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2. How Does A SwapRentSM Contract Work?

In the past few years the fictitious housing affordability in the US was created based on transient short term variable interest rates. When the rates were already trending higher the low-income borrowers were still lured into owning real estate properties 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 alternative true housing affordability offered through any effective 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 the rental 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 a property, a way to continue the legal ownership and synthetically switch back and forth between owning and renting only economically and temporarily according to the market conditions and their monthly income reality at the time.

That goal is what the SwapRentSM market was designed to achieve. Homeowners could use them in a SwapRentSM embedded mortgages HELM (Home Equity Locking Mortgage) either with their existing lenders through a loan mod conversion or with any other new lenders that offer them through a refinancing arrangement. Alternatively they 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 SwapRentSM rate is trading at 2% of the current house value and the current cost of owning as expressed in the mortgage funding cost is at 5% of the current house value in a 5-year SwapRentSM contract example, there will be an annual 3% cost differential between the SwapRentSM payments and the mortgage payments. That means renting is cheaper than owning at this point in time 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 saving subsidy in monthly payments from the economic landlord investors so that the borrowers could afford to continue to keep legally and stay in their homes.

If they agree to become economic renters (of their own houses) for a period of time they will not have any future appreciation benefits or downside depreciation risk during that time period, just like a conventional renter. The investors who act as the “economic landlords” by receiving the SwapRentSM payments and paying out the mortgage funding cost will.

The homeowner or mortgage borrower could switch back to the full economic ownership until SwapRentSM contract expires or whenever they want to unwind the contract without restrictions before the contract terminates automatically at maturity. This may become desirable for them because they may have more monthly income to acquire more economic ownership later on, because they may decide to move and sell the house or simply because their views on the real estate markets have turned more positive.

The SwapRentSM enabled 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 just enough monthly subsidy to afford a home while still enjoy the remaining partial appreciation benefit.

The low-income working family, first time homebuyers and the senior citizen 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 SwapRentSM trading market for their specific property, neighborhoods or cities.

Conceptually, SwapRentSM is a new invention of an alternative way between the buying/selling and the renting of a real estate property for property owners. The idea is to provide a very simple way in the mind of the property owners to let them protect the gains in their home or commercial property equity value. As long as a property owner has the mental capability to sign a contract to purchase a house or to sign a lease to rent an apartment he or she should have the ability to sign a SwapRentSM contract in order to stay out of the price fluctuation of his/her home or a commercial building that he/she owns for either a short or a prolonged period of time.

The core principle and goal of these new user-friendly consumer financial product innovations is that homeowners or commercial property owners do not need to have advanced knowledge or education in financial derivatives or any other sophisticated institutional capital markets instruments in order to make the SwapRentSM transactions.

The business idea is to design and create a very simple concept and method for property owners to simply “rent” (“SwapRentSM“) (to pay a “rent” or to pay a “SwapRentSM“ to stay in) their own house for a certain period of time and therefore to achieve the objective of not having a potential future loss or gain in their home equity value during that same time period, while continuing the existing legal title ownership of the property.

Currently the only business method available to a property owner to lock in the gains or loss in the home equity value is to do a “sale and lease back” transaction. This includes a real property sale transaction and the renting from the new owner of a property that the original property owner had already been occupying. The high transactional cost associated with it as well as the tax and legal considerations are usually the deterrents for property owners to widely adopt the “sales and lease back” transaction as a temporary tool for the purpose of simply locking in the financial gains or loss for a specified period of time.

Using exchange traded futures and options could be another way to lock in the home equity value but the index-based contracts do not offer a sufficient close relevance to the real fluctuation of the house value of a homeowner. The method involved is also way too complicated for most normal homeowners without advanced derivatives or market trading knowledge and experience.

From the consumers' perspectives, a SwapRentSM transaction could therefore be viewed as a synthetic version of “sale and lease back” that only captures the economic benefits of a “sale and leaseback” without the legal title transfers, triggering of a tax event or the associated high transactional brokerage cost.

As a derivatives instrument, SwapRentSM could be used with any kind of property price indices or no index at all. For example, the contract could be valued and settled by using property appraisals or the real transaction prices of the property.

As could be easily understood, the trading liquidity for a specific property will be very small. When the use of a house price index is selected in a SwapRentSM contract, the trading liquidity will increase with the size the geographical area or number of households that are covered in the particular index.

The transaction services between the homeowners and investors could be done directly through a peer-to-peer (P2P) format or they could be done with a financial intermediary. Either banks or local governments could be engaged to be the financial intermediaries in between the property owners and investors.

As illustrated on slide #4, there are three ways to bring the monthly subsidy from investors to homeowners in return for a part of the future appreciation, P2P (peer-to-peer), B2C (through financial intermediaries such as credit unions, banks, mortgage lenders, etc. or local governments using FARM or HELM to offer services to homeowners) and B2B (trading SwapRentSM contracts between financial institutions or local government housing agencies). The interests and participation from institutional financial intermediaries could greatly help create the critical mass of transaction liquidity necessary to provide the best pricing for end users that are either homeowners or investors.


3. The Benefits of SwapRentSM Transactions for Homeowners and Property Investors.
   


                                                                                                                                                                                 


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