What Is A SwapRent (SM) Transaction?
The SwapRent (SM) transaction is the realization of the newly created consumer financial concepts of “economic owning, renting, and temporary own-rent switching” while keeping the existing legal ownership structure for homeowners and other investment property or commercial property owners during the entire contract period.
Unlike the conventional way of using a “shared equity” or “equity sharing” method to accomplish the shared appreciation objective, a SwapRent (SM) contract was invented to use an innovative business method of quantifiable “shared cash flows” or “cash flow sharing” technique to accomplish the appreciation sharing objective of owning a real estate property.
A conventional legal ownership entitles a property owner the right to occupy and use the property, which is the “Shelter Value”, “Utility Value” or simply called “Use Value”, as well as the right to obtain future financial upside appreciation gains and the obligation of bearing downside depreciation loss, which is the “Investment Value”, “Financial Value” or simply called “Economic Value”. A SwapRent (SM) contract aims to separate the investment value of a conventional property ownership from the shelter value in order for the owners to better manage the financial risk and return aspects of a property ownership while maintaining their shelter value at all times.
This newly invented economic concepts of “economic owning, renting and switching” as facilitated by the three basic variations of SwapRent (SM) transactions (Generic, AG and DP) help both the defaulting mortgage borrowers hold on to their homes and the distressed RMBS, related CDOs or CDS investors curb their financial losses.
In the past few years the fictitious housing affordability in the US was created based on transientshort term variable interest rates. When the rates were already trending higher the low incomeborrowers were still lured into owning by the “teaser rates”. Those subprime borrowers were originally not qualified as owners. They could at most rent to have a shelter to sleep in. They should have been renters to begin with given there was no other viable true housing affordability offered through any conventional shared equity or shared appreciation finance products in the US.
The answer to the perennial question of to own or to rent varies as time evolves. Sometimes therental rate is higher (say at 2% of house value per annum) and more expensive than buying (say at a temporary teaser rate of 1%). Other times the reverse is true (say at a 5% mortgage rate when teaser rates expire). It would be nice if property owners can have a choice to separate the legal ownership from the economic interests and hence the financial risks and rewards of owning aproperty, a way to continue the legal ownership and synthetically switch back and forth between owning and renting only economically according to the market conditions and their monthly income reality at the time.
That goal is what the SwapRent (SM) market was designed to achieve. It functions as a flexible and reversible “temporary own-rent switch” driven by the own-rent cost differentials and/or investment views. Homeowners could use them in the new SwapRent (SM) embedded mortgages (Home Equity Locking Mortgage, HELM) either with their existing lenders through a loan mod conversion or with any other new lenders that offer them through a refinancing arrangement.
Alternatively it could be offered through FARM (Flexible And Reversible Mortgage), which is a new way to let renters flexibly and reversibly enjoy partial or full future appreciation of the real estate property that they occupy.
If the generic SwapRent (SM) rate is trading at 2% of the current house value and the currentmortgage funding cost is at 5% of the current house value for a 5-year SwapRent (SM) contract there will be an annual 3% differential between the SwapRent (SM) payments and the mortgage payments. That means the renting is cheaper than owning in this example.
So if the defaulting subprime borrowers decide to switch back to the more affordable renting only economically for a period of time they will be able to receive 3% annual subsidy in monthly payments from the synthetic investors so that the borrowers could afford to continue to keep legally and stay in their homes. If they agree to become renters (of their own houses) economically for a period of time they will not have any appreciation benefits or downside depreciation risk during that time period, just like conventional renters. The investors who act as the “economic landlords” byreceiving the SwapRent (SM) payments and paying out the mortgage funding cost will.
The borrowers could switch back to the full ownership until SwapRent (SM) contract expires or whenever they want to unwind the contract without restrictions before maturity because they may have more monthly income to pay for it later on or because they may decide to move and sell the house.
The SwapRent (SM) based economic renting could easily be done for only part of the house value, say 25%, 50% or 75% of the current house value instead of the entire 100%. That means the homeowners could decide to be only partial economic renters for a period of time so that they could get enough monthly subsidy to afford a home. The low income working family, young first timehome buyers and the senior community could all benefit further from the flexibility on both the notional amount and the duration of the economic renting period offered by a liquid SwapRent (SM) trading market in their neighborhoods or cities.
This new ability to separate the economic ownership from legal ownership has many other advantages. For example, the moral hazard and the home improvement issues of the conventional renting will be alleviated through the economic renting concept of SwapRent (SM). Having the legal ownership will give you the alpha of holding an asset, switching to economically renting let you hedge away the beta of owning a property.
Therefore a public housing project with SwapRent (SM) based economic renting will be a much better neighborhood than the one with a conventional renting only because people will invest in home improvement freely since they still legally own it no matter what happens next with the real estate markets in general. They will only give up the neighborhood appreciation/depreciation potential represented by a neighborhood or city property price index (such as the MSA level of the OFHEO HPI) in exchange for receiving the monthly subsidies.
Whatever home improvement investment they have already made to the properties they will be able to get to recoup those investments when they actually sell the properties legally later on. The development of this new economic concept will have great implications for urban planning and public housing policy in the future.
As a perhaps a bit extreme example, domestic servants for the first time may even live in the same building or neighboring buildings located in the same tony neighborhoods as their employers do due to this newly created “portable housing affordability”. Their employers may enjoy the full ownership (both full legal and full economic ownership, i.e. with the entire upside financial appreciation potential) because of the employers’ high monthly income earning power.
The domestic servants may get to enjoy similarly the full legal ownership and maybe only a much smaller economic ownership which entitles them to the financial value of only a small fraction of future appreciation potential because of their much lower monthly income levels. They can of course buy into more fractional units of future appreciation potential of either their own home or the city level property value through SwapRent (SM) contracts at their free wills any time when they start to have higher earning power in the future. Meanwhile they may enjoy a nicer living neighborhood and their children may get to attend the same high quality school districts as their employers’ children do.
While upon first thought, acquiring the future appreciation potential of properties could be a desirable thing to have, it does come with a cost and the cost of this investment could be totally wasted as we have seen in recent years if the value of real estate property declines, let alone the risk of bearing the financial losses that usually comes with economic ownership when the property value actually declines.
Houses may appreciate in value slowly through time under most usually competent governments but we can not always count on governments to do the right things. Crony politicians formulating stupid laws and policies to destroy national wealth is vividly visible in history, and whenever you turn on your TV.
Therefore the inability of the low-income people to participate in the boom and bust cycles of theproperty investment games may not necessarily be a bad thing after all. Through SwapRent (SM) contracts they could simply continuously enjoy the comfort and the security of their homes by having the legal ownership and becoming the “economic renters” of their own homes irrespective what may happen to the financial value of the property markets in the future.
The main implications of this are that first, cities may not need to waste taxpayer’s money to build that many low income housing complexes anymore, which often end up slums and they foster class distinctions and prejudice in our human societies. Second, low-income people will no longer be forced, duped, coerced or at some other occasions, be allowed to wilfully intend to go into borrowing and owning something they could not afford (i.e. the combined cost of both legal ownership and future appreciation potential as expressed in the economic ownership) based ontheir current earning power.
The abuse of over-leveraging with a hope to get rich quick that had caused our current default-led global financial crisis will have much less chance to get to be repeated on a massive scale again.
People will learn that success in life will have to be earned in an old fashion way through hard work instead of keeping hoping to gamble with other people’s money through borrowing. The practice of the simple economic concept of shared appreciation will indeed automatically discourage the abuse of over-leveraging in our economic societies. SwapRent (SM) and REIDeX are the newly invented business method and marketplace to make that simple economic concept a reality in the most effective and efficient way.
To summarize, among many other applications, the five key economic advantages that theSwapRent (SM) and its related consumer finance products are:
1. For those informed and educated homeowners to hedge the financial value of the properties that they own by switching between owning and renting economically only based on their views on what the overall real estate market will do in the near future while keeping the legal ownership of all their properties at all time.
2. Considering the relative cost of owning and renting, the less affluent homeowners could decide to be economic renters or owners solely based on how much monthly subsidy they could receive to afford legally owning the properties while being partial or entire economic renters for a period of time. This will increase the housing affordability for young first-time would-be homeowners, low income working families and retired senior citizens. Specifically, it offers a much better alternative to the ineffective, inefficient and expensive reverse mortgage product for the senior homeowners.
3. Due to the alleviation of moral hazard associated with conventional renting, SwapRent (SM) will improve the neighborhood quality of both the public housing projects and the conventional apartment rental complexes. It could thus reduce crimes and improve the overall well-being of the urban environments anywhere in the world. With this newly created “portable housing affordability”, municipalities will no longer have to waste taxpayers’ money to build affordable housing complexes that often turn into slums.
4. For both institutional and individual investors to become synthetic “economic landlords” by simply receiving SwapRent (SM) payments and paying out mortgage funding cost for a particular neighborhood or city. They could establish such cross border reversible long property exposures easily all over the world without worrying about the management of these properties and incurring the normally high transactional cost and taxes.
5. For current apartment or house renters to establish an “anticipatory hedge” position through receiving SwapRent (SM) payments based on a particular city level property price index so that they can lock in today’s real estate price levels for intended purchases of real estate properties in that city in the future. They would not be priced out of the market if indeed real estate prices rise sharply in the future.
Although the settlement of a SwapRent (SM) contract could be done with a property price index, a property appraisal method or the real transaction price, let’s use a simple application example of index-based SwapRent (SM) contract to illustrate the basic economic benefits of a SwapRent (SM) contract.
A homeowner who lives in Los Angeles may decide to be the “economic tenant” of his/her ownhome in Los Angeles by paying SwapRent (SM) rate (at say 1.5% per annum) based on the Los Angeles metropolitan area index to an investor who is willing to be his/her “economic landlord” investor for a contract maturity of 10 years and simultaneously receiving an annual mortgage funding cost (MFC) of say 5% from this investor for the duration of the SwapRent (SM) contract.
Once this contract is executed, during this 10-year contract period, he/she would have locked in the current price level of his/her own home and would not have any future appreciation potential or any downside depreciation worries anymore. The homeowner could decide to unwind and terminate this SwapRent (SM) transaction any time (e.g. 6 months, 1 year or 2 years later) before maturity due to relocation, new jobs with higher monthly income, investment timing views (i.e.cutting loss, taking profit, being bullish about the LA property market again) or simply free will.
The reason why this decision is to be made could be based on either a hedging purpose, an equity withdrawal or appreciation give-up cash-out purpose since he/she would receive a netted monthly payment from the investor, both as explained above, or simply a pure life style change purpose.
For example, this person may be retiring in 10 years and may decide to relocate to Hawaii for his/her retirement. He/She could then enter into another SwapRent (SM) contract of similar remaining maturity based on the Honolulu metropolitan area index with another counter-party homeowner in Honolulu by receiving a SwapRent (SM) rate (at say 2.5% per annum) and simultaneously paying an annual MFC of say 5.5% so that he/she could become an “economic landlord” him/herself in Honolulu.
By doing so he/she would be able to move to Honolulu 10 years later to look for an ideal dream house in that city and purchase the chosen house then at a price level (say per sq ft price) that was locked in 10 years earlier through the SwapRent (SM) contract.
Both of these two separate SwapRent (SM) contracts could be unwound and terminated earlier before or on the final maturity dates, either together or separately, at some freely traded secondary markets such as REIDeX, the dedicated SwapRent (SM) marketplace. Of course they would have to be unwound at the then market rates to reflect a profit or loss, just like how any other financial instruments operate in their own markets.
In the foreseeable future, homeowners might be able to apply this on an international scale. For example, a homeowner in London could decide to do a retirement life style change plan through SwapRent (SM) contracts so that he/she could retire in Nice in South of France. Homeowners could do the same between Tokyo and Singapore or between Beijing and Taipei.
The decisions could also be financial and investment view driven. A resident in Toronto may thinkthat the future real estate property appreciation potential in Australian metropolitan area could be higher for the next 5 years than Canadian metropolitan area. He/She could then make arrangement through city index based SwapRent (SM) contracts and be a 80% “economic tenant” in his/her own house in Toronto and be a 40% “economic landlord” investor in both Sydney and Melbourne.
Financially speaking, with very little hassle and transactional cost, he/she would then have a diversified investment exposure composed of 20% Toronto, 40% Sydney and 40% Melbourne in his/her medium term investment portfolio on the residential real estate markets. Socially speaking, he/she and their children will continue to enjoy the comfort of occupying 100% of his/her own house and the associated neighborhoods in Toronto for the next 5 years and more.
Innovations could indeed continue to make our world even flatter!
From the providers’ delivery perspective, on the Canadian side, the Ontario Provincial Government or Toronto Municipal Government could channel the net positive monthly subsidies from an “economic landlord” investor which it has a separate SwapRent (SM) contract with to this Toronto homeowner. The Toronto homeowner could then use part of these net monthly proceeds he/she has received from the local government to become the “economic landlord citizen” in Australia.
On the Australian side, the State Governments of New South Wales and Victoria, their housing agencies, or the Municipal Governments of Sydney and Melbourne could administer these SwapRent (SM) programs for their local residents. Among many other sources, they could even have a SwapRent (SM) contract with this Toronto homeowner directly to treat him/her as an “economic virtual citizen” of their cities and channel these net positive monthly subsidies to many other homeowners in their cities who may be in need of these monthly subsidies through another SwapRent (SM) contract or a HELM contract.
For better managing the homeowner counter-party credit issues, the best way would be for the municipal or state/territory and provincial governments at different geographical locations to communicate with one another for managing the credit risks of both “economic tenant” homeowners and “economic landlord” investors in their cities, states or provinces in order to make sure only ethically responsible and economically eligible law-abiding citizens get the chance to participate in these reciprocal programs.
These new social innovations derived from the cross-city and cross-border aspects of the SwapRent (SM) business provide certain privileges to people who behave in a morally decent way in our civilized human economic societies and are definitely not meant for everybody in every city around the world. Local governments’ active participation and proper regulations could ensure that will remain the case.
In this way, the Australian state/territory or municipal governments could simply accomplish their goals of providing housing affordability to their local low income families or other homeowners in need without having to resort to any of their own local taxpayer’s money since the money will be provided from private free market sources that may include both foreign or domestic institutional investors and the individual “economic virtual citizens” of their municipalities.
In addition, by being the middlemen to administer these SwapRent (SM) programs, the local governments could generate a reasonable fee to enhance the local governments’ own finances for offering these services to their local real citizens and many virtual citizens around the world so that they could reduce the local property and other tax burdens to their own local residents.
Wouldn’t this be a better free market based alternative addition to offer housing affordability that could discourage the abuse of irresponsible borrowing and lending in the various national housing finance systems for the future of our capitalism society?
Innovation Trio: SwapRent, FARJHO & TARELV 