This article provides general principles of law only.
Specific problems or fact situations should be referred to an attorney
for interpretation and advice.
Over the years in my LIFE AND LAW newspaper column, I have addressed living trusts and partnerships. This week, I would like to share with you how you might use one or the other of those vehicles to buy or sell a personal residence. The arrangement to which I am referring is called an “equity-share agreement”.
Sometimes parents enter into equity-share arrangements to help their adult children acquire their first home. The process may also be useful and attractive to individuals or couples who have reached retirement age and desire to move into a smaller and less expensive residence, but do not want to receive all of their equity at one time from the property they are selling and, for whatever reason, prefer not to carry back a note and trust deed against the property.
Of course, the concept of equity sharing is not restricted to family members or senior citizens and, in fact, does provide benefits to the equity investor as well as to the owner/occupant party in a variety of different situations.
An equity share agreement is basically part loan transaction and part partnership agreement (more specifically a joint venture since it is generally limited to one property), but is seldom referred to by either name due to the peculiar features of the a true equity share arrangement. Sometimes such an arrangement is called a “tenants-in-common” agreement, but again, the relationship of the parties in an equity share agreement differs substantially from the true legal rights that tenants in common have with one another.
In a true equity sharing arrangement, one of the parties uses the property as their personal residence will all the rights and privileges of ownership, while the other party allows an agreed upon dollar amount of their funds to remain in the property as a percentage of the equity until such time as the property is sold or the owner/occupant party buys out the interest of the equity investor. Unless the equity investor is simply trying to help a family member who otherwise would not be able to purchase a home, there is usually some intent or expectation by the equity investor that he or she is going to receive a larger financial return as the result of appreciated value in the property than he or she would receive from a conventional note and trust deed. Tax deductions on the property can also be shared with the equity investor
Because of that profit intent or expectation, an equity share agreement usually has some provisions restricting the rights or time frame in which the owner/occupant party can resell or otherwise buyout the equity investor.
Normally, the owner/occupant party will want the right to make improvements to the home. If the improvements are substantial, such as constructing a swimming pool, remodeling the kitchen, adding rooms or the like, the value of the home could easily increase as the result of those improvements. In such situations, the equity investor normally should not participate in a percentage of that increased value unless he or she also contributed proportionally to the cost of the improvements.
On the other hand, the equity investor would rightfully expect that the owner/occupant party to undertake normal maintenance and upkeep of the property – even possibly to the extent of repairing or installing a new roof if such became necessary – in order to maintain the property in good condition so that its value would not decrease.
In most equity share arrangements, expenses of repairs and upkeep are the sole responsibility of the owner/occupant party, since it is that party who benefits immediately from them as the occupant. Both of these issues, however, regarding improvements and general upkeep, are subject to negotiation and should be specifically addressed in the agreement.
Whether or not the equity investor’s name actually appears on the title to the property setting forth the percentage of his claim/interest in the property can vary from one agreement to another. How such is handled depends not only upon the agreement of the parties, but is often times dictated by the primary purchasing lender. In others words, if the owner/occupant is unable to qualify for a loan on his or her own credit and the equity investor (most typically a parent helping a child) is lending his or her credit in order to obtain loan approval, the lender will almost always require that the equity investor be named on the title to the property and also sign the loan documents jointly with the owner/occupant party.
In purchase money mortgage transactions (which I have discussed in previous LIFE AND LAW articles), the lenders recourse in case of default on the loan is against the property only and the individual borrows cannot be held personally liable (depending on state law). Nevertheless, the lenders still routinely require that equity investor execute the loan papers and be on title any way.
If the equity investor does not appear on the title to the property there is substantial risk that the owner/occupant could sell the property out from under the equity investor and abscond with the proceeds when escrow closes. That possibility exists because there would be nothing recorded to show that the equity investor had any rightful claim to any portion of those proceeds. This problem is sometimes overcome by simply recording a trust deed against the subject property in the name of the equity investor which serves to provide security for the equity sharing agreement itself.
Sometimes the owner/occupant and the equity investor will agree that the equity investor will make monthly contributions to the debt service on the property and/or to the property taxes. If they so agree, this contribution is usually made on the same pro rata basis as the parties’ equity interests. In other situations, the mortgage debt service, property taxes and other normal living expenses for occupying the property will be entirely the owner/occupant party’s responsibility. Unless the debt service (i.e. monthly payments on the mortgage) includes substantial payments toward the balance owed on the loans against the property, the expenses mentioned in this paragraph will not have any real bearing on the equity in the property. Thus, the fact that the owner/occupant party is normally required to make those payments will not result in a windfall profit to the equity investor by creating any substantial increase in the property’s equity.
If the parties intend to pursue a strict business relationship, a limited partnership agreement might be appropriate. Under such an arrangement, the owner/occupant would be the general partner and the equity investor would be the limited partner. Normally, title to the property would then be placed in the partnership. However, doing so may have negative repercussions when the equity investor is bought out by the owner/occupant party.
Under Proposition 13 in California, which relates property taxes to the purchase price, if the name on the title to the property is a partnership and it is then transferred to the individual name of the owner/occupant party, that event would likely trigger an increase in property taxes based on the market value of the property at the time of that transfer.
Again, one way to avoid these consequences, but at the same time apply a partnership arrangement and still protect the interests of the equity investor would be to leave the name of the property in the name of the owner/occupant party, but provide a trust deed in favor of the partnership which in turn would be obligated to pass the benefits of the trust deed on to the equity investor.
Another vehicle for accomplishing the same thing is a living trust. By putting the title of the property into the name of a living trust, the trust document itself would address the issues concerning the owner/occupant and equity investor just as would an equity share agreement. Its structure, however, would allow for the trust to continue in existence with the owner/occupant as the only beneficiary once the obligations to the equity investor had been fulfilled.
Obviously, all of the various options or alternatives that have been discussed in this article have ramifications that cannot be addressed at any length in this brief medium. Equity share agreements, however, can be beneficial to both a home buyer and an equity investor if pursued in an intelligent and well planned manner.