This is a very commonly asked question and has been addressed many times before in the blog. Here is a short recap. In short, the main difference is in the way to use leverage under the different structures.
Although both FARJHO as a new home ownership structure and the pooling of capital to make a commercial property investment both could employ the use of a simple LLC legal entity to accomplish their respective objectives, the outcomes could not be made more different due to their respective very different objectives!
In the conventional commercial real estate investment, the use of an LLC entity is to pool enough money so that the group of investors could borrow as much as possible in order to potentially achieve higher leveraged returns (or leveraged losses, it works both ways!). The objective of the use of an LLC is to shield the individual member investors in the LLC from the potential liability to the lender in the event of a default which may be caused by insufficient income cash flows from the property in the future. This conventional way to use borrowing to make real estate investments is described by a new term that I had created a while back called Pool-Borrow-Buy (PBB).
FARJHO, on the other hand, is employing a newly created alternative method under a new thinking called Borrow-Pool-Buy (BPB) to make investments in single family homes.
The advantage is that for investors who love to use leveraging for investments could still use borrowing, but only at an individual LLC member level under a FARJHO transaction, not at the group LLC or property level as how it was always done in a conventional mortgaged home ownership. As a result, FARJHO introduces a newly created social value by increasing the home occupancy stability for the renter/co-owner in a FARJHO LLC structure. This is simply because there is no mortgage, i.e. using the property as a collateral to borrow money, under a FARJHO structure and hence the home will never face the risk of a foreclosure by any lender.
Such a simple innovation in concept and practice could help us universally eliminate the foreclosure possibility in home ownership in our modern economic society, no matter where the home owners lives in the world.
As for the conventional shared equity mortgage, shared appreciation mortgage, and shared ownership mortgage, … etc. as most popularly practiced in the UK and to a small extent in Australia, although they do not use an LLC legal entity, the objective of the share equity component is still to pool enough money so that the shared owners could use that pooled money as a down payment to borrow a mortgage using the property as a collateral again to buy the home, i.e. another Pool-Borrow-Buy (PBB) method that will be subject to property repossession risks. This PBB practice in these old style shared equity mortgages is nothing different from how commercial property investors use an LLC structure to pool money, borrow and buy properties. The evil of the potential risk of foreclosure still exists. These old shared equity mortgages only introduce more lending and ownership disposal complexity without contributing much to housing affordability due to its limited acceptance by the lenders.
In FARJHO’s case, this lender’s dictatorship and the ownership complexity do not exist. Flexible and reversible shared home ownership under FARJHO could eventually be done as easily as buying and selling of a stock in a private or a publicly listed company on an exchange.
Lenders pretty soon would discover that they could easily develop a new profitable business by embracing this new “security-lending” business opportunity using LLC member interests as collateral at the member level instead to FARJHO LLC members.
For those old school mortgage lenders who would like to hang on to the old way of doing home mortgage business would also soon find out, to their pleasant surprise, the credit quality of their mortgage borrowers would be much better than before since the lesser credit borrowers may have all gone through the new equity sharing route and absorbed by using the new FARJHO structure. There seems to be no need for the lending banks to make more ill-conceived inventions such as a teaser rate or an Option-ARM to subprime borrowers any more.
It would indeed be a win-win situation for everybody.
Filed under: Economic Viewpoints, Equity Sharing, FARJHO, Housing, InvestorsAlly, Mortgage, PeoplesAlly, Borrow-Pool-Buy (BPB), Commercial property investments, FARJHO, Foreclosures, Housing finance, Pool-Borrow-Buy (PBB), Property repossessions, shared appreciation mortgage, shared equity mortgage, Shared ownership mortgage, Using LLC for real estate investment
Innovation Trio: SwapRent, FARJHO & TARELV 