This blog entry first appeared in SwapRent.com blog on 05/01/2010.
The rent-controlled apartment building owners could make a free market based offer to their current renters to let the renters own their apartment units either through the SwapRent based portable housing affordability solution or simply through InvestorsAlly’s FARJHO program.
Arbitrary round numbers were used for illustration simplicity in the following examples.
1. The SwapRent based portable housing affordability solution:
A generic SwapRent transaction is a “temporary own-rent switching” contract that facilitates the realization of the separation of the “Shelter Value” from the “Economic Value” of owning a residential real estate property, for a commercial property such as an apartment building, the “Usufruct Value” from the “Investment Value”.
The usufruct value is usually best explained by the annual rental rate that a property could command. In this case it is set at a controlled rate by the municipal government. The investment value of a property is the actual difference between the cost to own and the cost to rent. Therefore the investment value of a property could be either positive or negative based on the investment sentiments and the interest rate levels on the term structure, i.e. the cost to own at any given point in time.
Assume the current rent that a renter is paying for his apartment on the West Side of Manhattan is $1,000. The renter could use whatever cash that they may have as the down payment to obtain a long term fixed rate mortgage. If say a simple 30-year fixed mortgage requires a $3,000 monthly payment. They could become
a.) the 100% legal title owner with 0% economic ownership of their apartment unit if they continue to pay the same $1,000 monthly payment for a period of time. Nobody could foreclose on them or to kick them out as long as they continue to pay the same monthly rent payment as before the condo conversion.
b.) the 100% legal title owner with 25% economic ownership (hence the future appreciation) of their apartment unit if they have the ability to make a $1,500 monthly payment for a certain period of time (say 5, 10, 15, 20 or 30 years).
c.) the 100% legal title owner with 50% economic ownership (hence the future appreciation) of their apartment unit if they have the ability to make a $2,000 monthly payment for a certain period of time (say 5, 10, 15, 20 or 30 years).
d.) the 100% legal title owner with 100% economic ownership (hence the future appreciation) of their apartment unit if they have the ability to make a full $3,000 monthly payment for a certain period of time (say 5, 10, 15, 20 or 30 years).
The monthly payment shortfalls in case a.), b.) and c.) of the new condo unit owners are made up in whole by the apartment building property owner each through a SwapRent contract when the apartment unit is converted into a condo unit and sold to the current apartment dweller. The property owner could in turn re-sell these SwapRent contracts any time to any other free market based real estate investors through REIDeX.com in order to get back the money that he may need.
It is a much better way to help the current renters to obtain the financing they need than the inflexible seller carry-back financing in the form of a mortgage lien. In a seller carry-back, economically it is no different from a conventional mortgage in terms of the future debt burden. The new condo owner could be foreclosed if he loses the ability to continue to pay the higher monthly payments in the future. In this alternative SwapRent based solution, when the same situation happens, the new condo unit owner simply temporarily loses the economic ownership (and hence the future appreciation potential by a horizon date). No one could evict him as long as he continues to pay the current controlled rent rate as he did before.
2. The FARJHO solution
The current apartment renter could simply put up whatever cash he may have as his own equity contribution and try to find other would-be property owners through InvestorsAlly.com to put up the rest of the cash needed to buy this condo unit together using an all equity based LLC structure. He gets to pay either the same controlled rent, a newly negotiated rent on a case by case basis depending on the private negotiations between the LLC members in order for him to rent from the LLC and continue to occupy and use the unit as his own home.
Through the use of the LLC operating agreement, the buy/sell agreement and the lease agreement all these terms and conditions would be thoroughly discussed and negotiated before the actual agreement for condo conversion is signed and the purchase of the new condo unit is consummated. If there is no agreement, there is no deal between themselves and there is no need to convert. The current renters could continue to meet and discuss with other would-be property investors as many as they like through InvestorsAlly.com during their annual membership until a match is finally found.
The interesting part of this new FARJHO innovation is that the more the equity stake the current controlled renter may have in the new LLC structure to own the unit, the more likely he would agree to a higher market level rent payment in the lease agreement between himself and the LLC. This should not be too difficult to understand. Not only he himself would receive a larger portion of the higher rent payment back as the partial co-owner of the unit, the higher the rent (i.e. the positive yield of the property), the more likely this unit would indeed appreciate in price in the future which he himself would benefit as the partial owner.
The new innovative FARJHO structure seems to automatically help the best spirits of free market capitalism manifest themselves!