Getting the Agreement Right

(NOTE: This popular article originally aired on February 15th, 2008, on our old blog site. We are posting it here so new readers can enjoy it, too)

One of the biggest concerns about equity sharing is the inherent complexity of the agreement (contract). There’s a good reason for the complexity, however. Sharing property between two or more people requires careful consideration of all of the possible outcomes. By planning ahead, you can ensure that you are well protected and receive a fair outcome no matter what happens with the property or your co-owner(s).

For example, you may agree to a five-year term. But what happens if after five years the property has not appreciated enough to provide a reasonable return on investment? A good equity sharing agreement (ESA) must allow for this possibility and specify the minimum appreciation required before the property may be sold. If the 'required appreciation' is not reached, you can extend the agreement yearly until it is. This number should not be so high as to cause the agreement to continue in perpetuity. It should just be a hedge against loss, something like 3 to 4% appreciation per year is common.

A good agreement also protects the investor in the unlikely event that the Occupier (person who lives in the house) misses mortgage payments or fails to maintain the property or meet their other obligations. One option is to allow the investor to buy out the Occupier at a discounted amount payable in installments, or to sell the property and discount the Occupier's equity as a penalty. In addition to writing these protections into the ESA, investors can also record a deed of trust that will allow them to foreclose at default.

Similar provisions can protect both parties’ interests in the event the other party becomes involved in a bankruptcy, probate or other court action. Here again, a well written ESA is the key to protecting everyone. With a good ESA, the difficulty posed by one party’s default is offset by a financial advantage afforded to the other party.

Sometimes the Occupier is forced to move due to unforeseen circumstances. Your ESA should allow for this possibility as well, as long as basic conditions are met. And if one party needs to terminate the agreement early, the ESA can and should define the terms and consequences.

While it is unlikely that you will encounter these problems during your co-ownership, it is critical that you develop an ESA that considers these worst-case scenarios in an intelligent, equitable way. Though complex, a good ESA is the protection that allows two strangers to come together, confident that each will abide by the rules or accept pre-defined consequences.

The HomeEquityShare Team