In Southern California, all around us there are many wealthy people who own multi-million dollar homes along the coastal area from Malibu, Pacific Palisades, Beverly Hills, Manhattan Beach, Newport Beach, Laguna Beach down to La Jolla in San Diego. Many of them do not even have a mortgage.
On average many decent homes in these exclusive coastal area are worth above two million dollars. Wouldn’t it be a good idea for some of them to have a cash out refinance to put their idle home equity to work. Say they could simply borrow only one million dollars (50%) from their two-million-dollar home and use that money to invest in a partial interest through a member interest in a FARJHO/LLC deal to help some other less fortunate fellow Californians to own homes? One million dollar cash could probably help finance three or four FARJHO deals in the Inland Empire area for example, where average decent homes could sell around $300,000.
This is by no means just a charity work for these rich property owners. They could potentially do very well and become much richer by doing good this way. At today’s posting, the level of a 15-year fixed rate mortgage is about 3.83%. In a FARJHO deal the current market rental rate comes up to be between 5% to 7% annually. The positive carry could range between 1% to 3% after cost.
Generically speaking, that means if a rich home owner with a $2 million home borrows a fixed rate mortgage of $1 million (50% LTV) and invests the cash as a JPI (joint property investor) to help 3 to 4 other AHOs (Aspiring Home Owners) to buy homes through the FARJHO structure, he/she could earn a minimum spread of between 1 to 3% on the one million dollars every year for the next 15 years while turning his $2 million home equity in his current property into a total equivalent of $3 million home equity for the next 15 years.
When home prices start to go up anytime within the next 15 years (say 5 or 7 years later), he/she could simply unwind the trade by selling the homes he/she invested in when agreed by the AHOs, selling only the FARJHO member interests to the AHOs or to any other third party investors in order to take profit. He/she can then use the proceeds (much higher than $1 million) to pay off the original $1 million loan (either amortized or a balloon). He/she could have the choice of using either an interest only loan or a fully amortized loan for this 15 year fixed rate mortgage, with some benefits trade-off of course.
There are also justifiable tax oriented incentives such as the home mortgage interest deduction for unlocking this primary residence home equity through a moderate leveraging for these rich people. As long as they stick to the 30- or 15-year fixed rate mortgages so that there would not be unnecessary interest rate risk in the future, it could be made a prudent investment for them. Here below are a few other advantages as compared to his/her other investment alternatives with the cash generated through refinancing.
1. The annual dividend yield from the rental income in a FARJHO deal could also go higher periodically (say at every 3 year intervals) within the next 15 or 30 years while the interest rate cost has already been fixed for the next 15 or 30 years. That may make the total returns outcome even better than projected.
2. The key to success of this trade is the current positive carry (rent income could be obtained higher than the mortgage interest cost currently). Very few other relatively safe financial assets could generate such a high yield in dollar terms at the moment.
3. Using the money to invest in speculative gold, silver or other commodities would generate no yield at all and their high prices could suddenly crash and have a free fall. In contrast, it is unlikely there would be a further “crash” in the US residential real estate market going forward. It may at most drift a bit lower before it would eventually rebound, given a no inflation scenario within the next few years. As long as there is a positive carry, the chance that the trade would lose money would be minimal. With high inflation, this Bernanke Arbitrage trade could really win big.
4. Comparing with using that money to invest in stocks. Few stocks would have such high secured dividends for such a long period with such a high appreciation potential at the same time. Stock investments could also potentially end up being zero due to fraud or mismanagement such as Enron, WorldCom, etc. It is unlikely that investors would lose their shirts entirely on real estate.
5. With a current average 6% annual minimum dividend yield from rental income and the unlimited upside growth potential in home equity through investing in a FARJHO transaction, why would any free market investors put their money into a residential mortgage which only generates 3.86% annually at the moment with no upside appreciation potential at all for the next 15 years? The answer really lies in the name. This trading strategy is hence called a “Bernanke Arbitrage” trade.
Don’t stay a victim of Fed’s QEs. Big banks on Wall Street should not be the only ones who have benefited and continue to benefit from these unwise economic policies for our country. If we can not stop them. Why not join the loot? Let’s make Quantitative Easings work for the American working class people and home owners on Main Street!