REX Agreements Climb As House Prices Decline

Anyone with substantial equity in a home might want to consider using a REX agreement (offered by REX & Company) to reduce the risk of a declining house price. Your investment returns increase because you can redeploy the home equity into other investments that have higher returns. Reducing risk and having more money to invest can both be accomplished without selling your home or borrowing more money.

To be eligible for a REX agreement, the home must be a single-family detached dwelling and be owner occupied in one of the following states: California, Colorado, Illinois, Florida, New Jersey, Virginia, Washington, Oregon, Connecticut, Massachusetts, Maryland, Pennsylvania and (soon) New York. New construction is ineligible, but once a new development has sold all the houses to owner occupants, the houses will become eligible for REX agreements.

What is a REX Agreement?
A REX agreement, which is marketed by REX & Co., is a contract to share appreciation or depreciation in the value of your home with an investor (REX & Co.), which pays for a share of the house with an upfront payment. Because this is not a loan, no payments are necessary.

Legally, this real estate investment agreement is structured as a purchase option. Some features of the agreement include that:

  • You convert some of the home's equity to cash, allowing you to use the cash for other purposes, such as investing.
  • You share in the home's value - whether that value is a gain or a loss - with the investor. You choose the percentage of future appreciation/depreciation to share - up to a maximum of 50%.
  • You can sell the house at any time - the REX agreement remains in effect until you sell your house or for 50 years, whichever comes first. However, you would pay a penalty to terminate the agreement in the first five years. (Note: The REX agreement is limited to 40 years in Illinois and 30 years in North Carolina.)
  • You agree to limit the mortgage borrowing against the home to no more than 70-80% of the home's current value. This is enforced by recording the agreement along with a related security agreement but this does not interfere with mortgaging the property. (Find out more about mortgages and loans in First-Time Homebuyer Guide and Home-Equity Loans: The Costs.)

How Does It Work?
At the beginning of the contract, the homeowner and REX and Co. agree on the home's value. Typically, the value is determined by an independent appraiser. If the homeowner terminates the agreement prior to selling the house, the ending value is also set by an appraisal.

REX & Co. pays the homeowner an amount approximately equal to 28.57% of the home's value times the percentage of sharing chosen. Thus, if you choose to share 50%, you receive cash equal to 14.285% of the house value up front. When you sell the house, the amount due to or from REX & Co. is calculated and netted with the upfront payment to determine the portion of proceeds that go to REX & Co. However, suppose the house depreciated 28.57% over the life of the agreement. In this case, REX would get nothing at the end and the homeowner would keep all the cash received.

REX will share in a decline in value in the first 5 years if the house is sold. Under the agreement, if the homeowner wants to terminate the contract in the first five years, the house value cannot be less than the initial value. A penalty payment is then calculated as a percentage of the upfront payment.

For example:

Year Penalty As % Of Cash
1 25%
2 20%
3 15%
4 10%
5 5%

What Happens if the Agreement is Terminated?
A REX agreement automatically terminates when the house is sold. However, the homeowner can choose to terminate at any time. If you believe your house will soon appreciate rapidly, you can request termination. At termination, a settlement payment amount is determined depending on the change in the home's value since inception of the agreement. Assuming the home's value has not decreased more than 28.57%, the calculation of the termination payment to REX & Co. would be calculated using the following formula:

Settlement = Initial Payment + Change in House Value x REX % share

If the house depreciates, the change in house value amount will be negative. In this case, the settlement payment to REX & Co. will be less than the amount received by the homeowner at the beginning of the contract. If the change in house value drops by more than 28.57%, then the settlement amount is negative and REX & Co. will owe the homeowner at termination. For example, if REX's initial payment to you was $142,850 for a 50% share and the house dropped in value by $100,000 then at final settlement, you pay the company $92,850 (= $142,850 – $100,000 * 50%).

The formula above applies only after five years have elapsed. Before that, the change in house value amount cannot be less than zero, and the homeowner will also pay the penalty amount.

Why Do It?
Technically, the REX agreement is a derivative contract in which the homeowner sells an economic interest in the change in the underlying house (asset) value. Thus, the REX agreement allows you to hedge against a decline in your home's value without the need to actually sell the house. When evaluating this financial decision, consider that the REX agreement has no consequences with regard to you living in the house, which might mean fewer emotional strains.

The most important benefit of the REX agreement is that it allows you to hedge the risk of a decline in the value of your house. This hedging provides partial protection for the current value of the equity in your home. Even if you don't think that prices are declining in your area, you probably recognize that the risk should be properly managed. The REX agreement provides a way to manage this risk. (To learn more about hedging your risk, see Hedging In Layman's Terms and A Beginner's Guide To Hedging.)

Another aspect of risk that the REX Agreement can help address is diversification. Many people keep too much of their wealth invested in their homes. By redeploying some of this equity into other types of assets that have low correlation with home equity, you can reduce the chance of a large drop in your wealth. For example, if a homeowner pulls money out of home equity and invests it in foreign stocks, such an investment should be relatively unaffected by drops in U.S. house values. This investment technique helps to insulate retirement savings from the risk of an overly concentrated portfolio of assets. (Keep reading on this subject in Introduction To Diversification and The Importance Of Diversification.)

Besides minimizing risks, homeowners hoping to retire with substantial assets will want to maximize returns on capital. Even if home prices eventually recover in five years, this scenario would still imply no return on equity. Meanwhile equity reinvested elsewhere could produce cumulative returns over five years that are much higher, depending on the investment. Investment returns after taxes could be even higher if the money were moved into a tax deferred retirement account.

The REX agreement provides an innovative way to manage a previously unmanageable part of most people's wealth: their home equity. Like any financial product, it may not be suitable for all investors. Speak to a financial professional before you consider entering this type of arrangement.