Housing Partnerships: A New Approach to a Market at a Crossroads. - book reviews

Business Economics, July, 1998

By Andrew Caplin, Sewin Chan, Charles Freeman, and Joseph Tracy, Cambridge, MA, MIT Press, 1997, pp. 280, $35.00.

Purchasing a home is for many Americans the essence of the American dream. Unfortunately, the dream remains an unattainable dream for many. The current housing finance system requires large down payments that take years for people of moderate means to accumulate. Others can't seem to save at all, because the goal seems unattainable. For these and other reasons, many are kept out of the market. That is on the demand side. On the supply side, some investors would like to invest in the housing market as equity participants. Now it is done via owning a home larger than would otherwise be demanded, or investing in home construction or supply firms. Otherwise they can only participate via the mortgage debt market or in rental property.

The authors of Housing Partnerships propose an intriguing solution. They create Partnership Markets that they believe would enable millions more Americans to become home owners and equity investors. The would split or decouple home occupancy from home ownership, i.e., one could own half of the home with a limited partner owning the other half. The institutionalization of limited partnerships between prospective owners and financial institutions would, the book argues, assist many in attaining their dreams of owning a home.

Here's how it would work. Aspiring owners would have the option to buy part of a house; the other portion would be financed by an institutional investor, who would provide capital for part of the down payment and a mortgage in exchange for a portion of the eventual sale price. In essence the limited partner would have an equity interest. Thus, just as a business can finance assets with a combination of debt and equity, the household could finance its largest asset with a combination of debt and equity. The authors also argue that the introduction of institutional investors as partners with the occupant would tend to increase the efficiency of the market.

The Managing Partner would occupy the home as usual, buyers could devote less time to saving for a down payment, greatly reduce their monthly expenses with smaller mortgages, and retain more of their income to spend, save, and invest. For the broader financial community, Partnership Markets would provide new opportunities for investment and diversification into the vast residential real estate market. The Limited Partners would supply equity capital to households in the same way as is currently done to business.

The proposal is based on the argument that, in the current housing finance market, home owners must purchase the entire asset corresponding to the home in which they reside. The fundamental reason for developing the Partnership Market is that the asset defined by, say, the second half of the house, is worth less to the current home owner than it is to the financial community. They argue that, for the vast majority of home owners, much of their asset portfolio is tied up in their homes. What's more, housing is an extremely risky investment. Together, these two facts imply that a household that owns the whole housing asset should place less value on the ownership of the second half. After all, they argue, the second half of the home asset is perfectly correlated with the first half and is therefore the worst possible form of investment for asset diversification.

The book supplies a detailed structure of how the new arrangements would work and explains the economics behind the housing and mortgage markets as well as the financial risks. The authors also touch upon the innovation's wider impacts, including changes to the secondary mortgage market, the government's role and changes in housing policy, and the composition of assets held by institutions.

In Housing Partnerships the authors explain what typical home buyers face in the housing market and how Housing Partnerships might make the market work better for them. The book gives quantitative examples of the financial impact of the plan. In addition there is now a web site for the book, and it has a calculator where various alternatives can be entered. For example, a potential buyer who desires a $125,000 house with a $20,000 down payment is told that a traditional mortgage would be $108,750 and would result in monthly payments of $875. The Partnership mortgage would be $47,500, with monthly payments of $349. Or one can enter annual income, say, $40,000 with the $20,000 down payment. The calculator reports that the traditional maximum available mortgage would be $111,000 and would require monthly payments of $726. However, with the Housing Partnership a much larger home valued at $173,900 with monthly payments of $568 would be possible. The web site address is http://mitpress.mit.edu/ebooks/housing_partnership/calcpage.html/for those who want to conduct their own experiments. The web site also has an interesting section covering frequently asked questions on just how the system would work in practice.