New Twist on MEWs Not a Sign of Housing Euphoria

by: Russell Wood

Yesterday's WSJ had a story about a new twist on mortgage equity withdrawals. A San Francisco based firm, REX & Co., will pay cash to home owners in exchange for part of the proceeds when the home is eventually sold. Here is an example from the story:

The owner of a home valued at $750,000 might obtain $100,000 in cash by giving REX a 50% share of the change in the home's value. If the home sold for $850,000, REX would receive $150,000 -- the original $100,000 invested plus half of the increase in value. If the home sold for $650,000, REX's share would be $50,000, half of what it had invested.

The bubbleheads will see this as another sign of the irrational euphoria of the housing market, but I think it fits with the other legitimate innovations in housing finance introduced in the last ten years. This strategy attempts to take home financing from a debt model to a share of profits model, which better aligns the interests of the lenders and the borrowers. There are lots of details that could cause this type of funding to fail on any given transaction, but in general I think this is a good idea.

The significance of this will be missed by those that do not understand the current monetary inflation that is threatening traditional lenders. The inflation that began in 2004 is reducing the value of every dollar repaid by creditors to their lenders.

Housing in general benefits from inflation, as real assets eventually rise in price as a result of the inflation (despite the current slowdown which is temporary or cyclical, not permanent). Thus, home owners are sitting on appreciating assets and paying back debt with cheaper dollars. This new financing arrangement will protect lenders from the effects of inflation if they can make this scheme work.