Sample Equity Sharing Agreements
Equity sharing is an arrangement typically used when a homebuyer cannot afford the full down payment of the home he/she wishes to purchase, but has enough income to pay the full monthly payments.
An equity share can also be used where the homebuyer can afford the home but cannot qualify for a mortgage. Equity sharing is often considered at the same time as a shared appreciation mortgage and a lease-option, other transaction structures used in similar situations. A comparison of equity sharing, shared appreciation mortgage, and lease-option, and a discussion of the advantages and disadvantages of each for various circumstances, is beyond the scope of this article.
Our sample equity sharing agreements are designed for co-ownership of a single residential dwelling (which could be a detached home, townhouse, or condominium), where one owner or family (the “Occupant”) will occupy the house as a primary residence, and another owner or family (the “Investor”) will provide some or all of the down payment. In exchange for his/her investment, the Investor will get a fixed percentage of the appreciation of the home. After a predetermined period of time, the Occupant will buy out the Investor or, if the Occupant does not want or cannot afford the buyout, the house will be sold. For a more complete explanation of this type of equity sharing, and examples of how to calculate the allocation of appreciation between the Investor and the Occupant, please see Equity Sharing 101 (LLC) or The Home Equity Sharing Manual (LLC).
The equity sharing contract templates assumes that the Occupant will pay all of the ongoing expenses of ownership (including mortgage, property tax, insurance, HOA dues, maintenance etc.); however, the agreements can be easily modified if the Investor will be contributing to the monthly mortgage payments or other expenses.
Our sample equity sharing agreements are not suitable for use where all co-owners will live in, or share use of the property, and are also not suitable for use where none of the co-owners will use the property.
One of the key variations in equity sharing arrangements is whether or not the parties intend to create tax benefits for the Investor. If Investor tax benefits are desired, it is necessary for the Occupant to pay monthly rent to the Investor for the use of the percentage of the property the Investor owns. When this approach is adopted, the Investor typically uses the full amount of the rent to pay expenses related to the property. The result is that: (i) the total monthly expenses of the Occupant is the same as if no rent were paid (since the amount the Occupant pays in rent is offset dollar-for-dollar by the amount the Investor contributes to ownership expenses); and (ii) the Investor has no taxable income (since the amount the Investor receives in rent is offset dollar-for-dollar by the amount the he/she contributes to ownership expenses). The only point of the rent transaction is to allow the Investor to take a depreciation expense tax deduction.
When considering whether or not to structure the equity share so that it creates tax benefits for the Investor, it is important to weight costs and benefits. A key question is whether the Investor can actually use the tax benefits given his/her overall tax situation. Another question is whether creating the tax benefits for the Investor will diminish the tax deductions available to the Occupant. Answers to both of these questions will vary depending on the parties and the property, and it is wise to consult with an accountant or attorney.
Protecting The Investor
One of the key variations in equity sharing arrangements is the measures taken to protect the Investor from nonpayment by the Occupant. A well-written Equity Sharing Agreement, along with a recorded Memorandum of Agreement, provides a reasonable level of protection. With that document structure, the Investor has the right to force a sale of the property if the Occupant is not paying, but may need to enforce this right through an arbitration procedure that, depending on the circumstances, could be costly and time-consuming.
An alternative that provides greater Investor protection is to use an Equity Sharing Agreement and an Equity Sharing Note along with either an Equity Sharing Trust Deed (if the property is in a state where trust deeds are used) or an Equity Sharing Mortgage (if the property is in a state where mortgages are used). The trust deed states are listed below; unlisted states are mortgage states. If the Occupant is not paying, this document set is designed to allow the Investor to foreclose without arbitration or court. The foreclosure process is the same as a bank would use following default under a mortgage. But the Agreement/Note/Mortgage approach is more complicated and expensive to create.
We offer four different sample equity sharing agreements:
- A basic equity sharing agreement that does not create tax benefits for the Investor and does not provide the additional Investor protections. This version is entitled Sample Basic Equity Sharing Agreement, and should be used with our Memorandum of Agreement.
- A basic equity sharing agreement that creates tax benefits for the Investor but does not provide the additional Investor protections. This version is entitled Sample Basic Equity Sharing Agreement For Investor Tax Benefits, and should also be used with our Memorandum of Agreement.
- An equity sharing agreement that does not create tax benefits for the Investor but does provide additional Investor protections. This version is entitled Sample Equity Sharing Agreement With Extra Investor Security, and must be used with either our Equity Sharing Note and Trust Deed (for trust deed states) or our Equity Sharing Mortgage (for mortgage states).
- An equity sharing agreement that creates tax benefits for the Investor and provides additional Investor protections. This version is entitled Sample Equity Sharing Agreement For Investor Tax Benefits With Extra Investor Security, and must be used with either our Equity Sharing Note and Trust Deed (for trust deed states) or our Equity Sharing Mortgage (for mortgage states).
This Equity Sharing Agreement forms can be used for equity sharing arrangements (of the type described above) involving property in any U.S. state. They are 17-22 pages in length, and written in plain English with the minimum amount of legal jargon. The main topics are:
Owner contributions to down payment
Occupancy rights and limitations for owner-occupant
Periodic inspections by investor owner
Shared mortgage and payment obligations
System for paying bills
Verification by investor that bills are paid
Consequences for late payment and nonpayment
Responsibility and procedure for repairs
Allocation for cost of repairs
Procedure if occupant wants to make home improvements
Sale and buyout timing and procedure
Sharing of appreciation and sale proceeds
Effect of prior repair and improvement expenditures on sale/buyout allocations
Effect of mortgage principal reduction on sale/buyout allocations
Early termination of equity share by occupant or investor
Consequences and procedure for violating equity sharing agreement
Dispute resolution procedure
List Of Trust Deed States
The trust deed states are Alabama, Alaska, Arkansas, Arizona, California, Colorado, District of Columbia, Georgia, Hawaii, Idaho, Iowa, Michigan, Minnesota, Mississippi, Missouri, Montana, Nevada, New Hampshire, New Mexico (for residential properties), North Carolina, Oklahoma, Oregon, Rhode Island, South Dakota, Tennessee, Texas, Utah, Virginia, Washington, West Virginia, Wisconsin and Wyoming.