Taking their winnings off the table:
Are seniors over-invested in their home?
Let’s say in January 80% of your assets were invested in hotel and entertainment stocks that made you a healthy chunk of change. For sake of argument, let’s say these stocks consistently out-performed your expectations. Then came March and the arrival of the novel coronavirus. If you found yourself holding these positions after the pandemic broke you probably got clobbered in the market.
Much like being over-invested in one or two companies, many are over-invested in their home. That’s a point Hometap Equity Partners CEO & Cofounder Jeffrey Glass made in a last month’s RMD virtual event HEQ- the future of home equity in retirement. If the bulk of a client’s wealth was tied up in one stock a financial professional is likely to strongly recommend diversification. “If that were a stock, and you had 60-90% of your net worth tied up in one stock, no matter how much you love that stock, any financial advisor would tell you you’re over-concentrated, particularly since you’re over-concentrated in an asset that’s illiquid,” While Glass’ was speaking in the context of alternate equity products, his analogy nevertheless rings true.
So what about housing wealth?
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To be frank, home equity is an illusion that exists on paper until it is separated from the home. You can almost still hear the echoes of excited voices twelve years ago boasting of their newfound ‘wealth’ or equity they ‘made’. We all remember how that story ends.
The point is the equity, or value if you prefer’ in the bricks and mortar of a home is neither safe nor guaranteed to be there tomorrow. That leaves older homeowners with two choices to extract equity: sell and ‘right-size’ into a new home at today’s prices or separate a portion of the home’s value and remain in place. The former requires one to uproot themselves and later a tool to extract cash from the roof over their heads. So let’s stop here, right now for just a moment and ask ourselves this question. Will home values continue to rise in 2021? To be honest, we don’t know. There may be indicators of a correction but perhaps we should recall the lyric’s from Blood Sweat & Tears hit ‘Spinning Wheel’ ..” What goes up must come down. Spinning wheel got to go ‘round”. And go ‘round does the housing market go. It’s a cyclical market that ebbs and flows. Many experts see employment as the lynchpin of future real estate values.
All of which leads us to our original question. Should older homeowners be taking some of their winnings or equity off the table? Perhaps. The two hurdles that must be cleared are the fear and misunderstanding surrounding reverse mortgages, and the upfront costs to diversify their ‘equity holdings’. Before diving into the intricacies of how a HECM works it’s best, to begin with, the broad brush strokes. “Do you plan on living in your home for the foreseeable future?” And the bonus question, “Do you believe home values will continue to go up in the next year or two or go down?”. Even if they’re not reading the Wall Street Journal each week most homeowners are generally aware of the real estate market’s performance and more importantly, they’re old enough to remember earlier housing downturns.
So what are their options? You know them well. Besides selling there’s the favorite recommendation of media ‘experts’- a HELOC. Great, but now they’ve got a monthly payment in addition to their existing mortgage if they have one. Sell? The fact is most prefer to age in place? That leaves us with the question- how would you leverage your home’s values, take some of the risks of a fall in home values off the table, and not be saddled with a payment? Correct me if I’m wrong, but that seems to point in one direction- a reverse mortgage. Even more so a Home Equity Conversion Mortgage with a line of credit.
Equity makes great conversation over coffee but it’s meaningless and most importantly vulnerable until it’s separated from the home.
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3 Comments
Excellent video, Shannon – thanks!
Thank you Jim.
Equity is in fact a fleeting concept except equity in the legal sense. Generally, when we talk about equity, it is nothing more than the difference in a subtraction problem. Home value which is the minuend of the subtraction problem is dynamic and is subject to continual change not only from factors in the home but far more by factors outside the home such as the quality of schools in the immediate area, deterioration in homes near the subject property, the economy in that area and its effect on income from jobs, availability near the subject property such as grocery stores, gas stations, doctors, restaurants, jobs, and other community characteristics, and even drought on the landscape surrounding the property, frequency of fire in the area, overall weather conditions, location of polluting factories, and many other factors.
Debt, on the other hand, is the subtrahend of the subtraction problem that results in the difference that we name, “home equity.” Debt is changing but its changes are generally less volatile than the changes related to home value. However, unless the mortgage is an adjustable rate mortgage, the change is confined to the mortgage documents and compliance with their terms and covenants. An adjustable rate mortgage has one additional factor and that is the impact of changes in the index selected in the mortgage documents.
A reverse mortgage does NOT take equity out of a home. It will generally increase debt. When it comes to the two variables, home value and debt, home value has generally been the more volatile in the last two decades. What few talk about is that using the proceeds of a debt to invest with is known as leveraging. Leveraging should be discouraged when it comes to seniors. Its risks are simply too great whether such investing is done in a disciplined manner as those who advocate using reverse mortgage proceeds to mitigate the risk of the sequence of returns or not. Although the big three publicly traded stock indices have seen bear markets in the last seven months, the bear markets have been short lived. While the indices have also experienced correction, most of the time, their values have been above the correction range (generally considered values of 80% to 90% of an identified peak value) even though they are less than than peaks.
While risk can be hedged against, loss in the later years of life is much more difficult to recover from.. Too often in our industry we assume that the stocks in a portfolio or in an income tax favored retirement plan are not volatile; however, most growth stocks are and few seniors with stock investments in today’s investment world do not hold at least some growth stock. This is not to discourage all leveraged investing (otherwise, how would most seniors own a home?) but it is to discourage a thoughtless and reckless exercise of mitigating loss by simply taking out more reverse mortgage proceeds as some advocate. Afterall there has been no substantial empirical evidence demonstrating the prudence of this strategy even though there has been well written white papers on this strategy.
Some in the industry falsely claim that home equity is an asset and even refer to a reverse mortgage as a buffer asset but such is not the case. Home equity can be positive or negative even when nonrecourse debt is involved. For example, if a borrower decides to keep title to a HECM at termination and the unpaid principal balance is greater than the value of the home, the amount due and payable is not limited to the value of the home but is equal to the unpaid principal balance. Some have stated since home equity is an asset (just shown to be a false assumption), the debt related to it is an asset but that again is false. In accounting parlance, the phrase used to describe the subtrahend in the calculation of home equity is a contra asset, since its value is negative in the home equity value computation.
The home is not an investment like a stock. Imputed rental income is not generally spoken of when discussing a principal residence but it is the basic reason for owning the home. What stock can be lived in? A home is the place we raise our children, place musical instruments, have our clothes cook our meals, eat with family and friends and do many other activities. Who does any of that with stock? While Shannon appreciates the statements of Jeff Glass in the 10/11/2020 RMD article, I prefer those of Tom Sponholtz. Jeff makes rather thin arguments while Jeff dwells on the true nature of the home.