Why Buyers are using the Rent-to-Own model for Purchasing Homes?
What is the Rent-to-Own model?
Most people either rent homes or own them. But access to homes should not be a black and white concept. The rent-to-own model is a step in between renting and owning a home. This model gives you access to any home you want today, without any mortgage while getting the upside of owning a property. To buy a home and get a mortgage you should have at least 10% of the purchase price as down payment. However, after the financial crisis getting a mortgage has become very difficult. The banks have increased their FICO score requirements from 690 to 740, cutting out 20% of US consumers. At the same time 48% millennials have student loans greater than 20K. With such a high debt to income ratio, this makes them more financially complex, resulting in not qualifying for mortgage. Divvy Homes aims to help you increase your FICO score and become eligible for mortgages while simultaneously having access to the homes. All you have to do is pick a home and put in as little as 2% of the purchase price as down payment.
What is Divvy Homes?
Divvy Homes is a company that bridges the path to ownership. The company works with renters who want to become homeowners by buying the home they want and renting it back to them for 3 years. These renters are typically people who do not qualify for traditional mortgages. Divvy screens them on the basis of its own algorithms that predict if the user will be able to pay them back in 3 years, that is significantly less harsh than the mortgage screening process by banks. How it works is, you can select any home they want. Divvy buys it on your behalf while you put 2% at closing as down payment. Divvy then opens a synthetic equity account where you own 2% of the home and Divvy owns 98%. Every month you make market rate monthly payments that are split into rent (profit for Divvy) and equity (increase your ownership of the house). After 3 years, you would own 10% of the house that would make you eligible to apply for a mortgage. Then you have the option to either buy-back the house from Divvy or walk away and let Divvy buy your 10% stake in the house.
What the company does well?
What Divvy Homes does well is have a business model that focuses on ownership of homes. Apart from simply providing homes, the company believes in a complete path to ownership and offers integration of services like cable, internet, home security, landscaping, renters insurance, tech services and even covers maintenance costs like a regular landlord. This aggregation of services helps it to make the experience seamless particularly for millennials who are averse to hassles. Many people argue that the trend of millennials wanting to own large dollar fixed asset investments like cars and houses is dying. Looking at the success stories of Airbnb and Uber, it may make sense. But if you scratch beneath the surface and look at actual data, there have been studies that show that 89% of millennials want to own a home. The reason that Airbnb and Uber type companies became so big is because of the need. The same study also showed that only 40% of the millennials believed that their financial situation would allow them to buy a home in the near future. So in my opinion, the biggest benefit of Divvy Homes is its focus on bridging the path to ownership for people who could typically not afford to buy a home. This has further benefited the company. Based on the information revealed by the company, it’s been found that because the customers treat these homes like their actual homes instead of rented properties, they treat them better leading to lower turnover and significantly lower maintenance costs. Moreover, the company also generates more rent per homeowner than any other REIT, which is historically one of the best asset class performers.
Another aspect of the company that is interesting to point out is how it de-risks itself. Because Divvy outright buys the homes, it is able to hedge its risks to a significant extent from macro factors like pandemics and economic downturns. The company has raised $100M+ in debt financing to purchase the homes. This increased leverage allows them to own a cash generating asset whose value appreciates in the long term. On the other hand if it had adopted the model of taking long-term leases and giving out short-term leases to its tenants like other similar companies, it would have gotten into trouble during these times.
What is the opportunity in Asia?
Singapore and Hong Kong are countries with the fourth and second most expensive real estate globally, respectively. Both countries also have large amounts of upfront costs for buying homes and make it difficult for first-time home-owners to get mortgages. At the same time, in Hong Kong the median property prices were 20.9 times the median household income in 2018. While the millenials in this country want to own homes as it is considered a prerequisite to getting married and starting a family, they believe that they would have to work for 25 years before they could afford a home. In 2019 due to political unrest Carrie Lam did relax mortgage regulations for first-time home buyers. Despite that according to Bloomberg Intelligence, the new regulations did not benefit too many home buyers. In both these countries, Divvy would have the opportunity to tap into the millennial market. While for most millennials the sentiment in these countries remains that they will have to rent a home for life, if given a choice they would choose to own a home. Additionally, the usual stability of income and jobs in these countries (disregarding political unrest in Hong Kong) makes these countries relatively risk-free for Divvy.
In emerging economies like India, 49% of millennials aspire to be home buyers. However, the guidelines set by the Reserve Bank of India make it difficult. It requires them to put 20% of purchase value as down payment, maintain a good credit history and not take risks with their investments for a period of 3 years before purchasing the house. Apart from the cost aspect another reason for millennials not being able to buy homes is due to the complexity of the home buying procedures. The lack of digital infrastructure for purchasing houses as well as the paperwork and hassle involved in aggregating other amenities makes it a complex task for them to purchase a house. Divvy would be a perfect fit for a market like India where it could help millennials and first time home-owners establish credibility to get a mortgage as well as make amenities more accessible and easy to use.
Overall, a company like Divvy Homes would be able to generate a huge impact in Asia particularly for millennials and first-time home owners. Regardless of whether these countries are developing or developed, the system has made it incredibly difficult for this segment of people to own homes. Through the rent-to-own model, Divvy would make this bridge to home ownership an achievable goal.
