The chart above shows one of the stranger features of equity release mortgages: the wide variation between the projected indexed value of a property, and the actual sale value it achieved at auction. The data is based on Aviva’s Equity Release Funding No. 4.
The red line is the rebased value of the property index used by the fund, the Halifax, from October 2007 to July 2020.
The index is now at 169%, and weighted average loan to value at around 51%, so if every property were sold at around the index value, there would be no NNEG shortfall. However, the blue line, showing the cumulative nominal shortfall, demonstrates that some properties are selling at less than the indexed value, indeed sometimes less than the origination value 20 years ago. Indeed, 5 out of the 25 properties shortfalled over the last year were sold at less than the original valuation. Note the spike in the chart in October 2016 where a property initially valued at £1.2m, and expected to achieve over £2m, was actually sold for £625k.
We discussed this phenomenon in our Equity Release Guide. The figure below, taken from the Guide, shows a scatterplot of the ‘achieved rates’ of ERMed properties, i.e., the amounts that the lender was able to realise after the borrower exited, expressed as a percentage of the indexed value, based on the Shared Appreciation Mortgage Securities (SAMS) originated by HBOS in the late 1990s.
The red dots are the scattershot of the individual achievement rates in the sample. The darker blue line is a simulated house price index. As we noted in the Guide, the achieved values are all over the place relative to the index. On average the achieved value is about 94% of the index but there is a huge dispersion, and as the NNEG is a form of option where the seller takes only the losses, not the profits, the greater the dispersion around the average, the greater the losses.
The problem for regulating this form of risk is the length of time for the consequences to become clear. Aviva ERF 4 has been running for 20 years, and only now, with the prospect of stagnant house prices, are there signs of difficulty. The current incarnation of the equity release market is less than 10 years old, and it will be decades before problems become manifest.
The present cost of long term disaster is always less than the present value of short term profits.