What is a FARJHO structure?
FARJHO is the flagship product of AeFT’s subsidiary InvestorsAlly.com. It is an offshoot from the R&D work on SwapRent embedded FARM product. The new name reflects the fact that FARJHO is meant to be a new way of home ownership structure, not just another mortgage product.
At the present time, there are many opportunities for investors to set up a fund to invest for the long term in foreclosed or distressed single family residences in many worst hit neighborhoods in California, Nevada, Arizona and Florida. FARJHO was created as a new way of shared equity based home ownership to allow institutional money to come in by letting renters and property investors co-own the properties in a LLC structure so that there would be a positive yield on their investments, similar to a real estate syndication process on commercial properties but with much scaled down expenses and complexity.
Due to its simplicity, this new commercialized service is ready for use by investors and homeowners without relying on the participation or any involvements by the government or major financial institutions. A common base structure for the US market is currently composed of a real estate syndication using an LLC legal entity. Each structure will be put together by a syndicator with up to a total of 10 members in the LLC. One of the co-owner members will be renting the property from the LLC and treat the property as his/her own principal residence.
For example, a home seeking person could identify a property in a particular geographical location. Instead of using a down payment say 5, 10 or 20% of the property value to apply for a conventional mortgage, which under most current circumstances he/she would not be qualified to, he/she could join the group of property investors to co-own the property in this all equity based syndicated LLC structure.
Although further financing using the property owned by the LLC is always possible as a variation of FARJHO if all members of the LLC so desire and approve, it is not a recommended structure. The intention FARJHO is to help renters become homeowners through minority stake ownership in the jointly owned LLC. A pure equity based structure without borrowing provides the long term social stability for home ownership and increase true housing affordability.
Since tax considerations are entirely passed through to each of the members, there is normally no point to use further leverage at the LLC level, unless the investors are of foreign jurisdictions. The use of moderate and reasonable borrowing to deduct the taxable income could be considered but should never be done to the degree that negative yield or negative cash flow occurs.
Tax advantages are man-made by nature. They reflect a government’s housing and property investment policies. Better tax treatments will follow prudent government policies when the economic benefits of innovative housing finance methodologies are more fully understood and accepted in the future.
For the time being, under the existing tax rules, property investors could manage the interest deduction individually since the rental income will pass through to each of the US based LLC members. For the homeowner/occupiers in the FARJHO structure, they could take advantage of the tax benefits of principal residence such as interest deduction and capital gains tax exemption for the portion of the equity that they own in the LLC. If they are interested in getting more of these conventional tax advantages, they could either increase their equity holding in the LLC or simply switch to complete ownership through conventional mortgage borrowing anytime they want, as long as they are able to afford it and be qualified for it.
FARJHO will serve as an additional consumer choice to increase housing affordability under the free market, not meant to replace any housing finance methods already in existence. It will only become a creative destruction if its economic value is proven and adopted by the consumers through further public education and awareness. For now it serves as a perfect alternative when homeowners either can not afford the conventional borrowing or are not interested in the conventional burden of debt.
Buy-out arrangements could be customized and structured in each individually syndicated LLC between members in the operating agreement of the LLC to serve different purposes of the members. When SwapRentSM transactions become available at REIDeX.com in the near future, the flexibility and reversibility features as well as the benefits of FARJHO will only get to fully present themselves at that time.
When and how to apply FARJHO?
The following information is on how to apply the new economic concept of the separation of shelter value and the investment value of a conventional ownership of a real estate property.
A home seeking person who currently rents identifies a property in a geographical area of his/her choice. He/She has the 10% of the property in cash from his/her own savings and would like to seek to jointly own the property with other investors as the ideal home owning structure.
The reasons could be because that he/she may not have enough monthly income to qualify for a conventional mortgage, prefers to use the discretionary monthly income for other household expenses, does not think the property value may increase in the near term, for his/her particular religious belief that rejects the lending/borrowing concepts or simply any other personal preferences.
He/She commits to pay a pre-agreed rent to the LLC that holds the title of the property for a specific period of time. The remaining 90% property ownership could be shared among up to nine other individual, corporate institutional or even governmental entities.
A group of investors have identified and bought a particular single family house at bargain price through a syndicated LLC structure either through a short sale process or from a bank’s REO portfolio.
The syndicator of the LLC tries to find a long term renter of this single family house in order to generate stable long term rental income. Many renters do not commit to the long term and do not usually care about the houses that they rent.
The syndicator/property manager makes an offer to a qualified renter who has the ability to pay for a small percentage of the property value and invites him/her to join the LLC as a minority stake holder/member himself/herself. Once the renter becomes the minority homeowner, he/she may intend to stay for the long term and would treasure the property and take good care of it as thought it were his/her own. In fact it is hie/her own, albeit partially. Although he/she does not have the economic income capability normally required to own the property entirely he/she gets to enjoy the high quality home in the neighborhood of his/her choice.
Through buy/sell agreements between LLC members, the homeowners could increase his/her equity ownership through buying existing member’s interests. Alternatively, he/she could use SwapRentSM contracts to do so when they become available at REIDeX in the near future. In the worst case scenario, he/she could also become a LLC member in another property in the same neighborhood whenever he/she has the increased economic ability to do so and would like to have more investment exposures.
Comparing with conventional commercial property investments, FARJHO offer property investors less worries about vacancy and expenses. The investor’s SGI (Scheduled Gross Income) is his/her GOI (Gross Operating Income) and his/her NOI (Net Operating Income) since both annual vacancy loss and expenses are most likely zero in a FARJHO structure.
A homeowner currently has a deeply underwater house. He/She contemplates a strategic default on his/her own house but does not like the idea of becoming an apartment renter. A buy-and-bail strategy sounds more appealing to him/her. He/She could use an all equity based FARJHO structure to become the minority owner/renter of an alternative property in his/her neighborhood before he/she begins discussions with his/her current mortgage lending bank to give up his/her existing homes in either a short sale or a flat out walkaway foreclosure.
The strategic defaulters usually could not secure another mortgage to buy another comparable home before or after he/she walks away from his/her existing home. To qualify for a new mortgage on a second home, he/she has to either have 30% net equity in his/her existing home or a very large fully documented monthly income to qualify for the mortgage payments of two homes. This is often not the case with most upside down homeowners.
An all equity based FARJHO co-ownership structure makes it convenient for a smoother transition to a long term comparable or even nicer and often more spacious home through a partial equity ownership without having to lose the homeowner status by becoming a conventional apartment or house renter. It may turn a somewhat embarrassing, face-losing event into a move up in prestige as a partial owner of a much bigger house!