REPORT
A role for equity
finance in UK
housing markets?
Susan J. Smith, Christine M. E. Whitehead and Peter R. Williams
How innovations in equity finance could make home
ownership safer and more affordable.
Equity finance is an innovative way of helping consumers reduce the risks of
home ownership while providing additional funding for house purchase. It
can also make buying more affordable and potentially bring greater market
stability.
So far, most equity finance initiatives have been government sponsored. This
report looks at reasons and opportunities for the development of private
sector products for a wider range of households, who are looking to manage
their housing assets or debts more safely and effectively. The evidence that
most households want to buy, at least in the longer term, together with
the continuing shortage of debt finance makes these initiatives particularly
timely.
This report reviews:
• the reasons for introducing equity finance into home purchase;
• the products being developed to deliver equity funding to households;
• the challenges that have to be overcome if equity funding is to play a
significant role in the market;
• and the benefits that would flow from such innovation.
September 2013
www.jrf.org.uk
Contents
Executive summary
03
1 The case for equity finance
2 Equity finance and risk management
3 Retail product review
4 Funding for equity finance
5 The big issues
6 Conclusions
07
12
20
30
36
43
Notes
References
Abbreviations and terms
Acknowledgements
About the authors
46
47
50
52
53
1
2
3
4
5
13
14
18
22
24
List of tables
Traditional means of funding home ownership
Introducing equity finance
Linking products to risks
Products that help reduce credit risk
Products that help reduce equity risks
List of figures
1 The role of cash buyers 2005 to 2012
31
02
Executive summary
Equity funding could both provide an important
additional source of finance for owner-occupation
and help manage the risks associated with owning
your own home. A range of new products are being
developed that have the potential to improve the
way the housing finance market works.
Context
Home ownership in the UK is traditionally debt-funded. In recent years this
has proved risky for some households and for whole economies. Yet demand
for owner-occupation remains strong. To meet this demand, the project
considered the possibilities and practicalities of balancing traditional debt
funding with innovations in equity finance.
Equity finance is a method of funding home purchase that involves
sharing investment risks and rewards in housing markets between homebuying households and institutions (usually a financial organisation,
landlord or government). Such cost- and risk-sharing arrangements have
the potential to meet housing needs while making home ownership more
affordable, wealth portfolios less housing-centred and whole housing
markets less volatile. An injection of equity finance into the housing system
could in this way have a stabilising effect on the wider economy.
Other reasons to use equity finance to support UK housing markets
include: an ongoing shortage of debt finance; the wisdom of avoiding
high loan-to-value ratios in volatile markets; the need to manage housing
investment risks; and the possibility of providing a wider and better range of
housing options.
Methods
The potential for innovation in equity finance was explored through a
literature review, a detailed product survey, a round-table discussion and
interviews with product providers and policy makers.
03
The objective was not just to identify front runners, or collect examples
of good practice, but also to consider whether equity finance might play a
broader role in creating a more stable housing market. At a moment when
constraints on traditional sources are likely to continue for some time it is
important to consider whether equity finance offers a viable complementary
flow of funds, and if so what the barriers and enablers to this might be.
Equity finance and risk management
Currently most households buy with a mortgage along with their own equity
stake, which increases as the mortgage goes down. In the main, the higher
the level of debt the higher the credit risk, in terms of repayments and
potential loss of the home, while the higher the proportion of the equity
financed by the owner-occupier the higher the investment risks they face.
These investment or equity risks take three broad forms: portfolio risks (the
possibility that a housing-centred wealth portfolio will not do as well as one
in which assets are spread across a range of investments); capital or price
risks (the possibility that property values will fall, eroding the household’s
wealth holdings; and liquidity risks (the possibility that assets held as housing
cannot be realised when needed).
Equity finance, which introduces a third party part-owner, reduces
investment risks in particular but also reduces credit risks as loan-to-value
ratios are lower. Of course, reducing equity risks also means sacrificing
returns from any house price increases – but gives the benefit of greater
stability.
The product range
Government has led on equity finance, aiming to improve affordability
and support the construction industry through a range of equity-sharing
products. The equity stake acquired by government (and sometimes
developers) reduces the deposit requirement and loan-to-value ratio for
buyers. This lowers entry costs and reduces both borrowing and investment
risks as well as increasing the demand for new homes.
Private sector initiatives are less well developed but span a wider product
range. A large number of innovative products were identified in the study.
They fall into two main groups.
• Savings and investment products potentially form a gateway to home
ownership, by encouraging larger deposits and reducing loan-to-value
ratios on conventional mortgages. These vehicles are split according to
whether or not they are contractually linked to specific mortgages, and
according to whether the returns are linked to interest rates or house
prices. The latter are particularly innovative in protecting savings for
deposits against volatility.
• Home purchase products enable buyers to share the costs and risks
associated with buying, holding and occupying homes. These products
fall into three groups: shared ownership (where properties are jointly
purchasers, and the occupier pays rent on the investor’s share), equity
share (where investors buy an equity stake and receive a return,
sometimes deferred until the property is sold), and home purchase plans
(rent-to-buy arrangements which spread the costs of purchase across an
agreed payment period with the provider levying an occupation charge).
A role for equity finance in UK housing markets?
04
Currently, most equity-linked products are small and cluster at the margins
of the market. As yet they have neither achieved scale nor moved to the
mainstream.
Funding for equity finance
To operate at scale in future, the most important requirement is to attract
new sources of funds to support the equity investment. Three possible
funding models were identified:
• Retail to retail, for example using house-price-linked savings schemes to
fund equity share. This is the equity finance equivalent of using deposits
to fund mortgages, and providing the pattern of equity investments
matches that of the house price index, it is both feasible and appealing.
• Investor to retail, for example using institutional indirect property, or
property fund, investments to finance home purchase products whose
revenue streams provide the return.
• New financial instruments, for example independently traded houseprice-linked contracts that enable product providers to manage their risks
using financial markets. Such products may be necessary if the equity
finance market is to achieve scale, but reputational and other risks may be
prohibitively high.
Challenges
Whether innovations using equity finance can gain sufficient traction to
spread from the margins to the mainstream depends on overcoming a
number of key challenges:
• Securing significant consumer demand Equity finance, in principle,
offers qualities that debt funding currently does not. These are: greater
affordability with lower leverage; investment risk management (including
potentially protection against negative equity); and portfolio balancing to
avoid the concentration of wealth in a single home. There is demand for
the first of these, but success may, in the end, depend on a cultural shift
creating demand for the other two. The core issue is whether consumers
value these attributes, find the products cost-effective and prefer them to
more traditional debt funding.
• Ensuring consumer capability and protection Equity finance is a new
concept for most consumers and advisers, whose learning curve will
be steep and require active support. Regulation to protect consumers
against mis-selling without exposing providers to unmanageable
reputational risk is essential.
• Designing products that are legible, transparent and cost-effective
There are few equity finance products at or near the market today. Two
critical aspects of design relate to the apportionment of responsibilities
(for repair, maintenance and eventual sale) and price. Transparency is key
in both cases. Regardless of how products are priced, the challenge of
securing attractive returns for investors while delivering products that are
cost-effective to consumers is considerable.
• The question of scale and the possibilities for systemic stability The
future for equity finance may turn on government taking a lead, not only
in developing the product range but also in supporting the principles,
The case for equity finance
05
addressing regulatory matters and perhaps providing guarantees. This
may be justified if it is possible to achieve sufficient scale to help stabilise
housing markets and benefit the wider economy.
Conclusions
Equity finance is likely to form part of the future for UK housing markets.
The eventual size and significance of its market share will be determined
by: consumer demand, capability, and protection; product design, pricing
and transparency; institutional appetite for residential property investment;
regulatory requirements; and the position of government.
This vision of a housing system in which owner-occupiers can separate
housing investment decisions from decisions around housing consumption
may be far from realisation. However, simply by adding to the product range,
equity finance promotes welcome diversity at a time when debt funding is
under strain.
There is also the promise of greater financial inclusion (in that renters
as well as owners could have a stake in the housing market) and an easing
of the tensions generated by restricted access to home ownership. Equity
finance brings a new dimension to risk sharing in housing markets, potentially
changing the way households think about housing assets in relation to their
overall household balance sheet.
As the dominant provider of equity loan products the government is
central to the future of this market. However the current policy agenda
is driven primarily by concerns with easing access to home ownership
rather than by comprehensive risk reduction or any attempt to reform the
underlying structure of the housing system.
Overall, therefore, this report concludes that complementing debtfunding with equity finance could bring balance, competition and greater
completion to the market.
A role for equity finance in UK housing markets?
06
1 The case for
equity finance
The context
In common with much of the English-speaking world, the UK has sustained
relatively high rates of owner-occupation for over thirty years. Recent
surveys show that, although the appetite for ownership remains high
(Pannell, 2012), there has been a fall in ownership rates in England of at
least 4 percentage points over the past five years. While this decline in
owner-occupation may not represent a ‘U’-turn towards renting, it certainly
reflects some of the difficulties of sustaining housing systems centred on
owner-occupation in the wake of the worst financial crisis since the 1930s
Depression.
As a result of these difficulties the affordability and sustainability of
owner-occupation in the UK has suffered during a period of austerity
in which lenders have imposed much tougher deposit requirements on
borrowers. At the same time, buyers have been grappling with uncertainties
over jobs and incomes. Additionally there is growing awareness of, and
concern about, the risks associated with house price as well as interest rate
volatility. There is also an ongoing absolute shortage of funds for lending,
which at best will take years to restore. Very crudely, a market for the UK
that is sustainable for the long term would require around £250 billion of
gross lending per annum. In 2013 the figure for actual lending (including
remortgaging), is likely to be close to £150 billion gross, drawn mainly from
retail savings.1
Since the development of the modern mortgage market, debt-finance
has been the principal driver of the acquisition of residential property in the
more developed world. In recent years, however, the dependence of housing
markets on ever-increasing leverage has been shown to be risky, particularly
in Anglo-Saxon, home ownership-centred housing systems (Girouard et al.
2006 and 2006a). The UK’s housing finance system has proved particularly
vulnerable because of a trend towards high loan-to-value ratios (high
gearing) especially among first time buyers where the median advance over
a 25 year run of years to 2005 was in the range of 90–95%. Debt funding in
the UK has also enabled increased borrowing against increasing home equity,
whereby households with pressing needs, and few liquid assets, add to their
mortgages to release funds for other uses. This too can add to the risks of a
debt-funding environment (Ong et al., 2013; Smith et al., 2009; Wood et al.,
2013).
07
Debt funding will undoubtedly remain the dominant part of housing’s
financial future into the medium term.2 However, recent experience exposes
the limits to this model of housing finance, raising questions about the
possibilities for, and practicalities of, other funding approaches. This report
considers one potentially viable option, that of balancing traditional debt
funding with innovations in equity finance.
Equity finance
Equity finance is a method of funding home purchase which involves sharing
investment risks and rewards in housing markets between home-buying
households and institutions (usually a financial organization, landlord or
government). Such cost- and risk-sharing arrangements have the potential
to meet housing needs and support an underfunded housing market, while
making home ownership more affordable, wealth portfolios less housingcentred, and whole housing markets less volatile. An injection of equity
finance into the housing system could in this way have a stabilising effect on
the wider economy.
There are at least five reasons for looking to equity finance as a means of
bringing balance and completeness to the market. These are:
• The general shortage of debt finance is likely to persist into the medium
and long term. In that context, equity finance provides an important
complementary funding instrument.
• House prices are likely to become even more volatile in the face of
constrained housing supply and uncertain real income growth. Instruments
must therefore be developed which can both manage this volatility and
potentially help to reduce it.
• Investment risks are increasingly important in housing markets. Households
are increasingly vulnerable to housing investment risks especially as they
come to depend more on their own assets throughout life and into older
age. This creates both need and demand for more comprehensive risk
sharing products.
• Product innovation. Thinking creatively around cash flows is essential,
especially if the goal is to enable households whose income streams are
likely to grow, to enter owner-occupation.
• More critically, equity finance turns attention to the relative costs and
attributes of different tenure arrangements and to the possibility of
using innovative structures better to serve the variety of needs and
requirements in the housing system.
Equity finance regards the asset value of housing not (only) as security
for a loan but also as a direct investment opportunity that could – with
the aid of appropriate financial instruments and regulation – be attractive
to institutions as well as households. By sharing the risks and rewards of
residential property investment between home occupiers and non-resident
partners, equity finance could improve access to owner-occupation and
reduce price risks for consumers. This model could also reduce funders’
reliance on retail savings without exposing them to the more complex
structured debt products that drove mortgage lending into the financial
crisis. That is the essence of, and rationale for, equity finance. This report
seeks to address the question of whether this method of housing finance is
feasible, cost effective, practical and sustainable.
A role for equity finance in UK housing markets?
08
The state of the art
Equity finance refers to a variety of initiatives making imaginative use of the
asset value of residential property to bring (non-occupying) investor partners
into the financing of owner-occupation. There are two broad models. One
takes the form of shared ownership, in which the title to each property is
split and the occupying partner pays the costs of buying one share, and
renting the other. A difficulty with this model is that the institutional shares
tend to be illiquid and therefore not very attractive to investors outside
the social sector (although some authors, e.g. Caplin, 1997; 2007 have
developed ways to address this). Shared equity, the innovation that triggered
this review, is rather different, notably in that the title lies with the purchaser,
which is appealing to both home buyers and funders. In the future it may also
be easier to make investor shares for this model tradable (and thus attractive
enough to bring substantial private finance into the system).
Until now, both means of operationalising equity finance have been
geared primarily towards boosting ownership at the margins of the market
by making entry costs and housing outlays more affordable. They have also
been seen as a way of enabling households with limited means to place a
foot on the housing ladder and move incrementally towards full ownership.
There has been less practical emphasis on the role of equity finance in
sharing the risks associated with uncertain asset values. The scale of these
programmes has so far been small enough that their inflationary impacts
have been marginal (although they have put pressure on some housing
association and developer balance sheets since the financial crisis because of
their importance to cash flows). However, building on this approach has the
potential for reducing costs, sharing risks and potentially stabilising markets.
Equally, to date there has been limited interest in this innovation
outside government sponsored products. Governments in the UK have
been experimenting with shared ownership for some time. The first shared
ownership scheme introduced nationally in England was launched in 1980
and has remained available since then. It allows home occupiers to buy part
of the dwelling, lease the remainder from a Housing Association or other
non-profit provider, and engage in ‘staircasing’ towards 100% ownership
in due course. The first shared equity scheme was introduced somewhat
later in the form of an intermediate tenure product in 1999. Here buyers
acquire the entirety of the title to their home, and enjoy an equity sharing
partnership that is built into a mortgage contract. The product has taken
many forms over the years and from April 2013 has been available in the
shape of Help to Buy, in which the government acquires a 20% equity stake
in a (newbuild) property, and the owner funds the rest with a small deposit
and a conventional mortgage.
There have, from time to time, been market based attempts to develop
equity finance products, as well as builder-led products, especially during
economic downturns (Burgess et al., 2008). These were a subject of
interest for the JRF Housing Market Taskforce (jrf.org.uk/work/workarea/
housing-market-task-force) which recognised their potential in risk
management (Whitehead, 2010). They have also been considered relevant
for the Australian market (Pinnegar et al., 2008), and more generally on the
international stage (Smith, 2010, 2013). However, they have so far failed to
gain traction.
Part of the limitation undoubtedly relates to the mistakes of the past. For
example, all parties were damaged by the Shared Appreciation Mortgage
debacle (which offered an equity sharing arrangement which was overpriced and often mis-sold). There is, additionally, a range of concerns about
The case for equity finance
09
the health of the housing market and therefore the pricing of house price
risk which impacts on the appeal and viability of such products. On the
other hand there has been considerable interest recently in investment risks
associated with owner-occupation (Smith et al., 2009; Whitehead and Yates,
2010a) and in the extent to which housing wealth has been positioned as a
financial buffer (Benito, 2007; Lowe et al., 2011; Wood et al., 2013). This all
strengthens the case for introducing risk-sharing products for those whose
home is their most important asset.
There is, moreover, a new generation of products inspired by the
principles of equity finance, together with a series of proposals to restructure
mortgage contracts to include price risk sharing. Some of these innovations
are market based; some are in the form of joint ventures between
government agencies and the private sector. Most cluster in the margins
of the market, and none is yet fully operational at scale. However there has
been some real impetus behind a range of products that can address some or
all of the issues raised by the limits and risks of debt finance. Critically, there
may be potential to use equity finance to develop products which will not just
assist housing affordability but also help manage individual and systemic risks
more effectively.
A scoping exercise
Recognising the potential of seeking an alternative to ‘business as usual’ in
the world of housing finance, the Joseph Rowntree Foundation, as part of
its continuing effort to address housing market volatility, supported a project
to describe the character, and weigh up the strengths and limitations, of
products inspired, and underpinned, by the principles of equity finance. The
objective was not just to identify front runners, or collect examples of good
practice, but also to consider whether equity finance might play a broader
role in creating a more stable housing market. At a moment when constraints
on traditional sources are likely to continue for some time it is important to
consider whether equity finance offers a viable complementary flow of funds,
and if so what the barriers and enablers to this might be.
The research was in four stages:
1 A preliminary overview paper by Susan Smith and Christine Whitehead
which provided a basis for discussion at a Roundtable of professionals,
policy makers and academics.
2 The Roundtable itself, which was held in April 2012. This provided the
material for a further paper reflecting the views expressed.
3 Interviews with a range of stakeholders involved in developing products,
regulating the market and formulating policy approaches. The aim of
these interviews was to deepen understanding of the attributes of
products, to set out their objectives, costs and benefits, and to consider
the opportunities and constraints on rolling them out more widely in the
future.
4 Finally, all these elements are brought together in this report with the
aim of creating a typology of product attributes based on risk and cost
sharing, identifying gaps in the market, and formulating the next steps for
policy and research.
Chapter 2 of the report sets out the principles behind equity finance, and
identifies the attributes that might be needed to develop a market. Chapter 3
provides a systematic round up and typology of products that are currently
at or near the market. Chapter 4 looks at the supply side and identifies the
A role for equity finance in UK housing markets?
10
potential sources of funding for equity finance. Chapter 5 considers the key
challenges in bringing products to market. Finally Chapter 6 draws together
our findings and looks to the factors that might need to change if these
products are to be successful at scale.
The case for equity finance
11
2 Equity
finance and risk
management
Where equity finance fits into the market
In the UK today, public confidence in the housing market remains strong for
the longer-term, even though most renters and new households realize they
will to be unable to buy in the near future. What is limiting, for the short and
medium term, is the availability of housing finance. Of course, there is the
option to boost renting, but this is not a popular solution, nor is it a quick fix,
since the current offer remains small, is geographically limited and generally
unsatisfactory for households seeking enduring security of tenure. Moreover
for most traditional households owner-occupation is still the preferred and
cost effective option. In the event that this remains the norm, and if the drive
to ‘business as usual’ in debt-funding proves neither possible nor desirable,
there must be space in the market for a new approach. In this chapter we
consider whether equity finance might occupy this niche. In particular, we
ask whether and to what extent equity finance can help manage or reduce
the risks associated with housing markets, both for individuals and whole
economies.
We begin by noting a curious disjunction between the rationale for such
equity finance as has been introduced to the UK housing market so far,
and the case made for equity finance in a small but established literature in
housing economics.
In practice, most new products have been designed to enable access
to home ownership; they are affordability aids which usually involve direct
government support. They may be designed to reduce the need for (and
risks of) higher loan-to-value ratios, and they help reduce exposure to equity
risks, especially loss of deposit or negative equity. Products like this work
at the margins of the market to support owner-occupation and help meet
the aspirations of households who may not otherwise be able to afford it.
Of course, these objectives might be challenged, especially if house prices
were projected to fall in real terms. Nevertheless, equity finance has featured
reasonably prominently in government initiatives to expand the edges of
ownership. Providers have rarely looked beyond this horizon.
In the literature on the other hand the starting point for much of the
equity finance discussion has to do with the fact that housing investment
risks are largely unmanaged and unshared in societies with high rates of
12
owner-occupation where most households have a large part of their wealth
tied up in a single housing asset – their own home. Studies consistently
indicate that the possibility to ‘hedge’ (or insure) housing risks or diversify
housing-centred wealth portfolios would benefit households with lower as
well as higher incomes (Englund et al., 2002, Iacoviello and Ortalo-Magné,
2002, Quigley, 2006). This has led to an interest in a variety of financial
instruments that might achieve at least three things:
• enable house price risks to be spread across a wider range of housing
units, or a ‘basket’ of properties, rather than a single dwelling (to address
specific risks);
• allow owner-occupiers to balance their wealth portfolio across different
types of investments (to diversify across sectors); and
• provide an opportunity for home occupiers to share their single-property
price risks with different stakeholders; this also points to the potential
development of secondary markets to make shares of property, or
interests in property prices, liquid and tradable (see in particular Caplin
et al., 2003a; Caplin et al., 2007; Pinnegar et al., 2009 and the essays
collected in Smith and Searle, 2010, part 3).
At the present time, however, much of the emphasis is simply on supporting
housing markets by increasing the flow of finance. The aim is to enlarge the
opportunities for households to purchase homes they can afford and to
support economic growth through higher levels of construction.
One of the objectives of this chapter is to look more comprehensively
at the attributes of different products that might be used to fund different
forms of home ownership. In particular, we profile their costs and benefits
in different contexts. We do this first (in this chapter) by setting out the
range of possibilities and then examining the implications for access to
homeownership, risk management and liquidity.
Principles: the potential range of products
Traditionally, there have been three approaches to the funding of owneroccupation. These are illustrated in Table 1. At one end of the spectrum
there is outright ownership where the total equity is in the hands of the
owner-occupier, and no debt is incurred. At the other end is mortgaged
owner-occupation, in properties purchased with no deposit and a 100%
loan.3 In between stands home purchase via the traditional (debt-funding,
interest rate risk sharing) amortising mortgage, requiring a small equity stake
(deposit) at the outset, and a changing mix of capital injections and interest
payments until the home is fully acquired and the loan repaid. There are
many variants in this ‘middle ground’ of course: with annuity (or repayment)
mortgages the proportion of own equity rises through the term of the
mortgage; with interest only mortgages the equity stake does not change
Table 1: Traditional means of funding home ownership
Financing
mechanism
Outright
ownership
80% LTV annuity
mortgage
100% LTV annuity
mortgage
Own equity
100%
% equal to deposit then rising
over time
0% rising over time
Debt
0%
Loan-to-value % then falling
100% falling over time
Equity finance and risk management
13
until the end of the period, when the entire outstanding balance is due to be
repaid.
Adding equity finance to this equation allows for a range of additional
product types which bring in third party, or co-investor, equity injections.
Models include (i) short term equity funding where an investor partner
initially takes on part of the value of the property but the primary owner
is expected to staircase up to become an outright owner; (ii) long term
equity finance in the form of an investment which remains in place until the
property is sold. More complex – but more usual – products involve a mix of
equity and debt finance, again either (iii) with staircasing into full ownership
or (iv) with an equity stake whose returns are deferred until sale. Table 2 sets
out these four options though there is the potential for more complex mixes.
The addition of a co-investor creates a range of possibilities that home
buyers do not have in a debt financing environment. Some of these may not
be desirable. For example, rather than reducing costs, an additional equity
injection might simply encourage people to buy more expensive properties
for a given size of loan. The evidence in the 1980s was that this did not
happen: people who knew debt finance was more risky than it appeared or
who disliked risk more than average tended to purchase their first home
using equity based shared ownership products to fund cost-effective rather
than speculative home purchase (Booth and Crook, 1986; Littlewood and
Mason, 1984). In the 2000s, in contrast, there was evidence of people
buying more property than they could have afforded without the equity
finance instruments. The products therefore eased access but did not reduce
risk – so the jury is out. In theory, however, there are two ways in which
equity finance can help manage housing market risks. These are set out next
Principles behind the use of equity products 1: enabling
‘conventional risk’ reduction
A suite of risks routinely faces mortgagors especially in the period
immediately after home purchase. These risks are traditionally managed
(if at all) by a mix of public and private insurances – a tactic which has not
proved entirely successful (Belsky et al., 2008). Such risks include income
loss, interest rate rises, and increased expenditures occasioned by ill health
or other personal disruptions (including relationship breakdown). If these
circumstances reduce households’ capacity to repay the loan, there is the
possibility of possession, especially if the housing market is illiquid at the
time. Equity finance is not the only means of managing these risks: Ford et al.
(2004) for example have considered other kinds of risk-sharing partnerships;
Table 2: Introducing equity finance
Equity stake from investor
partner
Equity stake from investor partner
plus conventional secured loan
Short term,
Long term,
Financing
occupier buys returns settled
mechanism back over time on sale
Short term,
Long term,
occupier buys investment returns
back over time settled on sale
Own equity Deposit, then
Deposit, then
rising over time stable over time
Deposit, then Deposit, then stable
rising over time over time
Secondary
equity
Less than 100% Less than 100%
falling over time stable
Less than
100%, falling
over time
Less than 100%,
stable
Debt
None
LTV, % falling
LTV, % falling
None
A role for equity finance in UK housing markets?
14
and innovative payment waiver schemes – based on a contractual promise
from a lender to cancel the entirety of (not just the interest owed on) a
mortgage payment in the event of a specified event, such as sickness or
unemployment – have recently secured in principle approval from FSA and
OFT. Nevertheless, equity finance could play a role in at least the following
three ways.
Interest rates
Households who use a mix of debt and equity finance when purchasing their
home potentially have lower outgoings than with a conventional mortgage,
and a lower proportion of these relate to mortgage interest. So the impact
of interest rate volatility is smaller. The purchaser instead pays charge
relating to changes in the capital value of the property (i.e., related to the real
value of the asset they own rather than to a debt which does not adjust to
housing asset prices), often by sacrificing capital gains in the longer run.
Income loss
Equity finance enables households to take a lower mortgage than would
be the case in a debt-only funding regime, for a given value of property. At
the limit, they could take on no debt at all. This cushions housing outlays by
reducing interest payments. If incomes decline, this cushion should make it
easier for repayments to be maintained. The extent of this benefit depends
on the size and timing of payments (investment returns) that are charged by
and due to the other stakeholder(s).
Risk of possession
The risk of possession arises when borrowers cannot repay their loan
because of income loss or increased costs of all types, and when they cannot
sell up and move to renting. To the extent that monthly repayments are
reduced by equity finance these risks are reduced. As a result households
may not have to sell in a difficult market. Indeed, they could potentially
sell some part of the future price change of their property as a means of
managing their debts. On the other hand, when equity finance takes the
form of shared ownership, the illiquidity of the product could have the
opposite effect.
Principles behind the use of equity products 2: addressing
previously unmanaged risk
Investment risks in housing markets have received far less attention than
credit risks, and have to date been largely unmanaged. So, although housingcentred asset-bases form an important financial buffer for households, this
resource is illiquid and often most vulnerable to erosion when needed most.
Investment risks take three broad forms: portfolio risks (the possibility
that a housing-centred wealth portfolio will not do as well as one in which
assets are spread across a range of investments); capital or price risks (the
possibility that property values will fall, eroding the wealth holdings that
households at various positions in the life course may depend on); and
liquidity risks (the possibility that assets held as housing cannot be realised
when needed). Equity finance can be used to address all three of these risks.
Portfolio risks
Models of expected utility maximization in a risky world – i.e., models where
people make decisions which are best for themselves – suggest that risk-
Equity finance and risk management
15
averse individuals (almost all of us) should hold a diversified portfolio made
up of a ‘risk free’ product together with a mix of investments with different
patterns of risks and returns, and different degrees of liquidity. Ideally if the
investor wants to have a portfolio with stable returns they look to invest
in products where returns are uncorrelated, that is they move against one
another (ice cream and sausages; bankruptcy professionals and merger
specialists etc.). More generally if the patterns of returns differ at all (e.g.
house prices moving differently between regions) the returns on investing
across the products (or regions) will be more stable.
Owner-occupiers in the UK display almost exactly the opposite pattern
to that expected of the economically rational actor. Many, especially those
in the mid- to lower-income bands, hold the majority of their wealth in a
single owned home (a large, lumpy investment vehicle in a specific location).
Pension wealth also features for mid- to higher-income groups, but overall
the centrality of housing has increased over time, to the extent that over half
the UK’s personal wealth is currently held as housing.
As a big indivisible asset, owned homes may actively constrain the
capacity of all but the highest-income households to diversify their portfolios
effectively into other types of asset. This is problematic because housing as
a category of assets faces volatile returns that differ from other categories
of risk. Equity finance can help here, playing a portfolio-balancing role for
owner-occupiers by providing them with the opportunity to reduce their
equity stake in their home, in return for funds to invest elsewhere. Moreover,
it creates the possibility for a higher proportion of the portfolio than is
normal today to be held as savings – a much more liquid resource.
Capital or price risks
House prices are uncertain and volatile. Although it is arguable whether
in the long run residential property does better or worse than other
investments, the possibility of recent buyers entering negative equity, current
owners selling up or trading down when the market is in a dip, or even
owning a property that does not perform at least as well as average, are all
risks for owner-occupiers with housing-centred wealth holdings.
Such risks have always been present in housing markets, even in the
presence of substantial debt-funding. They take two forms: first, risks
associated with a particular dwelling (housing has some specific pricesensitive attributes, e.g. good neighbourhood, bad neighbours, which can
change suddenly and unexpectedly), and, second, risks associated with whole
housing market volatility (which affect regional as well as individual house
price risks). What has changed in recent years is that households have
become more vulnerable to both these elements of risk (by virtue of the
high proportion of wealth held in owned homes, and the role it now plays
as an asset base for welfare), and that such risks are better documented and
understood. Indeed the volatility in returns experienced even by owneroccupiers with a mortgage is much greater than it may appear because of
the gearing arising from debt finance. Suppose the owner-occupier buys
a specific property, taking out a 90% mortgage. If the price rises by 10%
the owner-occupiers’ own asset (the 10%) doubles in value. If prices fall by
10% they lose their whole housing wealth – a very good reason for being
concerned about house price volatility. On average and in nominal terms
house prices have increased by 10% per annum since 1971, but this does not
mean that such returns could always be realised when needed, or that this
trajectory will continue.
Equity finance can help reduce these risks. At its most fundamental
equity finance is a price-risk sharing instrument that can enable the transfer
A role for equity finance in UK housing markets?
16
of some of the investment and therefore some of the impact of price
volatility to a third party. Furthermore, while modellers generally agree
that a significant part of a household’s portfolio (perhaps 30%) should be in
housing, they also point out that rather than being held as a single property,
such wealth should be spread across the market (Caplin et al., 1997; Shiller
2007). An equity finance environment thus favours products like property
price-linked savings accounts or bonds which are benchmarked to a basket
of housing assets as captured by a price index. Investors hold the returns on
a little bit of a large number of dwellings with slightly different risk profiles
so that, overall, their housing wealth portfolio is more stable. Finally, equity
finance offers the possibility of creating products to insure against house
price risks, which might be a useful way of protecting new buyers against
negative equity. This suite of options is reviewed in more detail in Smith (2010).
Liquidity risks
While equity finance can offer no specific risk management in relation to the
capacity to sell when desired, there are products which can reduce the need
to do so. In particular, price risk sharing mortgages could be used to reduce
the possibility of negative equity, which is one of the factors that triggers the
need to sell in recession when the market gets increasingly sticky (Ambrose
and Buttimer 2012; Shiller et al. 2011). Additionally, although there are
currently very few examples, house price insurance could help avoid panic
selling if the market drops, thus helping to avert some elements of illiquidity
(Caplin et al., 2003b; Shiller and Weiss 1994; Sommervoll and Wood 2011).
A market for equity finance?
A market approach to managing house price risks involves third party
investors who can diversify more effectively than owner-occupiers, and are
therefore prepared (or even eager) to take on more, and different, risk. This
will often mean a pension fund or other institution looking for significant
involvement in housing which is spread over the market as a whole. This can
in turn generate demand for securitised instruments to be sold to investors
wanting exposure to housing. Such markets require scale if they are to be
cost effective or have an impact on housing market stability.
In the market context of optimal portfolios, innovations in Britain
(Ratcliffe 2006) and the USA (Labuszewski 2006) and studies Australia
(Caplin et al., 1997, 2003a) have set out the case for a market approach to
equity finance which would involve developing a new category of market
security or a new trade in house-price-linked financial instruments. In neither
case has it proved possible to develop large markets, and those instruments
that have come to market have tended to be for niche sectors among the
relatively well-off (Berry et al., 2006; Caplin et al., 2007, Pinnegar et al.,
2009; Whitehead and Yates, 2010a). The extent to which this failure is about
scale, consumer attitudes, funding and/or inherent market failure is unclear,
though a range of ideas is considered in Smith (2009), who finds no barrier
that is, in principle, prohibitive.
Risk sharing and transfer is most relevant for those whose wealth is
concentrated in a single housing asset not only because of the risks associated
with a lumpy individual investment but also because such households often
have high loan-to-value ratios and a significant chance of falling into negative
equity. On the other hand highly geared households do better out of price
increases as in these circumstances they receive a higher return on their
own equity (while their debt remains secured against the initial home value).
Equity finance and risk management
17
Perhaps therefore it is not surprising that equity finance has not been a feature
of high inflation environments in the past, or that some of the products that
have emerged are niche products likely to be of interest mainly to more
sophisticated consumers. On the other hand, in a low inflation environment,
in the absence of sufficient debt funding, and with a growing awareness of
households’ vulnerability to price risks, things might be different.
Relating products to risks
Table 3 takes the product range identified in tables 1 and 2 and sets out how
the mix of risks differs between product types.
The columns refer to the model of ownership implied by each product
group, arranged from left to right according to the size and trend in the
occupier’s equity stake. On the left is outright ownership, in which the
occupier is the whole home owner and therefore carries no credit risk but
assumes all the specific and systemic investment risk on that particular
property. On the right is purchase with a 100% mortgage in which the
owner owns only the title and has no equity stake at all (if for example
repayment was in the form of an interest-only mortgage this would be true
until the mortgage had run its course and the capital repaid from another
investment vehicle). This does not of course imply there is no investment
risk; there is always some risk of negative equity to which the lender is also
exposed. There are four equity share models in the middle of the table. All
of these always assign a share of the property price risk to the occupier (in
the staircasing models this grows over time; otherwise it is fixed at less than
100%); where this is combined with a conventional mortgage, there is credit
risk sharing too, declining to zero once the home is owned outright or settles
into an unmortgaged equity share.
The rows in Table 3 categorise the risks into two groups, based on those
identified above: credit risks which include loss of income, interest rate and
other cost variations and consequential loss of the property; and equity risk
which covers both specific risks associated with the individual property and
volatility across the housing market, as well as liquidity risk which reflects the
difficulties of realising a large, indivisible asset. The cells in the table indicate
Table 3: Linking products to risks
Product/ownership type
Risk type and
levels
Equity
Own
share
outright (staircase)
Equity
share
(long
term)
Equity
share
(staircase)
+ mortgage
Equity
share
(long
term) +
mortgage
Trad­itional
mortgage
(with
100%
deposit)
mortgage
None
None
Some
Some
Much
Credit risk
Income
None
Most
Interest rates
None
None
None
Some
Some
Much
Most
Loss of home
None
None
None
Some
Some
Much
Most
Portfolio
Most
Much
→ most
Much
Some →
most
Some →
much
Least →
most
None
Price/capital
Most
Much
→ most
Much
Some
Some
Least →
most
Least
Liquidity
Some
Much
Most
Much
Most
Some
Some
Equity risk
A role for equity finance in UK housing markets?
18
the level of exposure of the occupying household in each type of ownership
arrangement to each kind of risk.
As far as credit risks are concerned, the trend is easy to see. As we move
from left to right across the table credit risks of all kinds increase from none
(for full ownership and wholly equity financed purchase) to most (with a 100%
mortgage). The precise amount of credit risk and households’ particular
vulnerabilities to it depend on a wide range of contractual details and on
systematic stability or volatility. However, all else being equal, equity finance
helps mitigate credit risks for a household purchasing a property of a given
value. For all purchases requiring a mortgage (the four columns on the right
hand side of the table) credit risks reduce as the traditional mortgage is paid
down, and equity risks increase as capital is injected either routinely as part of
the mortgage contract, or through occasional lump sums (or, for the staircasing
equity share model, as home buyers also staircase up). Liquidity risks are difficult
to assess, since whether and to what extent any of these arrangements are
relatively liquid or not depends on a range of other factors. Physical housing
markets are not very liquid compared to markets for most other things.
In the main the higher the level of debt the riskier the product in terms of
repayments and potential loss of the home while the higher the proportion
of the equity financed by primary owners the higher the equity risk they
face. Adding a third party investor reduces both types of risk in many
circumstances although it can sometimes increase liquidity risks. Of course,
reducing equity risks also means sacrificing financial rewards.
Specific product features address these risks to different degrees. For
instance equity products based on price indices address only market equity
risks while portfolio balancing products help address specific risks. Property
bonds or savings instruments, on the other hand, can allow the investor to
benefit from the returns on a mix of dwellings without living in any of them.
Building from the mix of attributes we have outlined, a new generation
of products is gradually being put in place. These include not only products
enabled by equity finance, but also modified mortgage instruments, savings
products and insurances. The emphasis that each product places on
improving access to owner-occupied housing, managing different types of
risk and increasing the supply of funds also differs. Some are entirely market
based, while others take the form of joint ventures between government
agencies and the market place. None is yet fully operational at scale, or to the
point where secondary markets can readily be developed.
There may be other means of addressing the identified risks either by
modifying the debt financing products or by developing new insurances. In
this context, the government has now put in place a Help to Buy mortgage
guarantee which will offset any losses from high loan-to-value ratios and
so both reduce interest rates and enable households with little equity to
buy their own home. It should be emphasised, however, that none of these
credit risk management products provide any direct means of addressing the
investment risks of owner-occupation.
This chapter of the report has considered how equity finance fares
relative to, and alongside debt finance, in its capacity to share and manage
the mix of credit and price risks build into housing systems centred on
owner-occupation. Obviously the level of risk exposure faced by an individual
household depends on behavioural decisions and regulatory matters, many of
which have still to be resolved. Even so, the indication is that equity finance
could be used not only to mitigate hitherto mainly unmanaged portfolio,
price and liquidity risks in housing markets, but also to mitigate a range of
credit risks more safely than before, especially where mobilising housing
equity directly offers households an alternative to adding to mortgage debt.
Equity finance and risk management
19
3 Retail product
review
In this chapter we provide an overview of the retail
products that have come to market in the UK,
concentrating on those which – amongst other
things – enable owner-occupation of some kind to
be attained, sustained and expanded. In addition we
examine some products which are at an early stage
of development or are available in other countries,
but which may have UK applications in future. We
also include examples of where the various types of
Islamic finance fit into this scheme, as these must all,
by definition, be equity finance initiatives.
Our aim is to assess the potential for these new products to enable owneroccupation, to reduce costs and risks for purchasers, and potentially to help
stabilise the market by adding new funds and addressing more effectively
the investment risks and returns associated with home purchase. There are
different ways we could approach this assessment but we have chosen to
organize the products along a risk-related spectrum which taps into the
different ways in which equity finance enables some risks to be reduced or
shared. The tables in this chapter organise the products covered in this study
according to this principle.4 As we have already made clear risk management
is not the only – and often not the main – reason for developing
these products. In particular many are developed to support access to
homeownership and /or to increase liquidity in the market place. These
issues, however, are discussed in later chapters; here we concentrate on the
products themselves and how they work for consumers.
At one end of the spectrum of risk-management are attempts to use
equity finance to reduce the amount of debt funding required to attain a
given amount of owner-occupation. At the other end are products which
require no conventional debt funding, and rely entirely on equity funding
20
instruments. Most products can be arranged along this spectrum; however,
they fall broadly into two groups, and these are considered in turn.
Products that reduce risks associated with the high loanto-value ratios required for mortgaged owner-occupation
This first group of products is listed in Table 4. These potentially help reduce
the credit (income, interest rate and possession) risks associated with
home purchase (i.e., rows 1-3 in Table 3) generally by providing an equity
injection to reduce the loan-to-value ratio on a conventional mortgage.
For borrowers, this limits the amount of debt-funding required for a given
amount or value of home, potentially mitigating some of the credit risks
associated with unemployment reduced income or other financial disruption.
These products are also convenient for the lending industry at a time when
debt finance is in short supply, as they reduce the amount of credit required
overall.
The first three products listed are all stand alone price-linked savings
accounts or investments, whose returns (in two of the three cases) are based
on trends in house prices rather than interest rates. They thus provide for a
larger deposit and in two cases protect savings against house price increases.
These are not new financial products for the UK. However, the current
generation of HPI linked investment vehicles contains more variety (offering
more of the gain, for example, in return for some exposure to capital loss).
They also benefit from the possibility of including the first tranche of
investment in a given tax year in an ISA wrapper, so that – just as if the funds
were held directly in owner-occupation – the returns are tax free. This is
explicitly built into the HouSAs offered by Castle Trust. Any of these houseprice-linked investment vehicles could be used as an alternative to owneroccupation (appealing to those whose primary motivation for ownership
is financial return), and certainly as a savings gateway to ownership, an
alternative to Buy to Let.
Mill Group’s ‘Investors in Housing’ initiative is explicitly designed to
reduce the deposit requirement, even though the investment is long dated
with returns linked to the retail price index. Hearthstone’s UK residential
property fund helps first time buyers build a deposit that keeps pace with
rental property returns, and is accessible when needed. There is no downside
protection on either of these. Castle Trust’s HouSAs are linked to, and
guaranteed to outperform, the national Halifax House Price Index, and does
have downside protection. All these products are offered as a way of saving
for a deposit or to provide an equity injection to help a move upmarket.
Access to these three products is not conditional on house purchase.
Nevertheless, the Hearthstone and Castle Trust products both (arguably)
match savings against the performance of the housing market, and in some
regions at least may reduce the urgency that young households feel to get
onto the housing ladder (or to conform to the British norm of ‘buy early, pay
high’), whilst allowing lower loan-to-value mortgages when that time does
come. On the other hand, there is no requirement to use them to keep loanto-value ratios low; they could simply provide a larger stake for a more costly
home and a higher mortgage.
The four products in the next section of the table are explicitly developed
to ease access to owner-occupation and are formally linked to particular
mortgage deals. The first – the Nationwide’s ‘Save-to-Buy’ savings account
– is simply a device to demonstrate to the lender that the borrower can
make regular payments (in this case towards a deposit), at a level that is
Retail product review
21
A role for equity finance in UK housing markets?
22
iii) Risk insurance
Safer Mortgage Initiative
Quantum
Alpha
Hitachi
Capital (UK)
PLC
A proposed ownerProtects both the lender and the
occupier mortgage of
consumer against negative equity and
between 75% and 95%
the risk of possession
LTV with negative equity
insurance sold to the
lender
With parental support, households
can buy a new Barratt home with a 5%
deposit and an 80% LTV mortgage
5%/buyers savings, plus
15% deposit borrowed
commercially by parents
Note that with ‘local’ lend a hand,
the ‘helper’ is one of over
30 local authorities
Loan to parents with income
but no capital (linked to high
street loan on Barratt new
build)
5%/ buyers savings,
With extended family savings as
guarantee, households can buy with
plus 10% deposited
95% LTV mortgage
by extended family as
guarantee for three years
Requires buyer to demonstrate ability to
save fixed amounts regularly over 6 or
12 months
At least 5%/buyers
With helper savings as guarantee,
savings plus up to 20%
households can buy with 95% LTV
deposited by ‘helper’
mortgage
(totalling 25%) as
guarantee for 42 months
Barclays
5%/buyers savings
Lend a Hand savings account
Lloyds/TSB
(tied to Lend a Hand mortgage);
Family Springboard mortgage
ii) Mortgage-linked savings gateways
Save-to-Buy savings account
Nationwide
(available with ISA allowance)
(linked to save-to-buy mortgage)
Variable (according to
As above, returns linked to Halifax
house-price index, can be assigned to
lender and loan type)/
buyers’ savings (including children
HouSA funds from parents)
Priced by post-code and LTV,
independent of traditional
affordability requirements
and borrower type
Presumed gift (any
repayment is a private
negotiation)
Presumed gift (of difference
between interest paid by
Lloyds Banking Group/
interest on higher yield
account; or cost of payments
if mortgagor defaults)
Presumed gift (of difference
between interest paid by
Barclays/interest on higher
yield account; or cost of pay­
ments if mortgagor defaults)
Difference between this and
higher interest-rate savings
option
No charges
Not clear
A higher LTV mortgage which is
expected to be priced at between
20 and 40 basis points over standard
mortgages – which may be assumed
by lender. Price will be less if capital
relief available
12-year unsecured fixed rate (5.4%)
parental loan (high street lenders),
up to £50k to form a 15% deposit;
80% LTV mortgage
The borrower holds a 95% LTV
mortgage (with preferential interest
rate as if 75% LTV), fixed for 3 years,
variable rate thereafter
The mortgagor holds a 95% LTV
mortgage, fixed for 3 years, variable
rate thereafter
Qualifies saver for Save-to-Buy
mortgage at 95% LTV
Reduces need to borrow for deposit;
could reduce LTV overall
Castle Trust
(HouSAs)
A savings gateway to ownership:
some protection for savings against
house price inflation; returns linked to
performance of rental property fund
HouSA (residential property
price-index linked savings
vehicles, using ISA allowances
as appropriate)
Variable (according to
lender and loan type)/
buyers’ savings
Reduces need to borrow for deposit;
could reduce LTV overall
Role of debt finance
Hearthstone
Price to consumer
Residential property fund
investments
Equity stake/stakeholder Attributes of product
Reduces need to borrow for deposit;
could reduce LTV overall
Provider
i) Stand-alone savings vehicles designed (in part) as savings gateway to ownership and reduce LTVs
Investors in Homes
Mill Group
Variable from 5%/buyers’ Long-dated RPI-linked income via
Not yet clear
Co‑investment
savings
professionally managed residential assets
(potential alternative to ‘buy-to-let’)
Product name
Table 4: Products that help reduce credit risk
sufficient to justify a 95% mortgage. It is effectively a payment risk-screening
device helping the lender to assess the borrower’s credit record (as well as
facilitating a somewhat bigger deposit).
A rather different credit-risk management strategy for equally high LTVs
is Barclays’ ‘Family Springboard’ mortgage which is granted on the condition
that the borrowers’ extended family deposits 10% of the value of the
property in a savings account which is ‘locked’ for three years, and used by
the lender to meet any missed mortgage payments. The Lloyds/TSB Lend-aHand savings account is similar, though this requires a larger balance – 20%
– to be deposited by up to two ‘helpers’ (not necessarily family), which could
include a local authority. With a 5% borrower deposit, and this substantial
guarantee, the loan is charged as if it were a 75% LTV risk, reducing costs to
the buyer without adding credit risk to the lender.
The last product in this group, offered by Hitachi, extends the concept by
providing unsecured loans to parents with income but no capital, to serve
as a lump sum deposit. This device (which diverts credit risk away from both
lender and purchaser, and thus has a risk-sharing role) is repaid at a fixed rate
over 12 years.
The last section of the table profiles negative equity insurance, one of a
suite of home equity insurance products that could be engineered using the
financial instruments required to develop the equity finance market. Negative
equity insurance, however, is the only one close to market in the UK through
Quantum Alpha. In a similar manner to the Help to Buy mortgage guarantee
scheme, Negative equity insurance will be sold to the lenders who will then
create a “Safer Mortgage”. This offers protection against local house price
volatility, for buyers whose mortgages have LTVs ranging between 75% and
95%, and who wish to move home. The lender can also use the insurance to
extend forbearance and avoid possession. This product is presented as an
instrument that protects both lenders and borrowers, that could have the
government acting as a reinsurer of last resort, and might, at scale, have a
stabilising effect on housing markets and the wider economy.
Products which reduce the costs and risks of holding
housing assets
There are three product groups designed to reduce the costs and risks of
attaining and sustaining owner-occupation. These are summarized in Table 5
under the headings ‘Shared ownership’, ‘Equity share’ and ‘Home purchase
plans’. All aim to reduce the costs and risks associated with the common
tendency (or need) among owner-occupiers to holding the majority of their
wealth in a single owner home.
Shared ownership
Shared ownership is a method of reducing the costs (and therefore the
equity risk) of owner-occupation to households, by dividing the title
between the home occupier and other investors. This part-own, part-rent
arrangement was developed to help households to access homeownership
rather than to reduce risks. The vast majority of examples of shared
ownership have been government sponsored starting from a national
programme in 1980, and even earlier at local level. This model is based on
the presumption that the costs (and credit-rating requirements) of servicing
a small mortgage and paying a proportionate rent are less than the costs of
whole ownership. The fortunes of shared ownership have been fully reviewed
elsewhere: Yates (1992), Whitehead and Yates (2010a) and Whitehead
Retail product review
23
A role for equity finance in UK housing markets?
24
Provider
Equity stake/shareholder
Product attribute
Price to consumer
Role of debt finance
i) Shared ownership (SO): split title and part-rent
These schemes are mainly provided by Housing Associations to enable households unable to afford a mortgage for whole home ownership. They usually require debt finance (for the
occupying leaseholder share, which ranges from 25%–75%) and a payment of a rental stream (to the lessor who is the landlord). Private sector innovations include the following.
Assettrust
25%/purchase price of gifted Allows social renters with employment to Valuation fees refunded, legal
OwnYourHome mortgage
OwnYourHome
to buyer as a deposit from buy 30%–60% of their existing home
costs can be added to mortgage
(75% LTV on occupier share
social landlord to sitting tenant
of property) from Halifax
Musharaka shared Various Islamic/Sharia
Up to 90%/product provider, Shared ownership at outset; rental component Cost of rent (in proportion to
No mortgage allowed
purchase
compliant product providers joint purchase with occupier and gradual ‘staircasing’ to 100%
share rented) and share purchase
Co-investment
Mill Group
Up to 95%/investor
Households with small deposit buy as
Arrangement fee (£495) and monthly No mortgage required (but
‘co‑investment charge’, linked
occupier could later use a
Residential
‘tenant in common’ on a ‘part buy, part
rent’ arrangement with specified share of (and regularly adjusted) to share
mortgage to buy out the
ownership, costs, responsibilities and rights of property owned by co-investor, co‑investor)
(potentially increasing as occupier stake grows) but based on RPI (not HPI)
ii) Equity finance for whole home ownership: reduce costs to occupier without splitting title
Conventional mortgage up
No fees on equity injection for
Help to Buy
Government supported.
20%/Government
Reduces deposit requirement; to a
to 75% LTV
minimum of 5%, shares equity risk between five years, then 1.75% on the
Must be new build;
outstanding loan. increasing each
government and owner in 20% 80%
eligibility restrictions on
year by RPI plus 1%
home value
proportions
Partnership
Castle Trust
20%/Castle Trust (plus 20% Method of sharing capital risks and returns No monthly charge for equity stake; Conventional (capital and
mortgage
owner buyer – 10% for first of owner-occupation, enabling portfolio
return of equity investment plus
interest) mortgage for 60%
time buyers), fixed until settled balancing
40% of price appreciation on sale LTV
Adjustable/perpetual None in UK but could be Varies with market
A new style of mortgage contract adjusting Not yet specified
All based on debt finance
balance mortgages developed
to price (and potentially other) risks in
but with payment
with investment and
housing markets
adjustments in relation to
other risk sharing
capital values
Murabaha home
Various Islamic/Sharia
c.65%/bank
Bank buys property, sells it to occupier for Difference between banks
No mortgage allowed
purchase
compliant product
profit, cost to household spread over fixed purchase and selling price
providers. None in UK but
period
could be developed
iii) Home purchase plans
Genie home
Gentoo (for new build
100%/Gentoo (reducing
Households with no deposit can buy 100% £600 + VAT setup fee. Monthly
No mortgage required
purchase plan
initially)
annually over 25 years as
share over 25 years; buyer is leaseholder.
residence fee, increases by 3% pa, (but occupier could later
occupier share increases)
Aims to combine flexibility of rental with
and is adjusted every 5 years (plus use a mortgage to buy
long term security of ownership.
a service charge for flats).
provider out)
Ijara Home
Various Islamic/Sharia
Up to 100%/Islamic financial Households are leaseholders who can buy
No mortgage allowed
Purchase Plan
compliant product
product provider (stake reduces 100% share over 25 years
(lease to own)
providers
annually over agreed period
as occupier share increases)
Product name
Table 5: Products that help reduce equity risks
(2010) detail the nature of these products and the role that they have
played in accessing homeownership. Shared ownership provision remains
concentrated in the social sector, mainly because of the complexities of joint
ownership, as well as the lack of liquidity of each share and limited appeal to
investors and lenders alike. Shared ownership is not the primary focus this
report, however three points are worth noting.
First, the private sector is now showing renewed interest in this model, at
least in particular market niches. The Assettrust initiative OwnYourHome, for
example, recognises the potential to build on, and extract financial benefits
from, a process of tenure conversion, utilising the Right to Buy discount to
offer social tenants in employment a 30–60% share in their current home.
Second, shared ownership could in principle take a Sharia-compliant
form, offering a method of whole home purchase, with a small (perhaps 10%)
deposit, without an interest bearing loan (which is critical in Islamic finance).
This ‘Musharaka’ (or declining balance co-ownership) style of Islamic housing
finance presumes ‘continuous’ staircasing up (and progressive reduction of
rental payment component) towards 100% ownership over the life of the
agreement.
Third, The Mill Group’s Co-investment Residential model involves the
investor and occupying partner jointly purchasing a property, and sharing
the costs of this as ‘tenants in common’. Each holds an agreed share of the
property (the purchaser must buy a minimum 5% share of the home), and
this can be adjusted over time. The occupier must also pay a co-investment
charge on the portion they do not own. In this version (unlike the Shariacompliant products) it is assumed that the purchaser starts without a
mortgage but might use mortgage finance at any time to buy out the
investor partner using debt finance.
Equity share
In its purest form this is the model we set out to review, and it is striking
how few working schemes there are in the UK (or indeed elsewhere). The
distinctive feature here is that the title is not split (so the occupying partner
has the rights and responsibilities of whole ownership) and that the investor
partner bears the risks associated with their proportion of the equity.
Early examples of shared equity were also government sponsored,
starting in the late 1990s in the UK and very much earlier in Australia (Yates,
1992). Since the turn of the century many of these have involved a mix of
equity funding from government and developers in order to support not only
first time buyers but also the new housing market. During downturns in the
housing market there have also been examples of developer led products
(Burgess et al., 2007; Whitehead and Yates, 2010a).
Government initiatives started with Home Buy in 1999 and have
threaded through many different products, latterly FirstBuy and now Help
to Buy5. Earlier products aimed at providing support for both first time and
move on buyers who were thus able to access a wider range of products.
Latterly they have been used mainly to support first time buyers and to help
developers.
First Buy, available until April 2013, was available only to first time buyers
and was means tested and limited to homes with a value of up to £250,000.
It involved an equity injection of 20% of the purchase price with half of
this from the developer, half from the government. The latest version of
equity share, included in the Help to Buy package, is more broadly based –
it remains only available on new property but the property value has been
increased to £600,000 and the income limit has been removed. Moreover
the 20% equity stake, still free for the first five years, comes entirely from
Retail product review
25
the government. It is clear that this product’s primary objective is to kickstart
demand for new dwellings and is a bridge to ‘business as usual’, in which
‘whole home ownership’ remains the norm. Even so, this kind of product
could be key to a new way of thinking about, and funding, owner-occupation.
The one extant equity share initiative that aims for the middle of the
market – Castle Trust’s Partnership Mortgage – is presented, priced and
managed very differently. This is a way of financing primarily second hand
homes and requires a 20% buyer deposit (although only 10% deposit is
required for first time buyers). With a further 20% injection from the investor
partner, this is presented as a portfolio-balancing product for the risk-averse,
and is perhaps the only product on the market which offers owner-occupiers
with capital an opportunity to diversify their otherwise housing-centred
wealth holdings. This portfolio-diversification aim may, however, be reduced
by the exclusion of the over-60s – part of the age-group perhaps most
inclined towards it. And, of course, this style of equity finance can also be
used to buy more housing services for the same regular outlays, or to raise
cash for consumption. So whether and to what extent the initiative succeeds
in mitigating housing investment risks is an empirical matter.
Unlike the government sponsored products whose objective was to help
marginal purchasers, in the Partnership Mortgage, credit risks (as well as
the risks of negative equity) are managed by limiting debt finance to 60%
of the purchase price. Additionally, the investor partner insulates home
occupiers from 20% of any price decline between purchase and sale based on
a regional index. The investor also defers investment returns until sale (thus
avoiding the annual charges levied by the government schemes), when they
secure a 40% share of any price increase. This 20:40 ratio of investment to
return obtains for all house prices and irrespective of the length of time the
loan is held or the property occupied. The split is simple and transparent,
which adds to the product’s legibility. It is also in line with the split that
Miles (2012) argues theoretically might be required to support this type of
product. Of course, just as with government-sponsored products, and indeed
with any co-investment model, the repayment due depends on the resale
price of the property. This, in turn, depends on the ups and downs of the
market and could be higher (or lower) than households expect.
In fact, proposals for equity finance prefer to use instruments that
continuously adjust balances. Miles (2012), for example, argues not only that
it is possible for home buyers to sell all the downside risk of their housing
investment, and for providers to insure the entire risk of buying it, but also
that it is possible to price a continuous range of risk-trading arrangements,
whereby households give up a proportion of future price appreciation in
return for protection from possible falls in future values.
Just one row in Table 4 signals the position of these continuously riskadjusting products might occupy. There are none on, or near, the market
in the UK today. They have been largely developed with the USA market in
mind, although their potential has been considered in other countries. The
Zurich Cantonal Bank, for example, has developed a mortgage for whole
home purchase in the Swiss market, where repayments are continuously
adjusted to local home prices instead of (or in hybrid with) interest rates (Syz
et al. 2006).
Much of the interest nevertheless remains academic, and largely in
the hands of American scholars who have considered products which
automatically assign the contract provider (the lender) a substantial
proportion of the house price risk in the market. Shiller (2008, 2009), and
Shiller et al. (2011) for example proposed the continuous workout mortgage
(CWM) which adjusts to a local home price index. This has so far mainly been
A role for equity finance in UK housing markets?
26
presented as a means of managing the risk of negative equity (the primary
trigger for default), by continuously adjusting payments (as well as assets
and debts) so that mortgage balances are always lower than, or equal to,
the current value of the property. In this context, Shiller et al. (2011) argue
that CWMs have a role in improving the resilience of the financial system,
mitigating systemic risk, and enhancing quality of life. Ambrose and Buttimer
(2012) have also designed an adjustable balance mortgage (ABM) to reduce
the risk of negative equity (and the foreclosures that can trigger) which
works because it effectively includes an equity loan mechanism. It is inspired
by the Danish ‘mark to market’ or ‘buy your own’ mortgage contract, which
allows borrowers who benefit from generous tax treatment, to prepay at the
mortgage market value ‘today’ rather than at the value of the outstanding
loan.
Underlying these examples is a set of equity finance principles which is
concerned with an efficient allocation of the risks of buying, holding and
selling residential property between households and institutions. An overview
of what might be achieved in terms of contractual features, and indeed policy
goals, if products like these proved workable, possible to price and amenable
to wider adoption is set out in Smith (2010, 2012). Arguably such products
could aid neighbourhood regeneration, promote labour market mobility and
enable people to spend more safely from housing wealth, at times of financial
stress.
The majority of equity finance initiatives are, in practice, a mix of equity
and debt finance. They spread or reduce some risks by including an equity
finance component which transfers some capital risks to an investor partner
and reduces payments. However some work without debt. In particular under
the Sharia-compliant Murabaha home purchase arrangements the bank buys
the property outright, and immediately sells it back (with a mark-up and
costs added) with instalments spread over a fixed period. These products are
not generally available in the UK.
Home purchase plans
Home purchase plans are essentially rent-to-buy schemes that have no split
title and no element of debt finance. Instead purchasers pay a form of rent
which covers occupation costs and allows capital injection and accumulation.
These plans can have attributes in common with the Sharia-compliant
products discussed above. The occupier is legally a leaseholder (though
otherwise bears the rights and responsibilities of ownership) unless and until
the property is wholly acquired through incremental payments. One such
product is on the market, Gentoo’s Genie Home Purchase Plan6. This spreads
payments over 25 years, if the aim is whole home purchase. A residence
charge is applied on the un-owned share (adjusted five-yearly, but increasing
annually at 3%). This eliminates credit risks for the home occupier, unless
they default when interest accrues on missed payments. Home occupiers
have no claim on the property title until they have acquired a 100% stake.
They do, however, reap the returns (or bear the loss) on the share they
own at the point when the property sells. This arrangement is similar to the
Sharia-compliant Ijara Home Purchase plan.
The question of scale
A key question driving the research for this report is whether any of these
products has scope to operate at scale across the housing market. Part
of the answer has to do with funding, and this is taken up in Chapter 4.
Retail product review
27
However, it is worth considering here whether the motivation for developing
the products, the characteristics of the products, and the views of product
providers set the scene for any wider roll out should funding permit.
Some of the reviewed products are designed only or primarily to enhance
affordability at the margins. They are about financial inclusion rather than
whole housing market solutions and are not intended to operate at scale.
Indeed, they are often, as in the case of most HomeBuy products, meanstested to ensure they target those at the edges of ownership. Nevertheless,
as we shall see later, many of these can be seen as ways of substituting for
private debt finance, especially those (the majority) that are government or
developer sponsored and they do at least enable debt finance to go further
at a time when it is in overall short supply. So even these do have whole
housing market implications.
More generally, new products occupy niche markets which, while
currently small, could potentially expand. Gentoo’s home purchase plan is
perhaps at one extreme here, nestling at the edges of ownership in a single
UK region with a very small starting pool of properties (<100). Its wider
customer base is renters and first time buyers, however, and even from a
modest start, the aim is to scale up to about £150m worth of business in
the long run. Perhaps at the other extreme is OwnYourHome, the Assettrust
mortgage product which is looking to sweep a significant proportion of the
remaining social rented stock into shared ownership, and could create nearly
a million (900,000) new home buyers were it to succeed. It sits alongside Mill
Group’s co-investment products which are aiming at the edges of ownership
but could, if the model of joint purchase becomes widely appealing, also pick
up the second-hand market. So, if the market for first time buyer lending is
around £20–30 billion per annum, Mill suggests there may be the potential
for its model of co-investment to take 50% of the market and perhaps
achieve volumes of £10bn per annum.
The issue here is the source of funding in each case. Assettrust is looking
to bring in investors with a product linked to property prices; Gentoo will
use their access to debt finance as a housing association; while Mill intends
to tap the wholesale market. None has yet done so. The scale of products
in the mainstream such as Castle Trust’s partnership mortgage (which
could potentially roll out very widely), as well as some Islamic housing
finance schemes, equally depend not just on consumer demand and market
recognition but on raising equity finance in one way or another. This is the
subject of Chapter 4.
Conclusions
In this chapter we have reviewed two groups of products designed to
reduce the risks of owner-occupation. These are set out in tables 4 and 5
respectively.
The first group (in Table 4) mainly addresses credit risks by offering
various ways of bringing in equity injections or guarantees from the primary
purchasers, their family or others, into home purchase. This has the effect
of reducing both the costs of accessing owner-occupation and the risks
associated with high loan-to-value ratios. There are three clusters of
products in this first grouping.
One is a cluster of stand alone savings vehicles which may, if rolled into
a deposit, be used to reduce credit requirements (and risks) and mitigate
against negative equity in the event of price volatility. The returns on these
investments are linked not to interest rates but to various other indicators:
A role for equity finance in UK housing markets?
28
the retail price index, the performance of residential property funds, and the
performance of a national house price index. All of these offer some prospect
of savings keeping pace with house prices. The next cluster comprises savings
products which are formally linked to mortgage deals. These have much the
same aims of accessibility and affordability in mind, but include a requirement
that the savings and investments are rolled into home purchase. While none
of the products in either of these clusters reduces equity risk directly (and
are not designed to do so), they do address some credit risks and make debt
finance go further. The third cluster represents products which, arguably, do
not fit easily into either of the main product tables. For instance, negative
equity insurance reduces both credit and liquidity risk but is most directly
reduces equity risk.
The second group of products (in Table 5) bring equity finance in to the
home purchase equation more directly; they are products for home purchase
in which equity investment risks, which are traditionally borne by households
(and de facto by lenders who use them as security in the event of default),
are formally shared with other investors. Again there are three clusters of
products in the table: shared ownership where the title is split; equity share
which gives full formal ownership to the primary purchaser but includes
a contract which assigns a proportion of the price risk and return to the
investor partner; and home purchase plans in which the title lies with the
investor partner until purchase is complete.
If we consider that shared ownership is a ‘traditional’ style of equity
finance which has been in play for some time, and home purchase plans are
an elaboration of the reasonably-established rent-to-buy model, then it
is striking that equity share – the innovation we set out to document – is
limited to government schemes on the margin and to just one operational
middle market product. Internationally there are similarly few working
examples of equity finance (for any of the reviewed product ranges), even in
the USA where academic commentators have pressed for such products for
decades (but see Temkin et al. 2013).
This dearth of equity sharing models is one of the striking conclusions
from the product review; another is that none of the products inspired by
equity finance has gained a great deal of traction to date. One reason for this
may be that the role played by governments in supporting traditional debt
financing models leaves little room for equity-based innovation (a point we
return to later). It may equally reflect the power of inertia – equity finance
implies, in the end, a new style of mortgage contract, and it is costly, timeconsuming and risky to engage in real innovation when other routes are
available. It might suggest that equity finance is not as efficient as it looks in
principle raising issues of market failure and transactions costs (Whitehead
and Yates, 2010a). It may further be that the institutional framework
set by government and regulator does not leave adequate room for the
development of such products. Finally, it is possible that the problem is one
of liquidity; that funding for equity finance is the heart of the matter, and is
not seen as mainstream by potential providers. All these points are taken up
in the next two chapters. The question of funding is the one we turn to next.
Retail product review
29
4 Funding for
equity finance
A key question surrounding equity finance for
housing is whether it can attract additional funding
to help support the owner-occupied market. There
is also the question of who will provide such finance,
especially given current funding shortages. While
governments have hitherto placed most emphasis
on restoring business as usual in debt-funding, this
chapter considers the options for adding to the
overall level of funding for home purchase through
equity finance. We consider in turn the various
funding mechanisms in play, and assess their various
pitfalls and potential.
One option is to enable potential purchasers to accumulate their own
equity stake to bring to the market – to some extent this is addressed
in the saving products in Table 4. The impact of this is both to reduce
reliance on debt funding and potentially to provide a funding stream for
home purchase products. Another possibility is to attract third party equity
investors, particularly institutions who are currently under-represented in
residential property, to acquire various kinds of equity share. This creates an
investor-retail product link, which can be operated directly or, as we shall see,
indirectly by way of new financial instruments.
Running through all these is the possibility of using equity finance to
reduce the risks faced by institutions and lenders who provide debt finance,
thus increasing funding for housing finance overall. All these options
potentially provide additional financial capacity at the same time as improving
affordability. They also modify risks in different ways, and this in turn may
result in the development of further instruments to reduce the risks of both
purchasers and institutions e.g. through guarantees and insurance.
30
Householder equity injections
In practice, and ironically given all the talk of new instruments, the most
important form of equity funding has been the increasing incidence of cash
purchases. Figure 1 shows that for a short period cash buyers were actually
in the majority of transactions and still account for close on 40% of sales.
In cash transactions, the buyer incurs no direct credit risks but bears the
entirety of the price risks associated with specific dwellings and with market
volatility. In one way this is the purest – and most traditional – form of equity
finance; though as far as investment risks is concerned, it is potentially also
the most precarious.
Some of the reviewed products actively encourage home occupiers to
maximize their equity stake, and thus reduce their dependence on debt
finance. These are usually designed primarily to enhance housing affordability
at the margins and are not intended as whole housing market solutions, or to
operate at scale. Even so, they bring in the household’s own equity through
their deposits and repayment of debt. In the long run, when successful, they
also meet objectives of full ownership and lower housing costs in old age.
To the extent that they are government or developer sponsored they are
also important in providing a substitute for private debt finance. As the only
truly functional examples that are accepted in the market they are perhaps
underestimated as a means of enabling debt finance to go further and to
meet broader objectives. However at the present time little work has been
done on how to manage simultaneously both credit and equity risk more
effectively (Whitehead, 2010).
One product that is directly aiming to address the funding issue by taking
this a step further is Assettrust’s OwnYourOwnHome mortgage. Here
owners’ equity stakes are maximized by a ‘gift’ from the social landlord to
a sitting tenant – a discount that again reduces reliance on debt finance in
a product that could achieve substantial scale. The question of scale for all
Figure 1: The role of cash buyers 2005 to 2012
100
90
80
% of total transactions
70
60
Mortgages
Cash buyers
50
Cash buyer average rate
Post-financial crises
40
30
Pre-financial crises
20
10
0
2005
2006
2007
2008
2009
2010
2011
2012
Sources: Bank of England, HMRC, RICS calculations
Funding for equity finance
31
the equity finance products reviewed in this report depends, however, on
raising equity finance from a market that goes beyond individual households’
balance sheets. These markets have become used to delivering debt finance,
and with this flow of funds in partial disarray, the main de facto concern for
governments and banks has been to restore liquidity in the supply of credit.
The Bank of England’s Funding for Lending scheme is one such initiative.
However, there might equally be merit in exploring the possibilities for
creating liquidity in areas of the market suited to delivering equity finance.
The remainder of this chapter therefore considers the options for funding
innovations in equity finance for housing.
Government loans, subsidies and advocacy
Because the market is not used to delivering equity finance, the set-up costs
can be very high. It is therefore not surprising that most of the initiatives
have come from the state.
Government has supported equity finance products directly, either alone,
or in partnership with developers or financial institutions (as with HomeBuy
Direct and First Buy, where the equity injection and investment return was
shared equally by the state and the market). If Miles’ (2012) argument – that
these types of mortgage reduce leverage and therefore reduce the incentive
for consumers to overstretch themselves in terms of debt – is accepted,
this would provide an additional reason for governments to support marketbased demonstration projects.
There are other ways that public subsidy could be used to support
innovations in equity finance to address a range of problems. Wallace and
Ford (2010) for instance suggest that one way for the government to
support mortgagors in arrears would be to replace direct subsidies such as
Support for Mortgage Interest with the planned purchase of a proportion of
future price gains, thus regarding such measures as investments rather than
costs. Calls have also been made on government recently to act as reinsurer
for the launch of a negative equity insurance scheme, on the grounds that
it would be a low risk method of restoring a more affordable, less volatile
housing market, thereby adding stability to the wider economy.
For equity finance to roll far beyond the margins of owner-occupation
it will be necessary to look to market solutions, and the majority of the
products reviewed in Chapter 3 presume this will happen. Some of the
product providers interviewed for this study argued, nevertheless, that
government could support this roll-out not only through seed funding
and leadership but also through advocacy. New products are hard to bring
to market and government interest and, as appropriate, enthusiasm is an
important way of supporting nascent markets to gain traction. Some of the
other elements required to support such roll-out are considered next, as we
review in turn, three market-led approaches to funding for equity finance.
Market funding: retail-to-retail
An intuitively appealing way of securing market funds for equity finance for
home purchase is to look to home equity-linked savings. The investment
risks to equity finance providers (who are de facto increasing their exposure
to house price volatility) could be offset for a single institution if it also
offered an investment vehicle linked to the fortunes of the housing market.
This potentially provides a source of funds for the former just as deposits
A role for equity finance in UK housing markets?
32
funded lending in traditional mortgage markets. To that end – to build a
sustainable retail-to-retail funding circuit – both Castle Trust in the UK,
and the Zurich Cantonal Bank in Switzerland, have proposed establishing,
alongside their equity loan books, a suite of savings products whose returns
are linked to indices of home price appreciation (Syz 2010).
House price-index-linked savings and investment products may appeal
for several reasons. Notably, they provide an opportunity for savers to accrue
funds that provide access to the fortunes of the housing market without
acquiring the specific risks, costs and responsibilities associated with buying
and holding a particular property. Additionally, there might be tax efficiencies.
The Castle Trust savings product for example is offered as an ISA which
delivers a tax-free return in the same way as would investment into a primary
residence (though the HouSA is subject to the same investment limit as any
other ISA). SIPPS also, at least in principle, have the potential to provide a
tax-efficient wrapper for those who would like to invest in a property index
based product. Property bonds also provide access to the market for tenants
and owners who wish to diversify within the housing element of their
portfolio. If successful, house-price-linked savings and investment vehicles
(including residential property funds and bonds) could provide a pool of funds
suitable as a supply of equity finance for home purchase.
Whether savings linked to fluctuations in a national house price index can
be a source by which safely and effectively to settle equity loans on individual
properties (as in the Castle Trust model) is a different question. At scale, and
assuming that adverse selection is eliminated by tight eligibility controls,
and moral hazard reduced by the occupier holding the larger equity share,
the match should be close. In the meantime, the challenge is to balance
the geography of the lending undertaken to the movements in the Halifax
house price index to which the savings products are benchmarked. The initial
mismatch needs capital from a professional investor (in the case of Castle
Trust, it is JC Flowers, a private equity company; more generally it is a role
suited to private equity professionals).
Were the market to become more mature the equity finance and savings
products could, of course, be offered by separate providers.
Market funding: institutional investor-to-retail
The ‘success’ of equity finance – the possibility to offer a wider range of
products and build scale in the market – hinges on attracting institutional
investors into an asset class that has, hitherto, only been available in an
unappealing (physical) form. Synthetic markets (which are divisible, have
few holding costs and typically lower transactions costs) are more attractive
than physical property investments to most institutional investors, but such
markets are in their infancy and are small (and retail-sector orientated).
What institutional investors need, above all, however, is scale and liquidity.
Without them it is hard to envisage wider roll-out of either shared
ownership or equity share. Current shared ownership books are of low value
and difficult to trade. The question is how to change this, whilst recognizing
that institutional investors think very differently from consumers, so there
may be difficulty in building markets to meet their needs whilst also building
the foundations for a suite of equity finance products that are appealing to
households.
There is certainly a view from the market that there are institutions eager
to invest in residential property price linked instruments on a large scale if
a catalyst were to emerge. But much of that interest is, arguably, in relation
Funding for equity finance
33
to the private rented sector rather than the residential property pricelinked products under discussion here. This cautious but important increase
in institutional interest in investing in the private rented market is in part
a product of modest returns elsewhere but it is also a consequence of the
argument that a modest residential investment portfolio would be profitable,
not least during a period when debt finance is hard to come by. Government
support for Build to Rent is seen as one way forward in this context.
There are also currently a number of attempts to bring large scale
institutional investors into the world of equity finance (broadly conceived).
Hearthstone, Assettrust and Mill Group are all looking to large investors
to buy into their residential property funds for example. We also have the
recent example of M&G Investments buying a portfolio of 400 rented homes
from a housing association, although the direct effect of this is to increase
funding availability for social housing rather than funding the private sector.
Like M&G, Hearthstone’s main role is as a property investment fund
based on rental holdings rather than to support equity funding for home
ownership. Perhaps more directly relevant to the main thrust of this report
is Assettrust’s work to create a secondary market in shared ownership
shares. It has been buying up portfolios from housebuilders and housing
associations at a modest discount. This then generates a profit topped up by
HPI when those homes are finally sold out to outright ownership. As noted
earlier, Assettrust is currently piloting OwnYourHome, a voluntary tenureconversion programme for working households in social rented properties
to sit alongside the existing government Right to Buy programme. Assettrust
estimate it might allow up to 900,000 households to buy their homes and
release sufficient capital to deliver 1 new home for each home converted
(based on the embedded grant, if any, being retained by the Housing
Association to be recycled). In essence the differential between historical cost
and grant and current open market value drives the transaction allowing the
tenant to get a 25% discount which then forms the basis for a deposit and
qualifies the resident to get a linked Halifax mortgage. Any unsold share is
sold to the Assettrust Housing Association allowing that organization to build
up a portfolio of shared ownership homes.
Mill Group are looking to investors to place £10m–£100m into a
property fund which Mill will develop. The fund will help purchase homes via
co-investment with would-be owners. Mill estimate that most co-investors
will stay with the fund but 10% might sell shares back and 10% would buy out
the fund. A cost of occupation charge is levied and this is linked to RPI so that
it matches the asset/liability profile of investors. There is no maturity date
and investors are able to say when they want cash back.
Market funding: financial innovation
There is at least in principle a further option for funding equity finance at
scale and that is through the use of financial instruments settled on house
price indexes, i.e., in the form of synthetic markets. Financial derivatives
proved problematic in the unregulated financial and mortgage markets of
the early twentieth century, especially those built around mortgage debt.
But whether the problem stems from using tradable contracts or from the
unregulated environment in which they were licensed and used is unclear
(Smith 2013). Since there is a well-developed economic argument in favour
of trading contracts linked to house prices in the wider literature, and a claim
that these instruments are more suited than debt-linked instruments to
meeting households’ needs, it is at least worth considering their applicability
A role for equity finance in UK housing markets?
34
to the UK’s evolving system of housing finance. More details are set out
in the collection edited by Smith and Searle (2010), where the case is
made that sharing the risks and rewards of housing investments more
widely benefits households on the margins as well as in the mainstream of
ownership.
Financial derivatives – independently tradable contracts linked to the
movement in indexed asset and other prices – is an option whose credibility
has been severely undermined by the credit crisis and by the lack of progress
in other countries. However the mistakes associated with the development of
loosely regulated opaque credit derivatives do not mean that, in principle, a
simple, transparent and properly regulated synthetic market for home prices
could not succeed (as discussed in Smith 2009). So although derivatives
inspired solutions are a long way from practical reality there is an argument
that such instruments, properly managed, can make for greater transparency,
improve risk awareness and help to develop a robust measure of price
discovery – as well as enable more players to have a stake in the residential
property market.
Conclusions
At the present time, the vast majority of equity funding is provided with the
support of government. Arguably some government debt finance initiatives
may provide some of the benefits of equity finance discussed here, usually
through guarantees. However, without equity finance a range of risks
in housing markets will always remain unmanaged. Some of the private
initiatives could bring in funding at scale, given the fundamental demand for
portfolio development. Here the main competitor is private renting where
the markets, while currently limited, are more mainstream – and functional
in other countries. Notably institutional investors can own a portfolio which
spreads risks, without directly incurring management costs. This does not
exclude the possibility that they may also wish to invest in owner-occupation.
The most important private funding stream currently is probably through
the development of retail savings products which can then be used to fund
retail shared equity purchasers. However some larger scale possibilities still
relate to government sponsored products through for instance the extension
of shared ownership into Right to Buy or potentially even the sale of the
government’s own shared equity portfolio.
Arguably there is more innovation and movement with respect to funding
than there is in terms of the consumer products discussed in Chapter 3. This
is partly because the providers are larger and more knowledgeable about the
market. The challenge is to bring these funders together with consumers
to provide better-managed risks at prices that work for both sides of the
market.
Funding for equity finance
35
5 The big issues
Given that there are very good reasons in principle
for using equity finance to fund owner-occupation
we turn now to the question of why there is so
little effective innovation in the equity loan market.
It is tempting to think there are simply too many
insurmountable market failures to justify such an
approach. But this seems unlikely, especially as many
reservations apply equally to debt finance. Is it just
that equity finance (that is except as a method to
raise deposits, reduce entry costs and make equity
injections as mortgages are paid off) is a latecomer
which has yet to find its role? Is it that households
are prepared to bear – or do not understand – the
risks associated with debt financing and have no
inclination to manage price risks or share housing
investment returns? Or are there intractable
practical problems that have yet to be overcome?
In this chapter we examine the main requirements and challenges, discussed
with interviewees as necessary, which need to be addressed for equity
finance to take its place in a market dominated by debt finance. These
include questions around the adequacy of demand; whether products are
fully understood by either consumers or providers, and whether both can
be protected by regulation and market means; whether products can be
sufficiently clearly specified and transparently priced; whether the scale
needed to generate market-wide stability is achievable.
36
Securing significant consumer demand
Equity finance, in principle, offers three qualities that debt funding currently
does not. These are: affordability without very high leverage; investment risk
management (including potentially protection against negative equity); and
portfolio balancing to avoid the concentration of wealth into a single owned
home. There is certainly demand for the first of these, but the success of
equity finance may, in the end, depend on a cultural shift creating demand
for the other two. The core issue here is whether consumers understand and
value these attributes and find them sufficiently cost-effective to prefer them
over whole home ownership or traditional debt funding.
New financial products must address the needs and demands of
consumers if they are to have any long term value, remembering that there
is great variety among the consumers of financial products, and that their
competencies, needs and priorities are diverse and changeable.
Any shift towards privately provided equity finance for owner-occupation
is a new departure, in a world whose basic mortgage contracts have barely
changed over the years. This must, in itself, raise questions about likely
consumer demand. On the other hand, there was a great expansion in
mortgage products in the early 2000s, and lenders at the time claimed that
the turn to ‘flexible’ features was led as much by consumer demand as by a
flow of new funds (Smith et al. 2002). The idea of using mortgage contracts
to borrow up as well as pay down routinely was quite innovative at the time,
and it is not out of the question that the idea of housing finance making use
of equity rather than debt could appeal if suitably (and safely) packaged for
consumers. Indeed there is some limited evidence that this is the case (Smith
et al. 2009) For this to be true at least three prerequisites about consumers’
needs, motivations and preferences must be realised, and these are:
• that there is continuing demand for owner-occupation;
• that owner-occupiers are sufficiently concerned about housing equity
risks to take steps to reduce them, or that they prefer, and will take steps
to achieve, a more diverse wealth portfolio than the single-property
centred position commonly associated with home ownership; and
• that the products that are on, or near, the market now are sufficiently
intelligible, focussed, cost-effective and safe to appeal to consumers.
Demand for affordable homes
Builders and housing associations report considerable unmet demand
for affordable owner-occupation. The success of many of the HomeBuy
initiatives, and demonstrably high demand for the equity finance elements of
that programme, suggest further that an equity share component to home
purchase contracts is appealing to consumers at the edges of ownership
(Clarke, 2010). In the past, households who took advantage of shared
ownership schemes often intended to staircase up and only a very limited
second hand market has developed (Wallace, 2008). Some of those who
used HomeBuy products repaid their equity share without moving. Those
who did move normally purchased the next home on a traditional mortgage.
So, much of the evidence suggests that while there is demand for products
that make first home ownership more affordable, equity share is then just a
means to this end, and is taken on mainly for the shorter term.
Demand for investment risk management
Some of the products reviewed in this report depend on consumers
(sometimes in conjunction with lenders) not only recognising the risks
The big issues
37
associated with holding wealth in owner-occupation but being keen to pay
the price of managing these risks. There is some evidence that there may
be appetite to limit risks in the UK at least (e.g. Smith et al., 2009) but it is
limited – which is not surprising since there have been no options available
to consumers to manage these risks before, and certainly no price-risk
sharing built into housing finance contracts (which would constitute a
new style of mortgage). The counter-argument is that households like
the control that they have over their housing assets, and do not wish to
risk share, is strongly embedded in the literature, especially that rooted in
research on continental Europe (Elsinga and Hoekstra, 2005). It is possible
that stand alone products, such insurances, that are not formally linked to
home purchase contracts, may appeal. On the other hand, there is a welldocumented wariness among consumers about the value and reputation of
insurances in housing markets. So demand for investment risk management
is uncertain.
Demand for portfolio balancing
There has been considerable discussion about post-purchase portfolio
balancing for housing consumers across the past decade (and more).
A number of analysts looking at the motivations for mortgage equity
withdrawal or ‘equity borrowing’ have suggested there may be a portfolio
balancing objective. If that is the case, then it would certainly be more logical
to achieve this with equity- rather than debt-financing instruments. Likewise,
if equity extraction is the objective, debt-finance appears a costly way of
achieving this (Smith 2012; Burgess et al. 2013).
Because of the relative importance of owner-occupied housing in most
household’s assets, balancing wealth portfolios fully would require long run
partial ownership that enabled investment in both a more diverse property
portfolio (a property fund or price-index-linked bond, for example) and a
range of other (non-property) investments. The benefits are very real but
may be in part be offset by lack of transparency and other aspects of market
failure (Whitehead and Yates, 2010a and 2010b). Low income investors may
simply prefer whole home ownership; more sophisticated investors may be
rich enough to balance their portfolio without resorting to partial ownership.
At this early stage, therefore, the extent of demand is unclear.
Ensuring consumer capability and protection
Equity finance is a new concept for most housing consumers and advisers,
so there is a steep learning curve, which will need to be actively supported.
Regulation able to protect consumers against miss-selling without exposing
providers to unmanageable and uncapped financial, as well as reputational,
risk is also essential.
There is growing interest in the capability of consumers, and in the
behavioural factors driving the selection and use of different financial
products, notably among regulators. In the UK mortgage market, there is,
arguably, a tendency to under-estimate mortgagors’ capabilities, in that
all the evidence suggests that most borrowers manage their mortgages
effectively most of the time. However, equity finance is a new kind of
product, bringing new opportunities, but with complexities that should not
be underplayed. In the context of government sponsored schemes many may
not have understood what they are giving up in terms of capital appreciation
or been able to trade this off against lower costs of access to owneroccupation. Given that so much financial advice in this area comes from the
A role for equity finance in UK housing markets?
38
experience of family and friends, there will at the very least be educational
needs, for which special support measures, such as a requirement to provide
advice, might be warranted.
Designing products that are legible, transparent and
cost‑effective
There are few equity finance products at or near the market today. Two
critical aspects of design relate to the apportionment of responsibilities
(for repair, maintenance, and eventual sale), and the question of price.
Transparency is key in both cases, though perhaps the most efficient method
of pricing (continual adjustment of balances) is the least easy to understand
and to develop. Regardless of how products are priced, the challenge of
securing attractive returns for investors whilst delivering products that are
cost-effective to consumers remains.
Pricing
Mortgage pricing is itself a difficult issue. As has been pointed out many
times before (e.g. Miles, 2004) the majority of mortgagors are most
interested in first year pricing and decisions hinge on whether they perceive
themselves able to afford repayments. This may take no account of later
year cost adjustments built into the initial contract, let alone of potential
changes in (say) variable interest rates or of all the other risks that have to be
balanced.
The pricing of equity sharing and transfer products is far less easy to
evaluate. As can be seen from the tables in Chapter 3, which provide the
detail of existing and near to market products, in many cases it is not possible
to determine even the initial cost. In almost all cases the overall cost will
depend on actual house price changes. Thus the government has stated that
their new Help to Buy shared equity product will be self-financing – implying
that the cost to the mortgagor in terms of lost equity will be at least equal
to government borrowing rates. This means that if house prices rise rapidly,
the cost to the mortgagor could be very high. Whether this loss of equity is a
reasonable price to pay for access to home ownership and lower investment
risks has to be assessed a priori. This is a complex set of issues to take into
account at the point of purchase.
Often there are occupation or investment charges (as with Help to
Buy after 5 years). If these are linked to anything other than house price
changes, then the benefit to the consumer when there are house price
falls and negative equity in particular may be asymmetric as compared to
the proportion of gains paid to the investor partner. Assessing the cost of
purchasing the equity can also be difficult.
The evidence from Australia has been that pricing which provides
an adequate return to the providers of these products is too high – as
measured by the ‘price’ in terms of lost equity to the consumer – to appeal
to large numbers of consumers (Pinnegar et al., 2009). Whether this proves
to be the case for the UK has yet to be established, although at least one
product we have reviewed conforms to the split of proportions (a 20% stake
for a 40% return) seen by Miles as appropriate (2012). While the scale of
demand is not yet clear, with the more positive stance recently adopted by
government and the financial regulator prospects look more positive than in
the past.
The big issues
39
The risks addressed
A rather different but related issue arises in understanding the risks which
are addressed by each product. As was made clear in Chapter 2 there are
a multiplicity of risks associated with owner-occupation and most products
only address a subsection of these risks. The potential purchaser needs
to be clear about which risks are the most important to their individual
circumstances. Someone who has a more than adequate and secure income
will normally be interested more in managing their equity portfolio, while
those with uncertain income and a constrained budget are likely to be more
concerned about credit risks. Liquidity risks may be disregarded at the time
of purchase because people do not think of all the implications. Different
products are therefore more suited to different categories of consumers –
who then need to trade-off between different risks and their costs. Yet, even
with the relatively small number of products currently available it is difficult
to ascertain exactly what these differences are. There are clearly many
packages of risk attributes that are not yet covered in the range of products
available.
Transparency and legibility of products
Linked to these issues of pricing and risks are the more general ones of
transparency and legibility of products. It is clear that regulatory agencies will
not allow new products on to the market if they lack transparency, but this is
not the same as legibility notably in the context of pricing. Moreover, there
is always a question over the extent to which different groups of consumers
might be able to ‘read’ new products well enough to create demand, or
manage their financing products effectively.
This has important implications for optimal product design. In packaging
products for market, for example, there is likely to be a trade-off between
the financial ‘ideal’ of an adjustable risk-sharing contract – in which home
buyers can exercise choice over the proportion of house price risk they may
wish to sell, and how asymmetric a partnership arrangement they can accept
in return for lower housing outlays (for example) – and the practicalities of
delivering a simple, legible arrangement by which, for example, a fixed equity
loan is made available in return for a fixed proportion of house price return
on sale.
Arrangements for the delivery and regulation of advice to consumers is in
this context a priority, as is the supply, quality and clarity of information about
finance and financial risks. In this context, it is not surprising to learn that
many of the products reviewed here are only available through regulated
and independent financial intermediaries (though this is not necessarily
unproblematic).
Regulation and the potential for mis-selling
These issues clearly raise the possibility of mis-selling and the implications of
such concerns both for demand and for regulation. A number of discussants
suggested that the mis-selling of equity release and shared appreciation
products in the past was having a negative impact on the specification of
products (e.g. that they might not be available to older households); on
the costs of achieving entry into the market in terms of acceptance by the
regulator; and the extent to which consumers require reassurance.
Perhaps the greatest concern here is what happens if prices do rise
rapidly and consumers realise the high cost they have ended up paying for
risk sharing, especially in the current tax regime, in which housing gains are
exempt for owner occupiers. If all the information has been made available at
the time of contract and the consumer has properly been advised then there
A role for equity finance in UK housing markets?
40
is no mis-selling – but past experience might suggest that the regulator
would be difficult to convince. There is thus a regulatory risk to be taken
into account which impacts on the cost of the product. More generally,
such experiences can generate antipathy into the longer term reducing the
demand for such products.
Effective regulation of lenders and intermediaries is the key to successful
product innovation in the world of equity finance. A simple and transparent
regulatory framework is an absolute necessity if the products are to be
accepted by institutions and consumers alike. The biggest concern must be
that the product(s) become subject to an FSA (or other regulator) mis-selling
enquiry – as has been the case with some earlier initiatives. This raises a
whole range of different issues given the potential for both market failure
and data concerns. The recent Mortgage Market Review and the emerging
final rules goes some considerable way to addressing this. The recent
consultation paper by the Financial Conduct Authority (one of the successor
bodies to the FSA) on product intervention has begun the process of scoping
out how the new body will regulate products and intervene if it deems
products are being mis-sold (see www.fsa.gov.uk/pubs/discussion/dp11_01.pdf).
The FCA’s response to the consultation will emerge later in 2013
Attaining scale and the goal of systemic stability
None of these products can work effectively without sufficient scale.
To achieve this, they will have to gain traction across the market: in the
mainstream as well as on the margins. That requires both a supply of funds,
and demand for products covering all three main equity finance attributes:
affordability, price risk sharing and portfolio balancing.
If these aspects of supply and demand obtain, the use of wholesale
and derivatives markets, which have the capacity to lower the price of
risk, could also come into play. This in turn could help to stabilise housing
markets because: a) the housing finance regime would be more balanced
and complete; b) there would be greater potential for price discovery in
housing markets, which is one factor that can help dampen volatility; and c) a
wider range of risks – especially risks that contribute to volatility – would be
directly managed in this more fully funded housing finance regime.
This suggests a role for government both in ensuring a suitable regulatory
framework and in possibly providing backstop support if they accept that
there are wider benefits to the market and the economy as a whole.
Scale ultimately depends not just on the attributes of equity finance
itself but also on the alternatives available, and on the degree to which
government can support them all. On the one hand, private renting has
come to the forefront of policy over the last few years. This could be seen
an alternative way of balancing the housing system to that offered by
equity finance. And it could take all the efforts of government to make it
work. However, a revitalized rental sector could also form one extreme of
the equity finance continuum if ‘no home ownership’ were combined with
property bonds or price-linked savings accounts to give renter households
a stake in the housing market. It is also the case that more complex debt
financing products can build in insurance for many of the identified risks –
although some past attempts at insurance have been less than successful.
The big issues
41
Conclusions
Even with a variety of providers, assured funding streams, and an appetite
for change in the world of politics and policy, this chapter has shown that the
future for equity finance depends on overcoming at least four key challenges.
There is no reason why these challenges should not be addressed, but it is
clear that there can be no quick fix, and that governmental and regulatory
leadership will both be important.
The current policy environment is more about getting the debt finance
market working again and using shared equity as a means of increasing
access rather than reducing risk. However, issues of risk sharing and transfer
still remain fundamental to a well operating market into the longer term.
In that sense the issue has not gone away. With government extending its
equity involvement in the housing market plus taking on a guarantor role
we may be witnessing the move into a new era. Although all the schemes
are temporary at present the timescales may well be stretched to the point
where permanence might be considered. Much turns on how the debt
market responds over time.
A role for equity finance in UK housing markets?
42
6 Conclusions
Home ownership in the UK is traditionally debtfunded. In recent years this has proved risky for
some households and for whole economies. Yet
demand for owner-occupation remains strong. To
meet such demand, this report has considered the
possibilities and practicalities of balancing traditional
debt funding with innovations in equity finance. A
principle finding is that although debt funding will
dominate UK housing finance for the foreseeable
future, equity finance offers a complementary
approach that could ease affordability, reduce
volatility and add to macro-economic stability.
The principles underlying the innovation of equity finance are clear. In
practice, however, it has been drawn into the housing system by government
mainly as an affordability aid. As the dominant provider of equity loan
products, the government is central to the future of this market. That it is
following a policy agenda driven by concerns with easing access to home
ownership rather than by comprehensive risk reduction or any attempt to
reform the underlying structure of the housing system is therefore limiting.
Helping marginal buyers into owner-occupation, without extending the
individual and larger scale risks to consumers associated with high loan-tovalue ratios is of course a major achievement. However, equity finance is
more important than this because it offers an element of risk management
for home purchase and ownership that has not previously been available in
the UK market.
Profiling this wider role, a further set of findings reported here indicate
the many advantages to households associated with being able to hedge
housing investment risks, diversify their single-property centred wealth
portfolios (or simply hold less wealth as housing), and reduce housing market
liquidity risks (which themselves prompt credit default). Indeed, perhaps the
most important risks for households that equity finance potentially addresses
are those relating to declining capital values (and the related practical
43
problem of negative equity). By bringing this new dimension of risk sharing
into housing markets, equity finance might change the way households think
about housing assets in relation to their overall household balance sheet.
The question of whether equity finance could achieve still more, offering a
means of managing the relationship between housing markets and the wider
economy, came later into the debate (see Smith 2012; 2013; Whitehead,
2010). It is in this context that efforts to roll out equity finance from the
margins to the mainstream are of great interest. If this proves viable, there
is the prospect of introducing a wider range of products that could not only
reduce costs to consumers and providers alike, but also turn attention to
the relative costs and attributes of different tenure arrangements (and to
the possibility of using equity finance better to meet the variety of needs
and demands) whilst also helping to stabilise whole housing markets. This
is because equity finance can add balance to markets, make markets more
complete, address the tendency to conflate investment in mortgage debt
with investment in housing equity, and allow price discovery in housing
markets. There are however some caveats.
First the innovation of new flows of finance, as well as the development
of financial products to channel these, is not risk free, and equity finance will
itself bring risks to the table. Some of these are identified in this report. They
relate to the challenges of creating consumer demand, designing products
that are legible, transparent and cost-effective, managing reputational risk
for providers and avoiding mis-selling to consumers. Furthermore, if these
innovations are to address both market and individual risk, there is also the
question of capacity to assess equilibrium prices over time and to ensure
that there is no asymmetry in information or in conditions for entering and
leaving the contracts. This requires high quality data, a clear approach to
potential market failure and a realistic understanding of the costs.
Second, there is the question of achieving scale. The paucity of products
in or close to market is explicable but remains surprising, especially given
the growth in potential funding streams that has been seen in recent years.
There are also signs that some of the hurdles – notably with respect to
what is acceptable to the regulator – are beginning to be overcome now
that shared equity products have become embedded among schemes to
help lower income households into ownership. As funding and regulatory
constraints loosen, it might pave the way for a more general roll-out of
equity finance into the UK housing market.
Finally, however, there is a concern as to whether there is space in
the market for equity finance to flourish. One challenge here is how far
government could or should invest in diversifying into new (equity finance)
markets, or concentrate on supporting the existing (debt-funded) system
of housing finance. Generally in the post-crisis English-speaking world,
‘business as usual’ for credit and mortgage markets has been the dominant
leaning (Smith 2010), and this seems still to be the norm in the UK.
While the current market for housing finance is clearly weak it is far from
broken; indeed there are signs it is recovering quite rapidly. The initiatives
in the 2013 Budget point to strong support for existing debt financing
products through large scale guarantees (covering perhaps 20%–25% of
gross lending). These are relatively straightforward ways of helping financial
institutions to reduce the regulatory costs of high loan-to-value mortgages
and therefore to offer lower interest rates. However they also mean that the
purchaser is subject to all the risks associated with high loan-to-value ratios
– against the principles of risk reduction and risk sharing. Most importantly,
while these measures do not directly address the issue of where the funding
A role for equity finance in UK housing markets?
44
is to come from, they may nevertheless limit the extent of the market for
equity based products.
Even so it is encouraging that the Budget initiatives to support debt
financing are set alongside continued support for equity sharing products
to boost the sale of new homes – a funding stream which nevertheless
at least creates a space for equity funding products at the margin, if not
in the mainstream, of the market. The worry is that the first, much larger
(debt-funding), initiative, while to a limited extent mitigating credit risks,
points to an acceptance of the status quo around risks in housing markets.
That is it appears unconcerned when consumers take on the very large
and unmanaged equity risks associated with high loan-to-value ratios. This
acceptance is some way from the request made by some equity finance
product providers for government to validate and advocate the new
approach to housing finance. In short, government ambivalence may be
reducing the potential for innovation in this area. Certainly the answer to
the question of whether equity finance will prove to be more or less costly,
appealing, sustainable or policy relevant than debt funding is as yet unclear.
Unless and until these concerns are addressed, the vision of a sustainable
housing system in which renters can invest in the fortunes of property
markets, owner-occupiers can mitigate the risks of a single-property centred
wealth portfolio, and households can separate investment decisions from
choices around housing consumption, will be hard to realise. This study
nevertheless indicates the importance of finding space for both equity
finance and debt funding in the future UK housing. The case for this is
compelling.
Simply by adding to the product range, equity finance promotes welcome
diversity at a time when debt funding is under strain; and the argument
for allowing a thousand flowers to bloom to give consumers the choices
they require is hard to counter. Equity finance could, if rolled out more
widely, herald a significant shift in the character of owner-occupation and
the finance market that underpins it. Overall, therefore, this report finds
that complementing debt-funding with equity finance could bring balance,
competition and greater completion to the market. Moreover, achieving
these objectives is likely to be worth the effort required to secure regulatory
approval, to innovate, and to create an environment in which sufficient scale
can be achieved.
Conclusions
45
Notes
1
Under the new guarantee scheme announced in the 2013 budget, which is intended to cover
perhaps £40bn lending per year for 3 years, this figure may increase.
2
Cash transactions have increased in importance and now make up 30% of the market
compared to 10/15 percent a decade ago. Mortgages now account for 60/70% of the
market.
3
It has sometimes been possible to borrow more than 100% of the value of the property
though often the extra takes the form of an unsecured loan rolled into a conventional
mortgage contract.
4
We look at the other spectra discussed in Chapter 2 in Chapter 5.
5
Other government products involving guarantees are discussed in Chapter 5.
6
Others include the PlumLife’s Rent to Buy product – part of Great Places Housing Group
and the London and Quadrant Housing Association’s Up to You (see http://www.lqgroup.org.
uk/sales-and-rentals/home-ownership-and-rental-options/uptoyou/)
46
References
Ambrose, B., and Buttimer, R. 2012. ‘The adjustable balance mortgage: reducing the value of the
put’. Journal of Real Estate Economics, 40 (3), pp. 536–65
Belsky, E., Case, K. and Smith, S. J. (2008) ‘Identifying, managing and mitigating risks to borrowers
in changing mortgage and consumer credit markets’. UCC08–14, Harvard: Joint Center for
Housing Studies
Benito, A. (2007) ‘Housing equity as a buffer: evidence from UK households’. Bank of England
Working Paper 324, London: Bank of England
Berry, M., Whitehead, C., Williams, P. and Yates, J. (2006) ‘Involving the private sector in affordable
housing provision: can Australia learn from the United Kingdom?’. Urban Policy and Research,
24 (3), pp. 307–323
Booth, P. and Crook A. D. H. (1986) Low cost home ownership: an evaluation of housing policy under
the Conservatives. Aldershot: Gower
Burgess, G., Lyall, G. F. and Whitehead, C. (2007) Home ownership and the credit crunch: a report on
regional markets and competition with private developers, London: Tenant Services Authority
Burgess, G., Monk, S., Williams, P. (2013) Equity release amongst older homeowners, Cambridge:
Cambridge Centre for Housing and Planning Research
Caplin, A., Chan, S., Freeman, C. and Tracy, J. (1997) Housing partnerships: a new approach to a
market at a crossroads, Cambridge: MIT Press
Caplin, A., Joye, C., Butt, P., Glaeser, E. and Kuczynski, M. (2003a) Innovative approaches to reducing
the costs of home ownership. A report commissioned for the Prime Minister’s Home Ownership
Task Force. Canberra: The Menzies Research Centre
Caplin, A., Goetzmann, W., Hangen, E., Nalebuff, B., Prentice, E., Rodkin, J., Spiegel, M. and Skinner,
T. (2003b) ‘Home equity insurance: a pilot project’. Yale International Center for Finance Working
Paper, 03-12. Yale: International Center for Finance.
Caplin, A., Carr, J., Pollock, F., Tong, Z. (2007) Shared-equity mortgages, housing affordability
and homeownership, Washington D.C.: Fannie Mae Foundation, Available at: http://content.
knowledgeplex.org/kp2/cache/documents/3331/333181.pdf. Last accessed 7th August 2013
Clarke, A. (2010) ‘Shared ownership: does it satisfy government and household objectives?’
Chapter 10 in S. Monk and C. Whitehead (2010) Affordable housing and intermediate housing
tenures, Oxford: Blackwell
Elsinga, M. and Hoekstra, J. (2005) ‘Homeownership and housing satisfaction’. Journal of Housing
and the Built Environment, 20 (4), pp. 401–424
Englund, P., Hwang, M., and Quigley, J. M. (2002) ‘Hedging housing risk’. Journal of Real Estate
Finance and Economics 24 (1–2), pp. 167–200
Ford, J., Quilgars, D., Burrows, R. and Rhodes, D. (2004) Homeowners Risk and Safety-Nets:
Mortgage Payment Protection Insurance (MPPI) and Beyond, London: ODPM
Girouard, N., Kennedy, M., van der Noord, P. and Andre, C. (2006) ‘Recent House Price
Developments: the role of fundamentals’. Economics Department Working Paper 475, Paris:
OECD
47
Girouard, N., Kennedy, M. and Andre, C. (2006a) ‘Has the rise in debt made households more
vulnerable?’ Economics Department Working Paper 535, Paris: OECD
Iacoviello, M. and Ortalo-Magné, F. (2002) ‘Hedging housing risk in London’. Journal of Real Estate
Finance and Economics 27 (2), pp. 191–209
Labuszewski, J. (2006) Introduction to CME CSI housing futures and options. Chicago: CME
Littlewood, J. and Mason, S. (1984) Taking the initiative: a survey of low cost home owners,
Department of the Environment, London: HMSO
Lowe, S., Searle, B. A., and Smith, S. J. (2011) ‘From housing wealth to mortgage debt: the
emergence of Britain’s asset-shaped welfare state’. Social Policy and Society, 11, pp. 105–16
Miles, D. (2004) The UK Mortgage market: taking a longer term view. London: HM Treasury
Miles, D. (2012) ‘Demographics, house prices and mortgage design’. Discussion paper 35: Bank of
England (External MPC Unit)
Monk, S. and Whitehead, C., eds (2010) Affordable housing and intermediate housing tenures, Oxford,
Blackwell
Munro, M., Smith, S. J. and Ford, J. (2010) ‘An evaluation of the January 2009 arrangements for
support for mortgage interest’. Department for Work and Pensions Research Report 711. Crown
Copyright
Ong, R., Parkinson, S., Searle, B. A., Smith, S. J. and Wood, G. (2013) ‘Channels from housing
wealth to consumption’. Housing Studies
Pannell, R. (2012) ‘Maturing attitudes to owner-occupation’. Housing Finance, Issue 02, June,
1–13, London, CML
Parkinson, S., Searle, B. A., Smith, S. J., Stoakes, A. and Wood, G. (2009) ‘Mortgage equity
withdrawal in Australia and Britain: towards a wealth-fare state?’ European Journal of Housing
Policy, 9, pp. 363–87
Pinnegar, S., Easthope, H., Randolph, B., Williams, P. and Yates, J. (2008) ‘Innovative financing for
homeownership: the potential for shared equity initiatives in Australia’. Australian Housing
and Urban Research Institute, UNSW-UWS Research Centre, August 2009, AHURI Final
Report No. 137, Melbourne, AHURI. Available at: http://www.ahuri.edu.au/publications/projects/
p70394
Quigley, J. (2006) ‘Real estate portfolio allocation: the European consumers’ perspective’. Journal
of Housing Economics 15: 169–188
Ratcliffe, G. (2006) ‘Residential property derivatives’. Property Derivatives Essential Guide pp. 22–24
Shared Equity Task Force (2006) Report. London: HM Treasury
Shiller, R. J. (2007) ‘Risk management for households – the democratization of finance’. Paper
presented to the Sixth Annual Bank for International Settlements Conference Financial System
and Macroeconomic Resilience. Switzerland (June).
Shiller, R. (2008) The Subprime Solution. Princeton: Princeton University Press
Shiller, R. J. (2009) Policies to deal with the implosion in the mortgage market. The B.E. Journal of
Economic Analysis and Policy 8 (3), Article 4
Shiller, R. J. and Weiss, A. N. (1994) ‘Home equity insurance’. Cowles Foundation Discussion Paper,
1074. Yale: Cowles Foundation for Research in Economics.
Shiller, R. J., Wojakowski, R. M., Ebrahim, M. S., and M. B. Shackleton (2011). ‘Continuous workout
mortgages’. Cowles Foundation Discussion Paper, 1794. Yale: Cowles Foundation for Research in
Economics.
Smith, S. J. (2006) ‘Home ownership: managing a risky business?’ in J. Doling and M. Elsinga, eds.
Home ownership: getting in, getting out, getting from. Delft: IOS Press
Smith, S. J. (2009) ‘Managing financial risk: the strange case of housing’ in G. Glark, Dixon, A. and
Monk, A. H. B., eds. Managing financial risks: from global to local. Oxford: Oxford University
Press
A role for equity finance in UK housing markets?
48
Smith, S. J. (2010) ‘Housing futures: a role for derivatives?’ in S. J. Smith and B. A. Searle, eds. The
Blackwell companion to the economics of housing: The housing wealth of nations. Chichester:
Wiley-Blackwell
Smith, S. J. (2012) ‘Care-full markets: miracle or mirage?’ Tanner Lectures on Human Values 31,
pp. 245–76
Smith, S. J. (2013) ‘Crisis and innovation in the housing economy: a tale of three markets’ in
M. Haliossis, ed. Financial innovation – too much or too little? Cambridge, Mass: MIT Press
Smith, S. J. and Searle, B. A. (eds) (2010) The Blackwell companion to the economics of housing: The
housing wealth of nations. Chichester: Wiley-Blackwell
Smith, S. J., Ford, J. and Munro, M. (2002) A Review of Flexible Mortgages. Council of Mortgage
Lenders
Smith, S. J., Searle, B. A. and Cook, N. (2009) ‘Rethinking the Risks of owner-occupation’. Journal
of Social Policy, 38, pp. 83–102
Sommervoll, D. E. and Wood. G. (2011) ‘Home equity Insurance’. Journal of Financial Economic
Policy, 3, pp. 66–85
Syz, J. Vanini, P. and Salvi, M. (2006) ‘Property derivatives and index-linked mortgages’.
Manuscript, Zurich Cantonal Bank, Switzerland. Available at: http://papers.ssrn.com/sol3/papers.
cfm?abstract_id=927888
Syz, J. (2010) ‘Housing risk and property derivatives’. In S. J. Smith and B. A. Searle eds. The
Blackwell companion to the economics of housing: The housing wealth of nations. Chichester:
Wiley-Blackwell
Temkin, K., Theodos, B. and Price, D. (2013) ‘Sharing equity with future generations: an evaluation
of long-term affordable homeownership programs in the USA’, Housing Studies, 28 (4),
pp. 553–578
Wallace, A. (2008) Achieving Mobility in the Intermediate Housing Market: Moving up and Moving on?
York: Joseph Rowntree Foundation
Wallace, A. and Ford, J. (2010) ‘Limiting possessions managing arrears in a new era’, International
Journal of Housing Policy, 10 (2), pp. 133–155
Whitehead, C. (2010) Shared ownership and shared equity: reducing the risks of home-ownership,
Viewpoint, York: Joseph Rowntree Foundation. Available at: www.jrf.org.uk/sites/files/jrf/
homeownership-risk-reduction-summary.pdf, last accessed 7th August 2013
Whitehead, C. and Yates, J. (2010a) ‘Is there a role for Shared Equity Products in Twenty-first
Century Housing? Experience in Australia and the UK’ in S. J. Smith and B. A. Searle (eds) The
Blackwell companion to the economics of housing: The housing wealth of nations. Chichester:
Wiley-Blackwell
Whitehead, C. and Yates, J. (2010b) ‘Intermediate housing tenures: principles and practice’.
Chapter 2 in S. Monk and C. Whitehead (eds) Affordable housing and intermediate housing
tenures. Oxford: Blackwell
Wood, G., Parkinson, S., Searle, B. A. and Smith, S. J (2013) Motivations for equity borrowing: a
welfare switching effect. Accepted by Urban Studies
Yates, J. (1992) ‘Shared ownership: the socialization or privatization of housing?’ Housing Studies,
7(2): pp. 97–111
References
49
Abbreviations and
terms
ABM
Adjustable Balance Mortgage
A proposal for a new style of mortgage contract whose
balances adjust continuously to shifts in house prices
as well as interest rates, as set out by Ambrose and
Buttimer (2012).
CPI
Consumer Price Index
Measures trends in the price of a basket of consumer
goods.
CWM
Continuous Workout Mortgage
A proposal for a new style of mortgage contract whose
balances adjust continuously to shifts in house prices as
well as interest rates, as set out by Shiller et al. (2011).
Debt finance
The conventional method of funding home purchase
through a mortgage secured against the value
residential property.
Deposit
Usually presented as a proportion of the purchase value
of a property, the deposit is the equity stake injected
into home purchase by a borrower commencing a new
mortgage.
Equity finance
A method of funding home purchase that is based on
directly sharing housing investment risks and rewards
between home buying households and other investors
(usually institutions).
FCA
Financial Conduct Authority
Regulator for the UK financial services industry
FSA
Financial Services Authority
Previously the UK regulatory authority for all financial
services, the responsibilities of the FSA are now in the
hands of two new regulatory agencies, the FCA and the
PRA.
Help to Buy
The latest in a series of government sponsored
schemes using equity finance to boost access to, and
50
affordability in, owner-occupation. Includes (i) an equity
mortgage product and (ii) a more general guarantee.
HPI
House Price Index
Measures trends in the price of a basket of residential
properties. There are many such indices in the UK,
each using a slightly different ‘basket’. HPI can be used
as an alternative to the CPI, RPI or interest rates to
benchmark economic trends or returns on investments.
HousSA
An ISA marketed by Castle Trust whose returns are
linked to the UK’s national Halifax House Price Index.
ISA
Individual Savings Account
The distinctive feature of an ISA is that the gains are
tax-exempt. The amount of funds an individual can
invest in this way in a given tax year are limited.
LTV
Loan-to-Value Ratio
A measure of the magnitude of mortgage debt
relative to the value of the property that secures it.
LTV measures are used by lenders to manage credit
risks. High LTVs tend to be more costly or offered
preferentially to ‘safer’ borrowers.
PRA
Prudential Regulation Authority
Part of the Bank of England; responsible for the
prudential regulation and supervision of banks, building
societies, credit unions, insurers and major investment
firms.
RPI
Retail Price Index
Measures trends in the price of a basket of retail goods
and services.
Shared equity
A style of equity-financed owner-occupation in which
the occupier holds the title to the property but shares
the risks and returns of house price volatility with
another (non-occupying) investor.
Shared ownership
A style of equity-financed owner-occupation in which
the title to a property is split between the occupying
household and a non-occupying investor-landlord
SIPP
Self-invested Personal Pension
The government is considering whether to allow
residential property investments to be included in
SIPPs.
Abbreviations and terms
51
Acknowledgements
The authors wish to thank all those who have helped us during the research
and particularly those who attended the Roundtable, those who were prepared
to be interviewed about the details of the products being developed and other
stakeholders who set out their views about the potential for growth in an equity
finance market. We are grateful for their time; their patience in answering our
many questions; and particularly for being prepared to share their expertise. All
errors are of course our own.
We are also grateful to the Joseph Rowntree Foundation, and to Kathleen
Kelly in particular, not only for their funding but also for their continuing support
for new ideas and their positive partnership approach to research.
52
About the authors
Susan J. Smith is Mistress of Girton College and honorary professor of
social and economic geography at the University of Cambridge. She has
studied trends in equality, diversity and discrimination in the housing system
for nearly 30 years. She has published over 100 articles and books on these
themes, and is editor-in-chief of the International Encyclopedia of Housing
and Home, and co-editor of the Blackwell Companion to the Economics of
Housing. Recent projects include the edges of home ownership; unlocking
housing wealth across the life course; the causes and consequences of equity
borrowing; and the consequences of the uneven integration of housing,
mortgage and financial markets.
Christine M. E. Whitehead is Professor of Housing Economics at the
London School of Economics and Political Science and Senior Research
Fellow at the Cambridge Centre for Housing and Planning Research. Major
research themes include the relationship between planning and housing,
notably with respect to S106 policy; demographic change and housing
needs assessments; the role and financing of social housing in the UK and
Europe; regulation and financing in the private rented sector across Europe;
innovations in private finance; and the potential for intermediate tenures. She
has lately been specialist advisor to the Communities and Local Government
Select Committee on private renting and the supply of new affordable
housing.
Peter R. Williams is Director of the Cambridge Centre of Housing and
Planning Research, University of Cambridge. He has had a long career in
academia, government and industry. He has been deputy director general
of the Council of Mortgage Lenders, chair of the National Housing and
Planning Advice Unit, board member of the Housing Corporation and
professor of housing at the University of Cardiff. He was a member of the
JRF Housing Market Taskforce and is Executive Director of IMLA. His latest
publications have concentrated on opportunities arising from social and
intermediate housing initiatives as well as the impact of welfare changes on
social housing.
53
The Joseph Rowntree Foundation has supported this project as part
of its programme of research and innovative development projects,
which it hopes will be of value to policy makers, practitioners and
service users. The facts presented and views expressed in this report
are, however, those of the author[s] and not necessarily those of JRF.
A pdf version of this publication is available from the JRF
website (www.jrf.org.uk). Further copies of this report, or any
other JRF publication, can be obtained from the JRF website
(www.jrf.org.uk/publications) or by emailing [email protected]
A CIP catalogue record for this report is available from the British
Library.
All rights reserved. Reproduction of this report by photocopying
or electronic means for non-commercial purposes is permitted.
Otherwise, no part of this report may be reproduced, adapted, stored in
a retrieval system or transmitted by any means, electronic, mechanical,
photocopying, or otherwise without the prior written permission of the
Joseph Rowntree Foundation.
© 2013 Susan J. Smith,
Christine M. E. Whitehead,
Peter R. Williams
First published 2013 by the Joseph
Rowntree Foundation
ISBN: 978 1 85935 990 7 (pdf)
Typeset by Policy Press
Joseph Rowntree Foundation
The Homestead
40 Water End
York YO30 6WP
www.jrf.org.uk