As illustrated on slide #4 in the latest version of the SwapRent presentation file, there are three ways to bring the monthly subsidies from investors to homeowners in return for a part of the future appreciation, P2P (as described in the current prototype on REIDeX.com web site), B2C (through middlemen such as credit unions, banks, mortgage lenders, etc. using FARM or HELM) and B2B (trading SwapRent contracts between financial institutions). By having the participation of the financial middlemen such as banks, credit unions and mortgage lenders it could help create the critical mass of transaction liquidity necessary to provide the best pricing for both the homeowners and investors. However at the moment in the very politicized American financial markets, the credit unions seem to be the only type of financial institutions left with a proper image and credibility to be able to launch new innovative housing finance services to assist homeowners in the US. The self-serving reputation built up by Wall Street firms and major national banks seems to preclude them from introducing anything new due to the lack of trust from the public.
Among the many recent questions regarding SwapRent due to the renewed interests in using shared appreciation related concepts by the credit unions, there are a few worthwhile to visit again with an updated explanation.
1. The differences of the SwapRent embedded and detachable mortgages vs. conventional SAM (Shared Appreciation Mortgage), SEM (Shared Equity Mortgage)
There are many major deficiencies of the old ways of offering shared appreciation benefits through the conventional SAM (Shared Appreciation Mortgage) or SEM (Shared Equity Mortgage) products. Here are the three main reasons.
•SAM or SEM do not offer any price transparency since there is no either a primary or a secondary marketplace for homeowners and investors to negotiate what subsidy represents what percentage of shared future appreciation.
•There is no flexibility in maturity terms, percentage of appreciation give-up terms or early termination possibilities by the homeowners or investors.
•The provider banks could not regenerate the capital used to purchase the potential appreciation elements embedded in a SAM or SEM through selling these potential appreciation elements to other free market investors through a secondary market.
As a result, this simple economic concept of shared appreciation usually ended up only being offered by local governments to homeowners using taxpayer’s money in the past. The taxpayers’ money usually gets stuck for 20 or 30 years (the terms of the mortgage itself) in the way as they have been practiced so far in many countries.
A good recent example to understand why the conventional SAM or SEM would not work is by looking at what shared appreciation scheme that the Federal government had done in its H4H homeowners bailout program implemented in October 2008. The one recipe formula in its program contains all the problems and short-comings described above. To solve these problems, our financial markets need new innovations. It may not make sense for credit unions or any other financial institutions to spend resources now on the shared appreciation related concepts only to repeat the Federal government’s mistakes if the methodology is not drastically improved.
The key thing to make it successful is to design a new financial contract to extract out the shared appreciation component and detach it from a conventional shared appreciation mortgage product so that market participants can quantify it and give a fair value market price in a freely negotiated and traded secondary market. SwapRent is the new financial contract created specifically for this purpose and REIDeX is the secondary market to facilitate the price discovery and the capital regeneration functions for the benefits of the homeowners and investors. The combined new economic owning and renting concepts is the conceptual foundation of how to use the SwapRent transaction and apply these new housing finance methodologies.
On slide #5 in the SwapRent presentation file, there are examples on the two opposite entry points for homeowners to use either FARM or HELM to switch between economic owning vs. renting for the both the Muslim vs. Western worlds. FARM could of course be offered to Western consumers as well. There are no inherent obstacles other than the ideological issue and the lure of easy credit in our existing financial systems in the Western world. From the government’s perspectives, tightening the credit spigot a bit and introduce non-lending based FARM types of housing finance products to homeowners could stabilize the society without sacrificing any overall homeownership level for its citizens. While HELM seems to be able to offer helps to clean up the current mess through shared appreciation, as a new alternative, FARM seems to be much better suited to build a stronger foundation of a new housing finance system in the long run.
2. The differences between SwapRent and conventional financial derivatives such as calls, puts, forwards and swaps practiced in the institutional markets
The original objectives of the inventions of SwapRent and its embedded suite of financial products were to create a totally new consumer financial concepts and fool-proof uses of financial transactions so that they could continue to enjoy the same economic benefits of conventional financial derivative contracts without their complexity and the danger of potential abuses by either the consumers or the vendors.
The best example in the past of such successful consumer products is the prepayment option built in a fixed rate long term mortgage loan. It is in fact an interest rate derivative contract (a call option on the interest rate level). However, banks have never marketed as a derivative contract and consumers have been taking advantage of it without any potential dangers or problems. These objectives were exactly what SwapRent and its embedded financial products were originally designed to achieve.
3. The differences of economic renting and owning concepts vs. shared appreciation or shared equity concepts
By focusing on the newly created consumer financial concepts of full or partial “Economic Renting” and “Economic Owning” will make the explanations of shared appreciation or shared equity concepts redundant. Nor will there be any need to explain what selling covered call options or buying call and put options are all about. The best way to introduce new economic concepts to consumers is to introduce something new through something old that they are already very familiar with. For that matter, everyone is already very familiar with the difference between owning and renting a property.
Therefore if one is an owner of a real estate property, he will be entitled to the future financial appreciation of the property. At the same time he will have to bear the risk of downside depreciation. If he is a renter instead, he will not have any benefits of future appreciation or the risk of losing money if property value declines. Therefore by becoming an “Economic Renter” a consumer will understand that by being a renter, by definition, he will not have the benefits of any future appreciation.
For example, if a person chose to save money, sold his house and became a conventional renter for the next 5 years. He gets to pay a lower rental payments than the previously much higher mortgage payments every month. Five year later if the house 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 he may act., no laws or liberal politicians will be on his side.