a16z Podcast - a16z Podcast: Real Estate -- Ownership, Asset, Economy

Episode Date: January 13, 2017

The largest asset class in the United States is owner-occupied real estate, yet options for homeowners accessing this are very binary right now: either own 100% of your home (with a mortgage), or own nothing. And when people do “own”, that ownership is often skewed by debt. Of course, debt works out great for some, given their risk profiles and potential upside (if the house keeps appreciating); but the downside risk and costs are disproportionately borne by the homeowner. And millennials can’t even enter the housing market in the first place. So how can technology help address a system skewed by debt financing, by letting homeowners sell fractions of equity to unlock wealth without necessarily borrowing against their homes? How can such new approaches help homeowners and financers better align risk and incentives, and unlock a whole new asset class for all kinds of investors? How can they help avoid mortgage crises around the world, and the macroeconomic impact of reduced spending, lost jobs, and more? And finally, what is the role of policy here … especially since the government is de facto subsidizer of certain home finance products over others. We discuss all this and more in this episode of the a16z Podcast, featuring general partner Alex Rampell; CEO & co-founder of Point, Eddie Lim; and Atif Mian, professor of economics and public affairs at Princeton University who also co-authored (with Amir Sufi) the book House of Debt: How They (and You) Caused the Great Recession, and How We Can Prevent It from Happening Again — in conversation with deal and investing team partner Angela Strange.

The content here is for informational purposes only, should not be taken as legal business, tax, or investment advice, or be used to evaluate any investment or security and is not directed at any investors or potential investors in any A16Z fund. For more details, please see A16Z.com slash disclosures. Hi, everyone. Welcome to the A6NZ podcast. I'm Zonal. Today's episode is another one of our fintech conversations. This one is on rethinking the largest asset class in the United States, owner-occupied. real estate. Joining us to have this conversation, which is moderated by A6 and Z deal and investing team partner Angela Strange, is general partner Alex Rampel. They cover all things fintech and beyond. We have Eddie Lim, CEO and co-founder of Point, which aims to address a system skewed by debt financing by letting homeowners sell fractions of equity to unlock wealth in their home. And finally, we have Atif Mion, Professor of Economics and Public Affairs at Princeton University, who also co-authored with Amir Sufi, the book, House of Debt, how they,

and you cause the great recession and how we can prevent it from happening again. In this episode, we cover everything from the evolution of the mortgage market and its relationship to the macroeconomy, from the mortgage crisis and beyond, to the role of government as de facto subsidizer of certain home finance products. But we begin with the difference between equity versus debt exposure and why that matters. So right now, when you want to find a place to live, you've got two choices. You can rent, which means you own zero percent of your home. Or you can buy, which means you own a hundred percent, 100%, usually with the help of a mortgage from a bank. But why couldn't you own 80% or 85%? Not only would this make owning way more affordable, it would also mean that you wouldn't have like 300% of your

net worth tied up in this asset, which is completely against all standards of diversification. There's $18 trillion of equity locked up in U.S. residential real estate, and there's no solutions available to consumers except for debt, leverage on the home. If you think about 06-07, that was a massive over-leveraging of our economy. With equity solutions like Point, we can actually take money out of homes, put it back to the economy through remodels, through renovations, through small business investments, and help create that liquidity. So how is that different than the solutions that exist right now, like taking out equity loans?

In the stock market, there's equity. Everyone's familiar with buying and selling stocks in Apple or Google, and there's corporate bonds. And what doesn't exist in residential real estate is this ability to buy and sell effectively shares in your own. So let me just talk about the housing market in general and especially how it links to the macro economy. I think if you take the 2007-2008 episode in the U.S., one way to describe that is that the housing market kind of took the entire economy as a hostage.

you know, the boom and bus cycle in the housing market had implications, very strong implications for the broad macroeconomy, particularly on the downside when house prices fell 20, 30, 35 percentage points. That led to large layoffs in the population. And one of the key reasons for that was that people who were underwater on their homes, they felt that they had to cut back on their spending. And that cutback in spending had strong negative effects on the overall economy. Now, the point to keep in mind is that what we saw in the U.S. is not a unique episode. If you look at the rest of the advanced economies, you see similar patterns over and over again, which is that the housing market seems to lead where the rest of the economy is going.

And that's not necessarily a good thing. And so the question is, what are some of the things we can do to remove some of these close linkages between the housing market through these negative feedback cycles. And one area to focus on in this regard is the role of financing. The typical contract is this sort of debt-based contract. It works very well in general, but the problem with that kind of a contract is that in the event of a downside, the borrower, which is the typical homeowner, he or she is left holding the bag, so to speak.

So the entire loss on the downside, if not entire, but in a large proportion of it, it has to be borne by these levered homeowners. The things can get even worse if they go underwater. And so then they don't have sufficient equity, and they might just hand back the keys and walk away, which leads to this massive foreclosure problem. And so the question from the finance side is, can we think of an alternative arrangement where instead of the borrower facing all of the downside risk, can we share the down. downside risk with other segments of the economy that may be better able to withstand those shocks.

And that's where I think some of the more innovative products can play a role. Innovative products. One of the ways that we segment the fintech space at Andresen Horowitz is think about it, there's things that banks do, which is they lend money, they send money, they help you save money. And then there's a whole class of things that banks don't do. And that's often where you can find some really innovative products that can have big impacts. I mean, there are many different things that banks don't do. It kind of runs the gamut. Many of the things that we look at are related to esoteric areas of lending that banks just don't want to play in because it's hard for them to structure them, hard for them to understand it from a housing perspective.

It's very important when a bank underwrites a mortgage to understand the valuation of the home, but once they underwrite the mortgage, they own the debt, they have a lien on the property, and that's kind of it for them, as opposed to them being on your side from an ongoing basis. If you're late on your payment, their recourse is they foreclose on the property and then they take over the house and then they kick you out. They're not going to say, hey, we think you should leave us and go refinance your Wells Fargo mortgage with Bank of America. Whereas if you think about a co-owner of your property, it's almost establishing a neutral Switzerland-like partner that says, hey, you know, we own effectively 5 or 10% of the house with you. We want it to go up in value. And one of the things that we think you should do is maybe refinance your mortgage.

and has a better rate. It's something that the banks themselves would not do because they're locked into this notion of we own the debt, we want to own the debt. I wouldn't say it's necessarily an adversarial relationship, but they're not going to necessarily act in the same interest as the homeowner because they want to get the coupon from you remaining in that house for a long time, and they want you to be levered up. This is where we think of ourselves as that kind of co-owner, the guardian of the deed, where we want to optimize not just financial health, but also property health. In terms of use cases,

there's really three broad categories, wealth transfer, renovations, and debt payoff. So wealth transfer can include things like putting money, taking money out of your home to put into investment property, selling equity to invest renovations,

right? That's kind of like a reinvestment back into the home. And then you have debt payoff where a homeowner who's taken on some expensive debts, high interest rate loans, we can come in and pay those off

What's the catch? There's no catch, really. The great thing for homeowners is anybody that's optimizing for diversification of their assets, lower monthly payments, you know, this is a great solution. The really radical thing here is there's alignment with the homeowner, alignment between the investor and the homeowner, where when the homeowner does well, when their home goes up in value, that's when the investor does well. And that kind of alignment doesn't exist for any other kind of products out there for consumer. If you have perfect credit and you're really rich and you have really nice house and you want to take out a HELOC, the home equity line of credit and you want to make monthly payments, then great, take out a HELOC. But what if you have very high monthly payments? You don't want to make any more monthly payments and you don't want to take out a helock or there's a broad group of people that can't get a helock because their credit isn't good enough. So what do they do? There's no such thing as a free lunch here. But, you know, what I like about it is that it just empowers a lot of individuals that either for whom a he lock is not appropriate. And I would argue for a lot of people, it's not where they

can't get a he lock. You don't know your house is going to go up 10x in value. It could go down by 90%. You're convinced your house will go up 10x in value in the next year. You should go take out debt. Equity is more appropriate for certain situations. Bonds are more appropriate for certain situations. And it's just, it's another option. It's one thing to have different types of contracts. But I think if you talk to many homeowners, there's a lot of skepticism or shell shock from what many people had to endure during 2008 and their home prices, you know, really dropping precipitously. How do you think we can go about educating consumers or potential homeowners to these new methods that are where investor interests and consumer interests are much more aligned? From an education perspective, like 10 years ago, nobody woke up and said I'm going to rent out part of my home, right? Now it's the thing. Same idea here. Nobody wakes up and says, I'm going to sell some of my

equity to a third party. So it's important for us that if a consumer hasn't even looked at some of the other options out there. Maybe a HELOC is appropriate for them, maybe a private loan, maybe a lending club loan. We encourage them to look at their other options. None of our folks work on commission. If we can help you find a great refinance partner, if we can help you with a better, more comprehensive insurance policy, that's lower cost, that's lower risk for us. It's win-win for everybody. Let me talk about something related, which is the question of insurance. Let me just use the insurance in the auto industry. The government mandates insurance in some sense, and the argument for that is that if I'm driving around and I don't have

insurance, then if I hit someone, I cause a loss. But if I don't have insurance, I may not be able to pay that person for the loss that they have to incur because of my actions. I make this analogy because I think it's relevant for the housing market as well. And in particular, when we talk about homeowners that are getting into potentially over-leveraging situations, so think of someone who has a loan to value ratio of more than 80%, for example. They can either take out kind of a standard loan, a standard sort of debt. But the problem with that is that in case house prices go south, that person might go into foreclosure. they might cut back on their spending in a serious way,

and both of those actions actually impact the neighbors and the economy at large. So what I'm trying to say here is that there is an insurance argument that suggests that at least for leverage beyond a certain threshold, maybe it's 80%, maybe it's 75%, that leverage beyond that should be insured in some sense, which again is the same notion that the downside risk needs to be shared with the homeowner by the outside investors.

And that's a healthier arrangement as opposed to a situation where the homeowner has to bear the entire brunt, which typically these kind of homeowners who have to overstretch to buy a house in the first place, they are not in a good position to withstand those shocks. The point from a kind of a macro perspective that I want to bring in is that it's not just a question of what is good for that homeowner. I think from a policy perspective,

we need to think of this insurance motive as well and the wider implications of individual decisions. Just think of, think of it that way. We need to protect their neighbors from the potential foreclosures that might happen in their neighborhood. Yeah, if you think about the housing market in the U.S. in general, a lot of the reform arguments are focused around, you know, either privatizing Fannie or Freddie or various things around that degree.

So there's been a lot written on the 2008 crisis. But what I really liked about your book, Atif, in the subtext subtitle is how they and you, cause the great recession and how we can prevent it from happening again. You talk a lot about just the general role of debt and how we need to think about debt more broadly and how the trouble is that with a debt contract, you don't really share the risk between the borrower and the lender. And then you even went so far as to propose kind of an interesting solution that can link your housing payments to the price of what's happening in the

city. You talk about ideas around how you would actually enable the debt, enable the sharing, of the risk between the lenders and the borrowers and in this side? The reasons for recommending those kind of policies is, again, this idea that risk sharing is really important in the economy. The specific proposal that we had was called shared risk mortgages and or shared responsibility mortgages rather. And the idea there is that the payment, your mortgage payment is linked to the value of your house. And it doesn't have to be literally your house. It could be the value in the neighborhood that you live in. So the value of the city or it could be the value of housing stock in the zip code that you live in.

And so your mortgage payment is partially linked to those indices, specifically in the event of a downturn. That doesn't happen all the time. So typically your mortgage contract will just look like it looks today. But in the case of a housing bust, that's where this insurance aspect of these contracts kicks in. And if the house price generally in your neighborhood or your city goes down by 10%, then your mortgage payment also automatically goes down by 10%. And that's because the principal value basically goes down by 10% because it's linked to the value of the housing collateral that underlies the mortgage.

And if you do that, basically, you know, there is a lot less incentive for the homeowner to declare or default and declare a foreclosure because they natural. automatically get a reprieve. We argue in the book that if we have those kind of arrangements, a significant or substantial portion of the foreclosures and the resulting economic losses from those foreclosures could have been avoided. Sharing equity, really great alignment for consumers. It also provides interesting opportunities for investors. If I want to invest specifically in, you know, insert metropolitan area real estate, it can be difficult to do that or particularly expensive through various reits. There are a lot of different asset classes that investors just don't have access to. So typically, once you get beyond a certain size, you might diversify outside of just

like bonds and stocks. So if you look at large endowments, they might buy Timberland in the Northwest. And Yale kind of popularize this model of alternative investments that have a longer duration holding period, because a lot of times these things have an illiquidity discount. because if you're holding on to something for 10 or 20 years, that might not fit for somebody that has a 12-month CD-like characteristic around the investment that they want, but it might be great for a pension plan where having a 10-year-hold period is a feature and not a bug because they're able to get better returns. Likewise, if you look at residential real estate, we've spent a lot of time looking at, say, the hard money lending space where it's $75 billion a year and how do you

go invest in this category of people, buying houses, fixing them up, and selling them. And this is not like flipping condos in Miami or Vegas in 2007, 2008. This is like, you know, real real estate entrepreneurs. They can't go to a bank. Again, it's kind of a thing that a bank doesn't do. There's a lot of demand for secured assets. I mean, Lending Club kind of tapped into the demand for higher yielding unsecured debt. And then there's still ample demand for higher yielding, longer durations, secure debt. And if you think about housing stock right now, if you go to your local neighborhood and you say, okay, what are the rental properties and where are they located, and what are the owner-occupied properties? And, like, how are they different? In many cases, like, the owner-occupied

properties might be a better long-term investment. But how do you buy into that? And the answer is you can't. Right now, the option for an investor is you can invest in a residential reed, which is rental properties. So, like, this just unlocks an $18 trillion market that right now is closed off to investors. Of course, it's closed off to consumers in terms of all these different things around diversification and whatnot. I think the beauty of these kind of products where you have an alignment with the consumer means you can build off of that relationship, whether it's their financial health, their property health, other kinds of finance products, whether that's the alternative to reverse mortgage, the purchase product for millennials getting on the property ladder, HELOC products, and many more. So many different angles in terms of people that it would help from my next-door neighbors that bought their house 60 years ago that didn't have a mortgage anymore. There is a product called a reverse mortgage, which tended to be, I don't want to call it predatory because maybe there is a good one out there, just waiting to be unleashed upon the world. But it just wasn't clear to the consumer what they were getting, because it would target older people, not to target them like in a, we're going to target old people and take advantage of them.

But if you think about who has 100% of the equity in their house that wants cash out on a regular basis because they have no income, well, that does tend to be elderly people. But what the heirs of the elderly people didn't realize if they had signed up for a reverse mortgage is that when the elderly person would pass away, maybe they would own 0% of the house. The children would get nothing and that wasn't really anticipated because the interest payments got very, very high as opposed to saying, okay, I am elderly. I would like money right now. I'll sell 10% of my house. And that's a case where, you know, there is no L in the LTV because the person doesn't have a loan anymore. I mean, there's no such thing as a 60-year mortgage. Like, my next year neighbor has paid off their mortgage literally 30 years ago. So there are a lot of use cases like that where it helps unlock equity without producing this, the downsides of leverage and the opacity of just this indeterminate interest rate that you might

have in other products. I agree that there is investor interest and appetite for getting exposed to housing risk on the lender side, and I think they are open to those kind of suggestions. But there remains one big problem before financial products of this sort can really proliferate at a macro level that it can have an impact. And that bottleneck is regulation. So currently the housing finance market is heavily regulated. Let me give you three examples. I mean, starting from the big GSEs, you know, Freddie and Fannie. Their first order impact is just in terms of defining what is a conforming mortgage and what is not a conforming mortgage.

Now, any mortgage that falls within the definition of a conforming mortgage, that automatically gets this kind of subsidy, right, this insurance subsidy that the government provides. So if you are coming with an alternative financial arrangement, and even if that arrangement is actually better for the overall macro economy, you are kind of, to some extent, fighting an uphill battle against this sort of subsidized products in a way. So I think we need to think seriously about what kind of products the government should be in the business of subsidizing if it is to do anything in this market at all. The second example I would give is

taxation. If I take out a mortgage and I'm going to pay interest on that mortgage, I can deduct that at the time I file my taxes. So that gives, again, a standard sort of debt-based financial contract and advantage compared to other more equity-based financial contracts. Now, that's just an artificial advantage, and it sort of goes against the economic value of the alternative, which is that more risk-sharing contracts, more equity-like contracts, actually are better for a macro economy. So we have the tax side if it kind of has it backwards, which needs to be addressed. And the third example I'll give on the regulation side is a sort of Basel regulation, which are the regulations that are applied to the banking sector. If I'm a bank, for example, I mean, I'm a lender.

and the business of financing, the housing purchases, and so on. If I lend you money in the form of a debt contract, and I can get good rating on that, I don't have to hold much equity, much capital against that. But if I gave you the same loan in the form of an equity contract, then all of a sudden my capital requirements are a lot higher. Now, we might think that this makes sense from an individual bank's perspective, but it actually does not make much sense from an overall system, wide perspective, because from a system-wide perspective, it is actually the more equity-like

contracts that are much more stable, that have much more beneficial qualities as opposed to the characteristics of the typical debt-based contract. So again, from a regulation perspective, I think we kind of have many of these features backwards, and there is an important issue of revisiting the way we regulate this entire market. That's, in a sense, is a bigger problem that that needs collective action. That's where the government needs to get involved. The irony of my Charles Schwab account, right, is as soon as I go do margin trading, I get all these warnings of my account, somebody calls me and asks me, do you know what you're doing?

And that's really, you know, kind of adding debt to my account. But it's a fair point, right? Half of the regulations that the CFEB has put out are around mortgages. So we, understanding all the safeguards there, have incorporated many of those into our product, We have created disclosures and other kind of materials for homeowners that go above and beyond. We follow the waiting periods, precision periods, and we go state by state in our rollout, getting licenses, making sure that we're abiding by all the regs. But it's an interesting point because this product doesn't actually exist. So we would love nothing more than for new regulations and procedures to be created around this.

There is a new direction in the marketplace that we did not see before. This idea that the outside investor is willing to take an equity position in someone's house, that's sort of a new idea that is getting more and more traction. Other people have thought about this before, but they have largely been proposed as kind of these conceptual theoretical constructs. There are now actual companies that are trying to do that. So that's one major change that I see that's coming from the private market. side. The second change I want to highlight is that this old model where the government was

heavily involved in backing or ensuring this market, that that may not be the best way to do it going forward, particularly coming more to the surface in places that at this point are in danger of overheated housing markets. I'll give you one example of Canada. In the Canadian housing market, obviously house prices have been rising very rapidly, especially the foreign capital coming in and so on. And next to it is the fact that most of the mortgages are a large fraction of the mortgages in Canada are actually insured by a government agency. So the Canadian government is at this point very interested in thinking about alternative ways of insuring these products without the government having to be on the hook.

Essentially, they are interested in outside investors or private capital to share that insurance risk. That's where those two things coming together can actually lead to sort of substantive changes that can change the landscape of how we currently view housing finance. And the other thing that's interesting is as interest rates have gone and plummeted to zero or in some countries negative, which is a very, very hard concept. How can you have a negative interest rate? Like if interest rates were to suddenly tomorrow go to 20%, and that's what you had to pay to get a house. Your mortgage rate was 20%. Demand would plummet. And likewise, if interest rates go down, that means one thing for asset prices, they go up.

So that's the other thing. Like investors, it's hard for them to get a good return in an era of zero interest rates. There are two really interesting things about this kind of shared equity investment. One is it's a great inflation hedge for lots of investors out there. right, let's take insurance companies. I want to hedge against their liabilities. Residential real estate exposure has been one of the best inflation hedges historically. The other really interesting thing here is there are all these investors out there that buy mortgages.

They're mortgage hedge funds, mortgage reeds, the real estate investment trust. And what's interesting is, like, all they've had exposure to in buying these assets is debt, right? So they've never had exposure to the equity side. And so this kind of investment allows them to actually combine those together and have a single vehicle or a single pool that has both debt and equity characteristics. What that means is you get exposure to not just the debt characteristics, but also the equity alpha, the equity upside and downside. I think what's really exciting from the consumer angle is thinking about the populations that don't own homes yet. And with rising home prices, so many consumers of all ages are just completely locked out of even having. the option to own a home? If you don't have a rich uncle, what do you do? And now with products

with equity home ownership, it can make the option of owning a home much more affordable and an opportunity for a broader set of the population. You can imagine more portability. If it's more liquid, I mean, more liquidity is good for portability. Real estate is an illiquid asset class, but it's also binary right now, like you either own it or you don't. Imagine that real estate is wholly liquid. You can sell one share of your house. and there are 100 shares of every home, and maybe you can't sell all 100 shares at this point in time, which would enable you to leave and move somewhere else,

but you could sell 57. That would make it easier for you to make the down payment on the next house that you buy. The Bay Area is this, like, crazy, crazy sub-area of real estate, but that's not like the rest of the world. A lot of the world works where I want to go buy a house, and then there are contingencies on that actual purchase contract. one is getting a mortgage. So you'll submit an offer, but it's obviously contingent on the bank financing the property as well. The other one, which is very, very common, it might be contingent on me selling my current house. So imagine you're the seller and you get this offer that says, okay, this particular buyer needs financing and hasn't been approved yet or isn't the process of being approved. I think they can make the down payment, but the bank still has to come through with the funds, and they have to go sell their existing house. And I don't

don't know what the chances of that are. So a lot of people get caught in this limbo. It just takes a long time for them to sell 100% of their house because that's the only option right now for liquidity. And they're caught in this other limbo of like until that happens, they can't move somewhere else. So if you get a great job prospect and you want to move 2,000 miles away and the company's not going to pay for your relocation and you've got this giant illiquid asset that you own 45% of right now, like, what do you do? Yeah, I think what gets us really excited about these types of solutions is at scale, you can create, you can make residential real estate efficient and create that liquidity and help prevent the boom and bus cycles that have really defined

residential. So most homeowners, they have most that are net worth tied up in their home. That's like having a stock portfolio with a single asset. And we would love to help be part of this wave of changing that kind of behavior. And this idea of distribution of home price risk, wealth diversification, we would love nothing more than there to be an ecosystem of companies that allow consumers, allow homeowners to take money out of their home, use it for many of these use cases, but one great use case that could actually be diversifying, you know, back into the ecosystem. Real estate as an asset class is just very interesting in general in that if you were alive 300 years ago in Britain. I mean, the South Sea company was started in 1711. That's where

Isaac Newton famously lost a lot of his money. You could have invested in the stock market, but companies are changing all the time. And likewise, with corporate bonds, you know, sometimes they're great until they aren't. The nice thing about real estate is it, I mean, it's called real estate for a reason. It's real and it's an estate. It's actually part of the ground. How do you invest in the equity of that for a considerable long period of time? And it's hard to. It's been one of the best performing asset classes of all time because you have human population growing, you have this migration to cities that's driving up the asset. I mean, this is bad for many of the millennials. It's harder to get on the home ladder because there is more demand. And when demand is up and

supply is constant, like that means one thing for prices, they go up. I just think this idea of unlocking this asset class in a long-term fashion, it just has so many disparate benefits. And it's not even just about like the idea of buying into a property and then, you know, diversification or whatnot from the consumer perspective. It's also what you can do as a co-owner. It's almost like a personal financial manager for your house, this idea of if I am an owner with you of your property, what can I do to help you because we're now aligned? Thank you very much, Alex, Eddie and Atif. Awesome. Thanks for having us here. Thank you. Thank you very much.