The Equity Crowdfunding Platform of Unison Home Ownership Investors Student name: Rogier Arends Student number: 10645136 MSc FIN: Dual Track – Real Estate Finance & Corporate Finance Document: Master Thesis Thesis supervisor: Dr. M. Constantinescu Month and Year: August, 2018 Abstract This thesis investigates the sustainability of the real estate platform of Unison Home Ownership Investors. The results are achieved by comparing the investments by Unison Home Ownership Investors to real estate derivatives and applying a methodology proposed by Van Bragt et al. (2015) to value options. The research shows that the final call option values indicate a positive value, which means that the equity crowdfunding platform of Unison is profitable. In addition, the findings suggest that each state has a different option value, although all are positive. Statement of Originality This document is written by Rogier Arends, who declares to take full responsibility for the contents of this document. I declare that the text and the work presented in this document is original and that no sources other than those mentioned in the text and its references have been used in creating it. The Faculty of Economics and Business is responsible solely for the supervision of completion of the work, not for the contents. 2 Table of Contents 1. Introduction 4 2. Theoretical Framework 6 2.1 Potential Diversification Benefits and Drawbacks 6 2.2 The effects of an increase in homeownership 7 2.3 Unison HomeBuyer Transaction 9 2.4 Derivatives 10 2.5 The Product of Unison: HomeBuyer Agreement 11 2.6 Real Estate Derivatives 11 2.7 Real Estate Derivative (Option) Pricing 13 3. Thesis Objectives 15 3.1 Hypotheses 15 3.2 Data 16 3.2.1 Explanation of Data Sources 16 3.2.2 Descriptive Statistics 17 3.2.3 Correlation matrices 19 4. Methodology 21 4.1 Binomial Trees 21 4.2 Methodology to Value European Options 22 4.2.1 Adjusted Volatility 22 4.2.2 Asian options 23 4.3.3 Pricing Formulas 23 5. Results 24 5.1 Binomial Trees 24 5.2 Results Methodology to Value European Options 26 5.2.1 Outcomes Adjusted Volatility 26 5.2.2 Outcomes Asian Options and the Pricing Formulas 27 6. Robustness 30 7. Conclusion and Discussion 32 Reference List 34 Appendices 37 3 1. Introduction Tech companies are becoming more interested in the world of real estate and they have introduced all kinds of new initiatives (Financieel Dagblad, 10 January 2018). These are called ‘PropTech’, which is a contraction between property and technology. One of those initiatives is, Unison Home Ownership Investors (commonly known as Unison), and it will be explained shortly below. In the United States a buyer of a house normally only gets 80% of the value of the house financed by debt. This means that when a house costs $500,000, the buyer has to have $100,000 up front. This implies that a large number of people will not be able to buy their own house or the house they want. A company, called Unison, has started in the United States and tries to solve this problem by pairing investors with prospective buyers. Unison provides 50% of the down payment and then will share in the profit or loss of the house. The buyers of the house still need to get a traditional mortgage of 80%, which in this example means a mortgage loan of $400,000. The share of change in value of the house will be split into 65% for the buyer and 35% for Unison (the investors). There is also a possibility to share a down payment of 25% and in that case Unison (investors) share in 43.75% of the change in value. The money Unison provides is an investment, not a loan, so there are no interest charges and you don’t have to make monthly payments to Unison. Instead, Unison hopes to earn a return on its investment from a portion of the appreciation when you sell at a profit. When you sell, Unison receives a single payment equal to its original investment plus or minus a share of the change in value of your home. The concept of this online real estate platform allows investment- and pension funds and insurance companies access to one of the biggest market is the world: houses. In the US, alone, this market has a value of 21,000 billion dollars, of which approximately half are owned houses and half of them have a mortgage. Unison Home Ownership Investors has announced in February 2017 that they raised over $300 million in total capital (PR Newswire, 2017). This means that investors see a lot of opportunity in the platform, and this raises the question: Are equity crowdfunding platforms for real estate, such as the platform of Unison Home Ownership Investors, profitable? There have been various studies on the effect of adding real estate to the portfolios of heterogeneous investors (Hudson-Wilson et al., 2003; Ennis and Burik, 1991; Ziobrowski and Ziobrowski, 1997; Chaudhry, Myer and Webb, 1999; Hoesli et al., 2004). On the other hand, potential drawbacks of including real estate are also mentioned (Hoesli et al., 2003; Solnik and McLeavy, 2013). Others have investigated the effects of an increase in homeownership and Coulson and Li (2013) and Andrews and Sánchez (2011) both give an overview of these studies. Furthermore, the use of real estate derivatives has been researched (Fabozzi et al., 2010). Methodologies to price the real estate derivatives are provided by a number of different studies (Ciurla and Gheno, 2009; Van Bragt et al., 2015; Cao and Wei, 2010; Fabozzi et al, 2011). 4 In order to answer the research question, I will argue that the investments can be seen as options and thereafter I will analyse the option values. These values will be determined first by calculating the binomial trees for each state that Unison operates in. In addition, the methodology proposed by Van Bragt et al. (2015) will be used to calculate the option values more precisely. There will be three hypotheses investigated in this research. The first and main hypothesis is about the profitability of the equity crowdfunding platform of Unison Home Ownership Investors. This means there will be taken a look at whether the final call option values are positive of negative. The second hypothesis deals with the question whether each state has the same option value or if they differ. The third and final hypothesis examines whether each state is worth investing in or if some states are profitable to invest in and other states are not. This study adds to the existing literature in multiple ways. First, it applies option pricing to a real estate platform in a way that has not been done before. Second, it tries to investigate whether real estate platforms such as the Unison platform could lead to potential diversification benefits for investors. In addition, it might be a viable way to increase homeownership, which overall has a positive impact on society. This thesis has the following structure. Paragraph 2 will describe the theoretical background of the topic and elaborate on existing literature on the topic. Paragraph 3 explains the data, the fourth paragraph will propose the methodology and paragraph 5 will clarify the results. In the sixth paragraph, the 3 robustness checks will be explained and finally, the conclusion will follow in paragraph 7. 5 2. Theoretical Framework 2.1 Potential Diversification Benefits and Drawbacks As mentioned above, the product offered by Unison Home Ownership Investors allows investors access to the housing market of the states the company operates in. This therefore means that investors are able to invest in another asset class, i.e. they will be able to diversify. Geltner et al. (2014) mention the importance of a bigger quantity, variety and range of alternative assets that can be offered to heterogeneous investors. This is achieved because real estate, and specifically houses, represents a different type of underlying physical assets. In the bigger picture, four major asset classes can be identified: stocks, long-term bonds, cash (T-bills), and real estate (Geltner et al., 2014). A study by Hudson-Wilson et al. (2003) proposed five reasons for the inclusion of real estate in a properly-managed institutional investment portfolio. The first one is that the overall risk of the portfolio will decrease since asset classes that respond differently to expected and unexpected events are combined. Secondly, an absolute return that is competitive with other asset classes can be achieved. Next, it is a possible hedge against unexpected inflation. A fourth reason may be to manage a portfolio that is closest to an indexed, or market-neutral portfolio. This signals a reasonable reflection of the overall possible investments. A final reason is to achieve an income return, which equals a strong cash flow (Hudson-Wilson et al., 2003). There have been multiple studies (Ennis and Burik, 1991; Ziobrowski and Ziobrowski, 1997) which concluded that approximately 15 to 30 percent of a mixed-asset portfolio should be allocated to real estate. They argue that real estate returns have a low correlation with the returns of stocks and bonds and in addition, Chaudhry, Myer and Webb (1999) find that stocks are inversely related to real estate on the long term and furthermore they note that the overall impact of stocks on the real estate market is less severe than its impact on bonds and T-bills. Hoesli et al. (2004) determine in their paper that the optimal allocation to real estate using hedged returns is 15 to 25 percent. Despite the optimal allocation to real estate, Chun and Shilling (1998) and Geltner et al.