Equity Sharing Example
Karen currently rents a house from Brian. Brian bought the house for $500,000 and owes $100,000 on the mortgage. Karen wants to buy the house but can't fully afford it. Brian would like to pull some of the equity out of the home. Karen and Brian decide to meet both of their needs by entering into an equity sharing agreement.
Karen and Brian agree that they will value the home at $1,000,000. They mutually agree that post-sale Brian will have 60% of the ownership and Karen 40%. Karen will put down $50,000 as a down payment and take out $350,000 in a mortgage loan for a total of $400,000. Brian will receive the $400,000, pay off the remaining $100,000 of his mortgage loan, and keep $300,000 as profit. He will apply the remaining $100,000 of equity value towards his 60% equity ownership in the property by receiving less cash ($100,000) than he otherwise would have in a clean sale.
Sale price: $1,000,000
Brian's Cash Equity in the Home: $400,000
Brian's Outstanding Loan: $100,000
Karen's Down Payment: $50,000
Karen's Loan: $350,000
Brian's "Equity Payment": $100,000 (he chooses to receive less cash from Karen in exchange for more ownership in the property in the equity sharing arrangement)
Karen's used her loan to pay Brian $300,000 in cash plus $100,000 to pay the remainder of his original mortgage loan. The "equity payment" of $100,000 is taken from Brian's appreciation on the property during his time of ownership. Had he not chosen to apply this as equity in the property, Karen would have had to pay him this in cash and the equity ownership split would be 50/50 versus 60/40.
Karen and Brian agree that the equity sharing term will be for 5 years at which time Karen will either buyout Brian for an amount equal to his total capital contributions (in this case $600,000) plus 60% of the appreciation in the property (if Karen declines her option, Brian has reciprocal buyout rights). If neither party wants a buyout, they will sell the property on the open market with Brian receiving 60% of the total proceeds and Karen 40%.
Keep in mind that this is a basic example. In reality both parties would have to consider closing costs at sale, attorneys fees, property taxes, and any additional capital contributions.
Another example of equity sharing would be when two people decide to own a home and neither currently owns the property.
John and Karen are friends. Karen wants to buy a home but can't afford the place she wants on her own. John agrees to partner with her in an equity sharing arrangement. John won't live in the property, he will simply be an equity investor in it. Karen will live in the property. Karen finds a two bedroom home and they decide to purchase it for $1,000,000. John puts $200,000 cash down as down payment. Karen puts $50k down and takes out a loan for $750,000. John's ownership percentage is 20% and Karen's is 80%.
The equity sharing term will be for 5 years. At the end of that time Karen either has to buyout John for hit total capital contributions ($200,000) plus 20% of the appreciation of the property or they will agree to sell the property on the open market with John receiving 20% of the proceeds and Karen 80%. Note that closing costs, attorney fees, property taxes, and additional capital contributions by either party will have to be allocated for before exiting at end of term.