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Alternative Housing Finance: How Does “SwapRent” Work

Posted by Larry Doyle on August 24, 2010 11:58 AM |

Our nation rests on a foundation of entrepreneurial risk taking. I am a strong proponent that our government should work to promote those who have the minds and spirit to take risk and drive our nation’s future economic growth ever higher. That spirit has brought us untold gains over the years. We need to continue to tap into that spirit whenever and wherever we can. On a day in which we just reported that existing home sales dropped 27% in the month of July, I believe it is timely that we tap into this ‘spirit’ and address another alternative housing finance solution.

I referenced the need for real entrepreneurial spirit the other day in writing, A Proposed Solution to the Foreclosure Crisis:

With the Conference on The Future of Housing Finance being held in Washington today, do we really expect the government to propose anything that may help support or fix our system of housing finance? 

I am not optimistic and I am an optimist by nature. I am a big believer in unleashing the power and strength of entrepreneurial minds to address our problems. Why haven’t these minds developed solutions? Do you think that these minds are stifled by the overwhelming presence of Uncle Sam? I do. Back to housing and entrepreneurial spirits.

I love when Sense on Cents can provide fertile ground for the free and open exchange of ideas, opinions, thoughts, and analysis on critically important issues of the day. I am deeply grateful when people not only comment here at Sense on Cents but I encourage people to provide written commentary.

On this note, I thank Ralph Liu, Chairman and CEO of the Newport Beach based Advanced e-Financial Technologies, Inc. (AeFT), a research and consulting firm (http://www.SwapRent.com), for providing a very insightful perspective on an alternative housing finance solution. Ralph’s treatise is a little lengthy, but we are not going to solve our housing finance dilemma in the midst of  a few paragraphs. Ralph writes:

SwapRent as a third economic policy management tool for governments.

Dear Larry,

In light of the recent Conference on the Future of Housing Finance on the 17th of August held by the Treasury Department, I would like to have an opportunity to share with your readers on how a third economic policy management tool could be made available to central bankers. This new third alternative economic policy management tool, in addition to the conventional monetary and fiscal policies, will finally make it possible for policy makers to help our country de-leverage and stimulate at the same time.

This could be a very timely subject since the current market is extremely concerned on whether the Fed may be building up other asset bubbles such as the bond market by keeping an extremely low interest rate level. This could have been the alternative soft landing policy to de-leverage that the Fed needed before they decided to precariously pop the real estate bubble by raising rates between mid 2004 to mid 2005 without a plan for the aftermath that had caused the financial crisis of 2008.

Now that they had reverted back to the bubble building policy again by keeping a near-zero interest rate level, it certainly makes people wonder why they had even bothered to pop the bubble in 2004 to begin with. What would have happened if they did not rush to pop the bubble without being prepared for its drastic consequences? Would they have learned the lessons by now and be more willing and open about learning other policy alternatives?

Please allow me to propose an alternative housing finance solution designated SwapRent. This proposal has been made available to most of the relevant policy makers and key decision makers since July 2007. Many of them and their relevant staff members are still studying the proposal. It would be interesting to observe if and when the policy makers would be willing to take a public stand on these innovative proposals and/or open them to public debate.

The detailed quantitative and technical explanations are available in an article entitled “The SwapRent Transactions for Homeowners, HELM and FARM – A New Alternative Housing Finance System” that I have published in the Journal or Housing Finance International (HFI) by The International Union of Housing Finance (IUHF) in December 2009. ( http://www.swaprent.com/files/IUHF_SwapRent_Mr_Liu.pdf ) Here below are a few summarized points.

A generic SwapRent transaction was created as a new “temporary own-rent switching” contract that facilitates the realization of the separation of the “Shelter Value” from the “Investment Value” of owning a real estate property. The shelter value is the right to occupy and use the property similar to those rights of a conventional renter. The investment value of a property is best demonstrated by the actual difference between the cost to own and the cost to rent.

To put in layman’s terms, a SwapRent contract allows either a property owner or an investor to choose between receiving a stream of monthly cash flows vs. receiving a portion of the property’s future appreciation or depreciation potential and vice versa.

Since this new alternative housing finance system is not based on a lending concept but rather a tradable co-ownership equity financing concept to help our nation de-leverage, it does not have to rely on a low interest rate environment to be effective to create jobs and to stimulate our nation’s economic growth. Therefore, once a SwapRent market has been established, the Fed or central banks in many other countries could raise rates at any time as they see fit in order to prevent growing further asset bubbles, to fight potential inflation or to save the value of the national currencies without having to worry about its potential impact on hurting the chances of an economic recovery. This is due to the fact that SwapRent could pick up the role to stimulate the national economies independently of the interest rate levels.

Among the most relevant job creation SwapRent applications to our economy now is that entrepreneurs could create new monthly income by willingly giving up a portion of the future appreciation potential of their own homes, which may or may not be realized by the horizon date (e.g. 2, 3, 5, 8 or 10 years) given the current economic situation. The entrepreneurs could then use these pooled new monthly cash flows to start a new business, hire people or to make new investments at the grassroots level.

As for defaulting homeowners, all the government needs to do is to encourage, and/or to facilitate as a middleman, the current risk holders of those distressed mortgage assets to be very generous in the design of the initial monthly subsidy income scheme so that local home owners, commercial property owners and other normal small business owners feel it is too good a deal to pass.

Based on pure free market principles, the more people there are in a neighborhood to sign on to this new program the more likely the local property markets and the local economic prosperity will indeed recover and the more likely free market based investors will rush to inject more fresh new fund into the local communities directly through this new free market mechanism. As a result, the government’s role will be limited to being a middleman to channel this fresh new capital from private sectors to the local communities without having to fiddle with taxpayer’s money.

As a result the more the SwapRent contracts will appreciate in value due to the property market recovery that will reward the initial monthly subsidy providers. This new economic concept of a farming approach to wealth creation is indeed a self-fulfilling prophecy in the true spirit of capitalism. The more you sow, the more you’ll reap. None of this will be based on lending and hence no more fear of building up further bubbles.

Homeowners who see the signs of an imminent swift recovery will think twice about their earlier plans to walk away. The only way for homeowners to feel that they should not purposely make a strategic default and walk away seems to be to somehow make them feel that they might be missing out on a swift recovery if they do walk away.

If the government itself is the credit risk stake holder of these distressed assets (through Fannie/Freddie etc.), it would be an excellent opportunity to use these GSE entities or HFA for the purpose of providing the initial monthly subsidy through the SwapRent transactions. The initial offerers of these monthly cashflows to homeowners through these SwapRent contracts, whoever they may be, could later sell these appreciated SwapRent contracts to other free market investors to get their money back, perhaps even with a nice profit if property value has indeed recovered.

Pension funds and insurance companies could be the ideal long-term investors as the economic landlord investors to provide the monthly subsidy cash flows to either credit worthy homeowners or property owning small business owners in this farming approach to wealth creation since they normally would have more longer term liabilities to match.

As the property owners who do not even need any additional monthly income from swapping a part of future appreciation of their own properties also get motivated due to their own profit driven motives  since they do not expect the property market would appreciate by the horizon dates anyway (e.g. 2, ,3, 5 or 8 years, etc.) given the current economic conditions and the lack of a prudent government policy, these additional monthly income would become their discretionary disposable income that would make them the ideal consumers with a new found consumption power to purchase the goods and services from the small business owners in the local communities, hence enhance the results of the goal of economic stimulus.

From the homeowners or commercial property owners’ perspective, a 100% ownership of future zero appreciation by horizon date is still zero, a partial shared 50% ownership of future 20% or 30% appreciation of their own properties driven by the new fresh capital injection into local communities induced by the SwapRent program will translate into a 10% or 15% gain for them. It seems a much better deal, especially when they realized that they would have been paid a generous stream of monthly cash flows along the way to achieve this partial appreciation gains.

Meanwhile with the new swapped current monthly income streams they could enjoy the additional flat screen TVs purchased at local malls, lease another new electric hybrid car from local car dealers or eating out more at local restaurants. Wouldn’t that be the American way as usual without piling up any more debts?

In a sense, the more participation by local property owners to the SwapRent program the more additional fresh new capital would be injected into the local community through the new economic landlord investors from both here and abroad. That is exactly the reason why this SwapRent program has to be open to all property owners to participate, not just for the distressed homeowners. Let the free market forces reign and the economic prosperity will happen. If you build it, they will come.

This proposed SwapRent program could be implemented on top of many other government plans already in place or currently in the pipeline in order to prevent political conflicts. It could also be made to be complementary, not competing with any other homeowners rescue or economic stimulus plans proposed by many other economists.

I thank Ralph for laying out this program. He has already made a meaningful impact on the housing finance industry globally. Might this SwapRent product have a larger impact on our nation’s system of housing finance?

What do people think? Thoughts, comments, questions strongly encouraged. I am sure Ralph will be happy to respond in kind.

Larry Doyle

I have no affiliation or business interest with any entity referenced in this commentary. As President of Greenwich Investment Management, an SEC regulated privately held registered investment adviser, I am merely a proponent of real transparency within our markets, including our financial regulators, so that badly needed and real investor confidence and investor protection can be achieved.

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  • Lou

    Ralph,

    How would you compare your product to Shared Appreciation Mortgages which had been promoted in the UK but never seemed to develop a following here in the States?

  • Hi Lou,

    This is a very important clarifying question. There are many explanations on the SwapRent.com web site. Here is the link to an earlier article for the full explanation.

    http://www.swaprent.com/files/SwapRent_Embedded_HELM_vs_SAM_and_SEM.doc

    In short, SwapRent embedded mortgage products such as HELM, FARM, etc. provide new economic benefits to allow the consumers and the providers to detach the shared appreciation component, i.e. SwapRent, trade it or hedge it in a secondary market for price discovery and capital regeneration purposes and could even be re-attached back into any normal mortgage product again whereas the conventional rigid one-recipe-formula built into a SAM or SEM do not provide.

    In fact, those existing SAM and SEM which had been popular in the UK for over 30 years were exactly what these SwapRent related new innovations were originally created in early 2006 to replace in the initial research efforts.

    Ditto for reverse mortgage product that has been popular here in the US. SwapRent embedded product was a much superior replacement since there is a chance the heirs of a reverse mortgagor could inherit the entire property with no debt (they had only given up the appreciation “potential”) whereas in reverse mortgage the inherited property will be piled up with debt for sure.

  • Abigal Brown

    Very nice article and thanks for the useful information

  • American Citizen

    Uhhh,

    Can anyone sum this up in a few sentences? I can’t form an opinion on something I don’t understand. Thank you.

  • Wis

    Since your primary objectives is to stimulate local communities and local small investors, my concern is how can you be sure that this new investment strategy will not be taken over by big banks and/or by wall street, therefore crowind out small investors.

  • Hi Wis,

    Excellent question. The best economic solutions or a new economic system could be totally ruined again when left in the wrong hands. Therefore the process has to be revolutionary rather than evolutionary. The incumbent establishments will have to go before new reforms could see any real results.

    We are waiting for the new generation of intelligent and competent local politicians to stand up and champion the implementation of these solutions. There is no need of the participation by Wall Street big banks or the federal government. The implementation will have to be done locally at state, county and city levels. Please kindly read the following blog post on how this could be successfully done.

    http://peoplesally.wordpress.com/2011/08/02/0802-2011-implementation-strategies-of-farjho-and-swaprent-good-economic-stimulus-public-policy-or-cornering-the-real-estate-market-by-investors-for-profits/

    We have also set up the PeoplesAlly Foundation ( http://www.PeoplesAlly.org ) earlier this year in order to create a political voice to prevent the potential Wall Street hi-jack that you mentioned from happening. Please kindly support the foundation. Let FARJHO and SwapRent bring housing finance from the hands of Wall Street back to the people on Main Street.

    Furthermore, we have recently submitted our response to FHFA’s August 10th, 2011 RFI. Please feel free to download a copy through the following blog post.

    http://peoplesally.wordpress.com/2011/09/24/0910-2011-our-response-to-fhfas-rfi-farjho-and-swaprent-from-peoplesally-foundation-and-investorsally-inc-a-letter-to-the-fed-the-administration-gses-hud-sec-cftc-other-agencies-and-the/

    The advantages of our FARJHO based proposal are:

    1. It eliminates the need to let privileged private parties have access to and engage in quick short term buy-low-sell-high flipping activities at preferential bulk sale discount prices to profit from the potential privatization of our national assets owned by the GSEs and FHA.

    2. It helps avoid the federal government, the elite private equity firms in DC or hedge funds on Wall Street from becoming new long term serfdom landlords to low income working families on Main Street by allowing renters to become partial co-owners of the home properties through FARJHO LLCs.

    3. Potential wealth created from a future recovery of the US housing market will be able to be channelled through FARJHO back to small town investors, mom’n’pop’s self-directed IRAs, state, county and local pension funds, church groups, non-profit endowments etc. on Main Street to fix the local government’s pension liabilities and budget deficits by investing on a more level playing field with other elite institutional investors on Wall Street who already have exclusive access to the use of leveraged low cost of funds as a result of the Fed’s loose monetary policies to profit from the potential price appreciation.

    4. Through the new Borrow-Pool-Buy (BPB) member level borrowing concept that replaces the old Pool-Borrow-Buy (PBB) property level financing practice in other conventional equity sharing schemes, future foreclosure possibilities could be totally eliminated once and for all in this new FARJHO home ownership structure.






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