Hailed as the biggest potential asset class in Australia, the $3.1 trillion locked up in residential property has always been in the sights of institutional investors, but barely features in their portfolios. A new home loan product may change all that as CATHERINE JAMES reports.

Loosely termed an “equity finance mortgage” (EFM), the product’s name is somewhat misleading since although the EFM is, legally speaking, a mortgage, it does not carry any interest rate and has returns that replicate valuations of the equity in the underlying residential home.

On the other hand, the EFM is not equity either – that is, investors have no ownership stake in the borrower’s property, just a mortgage secured over it. This is one of the appealing aspects of the product since it means that investors do not suffer from the traditional transaction cost leakages (eg, stamp duty, land tax, and maintenance costs) that usually hit direct property investments.

The return for the investor is made upon sale of the property. The investor receives a higher percentage of the capital growth on the property than the percentage they initially loaned. For example one EFM provider, Sydney-based Rismark, provides finance for 20 per cent of the value of the borrower’s home on a zero-interest basis in exchange for 40 per cent of the future capital growth. If the value of the borrower’s home falls, and they sell their home for a loss, Rismark will also potentially wear up to 20 per cent of the losses.

Despite residential property being one of the most developed investment markets globally, mortgages appear to have become a dirty word as, in the words of one investor, “it’s the market that’s biting the world at the moment”. A handful of superannuation fund executives approached for comment on investing in residential property said they wouldn’t touch it. But then, nor had they heard much about EFMs.

However, some institutional investors must be interested in EFMs, or else Mercer Investment Consulting wouldn’t have one of its principals dedicate months of research to the emerging asset class. Still in the throes of this research, Melbourne-based David Lee is reluctant to pre-empt his findings with statements on what he has found so far, but he admits “it’s proven to be one of the most complicated things I’ve ever looked at”. “On the one hand this is a very simple financial concept. There is not much new in adding an extra layer in the ‘stack’ of securities that are used to finance any particular asset. But on the other hand the execution and implementation of this concept for residential real estate has proven to be complicated and challenging,” he says.