05/18/2009 Islamic banking application of the SwapRent transactions for homeowners.

A bit background on the current Islamic mortgage practice. Most of the current home finance products offered in Muslim countries are using either a “Murabaha” (cost plus credit sale), Ijara (leasing) or a Diminishing Musharakah (declining co-ownership) legal structures. Since the SwapRent system and its embedded mortgage HELM were originally created based on a flexible and reversible economic shared ownership concept which automatically discourages the unnecessary borrowing of money or “Riba” to own properties. In an extreme application, the borrowing of money could be totally avoided and that is why they are so attractive to be utilized as the mathematical backbone for a new type of Islamic mortgage products.

The key to understand why SwapRent could offer value to the existing home finance operations of most Islamic banks is to understand the new “economic owning or renting” concept that the current Islamic mortgages do not have. “Economic owning or renting” entails the conceptual separation of economic ownership interests away from the common underlying legal ownership structure. There are many ways to implement the SwapRent in an Islamic mortgage product. In one simple example, a homeowner could start out either as a legal owner and simultaneously a partial economic renter or as a legal renter and simultaneously a partial economic owner of a residential property. The homeowners could also reversibly buy future appreciation units represented by either Generic or AG SwapRent contracts now or when they have more money allocated for financial investment purpose in the future. This new structure is tentatively called a FARM (Flexible And Reversible Musyarakah or Musharakah) housing finance product.

The homeowners certainly are not required to buy these appreciation units of his home and it should be left as a separate investment decision for the homeowners. They could buy even more or sell away these SwapRent contracts they already bought at any time they want before the maturity date through the secondary market for these SwapRent transactions, REIDeX.com.

The second most important point is that the SwapRent package could act as a mathematical bridge between the new Islamic mortgages to the current Western financial systems. Therefore the provider banks could easily hedge off the real estate property risks and the interest rate risks themselves due to the precise quantitative linkages to the current Western financial systems at the manufacturing level by the providers, even if the banks start out owning part of the homes in a co-ownership legal structure with the homeowners. This means that the underwriting banks themselves could use the very same SwapRent contracts to efficiently transfer these real estate property exposures to other free market investors through REIDeX in a very low cost way to effectively hedge off the property exposures acquired in the co-ownership structures. There would no longer be a need to pool the real estate exposures acquired in co-ownership structures through another legal structure such as a resi fund or unit trust in order to sell them off to other investors in an inefficient and high cost way anymore.

All these new features will be crucial to create the critical mass and to make the new type of Islamic mortgages more mainstream, acceptable and widely embraced by both Muslim and non-Muslim homeowners as well as all kinds of banking institutions around the world.

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