FAQ #12: (added on May 25th, 2008) What is the difference between SwapRent (SM) and the recent promotion of an “Own-to-Rent” plan?
There indeed seems to be a lot of effort to promote this variation of the conventional “Sale and Lease Back” concept, more often called “Sale and Rent Back” in the UK, as a new plan to rescue the homeowners since it would be a forced renting after foreclosures. On May 20th, 2008 Congressman Raul Grijalva from Arizona (D, AZ) even introduced a bill tentatively called “Saving Family Homes Act of 2008” to promote a similar plan and it has been in the news since then.
This heavily touted “Own-to-Rent” plan appears to be simply a forced extension of the conventional “sale and lease back” concept whereas the homeowners could have better done it with any other free willing parties in a “short sale” transaction prior to foreclosures. I am not sure about the innovativeness of such a plan or the need to promote it. Other than the existing common practice that the homeowners could have initiated a short sale and rent back on their own with any other third parties prior to foreclosures (which is often scam prone, see Forbes article on Rent-to-Buy scams), the lenders and the homeowners can at their own will, based on mutually agreed terms, enter into such a conventional rental contract upon foreclosures if it is indeed to both parties’ interests to do so under a free market. A better and more intuitive name for this “Own-to-Rent” scheme may be “Foreclose and Force Them to Rent Back”.
I am equally puzzled by the need to introduce a legislation to force the lending banks into such an obligation at their own expense. Banks these days have enough troubles to manage their own survival. When burdened by such a new legislation more banks and Wall Street firms may fall and more government led bailouts may be necessary further at taxpayers’ expense. When the assets are transferred to the government after these banks fall again the government will become the de facto landlord to millions of homeowners. So this “Own-to-Rent” plan seems to bring us further prepared to be a central planning state, away from our current free market capitalism based system.
The good intention of such an “Own-to-Rent” plan to help many homeowners be able to stay in their own homes seems to be laudable though. The spouse and kids may have emotional attachment to a place where they grew up or lived for a long time. This is exactly one major part of the many advantages that the SwapRent (SM) based solution could deliver, i.e. the social good to help homeowners continue to stay at their own homes. However, that is where the similarity ends.
The Own-to-Rent plan will not be able to deliver any of the other major advantages of SwapRent (SM) in terms of the ability to help solve our current economic crisis. In their plan the mortgages will continue to default, written down on the book by the lending banks and the properties will continue to be foreclosed, and hence the investors losses and the banking credit crunch continue …
It does not really make economic sense for a bank to trash its mortgage, incur lots of expenses and troubles to foreclose a property only to get stuck with the foreclosed property to become a landlord to an irresponsible borrower when it could simply leave its existing mortgage intact, give the homeowner in need a fair, quantifiable monthly subsidy and become a temporary “economic landlord” through a simple SwapRent (SM) transaction. The lending bank could subsequently transfer this newly obtained real estate exposure through another opposite off-setting SwapRent (SM) contract to some other investors much easier and much cheaper than trying to repossess first and then sell an actually foreclosed physical property. This is the essence of the newly created consumer finance concept of the “economic renting” of a property while letting the homeowners continue to keep the legal title ownership and stay in their own homes.
In the conventional “sale and lease back” transaction or this new “Own-to-Rent” forced contract there will be legal title transfers and hence the associated high transactional cost and hassles. In addition, the tax events will be triggered by these legal title transfers. SwapRent (SM) transaction is a synthetic version of the conventional “sale and lease back” transaction to be initiated by free willing parties in a free market. By separating the legal title ownership and the economic interests the new “economic renting” concept could be realized. Among many other advantages, there won’t be a default of the existing mortgages, hence both the credit records for the borrowers and the pockets of the mortgage lenders or the MBS investors will remain intact. The property will not be foreclosed and continues to be legally owned by the same homeowner. The bank will get to easily transfer these SwapRent (SM) contracts later on as a simple single combined trade or trades in the REIDeX.com marketplace with other long term real estate investors such as pension funds or insurance companies since banks do not usually want to treat long term real estate investment as their core business, nor do they want to be actual legal landlords and manage properties all day long.
In short, the homeowners will continue to keep and stay in their homes but act only as “economic tenants” of their own homes. The retail or institutional real estate investors will act as the “economic landlords” through the same SwapRent (SM) transactions. The cost associated with the management of an actual real estate property investment such as brokerage fees, property management fees, taxes, insurance premium and so forth could be totally avoided.
Again, all these could also be done partially, say 25%, 50% or 75% of the current house value and for a shorter period of time say, 2, 3 or 5 years only, depending on how much monthly subsidy (determined by the economic rent-own cost differential) that the homeowners may need. Furthermore, both parties could cancel and unwind the reversible SwapRent (SM) transactions any time based on pre-agreed terms or by doing off-setting transactions for the remaining maturity in the secondary market with any other free willing parties later on.
Therefore, if you like the charitable nature of Congressman Grijalva’s new bill to help the homeowners, you will love the additional economic crisis solving benefits that the SwapRent (SM) plan can further bring to the table. If you do not like the socialist tone of Congressman Grijalva’s new bill, then SwapRent (SM) could just be the free market alternative that you are looking for.