you do have a hit song, right, you have a hit, you can monetize that today, get the money based on the future royal streams.

Those are some examples thinking about selling equity or taking out that the benefit of equity is more flexible often times, especially with uh, home equity share agreement, there is no payments to be made or the payment could be cat fully dependent based on your income stream. The are potentially higher cost of equity as a rule is more expensive than that. And that's why corporations were often, instead of history, new stock, which might have a good estimated cost of ten twelve percent.

There are more likely to issue debt. And because the interest is tax deductable for the corporation, IT becomes a lower former capital. But often the equity is more flexible because the company doesn't.

So how to pay divided, they can cut their division if they choose where is debt if they take out that, they have to make the payment. And if they don't, then they can be in to fall. So more flexibility with equity, but generally a higher cost debt is more cash constrained.

And so you have to service the debt set payment schedule. Now the interest rate could be variable, but IT is generally lower. One advantage of debt, especially we look at some of the the examples that we gave, royalties, home equity share agreements, income share agreements for student mounds is those are are much newer markets.

And so they're not as standardize. And so there are fewer options in terms of being able to sell some of that equity. Where is death standardize? The mortgage market, for example, works very, very smoothly.

And the government guarantees the mortgages and their package and securities and IT works like a machine. Where is when the home equity investment, when point securitize those they did a press, this is a big deal. Only, only second time it's happened.

So nco market, newer market. And so it's just not as established, which potentially could lead to higher cost with both equity and death. It's important to understand the fine print, what happens when things go wrong with the mortgage.

You can walk away and turn the keys with the homework ity investment potentially depending on how its structure with the student long versus an income share agreement. Again, IT comes down to the fine print, understanding what's the downside. If things don't work out is smooth.

So look at the fine print financial markets, always evolving. Maybe one, invest in what is now you can for why you could invest in student income share agreements. Now that seems like a little more chAllenging to do.

I'll see how that involves. That's episode four ninety four. Thanks for listening. You may be missing some of the best money for the rest of us content. Our weekly inside sky IDE aim on this letter goes beyond what we cover in our podcast episodes and helps elevate your investment journey with information that works best in written visual formats.

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