What Is A SwapRentSM Transaction?
The SwapRentSM transaction is an optional service between homeowner/renter and the property investors in the jointly owned LLC so that the homeowners could establish a synthetic long (i.e. ownership) real estate market exposure to benefit from a potential future appreciation. However, they should be aware that real estate market investment has its own risks. The property market could depreciate instead by or on a horizon date.
Not only the cost to acquire such a real estate market exppsure could vanish without a positive return, the realized depreciation could also represent future financial losses. The SwapRentSM transaction could therefore also be used as a hedge to syntheticaly short (to disown) a real estate market exposure to help homeowners and/or investors minimize the loss potential of holding on to a particular property for a certain period of time in a declining market without having to physically sell that particular real estate property in a conventional way.
For homeowners and property investors alike, they would be free to flexibly and reversibly take either long or short positions on SwapRentSM transactions for whatever lengths of durations on any properties or on any house price indices at any different regions at any time. It would be simply be based on their own investment decisions.
The optional SwapRentSM services would only be available at http://REIDeX.com when it is ready to launch in the near future. Since its creation back in 2006, prior to the financial crisis, the potential negative regulatory sentiment and political sensitivity to introduce anything related to home mortgages that is new has prevented the timely official launch of this powerful service that could have lessened or alleviated the severity of the housing finance led financial crisis.
InvestorsAlly makes no recommendations or demand requirements for its customers to make these optional transactions.
The SwapRentSM Story
More detailed info on SwapRentSM is available at the http://www.SwapRent.com web site.
1. Background and Introduction of the SwapRentSM Concept.
The history of SwapRentSM traces back to an effort to develop a consumer-oriented real estate derivatives business that included an Internet based on-line real estate index based futures and options exchange in the US back in 2001. The purpose was to bring the economic benefits of simplified financial property derivatives to the consumers who are already or intend to be involved in property investment related transactions.
Bearing in mind that conventional financial derivatives in the way they had been practiced before had too many potential problems if not managed carefully and they are typically way too complicated for the average consumers, the goal was aimed at inventing something totally new from scratch and developing a fool-proof business methodology so that the new concepts and financial transactions could keep the similar economic benefits for consumers to enjoy but get to avoid all those potential pitfalls of conventional financial derivatives.
Therefore the original objectives of the inventions of SwapRentSM and its embedded suite of consumer housing financial products were to create a totally new set of consumer financial concepts and products as well as a new system of fool-proof uses of related financial transactions so that homeowners and property investors could take advantage of the economic benefits of conventional financial derivative contracts like what the stock market investors have been doing for decades without the complexity, opaqueness and the danger of potential abuses by either the consumers or the financial institution vendors.
The best example in the past of such successful consumer banking products in housing finance is the prepayment option that was built into a conventional fixed rate long-term mortgage loan offered in the US market. The prepayment option is the choice for borrowers to re-finance for whatever reasons at will, with the usual main economic reason being a new lower borrowing rate has become available. This option is in fact a form of an interest rate derivative contract (a call option on the interest rate level).
However, banks that offered this economic benefit to homeowners have never marketed it as a derivative contract and consumers have been taking advantage of its economic benefits without any potential dangers or problems for decades. These objectives were exactly what SwapRentSM and its embedded housing finance products such as HELM (Home Equity Locking Mortgage) and FARM (Flexible And Reversible Mortgage) were originally designed to achieve in a similar way.
The research and development breakthrough came in early 2006 and hence the birth of the new “economic owning”, “economic renting” and the “temporary own-rent switching” financial concepts. A new type of financial transactions was created to facilitate the temporary own-rent switching concept by the homeowners or commercial property owners. The name chosen for it was “a SwapRentSM transaction”.
Therefore a SwapRentSM transaction has become 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.
A conventional legal ownership of a property entitles a property owner the right to occupy and use the property (a usufruct), which we could call it the “Shelter Value”, as well as the right to obtain future financial upside appreciation gains and along with it, the obligation of bearing downside depreciation loss, which we could call it the “Economic Value”. A SwapRentSM contract aims to separate the economic 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.
A generic SwapRentSM transaction will allow a property owner to efficiently and effectively switch between owning and renting for a part or in full of his economic ownership in the property for a finite period of time at any time at a very low cost. It also allows the owner reversibly to switch back later on if it has become desirable at any time at the same low cost. This could all be done while the property owner keeps the legal title of his property and the right to occupy and use the property at all time. Therefore all the economic benefits of shared appreciation on the upside in exchange of a stream of present cash flow income or those of downside protection hedging objectives could be automatically realized when he simply does the reversible switch between economically owning and renting for a finite period of time.
From a commercialization perspective, by focusing on the newly created consumer financial concepts of either full or partial “economic owning, renting and temporary own-rent switching” will make the education and promotion of those inflexible conventional Shared Appreciation Mortgage (SAM) or Shared Equity Mortgage (SEM) concepts and products redundant since the new SwapRentSM concept and its embedded mortgage product could deliver the same economic objectives as a much better alternative. It offers much more benefits due to the flexibility in that the appreciation component could be easily detached, traded in a secondary market and be re-attached to any conventional mortgage products again.
Nor will there be any need to educate the consumers and promote the complicated derivatives trading strategies such as selling a covered call option strategy or deciding when and how to buy call options and put options, … etc. since a SwapRentSM contract automatically delivers the same economic benefits of these derivative trading strategies by simply letting property owners switch between owning and renting for a period of time.
For consumer-oriented business, sometimes the best way to introduce a new economic concept to consumers may be to introduce something new through something old that they are already very familiar with. Every consumer around the world is already familiar with the difference between owning and renting a real estate property. For example, by being an owner of a real estate property, the owner knows he will be entitled to the future financial appreciation of the property in the future. At the same time he knows he will have to bear the risk of downside depreciation. By being a renter, the tenant of a real estate property knows that he will not have any benefits of future appreciation or the risk of losing money if property value declines. Therefore similarly, by becoming an “Economic Renter” a consumer will understand that similar to being a conventional renter, by definition, he will not have the benefits of any potential future upside appreciation or the risks of potential future downside depreciation.
For example, if a person chose to reduce monthly expenses that he spent on housing every month, he sold his house and became a conventional renter for the next 5 years. He got to pay a lower monthly rental payment than the previously much higher monthly mortgage payment every month. Five year later if the house has appreciated in value by 20%, he will have no right to go back to the new owner and ask for a part of the financial gains. No matter how dumb this person may act for his failure to read the fine print, no laws or liberal politicians would be on his side.
A very important thing to note is that as a new concept and methodology a SwapRentSM transaction will only function as a tool and add a well-defined time horizon to help property owners realize their investment views or to face up the monthly income reality when he is forced to make the temporary own-rent switch when he loses his economic monthly income capability. It will not alter the original reasons why people may want to switch or be forced to switch between owning and renting. People make own-rent switch based on normal economic reasons or personal factors such as monthly income reality, investment views, change of household economic situations, … etc.
The SwapRentSM transaction will only facilitate it and make the transition easier since the transaction cost is drastically lower as compared to the conventional own-rent switching that involves the buying and selling of the conventional legal title ownership in a real estate property. Therefore the SwapRentSM methodology should not have to bear the burden of the questions why do homeowners or investors want to make certain switching transactions. It is only a more efficient methodology to make the switching more flexible and reversible in a very low cost way.
When a homeowner has already decided at his own will or be forced to make an own-rent switch when he faces an imminent foreclosure and when an investor has already made the decision it is time to for him to go long on real estate, both the homeowner and the investor could save plenty of money and administrative hassles by using the SwapRentSM alternative, as compared to the conventional own-rent switch by transferring the legal title of a real estate property in a purchase and sale contract which usually requires brokerage commissions, title search fee, property taxes, insurance cost and property management expenses to find a renter for the property, … etc.
The following sections of this paper comprise further descriptions and applications of both the transactional mechanics of a SwapRentSM contract and its related consumer housing financial products such as HELM and FARM. Put together, they are meant to outline a generic blue print to develop an alternative housing finance system to stimulate readers’ further thinking and research on how to customize these new innovations according to local real estate market practices for a potential implementation in various countries around the world.
From the government's perspectives, tightening the credit spigot a bit and introduce non-lending based FARM type of housing finance products to homeowners could stabilize the society without sacrificing any overall homeownership level for its citizens. In fact, FARM may actually help increase it and build the homeownership on a much sounder footing.
For the first time federal government in many countries would be able to perform economic stimulus without resorting to using interest rates only. The new dimension offered by the SwapRentSM contracts will allow the governments to increase or decrease the demand for real estate property by simply adjusting the availability of monthly cash flows used for shared economic co-ownership with property owners as provided by the free market based economic landlord investors.
As shall be fully explained below, while HELM seems to be able to offer timely helps to the current mortgage default mess through the shared appreciation concept, as a new alternative, FARM seems to be much better suited to build a stronger foundation of a new housing finance system going forward for our capitalism society.
2. How Does A SwapRentSM Contract Work?
3. The Benefits of SwapRentSM Transactions for Homeowners and Property Investors.