ranchodeliu.com Blog

Alternative sites for my blogs

I have not had a chance to update this site for some time. Here are some alternative sites for my blogs and research work.

http://swaprent.com/blog/

http://www.SwapRent.com

http://www.InvestorsAlly.com

http://www.PeoplesAlly.org

Twitter Accounts:

@SwapRent

@FARJHO

Linkedin Profile:

http://www.linkedin.com/in/ralphyliu

Foreign exchange rate is the competency report card of a government’s ability to manage a country’s economy

This blog entry first appeared in SwapRent.com blog on 10/15/2010.

It is quite a amazing how the current Administration of our government has tried and almost accomplished the goal of brainwashing or duping the American public into believing a lower US Dollar value is good for us. They even got many financially illiterate politicians (Congressmen) to sing their tunes with them.

Try to imagine that your kid comes home back from school with a D on his report card, argues with you and tries to brainwash you that an F should be better so that he would be able to compete with other more diligent and industrious kids? Furthermore he complains that the rules need to be changed so that the other kids should not study hard and instead should be playing more like he does? He calls the bad grades on his report card a “manipulation” by those hard working kids. He even labels those industrious kids “Grade Manipulators”.

The simple truth is that a lower exchange rate would produce the immediate wholesale sell-off of a country’s wealth in the global marketplace, not increasing any genuine economic competitiveness. Economic competitiveness is produced through productivity and innovations, not by artificially altering exchange rate so that incompetent politicians could cosmetically buy some more time to hang on to their jobs a bit longer.

Competent governments in managing the country’s economy will be rewarded with a stronger currency and hence increased national wealth. Responsible and hardworking citizens under an incompetent government, on the other hand, will lose their personal wealth instantly in the global marketplace when their national currency is devaluated, no matter how hard they may have worked individually.

There is no quicker way to make the US lose its position as the No. 1 economy of the world and its associated super power status than de-valuating the US dollars. Foreigners with a stronger currency would then be able to buy our treasured assets in a fire sale. In addition, with a weak currency, the US would not be able to compete in the global marketplace to buy commodities such as crude oils, rare earth materials, gold, silver, platinum, food, crops, other raw materials etc. The cost to produce manufactured goods in America will be getting harder and harder as well as more and more costly. It will make the US lose even more economic competitiveness and get our country in a downward spinning vicious cycle. The list of the potential problems and disasters goes on and on …

Perhaps it is time that the parents sit down with their kids for a serious talk?

P.S. I made a keynote speech for ISDA’s Annual General Meeting held in Singapore back in March 2006 regarding the China’s role in the global financial market. In that speech I spoke about the exchange rate issues. The points are still quite valid. Here are the links to the presentation and the speech video.

http://www.slideshare.net/SwapRent/aeft-isda-2006-agm-keynote-speech-in-singapore

http://www.slideshare.net/SwapRent/day-1-3-web-custom

Shared Equity, Shared Appreciation, SwapRent and FARJHO

This blog entry first appeared in SwapRent.com blog on 10/01/2010.

It is quite encouraging to learn from recent news that there seems to be more and more people who have come to the realization of the power of the simple economic concepts of shared equity and shared appreciation to own homes. It may be time to revisit some introductory explanations again on what SwapRent and FARJHO mean relative to these shared equity and shared appreciation concepts. It may be helpful to let people understand where SwapRent and FARJHO stand and how they could effectively help implement these shared equity or shared appreciation related economic concepts.

Most people who are new to these concepts can not distinguish whether it is the new “concept” or the new “method” that they are learning. It could be very difficult for them to distinguish the two if both are new to them. At the moment most people are simply amazed at what the new concepts could do to help us build a new alternative housing finance system and to help restore our national economy.

If fact, only after they have had a chance to learn the “concepts” well from reading about the potential applications of SwapRent and FARJHO then it would be easier for them to start asking questions and learning what business methods may be best to make these concepts a practical reality. That is when they could really start appreciating the quantitative, technical and systematic details of SwapRent and FARJHO that I have put in more than 10 years of research work to develop. An economic concept is not patentable but business methods are.

To use an analogy again, a generic concept of “mechanic transportation” could be new to people who used to ride horses only in the old days. They would not be able to tell the economic utility of an electricity battery motorized SUV from that of a bicycle as both are mechanical, both have wheels on them and both fall into the “mechanical transportation” category that move people from one place to the other.

Due to the fact that the whole concept is new to them they would not be able to know that the end products are actually results of very different “business methods” to implement the same simple generic concept at very different evolutionary stages. To put even more bluntly, if a person who does not speak French, he or she may not be able to tell a baby gibberish from a poetic recital in French simply because both sound new and foreign to them.

Shared equity and/or shared appreciation related generic concepts are not new and they have mostly been practiced in the UK for over 30 years. Most recently in the US and Australia we had also seen some commercial ventures back in 2007 trying to introduce those same old methods before the mortgage crisis started. These concepts have not caught on simply because those primitive business methods engaged in the UK and more recently in Australia and the US to provide the economic benefits to consumers were not good enough. There existed plenty of room for new innovations on new business methods in this field back then, similar to the opportunity of how Steve Job’s iPhone had potentially replaced Gordon Gekko’s Motorola platform shoe sized cell phone. Social sciences evolve just like technologies would.

That was exactly the reason why the deliberate research efforts of the SwapRent method, its subsequent simplified version of FARJHO and their related various new mortgage instruments and markets were originally embarked on and were subsequently invented back in 2006. These events were chronicled in the original patent applications back in 2006 and many subsequent academic publications or in many leading trade journals listed on the SwapRent.com web site. In short, SwapRent and FARJHO represent the more mature and the latest developments of “actual business methods” in the evolution spectrum of the “shared equity or shared appreciation concept” to own homes.

Without the crisis in 2008 few would pay attention to and appreciate the timely new economic utilities of these new inventions of real business methods to make the simple shared equity concept practical and possible but these new inventions were not created in 2006 only to simply anticipate and cater to some particular needs of solving the crisis, such as rescuing the underwater houses. These new inventions together would provide an alternative housing finance system with many potential application opportunities that have very broad implications to our capitalism society.

Regarding the investor’s sentiments, the currently proposed economic implementation strategy to our country’s decision makers to help boost free market based investor’s confidence is to make it a self-fulfilling prophecy without using debt. The more free market participation the more likely the property prices will indeed rise, hence the more likely the economic prosperity will be brought back up, hence the more likely the investors will make money through SwapRent contracts and hence the more likely investors will flock to offer to provide the SwapRent cash flows to property owners who are willing to do this exchange of cash flows for appreciation potential. “Wealth begat wealth” is what self-fulfilling means in this new twist of an innovative implementation of the basic capitalistic mechanism.

The only caveat emptor is that when it is done with excessive debts, i.e. borrowed money, hell may break loose. As we have seen now and many times in our history in the past. So although this new economic policy management tool of SwapRent may be similar to how the Fed uses monetary policy to lower the interest rates to “stimulate the economy” or to “corner the property market up” in the past but there is no debt or any borrowing concepts involved this time around with this new SwapRent program.

Now that many people have understood the powerless state of the conventional monetary policy to channel credit down to the small businessmen and property owners in the local communities across America in order to restore our economic prosperity, perhaps it may be time to consider using some new innovative equity based home financing methods such as SwapRent to “stimulate the economy” or to “corner the market up”. These concepts and specific detailed methods on what the government or central banks could do were again described in the HFI-IUHF paper that I have published in December 2009.

The beauty of all these inventions is that these new economic benefits would be made available to everyone on a pure free market basis. Nobody would force anybody to accept and give up anything unwillingly. Consumers make their own choices for their own good and pay for what they want at a fair market value in an uninhibited marketplace.

If some folks do not like some particular aspects of these potential applications for ideological, religious, opinionated, individual preferences and tastes or any other reasons, they could simply skip those applications and move on with those that would make more sense to them in their particular situations. These are exactly the kinds of free market spirits that the marketplaces for SwapRent and FARJHO, i.e. REIDeX.com and InvestorsAlly.com were originally based on and will continue to operate on.

The polarization of American economy – from fictitious housing affordability to fictitious economic recovery

This blog entry first appeared at SwapRent.com blog on 9/3/2010.

While short term floating rates, teaser rates and subprime mortgages had contributed to the fictitious housing affordability with Wall Street’s promotions and the politicians’ blessings, historians in the future will realize the illusionary nature of the currently touted fictitious economic recovery when they examine the legacies of the policies of the current Administration and the Fed. A strong stock market and bubble-like bond markets built by near zero interested rate Fed policy have created the mirage necessary for politicians to temporarily hang on to their jobs.

As the near zero interest rates have made the Wall Street bank fat cat even fatter day by day, leading US corporations have made billions due to low borrowing cost in the US and cheap labor cost overseas, small businessmen and local property owners in America could not even borrow to survive and local residents could not hang on to their old homes or to borrow to buy new homes, the fundamental economic structure of the US has been going through a fundamental paradigm shifting polarization. The wealth has become more unevenly distributed at a historically unprecedented proportion.

A big portion of our GDP and consumer consumptions were indeed created by those elite segments of our economy that circle around fortune 500 corporations, big banks, Wall Street firms. It is quite amazing and ironic to realize that this phenomenon has been partly created and further exacerbated by the Democrat Party controlled Administration.

It seems to be a case of a lack of intellectual capability, constructive attitude rather than political ideologies. Many of these old school economic policy makers and advisors may need to be re-tooled and recharged and have an open mind to learn and adopt new innovative solutions to keep up with the time. Fighting an evolutionary trend of new ideas by playing ostrich will not be the solution for long. New ideas will catch on with or without them.

From the macro-policy standard point, keeping extremely lower interest rate levels may only help the big banks and Wall Street firms make more monopolistic money through many no-risk spread trading strategies that include investment strategy as simple as borrowing money from the Fed at near zero cost and invest in US treasury securities and other low risk assets. It is almost equivalent to the license to steal granted by many governments to the well-connected crony oligarchs in many third world countries.

These obsolete monetary policies (by simply moving interest rates up and down) do not trickle down to home owners and small businessmen through more mortgages or business loans offered by credit unions and local community banks. There is an obvious problematic disconnect between the existing monetary policies and our country’s banking credit systems, hence an opportunity for innovative solutions.

For a viable new economic policy management solution through the SwapRent contracts please visit the recent blog by Larry Doyle. http://www.senseoncents.com/2010/08/alternative-housing-finance-how-does-swaprent-work/

There are no better entities and infrastructure than the existing local community banks, credit unions and their industries to implement these new innovative solutions at the grassroots levels so that we could finally take the helm of deciding our country’s economic destiny from those big banks and Wall Street firms back to the risk-taking entrepreneurs and small businessmen at the various community levels and let the American entrepreneurial and hard-working spirits flourish once again to form a more solid economic foundation for our country and to build a more stable and long term prosperity.

Any budding aspiring elected officials with political ambitions willing to stick your neck out? It does not matter whether you are a Democrat, Republican or Tea Party member. Our country urgently needs new effective economic policies implemented by whoever can make it happen, irrespective of your political stripes.

The future of housing finance is here. No kidding.

This blog entry first appeared in SwapRent.com blog on 08/18/2010.

In light of the recent conference on the future of housing finance on August 17th, it may be pertinent to explain again how the FARJHO services offered at our subsidiary InvestorsAlly, Inc. ( http://www.InvestorsAlly.com ) as an alternative home ownership structure could be used as a free market based replacement solution to Fannie and Freddie. It may just be the Werner Sombart’s “creative destruction” concept that the legendary Austrian economist Joseph Schumpeter referred to in his “Capitalism, Socialism and Democracy” back in 1942.

Practically in the current market, these new FARJHO services could also present a great way for fixer-upper or distressed real estate investors/flippers in either a REIT or a private equity real estate fund to have a quicker exit strategy by offering a genuine housing affordability to homeowners. We have been busy preparing for the official launch to introduce these free market based services to aspiring home owners and prospective joint property investors in California.

The simple way to describe the business model for InvestorsAlly is an Internet-based peer-to-peer marketplace for aspiring home owners and would-be property investors to meet and negotiate, combined with conventional real estate franchisee brokerage offices across the country. Although it has an Internet based operation for gathering and capturing investors, the actual operations of the property transactions for homeowners will be done by the local franchisee agents across the country in shopping centers or office complexes in each city to help conclude these all equity deals to buy homes.

Most of the participants of the conference on the 17th such as Bill Gross, Timothy Geithner, Shaun Donovan, Michael Stegman, Ingrid Gould Ellen, Lew Ranieri, Barbara J. Desoer, Mike Heid, S. A. Ibrahim, Alex Pollock, Mark Zandi, many other Congressional staff, Fed, Treasury Dept, FDIC, HUD officials as well as their staff members have all reviewed SwapRent related ideas as an alternative housing finance system through the years since as early as 2006. When asked about the status, many of them explained that they are still studying it. It would be interesting to observe when they may finally take a stand on these innovative proposals in public.

From an economist’s perspective, it may behoove them to review again how central banks and governments could use SwapRent as the third alternative economic policy management tool, in addition to the conventional monetary and fiscal policies in order to finally be able to de-leverage and stimulate at the same time. These new concepts have also been explained in details in the SwapRent article that I have published in the Journal of Housing Finance International of the International Union of Housing Finance in December 2009. ( http://www.swaprent.com/files/IUHF_SwapRent_Mr_Liu.pdf )

http://swaprent.com/blog/2009/12/06/12062009-how-small-business-owners-could-use-swaprent-transactions-to-create-jobs-at-grassroots-level/

http://swaprent.com/blog/2009/11/01/11012009-swaprent-rates-offer-another-new-dimension-for-governments-to-perform-economic-stimulus-without-resorting-to-lowering-interest-rates-only/

http://swaprent.com/blog/2009/10/13/10132009-how-swaprent-program-could-reduce-the-re-default-rate-and-create-local-neighborhood-prosperity/

It should be made known that as a private company, we do not need any specific favors or assistance from the federal, state, county or city governments but hopefully those officials could see that this 100% pure free market based alternative home ownership solution could indeed help the local residents and boost the local economy. As public elected officials this new development could indeed help them advance their political careers if they could help champion this good cause for our country and give those people who elected them what they deserve and need.

If the politicians would like to pro-actively make a difference, the state, county (and city) public employees and teachers pension funds could be made the best candidates to become the anchor local institutional property investors to help home owners to co-own homes either through the new FARJHO structure or through the more sophisticated SwapRent transactions in order to foster local economic revivals and to ensure their continuing prosperity.

The pension funds could of course resell those FARJHO LLC member interests or the SwapRent contracts to other free market based investors both here and abroad at any time in order to regenerate and scale up the scope of available capital. Attracting fresh capital from around the world this way to local communities could certainly help the state, county and city governments fix their current budget deficits under a free market mechanism. In addition, they may also help our federal government get out of its own debt problems.

Policy-wise, the simple new economic concept again is that people would need to start thinking outside the box, borrowing money to own homes should not be the only way to own homes. Promoting home ownership for social good purposes could also be accomplished through partial equity sharing, just like how corporate ownership has evolved in the last few centuries with the development of a stock market in each country. It is about time that we should seriously treat equity financing and developing a tradable secondary market of home equities as a viable way to promote home ownership.

In addition, as mentioned before, with the introduction of the separation of shelter value from the economic value (or usufruct value from the investment value) of owning a real estate property by the new SwapRent related methodologies and its secondary market REIDeX, boom and bust cycles created by the investment value of properties and exacerbated by the abuse of lending/borrowing could easily be avoided and home owners could get to enjoy the social stability as long as they decide to stick to the shelter value part of their home ownership and only participate in the investment value of owning a property in a rational and prudent way.

FARJHO helps Native Americans financially reclaim the land

This blog entry first appeared in SwapRent.com blog on 06/16/2010.

FARJHO could help the investment managers at the various tribal casinos achieve their investment goals through either participating directly as the prospective Joint Property Investors (JPIs) or through a dedicated commingled real estate fund as the JPI to invest in a FARJHO/LLC structure on residential properties throughout the country.

In the current market, through FARJHO, property investors as InvestorsAlly’s customers could expect around 5 to 7% or even higher current dividend yield while waiting for the market recovery and the further price appreciation of US residential properties without worrying about vacancy or excessive annual operating expenses. The “total returns” could be quite significant due to the potential price appreciation from many distressed and foreclosed properties.

Unlike the conventional practice of many commercial real estate investment funds to boast an arbitrary extraordinary returns by simply using unsubstantiated annual “projected appreciation”, FARJHO leaves the entire issue of upside appreciation potential during a holding period for investors open, like those expectations of a typical home owner.

To be more specific, many of the beautiful stucco houses of over 4,000 or 5,000 sq ft built between 2003 to 2006 in the Inland Empire area in Southern California once sold for higher than $1,000,000 could be bought today at between $400,000 to $500,000. With a $2,500 monthly rent, it is just a simple math why FARJHO could make these excellent investment opportunities come true for diligent property investors.

In addition to providing a superior investment returns opportunity, FARJHO could also help the descendants of these First Nations financially reclaim the land in America, so to speak. With all that cash generated from the casino operations, where else could those tribal casino investment managers get such a high un-leveraged current yield with the unparalleled capital appreciation potential than being a FARJHO landlord?

This tribal investment opportunity through FARJHO (or a SwapRent contract) provides an interesting political angle to this otherwise a great financial investment opportunity to any other types of astute investors around the world.

How SwapRent and FARJHO could help rent-controlled apartment owners get out of their dilemma

This blog entry first appeared in SwapRent.com blog on 05/01/2010.

The rent-controlled apartment building owners could make a free market based offer to their current renters to let the renters own their apartment units either through the SwapRent based portable housing affordability solution or simply through InvestorsAlly’s FARJHO program.

Arbitrary round numbers were used for illustration simplicity in the following examples.

1. The SwapRent based portable housing affordability solution:

A generic SwapRent transaction is a “temporary own-rent switching” contract that facilitates the realization of the separation of the “Shelter Value” from the “Economic Value” of owning a residential real estate property, for a commercial property such as an apartment building, the “Usufruct Value” from the “Investment Value”.

The usufruct value is usually best explained by the annual rental rate that a property could command. In this case it is set at a controlled rate by the municipal government. The investment value of a property is the actual difference between the cost to own and the cost to rent. Therefore the investment value of a property could be either positive or negative based on the investment sentiments and the interest rate levels on the term structure, i.e. the cost to own at any given point in time.

Assume the current rent that a renter is paying for his apartment on the West Side of Manhattan is $1,000. The renter could use whatever cash that they may have as the down payment to obtain a long term fixed rate mortgage. If say a simple 30-year fixed mortgage requires a $3,000 monthly payment. They could become

a.) the 100% legal title owner with 0% economic ownership of their apartment unit if they continue to pay the same $1,000 monthly payment for a period of time. Nobody could foreclose on them or to kick them out as long as they continue to pay the same monthly rent payment as before the condo conversion.

b.) the 100% legal title owner with 25% economic ownership (hence the future appreciation) of their apartment unit if they have the ability to make a $1,500 monthly payment for a certain period of time (say 5, 10, 15, 20 or 30 years).

c.) the 100% legal title owner with 50% economic ownership (hence the future appreciation) of their apartment unit if they have the ability to make a $2,000 monthly payment for a certain period of time (say 5, 10, 15, 20 or 30 years).

d.) the 100% legal title owner with 100% economic ownership (hence the future appreciation) of their apartment unit if they have the ability to make a full $3,000 monthly payment for a certain period of time (say 5, 10, 15, 20 or 30 years).

The monthly payment shortfalls in case a.), b.) and c.) of the new condo unit owners are made up in whole by the apartment building property owner each through a SwapRent contract when the apartment unit is converted into a condo unit and sold to the current apartment dweller. The property owner could in turn re-sell these SwapRent contracts any time to any other free market based real estate investors through REIDeX.com in order to get back the money that he may need.

It is a much better way to help the current renters to obtain the financing they need than the inflexible seller carry-back financing in the form of a mortgage lien. In a seller carry-back, economically it is no different from a conventional mortgage in terms of the future debt burden. The new condo owner could be foreclosed if he loses the ability to continue to pay the higher monthly payments in the future. In this alternative SwapRent based solution, when the same situation happens, the new condo unit owner simply temporarily loses the economic ownership (and hence the future appreciation potential by a horizon date). No one could evict him as long as he continues to pay the current controlled rent rate as he did before.

2. The FARJHO solution

The current apartment renter could simply put up whatever cash he may have as his own equity contribution and try to find other would-be property owners through InvestorsAlly.com to put up the rest of the cash needed to buy this condo unit together using an all equity based LLC structure. He gets to pay either the same controlled rent, a newly negotiated rent on a case by case basis depending on the private negotiations between the LLC members in order for him to rent from the LLC and continue to occupy and use the unit as his own home.

Through the use of the LLC operating agreement, the buy/sell agreement and the lease agreement all these terms and conditions would be thoroughly discussed and negotiated before the actual agreement for condo conversion is signed and the purchase of the new condo unit is consummated. If there is no agreement, there is no deal between themselves and there is no need to convert. The current renters could continue to meet and discuss with other would-be property investors as many as they like through InvestorsAlly.com during their annual membership until a match is finally found.

The interesting part of this new FARJHO innovation is that the more the equity stake the current controlled renter may have in the new LLC structure to own the unit, the more likely he would agree to a higher market level rent payment in the lease agreement between himself and the LLC. This should not be too difficult to understand. Not only he himself would receive a larger portion of the higher rent payment back as the partial co-owner of the unit, the higher the rent (i.e. the positive yield of the property), the more likely this unit would indeed appreciate in price in the future which he himself would benefit as the partial owner.

The new innovative FARJHO structure seems to automatically help the best spirits of free market capitalism manifest themselves!

Examples on SwapRent’s commercial property applications

This blog entry first appeared in SwapRent.com blog on 4/20/2010.

A generic SwapRent transaction is a “temporary own-rent switching” contract that facilitates the realization of the separation of the “Usufruct Value” from the “Investment Value” of owning a commercial real estate property. The usufruct value is usually best explained by the annual lease rate that a property could command. The easiest way to visualize it is the cost to rent the property or more conveniently viewed by an investor, the cap rate of the income producing property. The investment value of a property is best demonstrated by the actual difference between the cost to own and the cost to rent. Therefore the investment value of a property could be either positive or negative based on the investment sentiments and the interest rate levels on the term structure, i.e. the cost to own at any given point in time.

Exaggerated round numbers are used in the following examples for illustration simplicity.

Example 1:

Let’s say an office building (multifamily, retail shopping center, hotel or industrial building) was acquired in 2003 based on a cap rate of 8% for $40 million with a $28 million first lien mortgage note of 6%. By 2006, the property value has increased to $60 million. Assumed that the owner had entered into a 5-year SwapRent transaction with an investor based on a commercial property index (e.g. NCREIF Property Index, S&P/GRA Crex, Moodys/REAL CPPI, etc.) for 50% of the property’s value, i.e. $30 million (50% of $60 million) as the notional amount.

A SwapRent contract does not have to be tied to any particular property index and it could be used with or without an index. For example, the settlement valuation could be done by simply using various appraisal methods or the real bought/sold transaction prices. We have chosen to use an index method purely for illustration simplicity. Investors in general would usually prefer to have an index-based SwapRent transaction since it would provide much more liquidity in the secondary market so that they could sell the SwapRent contract they own to other investors more easily. The choice of an appropriate index to use would be best covered as a separate topic.

Let’s further assume in 2006 when a SwapRent transaction was entered into by the property owner and an investor, the interest rate swap rate for 5-year maturity was 5%, which represents the cost to own. The SwapRent rate was 3% which represents the cost to rent. There is an annual premium of 2% (difference between 5% and 3%) which represents the investment value for a 5-year horizon through a SwapRent contract. The reason why that the SwapRent rate is lower than the cap rate is because that a negotiated SwapRent rate typically reflects the information of both the actual cap rate of a property and its expected price appreciation for a investment horizon holding period. A lower SwapRent rate indicates a bullish sentiment that the investors expect a high positive price return on an investment horizon date.

During the course of the 5-year period, the property owner received a monthly cash flow of $50,000 (one half of 2% of $60 million) from the investor. At the same time he continued to receive the expected yield of $266,667 in monthly cash flows (8% cap rate of $40 million) and pay the monthly interest of $140,000 (6% of $28 million).

Assume by settlement date in 2011, the property value was determined at $30 million based on the settlement property index value. The 5-year transaction which was put on in 2006 with the initial notional amount of $30 million would generate a loss for the investor of $15 million since the property has lost half of its value ($30 million). The property owner bears the other half of the capital loss of $15 million since he had only hedged one half of the property’s value when it was worth $60 million in 2006. However, he had received $3 million as income during the course of the 5-year period from the investor. So his net loss is really about $12 million only, without considering the tax effects.

The investor would have to cut a check to settle the loss of $15 million to the property owner, on top of the $3 million he had paid in total to the property owner from the $50,000 check every month for 5 years. His total loss is about $18 million.

In this example, the investor seems to be a loser in the deal. It has nothing to do with the SwapRent contract. If the investor has teamed up with another investor and bought the property in 2006 at $60 million through the conventional method of taking over the title, he would have lost the same $15 million through his share by 2011 when they sold the property again at $30 million. During the course of the 5-year holding period, he would have paid a lot higher carrying cost than the $50,000 monthly check in a SwapRent contract. In addition, he would have incurred much higher expenses from transferring the legal title of the property in 2006 and 2011 when he bought and sold the property. His total loss would have been much higher than $18 million.

A SwapRent contract simply carves out the economic interests and financial consequences of this same round-trip investment activity at a much lower cost to the investor and the property owner by avoiding the transactional brokerage cost, related legal bills, property taxes, insurance premium, the expenses to hire a property management company to find renters and fix the property, etc. The low cost would then encourage more trading liquidity in the secondary market among investors. Otherwise, a SwapRent contract does not alter the investment payoff or the reasons why an investor may or may not want to make a particular investment in a property.

Example 2:

The similar property owner as above had borrowed additional $5 million in 2006 at 7% in a second lien when the property was valued at $60 million. His total debt is $33 million. In 2011, he faces a severe vacancy problem in this office building due to the recession in the US. Not only his property is under water by $3 million, he also could not meet his combined monthly mortgage payments of $169,167 ($29,167 + $140,000). His new NOI in monthly cash flow became $135,000 a month. He is $34,167 short every month. He has stopped the monthly payments and the two trust deed notes are now in arrears and non-performing. His bankers are worried as the two trust deed notes were marked to market at a big discount on their books.

Assuming a SwapRent transaction is available at 2011 with similar terms above. An astute investor saw the opportunity and seized it. He first approached the banks and bought the two trust deed notes from the banks at a 40% discount each (60 cents on dollar). He then turn around and went to the property owner and offered the SwapRent transaction to him. The property owner agreed to give up 75% of the economic ownership through a SwapRent contract (with a notional amount of $22.5 million, i.e. 75% of the current value of $30 million) and hence 75% of the potential appreciation from today’s property value of $30 million to the investor. The investor would then pay the $37,500 monthly cash flows in total every month and perhaps $34,167 of which to the lien holders directly to cover the shortfalls in an arrangement with all parties involved and help the property owner bring the two trust deed notes back to current and performing, hence avoiding an imminent expensive foreclosure.

Since a foreclosure had been avoided and the notes were all brought back to current and performing. The investor got to sell them at par (perhaps even higher than par since the credit of the two notes has been enhanced) and hence pocketed a realized short-term trading gain on the two trust deed notes within a few weeks’ time. He still sits on the 5-year SwapRent contract with the property owner. Since the carrying cost in the commitment of the SwapRent contract is very low ($37,500 a month) he is in no rush to re-sell it. He could either hold on to it and wait for the future appreciation of the property and pocket 75% of the appreciated value either at maturity date 5 years later in 2016 or at any time between now and the maturity date when he finds a good price with another investor or trader through REIDeX.com, the secondary marketplace for all SwapRent contracts.

The reason why the arbitrage opportunity existed for the astute investor was partially attributed of the bureaucracy and reluctance to learn new ways of doing business by some of the regional and local banks. Their preference to do the business in old fashion ways by selling off the distressed assets presented smart and aggressive investors these market opportunities. The banks’ board and shareholders could be quite happy that they stick to their conventional lending business and get out of troubles the old fashion way as long as they could get rid of the distressed loan assets quickly.

Driven by profit making motives, these smart arbitrage investors/traders, in an effort to outbid other investors, would have paid a much higher price for these distressed loan assets than what the banks would have gotten otherwise without the arbitrage traders’ deployment of the SwapRent solutions with the property owners.

By making the extra efforts and adding value to fix up the distressed assets, the smart arbitrage investor/trader was well compensated for the efforts he made to help the property owner hang on to his property. The banks were happy that they had avoided a receivership by FDIC, the property owner was grateful to hang on to his property and his bread-earning means, the investor/trader was even happier with the realized short-term trading profit.

Last but not least, the broker who had put everybody together and engineered the proposed SwapRent transactions should have been fairly compensated for his efforts as well. It would be a win-win deal for all parties involved no matter which way you look at it. Even FDIC, Treasury Department and Congress would have also been thankful that they no longer have to beg for more tax payer’s money for more bank bail-outs. Free market based innovative solutions proved once again it could indeed automatically correct the excesses and abuses in a capitalism society, without the need of the government’s intervention.

As more and more of the free market based SwapRent solutions were put on from 2010 onward to rescue the banks, the property owners by the smart arbitrage investors/traders, the imminent collapse of the commercial property market would be halted and the market would indeed start to turn around due to the buying demand once again. Try to imagine how much more money the eventual holder of the SwapRent contract and the property owner could make by 2016 when the property has appreciated from its starting value of $30 million back in 2011 when this 5-year SwapRent contract was put on.

Commercial property applications of SwapRent and PELM

This blog entry first appeared in SwapRent.com Blog on 3/15/2010

Although the SwapRent related efforts were originally designed for both residential and commercial properties, due to the housing related residential mortgage crises, so far most of the attentions have been focused on developing applications primarily from a residential property owner’s perspective. The application opportunities are indeed equally available for commercial property owners to enjoy similar economic benefits.

Now that the commercial real estate property market has started to crack after the residential shoe has dropped two years ago, it would appear to be a very good timing to launch the SwapRent services to mid sized regional banks to assist them with managing their distressed loan portfolios on commercial properties again. It may make sense to revisit these services to the commercial real estate investors and distressed mortgage assets holders.

The key concept to help the distressed banks get these legacy assets off their books is to promote the arbitrage trading by sophisticated investors to buy these assets on the cheap, fix it up by making value added efforts to increase the value of these legacy assets through effective innovative foreclosure prevention and loan loss mitigation methods, similar to what could be done on the distressed residential mortgage assets.

To borrow the simple analogy again, if the buyer of a fixer-upper dilapidated property is doing nothing to fix up the run down property he bought (i.e. fixing the leaking roof, doing a new paint job, etc.) he would not be able to sell it at a higher price to others in order to make a trading profit on the investment by simply sitting on it, hoping for a price turn-around at a very expensive monthly carrying cost.

As an example, a shrewd investor could first act as the “economic landlord” to offer monthly payment assistance to commercial property owners in exchange for a part of the future appreciation of their properties. The property owners who may want to receive monthly subsidy assistance could be any types of property owners such as offices, retail shops, industrial buildings, hotels and apartment complexes, whether with good credit, income potential or not, as the pricing will automatically reflect the riskiness for the investors. These opportunities should not be restricted or directly only to the distressed property owners only so that these new services will operate under a pure free market mechanism. When employed by speculative investors, it may create the natural demand for buying interests that may further boost up the commercial property market value.

Through the new “temporary own-rent switching” or “economic renting” concept as facilitated by the SwapRent contract and its related mortgage product PELM (Property Equity Locking Mortgage), property owners could have much more flexibility in partial owning and renting and for different maturity terms in a SwapRent contract, e.g. he could decide to only do a 25%, 50% or 75% temporary own-rent switch and therefore share only 25%, 50% or 75% of future appreciation of the property by receiving only $25,000, $50,000 or $75,000 monthly assistance from the investors for various maturity terms, … etc.

The business opportunity to derive more short term trading profits for distressed asset fund managers and speculative investors is to trade distressed trust deeds or CMBS by adding value through offering the new SwapRent loan workout program to the property owners directly.

As a very simple example, after buying the distressed trust deeds or CMBS at deep discounted prices (say 30 cents on the dollar), by offering a $25,000, $50,000 or $75,000 monthly subsidy through the SwapRent contracts to a distressed property owner, depending on his/her particular need, in order for the commercial property owner to have enough monthly subsidy to hang on to his/her property, an investor or current holder of the trust deeds could get to avoid an expensive foreclosure.

Once the SwapRent transaction is executed with the property owner, the value of the distressed trust deed notes will recover immediately once the uncertainty of potential defaults/foreclosures is removed by closing the SwapRent deal with the property owners, at least for the next 2, 3, 5, 7 or 10 years (whatever maturity term of the chosen SwapRent contract).

The investor could then immediately re-sell these worked-out trust deed notes back to other longer term fixed income institutional investors to realize a handsome short term trading profit (say selling at 80 or 90 cents on the dollar). This is because by closing the deal on the SwapRent contact with the commercial property owner directly, monthly cash flows will be provided to the lender directly (or through a PELM), he/she would have turned the non-performing asset that he/she owns into a performing asset before re-selling it.

After realizing the short term trading profits on the trust deed already, the investor could also resell these SwapRent contracts (the equity piece, so to speak) which retain the financial value of the future appreciation potential of the underlying commercial property to other free market investors through REIDeX.com to get the money back in order to recycle the capital for the next investment opportunity or to simply put the SwapRent contracts in his/her drawer and wait for the future appreciation of the underlying commercial property.

The point is that chances are they may have already made enough money from the short term arbitrage trading of the distressed trust deed notes or CMBS, whether or not they could further make more money on this equity piece might not have been an important motivating factor for them to initiate the transaction to begin with. The much larger short term trading profit has already been realized on the trust deed notes. That would be what matters most to these short term traders.

The carrying cost of holding on to the SwapRent contract is very low anyway as it was specifically designed as a stream of small monthly cash flow commitments made out to each property owners that is usually spread out throughout the life of each of the SwapRent contract.

Creating and a tradable equity market for homeownership and making SFR an investable asset class for institutional investors

This blog entry first appeared in SwapRent.com Blog on 2/20/2010

In the current market, through FARJHO, property investors could expect around 5 to 6% current dividend yield while waiting for the market recovery and further price appreciation of US residential properties without worrying about vacancy or excessive annual operating expenses. The total return could be quite significant due to the potential price appreciation from many distressed and foreclosed properties.

The more popular this type of non-debt, fractional interest equity investment to attract fresh capital injection from around the world to jointly own homes becomes, the more likely the property market will indeed be restored to its previous value with a “non-leveraged stable growth” sooner. Homeowners would get to enjoy the social stability at the same time.

Academically, one of the main economic benefits that both FARJHO and SwapRent contracts provide to investors is to make Single Family Residences (SFR) income producing assets (with a stable positive yield like that of owning a rental apartment) and hence made investable by professional institutional investors. It would be a great way for pension funds and insurance companies to diversify their portfolios by extending the investment choices into currently the world’s largest asset class through these new innovative investment vehicles.

Policy-wise, the simple new economic concept is that people would need to start thinking outside the box, borrowing money to own homes should not be the only way to own homes. Promoting homeownership for social good purposes could also be accomplished through partial equity sharing, just like how corporate ownership has evolved in the last few centuries with the development of a stock market in each country.

It is about time that we should seriously treat equity financing and developing a tradable secondary market of home equities as a viable way to promote homeownership.

In addition, with the introduction of the separation of shelter value from the economic value (or usufruct value from the investment value) of owning a real estate property by the new SwapRent related methodologies and its secondary market REIDeX, boom and bust cycles created by the investment value of properties and exacerbated by the abuse of lending/borrowing could easily be avoided and homeowners could get to enjoy the social stability as long as they stick to the shelter value part of their homeownership.