Transitional equity stream

Purpose

The Transitional Equity (TE) stream serves as a combined entry point for both those who have financial capital, and those who have none, allowing them to collaborate on a housing collective project without supporting a rentier class. It recognises that while housing would be better provided as a universal right to everyone, leveraging some form of existing equity might provide better security for the current generation.

For those without financial capital, the TE stream is intended to increase access to the sense of shelter security that, in the capitalist system, is typically limited to property owners.

For those who currently have investment capital, housing equity, or are otherwise well positioned to participate in the conventional housing market, the TE stream incentives transitioning to more equitable housing systems. It allows people to continue to have some of the wealth storage they currently expect from housing, while recognising that in order to acquire property, investment of capital and acceptance of risk will be needed from individuals.

While it is the purpose of the TE stream to provide reasonable security for invested capital, it’s distinctly opposed to forms of inequality caused by capital amassing more capital. As such, equity held in the system does not amass interest, does not appreciate with property values, and is very limited in its transferability to future generations.

Regular financial contribution

If regular financial contribution was calculated entirely under the TE stream, then there would presumably be no mortgage, and yet the value of the housing is still basically indebted to individuals in the form of transitional equity. From a day-to-day perspective, the community would only need to cover non-mortgage operating costs, and so theoretically contribution could be quite affordable.

However, the TE stream is intended to be a transitional stage of the model, and there are many advantages to be realised by a collective as it continues moving to the following Collective Stewardship stage. As such, regular financial contribution is needed over and above non-mortgage operating costs in order to buy back transitional equity and move the collective fully into community hands.

The amount of financial contribution under the TE stream must sum to a total greater than the non-mortgage operating costs. That minimum amount could be apportioned in any way by the collective, such as a minimum amount per room, or by formula considering several aspects.

However, providing the minimum is reached, the per-person contribution should be set to the affordability metric, in order to continue to move through the model.

Overall, the regular monthly contribution of the TE model should not feel like a bargain. Living in the collective has many other benefits compared to conventional rent (security, agency and community to name a few). The goal of the model is to demonstrate that as the collective moves into the Community Stewardship stream then housing becomes radically affordable.

Affordability metric

The collective should choose an affordability metric for the BM stream that feels similar to the rental market. A recommended default is 30% of the gross income of the participants.

There are several other calculations the collective could adopt for this, including setting the contribution to the average local market rental of the spaces being lived in. More complex formulas based on residual income after non-residential living costs are also possible and possibly fairer.

Changing financial circumstances

Under the TE scheme, relief from financial contributions mainly occurs by people spending Transitional Equity they have amassed. If someone has an expected regular financial contribution of $1,000, they can reduce that to zero by reducing their TE balance by $1,000. There is no downside to the collective of this happening, providing the total rent covers non-mortgage operating costs.

In practice, this probably means that there is a minimum amount of contribution that is a share of operating costs. Lets say that’s $300 in the above example. The person above could spend $700 of their TE balance to reduce their contribution in any given month, with no approvals from the group. To spend equity to reduce the last $300, the group would need to ensure that enough people were paying more so that operating costs were covered. There may also need to be a process or policy for approval of such reductions. It is likely that this would be fairly affordable by a group predominantly using this stream, so such a process should be quite accessible.

If someone cannot afford their expected regular contribution and yet does not have Transitional Equity available to spend, the group may wish to have some additional options for emergency financial assistance. Under the TE stream collectives can afford to provide emergency financial assistance more easily than under the BM stream. Each collective should set a policy for what assistance it will provide. If the regular contribution formula is based on income, then it will naturally drop if income is lost. It may still want to have a policy for emergency pause of financial contributions.

What is Transitional Equity?

Equity earned by an individual is a credit on an internal account with the collective. It does not represent true ownership of any part of any house owned by the collective, and the individual’s name does not go on the title. However, it is intended to have real monetary value that can supply some of the benefits currently enjoyed by those who build equity in their house, without acting as a driver for wealth inequality.

Equity accumulation

For a given housing collective in its early stages, costs that must be met include non-mortgage costs (rates, maintenance, insurance, etc), and mortgage costs (paying off interest and principal). The wealth of the collective is represented by the current value of its unmortgaged property, which generally goes up through the payment of loan principal (assuming no change in property value).

When a mortgage is paid off, the repayment schedules are amortised across the life of the loan. In order to keep payments the same, less principal is paid off in early years compared with later in the loan. For example, for a new loan, about $1 of principal might be paid for every $4 of regular loan repayments.

The contributions paid by an individual under the TE stream pay for non-mortgage costs too, so it might be that, say, $6 of monthly contributions by an individual are needed to reduce loan principal by $1. However, if they voluntarily pay more, then that all pays off principal. So, for example, $7 pays off $2 of principal. Just like with conventional mortgages, this provides an incentive to pay loans off faster, and reduce the overall amount we ever have to give the banks.

When principal is paid off, the collective grows in wealth, and some of this wealth can be credited to the equity balance of the individuals who paid it off. It could all be credited to them, but then the collective would lack an income stream to execute on its mission. Given that, a collective using this stream should set an equity accumulation percentage, we recommend 80%. This means that for every $1 of principal you pay off, you earn 80 cents of personal equity, and the collective earns 20 cents which it spends on its purpose.

Equity holding

Given that the equity held by individuals has real monetary value, and could be paid out, the housing collective does not want to become over-leveraged to its members, even though equity held by its members is better than having it held by the bank (as it is a more limited equity, without a mortgage on the title). The collective only hands out equity when it pays off loan principal, so this should ensure that it doesn’t owe more equity than it has property value (in fact, less, due to the equity accumulation percentage), but one thing that could change this is a reduction in property value (eg, a housing bubble crash).

In the case of a reduction in housing value (checked by regular valuations of the properties), the value of everyone’s equity in the collective is reduced. For example, if the value of the properties owned by the collective drops by 15%, then the value of everyone’s equity account with the collective reduces by 15%.

The inverse is not true if property values increase, as the accumulation of equity due to the expectation of infinite growth is an aspect of the property market that we do not wish to replicate. If the properties gain in value, that gain goes to the collective, not to individual equity holders. However, since the ability for equity to reduce but not increase, this could create a risk that regular fluctuations in property value will cause equity amounts to ratchet downwards. To avoid this, the initial value of each equity grant is recorded. If they are reduced below this amount, a later increase in property value is used to increase equity amounts, but only back as fair as their initial grant amount.

Furthermore, the collective imposes a negative interest rate on equity holding. The suggested value is -2%. This means that your equity balance decreases by 2% per year (calculated monthly). This value is small enough to ensure that it doesn’t dramatically decrease your equity value, preserving most of it for your potential exit strategy, but inexorably moves the model towards community stewardship. Using a percentage like this also reduces smaller equity balances by a smaller amount, and will never entirely remove your equity as it asymptotes towards zero.

Equity uses

Reducing financial contributions

In a capitalist system, the primary use of housing equity is for rent reduction. If you buy a house, and you pay it off, you no longer have to pay a mortgage (although you still have to pay rates and other non-mortgage costs). This stream provides a similar system, by allowing you to “spend” equity to reduce regular payments. Essentially, you are able to use $1 of equity to reduce your monthly contribution by $1 this month.

Equity reduced this way is essentially bought by the collective. If there is a surplus buffer to do so under the Collective Stewardship (CS) stream, then this equity is effectively moved out of the TE stream and into the CS one. However, if no funds exist for this, the equity might be purchased under the TE stream by using buffer funds, possibly resulting in a draw down on the mortgage (increasing bank debt) if this continues. Depending on how much of the mortgage is paid off, there will be a limit in the group’s ability to do this, resulting in a limitation set on the amount of equity that can be spent in this way. However, over time as equity is amassed, the group’s debt burden also decreases and this option becomes more available.

Shelter assistance if living outside the stream

If a collective member holding equity is not living in a collective house for some reason (perhaps they left for an extended period, came back and there is not yet a room available for them), then they might be living in conventional housing paying rent or a mortgage.

If this is the case, they are allowed to sell their equity back to the collective for cash, up to the amount per month of their monthly accommodation cost in their other housing arrangement, and limited by the collective’s available liquidity as described above.

Cashing out equity on exit

If a member wishes to move out, and leave the collective permanently, they are able to cash out their equity at the fastest rate that the collective can afford. This is described in more detail under Exit strategy.

Collective Liquidity

In this transitional stream, the legal organisation representing the collective is taking on bank loans, and buying property. The net wealth of the collective (the value of its properties minus its bank loans) will fluctuate, but should grow as loans are paid off. Some proportion of the net wealth is potentially liquid. For example, home loans often allow money to be withdrawn, providing equity in the property doesn’t drop below a certain amount (e.g., 20%). The total amount that these loans can be drawn down is the collective liquidy of the group.

This is relevant for equity holders, because the collective is unable to cash out liquidy in any of the three ways above if it physically doesn’t have it. As this acts as a limitation on equity use, and even on the exit strategy, the group’s collective liquidity is always fully transparent and considered by the group if it will be impacted by group decisions (such as buying another property).

Shelter provision

The housing collective exists to provide secure shelter (housing) for members. Under the T2S model, that housing comes with a lot of autonomy of use, similar to ownership (although collectively governed).

Under the TE stream, shelter is contingent on being able to continue to pay monthly contributions, to offset those contributions by spending equity, or to receive payment relief for emergency hardship. The TE stream makes little concession to true affordability. The total amount of monthly contributions received by the collective must cover all loans and costs, and so could end up being above market in the case of a housing bubble collapse. This could lead to it being hard to provide security of shelter if income drops (at least without a lot of equity), and so a transition to the CS stream is desirable.

Once the group has reached its desired size, it would do well to focus on providing resilient ongoing shelter by paying off bank debt as quickly as possible, shifting it to individual equity, and then focus on paying that off collectively, shifting to community stewardship.

The shelter provisions of the CS stream are described under ‘Collective Stewardship Stream

Exit strategy

The TS stream needs a financial exit strategy to ensure that people are comfortable putting in capital they might otherwise use for individual rental options or property ownership. Having the ability to exit reduces fear of getting involved, and ensures that no one is stuck in the group due to their financial circumstances.

In an ideal world, once someone decided to exit, they would get all their money back. In practice, this may be delayed due to the limited liquidity of the group. To account for this, when someone exits they are immediately paid out for their equity up to a maximum cap. This cap is based on the available liquidity, but it is not the total liquidity, or there would be none left for a second person to exit. Instead, the payment cap is based on the following formula:

initial_payment_cap = (exiting_member_liquidy / total_member_liquidy) x collective_liquidity

This means that in a group where Sally has $100,000 of equity, and other people together have $400,000 of equity, Sally can only take 20% (1/5th) of the available liquidity immediately upon exit. If the group had $200,000 of available liquidity, Sally could only be paid out $40,000 immediately on exit, with the other $60,000 still needing to be paid over time under conditions described below.

In the early years of the collective, this is unlikely to be enough to fully cash out a member who contributed a large chunk of equity. While holding member equity is more affordable for the group than bank equity (as it is interest free), it’s not desirable for the group to continue a financial arrangement with someone who wants that arrangement ended, as it could get acrimonious. As such, the group continues to pay out the equity as quickly as possible. It does this by directing all increases in principal towards paying this equity out (so it is stalled on reducing bank loans until this person is paid out).

Additionally, the collective agrees to a minimum rate of repayment, which is set at the median monthly contribution of group members (i.e., about one person’s rent). It also further agrees to fully pay off the equity within 7 years, even if that involves selling a property to make that possible.

Note that during this pay-out period, it’s possible for a person’s equity share to fluctuate in value, such as decreasing due to a property price crash. This is to ensure the collective does not end up underwater (indebted to paying off equity at the original purchase price, despite property no longer having that value).