Monthly Archives: August 2009

08/18/2009 SwapRent-empowered FARM – A new type of housing finance products without foreclosure possibility

The following was published by Mr. Leo Kolivakis at his Pension Pulse blog site and Nakedcapitalism blog site on August 14th. Leo asked me to write up a short and concise introductory text on FARM and SwapRent so that I may put my 8 years of research work into 8 minutes of reading for people to have a quick big picture overview for the first time. Here are the links to the original published articles and part of the text.

This past week, I received an email from Ralph Liu, Chairman & CEO of Advanced e-Financial Technologies, Inc. (AeFT). Ralph sees problems with Feldstein’s proposal and he wrote me the following comment on how he is working on innovative solutions to tackle the US housing crisis.


There have been many proposals on how to fix the current mortgage default crisis. It does not seem that the politicians have not been presented what the better ways may be to fix the foreclosure problems but rather the politicians’ lack of political will to adopt any of those good ideas. Looking back in history, most of the time people do not get what they deserve that makes most economic sense. They get what the politicians tell them to get, in most instances, based on the politicians’ own non-economic considerations. This time around it seems no different from before.

So irrespective of what route we may take to get out of this current credit default crisis. Even no more measure is taken there will still be an end to it when the last house gets foreclosed. At that time what alternative housing finance system should we adopt for the future? Are we going to tread on the same old path or should we learn the lesson well and look for something that will give us a paradigm shift in the way people own homes going forward so that the same mistake of lending and borrowing abuse of an even more massive scale could be avoided?

FARM (Flexible And Reversible Musharakah or Mortgage) is one of such paradigm shifting new methodologies that many governments could consider an implementation for their nations. At Advanced e-Financial Technologies, Inc. (AeFT) we have been working on developing consumer financial products for the past 8 years that could offer the same economic benefits of the conventional complicated financial derivatives without its opaqueness and potential shortcomings. It has been a long way to get to these innovative ideas fine-tuned and come up with the mature design of a few new consumer housing financial products for a new housing finance system.

First we developed a quantitative methodology based on the cost differentials between owning and renting a real estate property in order to put a value of the two major benefits of owning a real estate property. The first benefit is the right to occupy and use a property similar to a conventional renting. The second one is the right to future financial gains from appreciation and the obligation of bearing the downside risk of financial losses due to depreciation. We created a new financial instrument called a (Generic) SwapRentSM contract to represent this financial profile of a property ownership. We then took one more step and split the Generic SwapRentSM contract into two more sub-contracts to separately represent each of the future upside appreciation potential (an AG SwapRentSM) and the downside depreciation risk (a DP SwapRentSM).

The secondary marketplace for people to trade these new SwapRent contracts is called REIDeX and currently hosted at . For those interested in more details please visit our research web site at .

Developing those quantitative methodologies was the hard part. Once a new way to quantify and trade these future appreciation units of owning a property is done then things could get a lot more interesting when you start applying these new methods into a few real fool-proof consumer financial products. For example, FARM is a new consumer property finance product where would-be homeowners could start out as a renter and buying these appreciation units represented by SwapRentSM along the way based on their own economic monthly income capability at the time. The homeowner’s down payment will entitle him as being a co-owner with the bank or a local government agency in a bankruptcy remote trust account that he rents from. This co-ownership legal trust structure is already a common practice in many conventional Islamic mortgages that FARM was also based on.

Here are two original product design white papers, FARM – A new type of housing finance products without foreclosure possibility and FARM vs HELM – The Two Opposite Entry Points to Adjust Economic Ownership in Real Estate Property.

The homeowner could purchase the entire property from the bank (or the local government agency provider) any time if he has the money. If he doesn’t, then the monthly payments will first go to cover the regular rental payments so that he will have the right to occupy and use the property for whatever length of time he desires. Whatever additional monthly income capability will then go to purchase these appreciation units represented by SwapRentSM contracts to mimic a conventional property ownership.

Two immediate benefits are first, he could purchase the appreciation potential of the property for only part of the entire house value if he does not have enough monthly income to own entirely. This opens up opportunity for a lot more people to own homes who normally may not become homeowners without such a new product like FARM, hence the increased portable housing affordability and homeownership in a country. In the past, the way for these low-income families to own homes was to be offered a subprime mortgage. That was the root cause of our current financial crisis. SwapRentSM and FARM allow the low-income families to occupy and use the property at their own preference and still get to own a part of the future financial gains derived from the appreciation potential without the risk of being foreclosed.

That leads to the second major advantage that is when the homeowner loses his monthly income capability due to unforeseeable loss of job or disability in the future, he will probably only lose a part of these future appreciation units. As long as he still has the monthly income to pay the rent to the trust he could continue to own, occupy and use the property for whatever length of time he wishes. Nobody will ever be able to foreclose and evict him, as in addition to being a renter of the house he himself is still a part owner of the house in the co-ownership trust he set up with the bank or local government agency before. That is why we call this new invention of SwapRentSM-empowered FARM a new housing finance product without foreclosure possibility.

From the institutional investors’ perspective, pension funds for the first time could have a liquid way with very low transaction cost to establish a position in pure residential real estate market exposures through these SwapRentSM contracts that either the homeowners or the co-owning banks and local government agencies would like to pass on to other free market-based investors. The institutional investors could therefore easily further diversify their investment portfolios with many residential property exposures located in different parts of the country or even different parts of the world. The residential real estate could finally be treated as a separate investable asset class in the institutional investment world.

Although SwapRentSM would actually operate much better in a totally free market environment without any of the government’s involvements but the government’s awareness and regulatory support as a gamekeeper may offer certain degree of comfort for these potential economic landlord investors to be more willing to work with homeowners with or without any financial intermediaries in a fair and equitable way under a pure free market mechanism.

End quote.

There are more details to the execution part of the methodology then could be covered here. If you have any questions, contact Ralph Liu directly at and he will be pleased to answer them.

[Important disclaimer: I have no affiliation to Ralph Liu or his firm.]


08/06/2009 What does switching between owning and renting a real estate property really mean?

Some time going back to basics again may help people have a new, refreshed understanding of things. Let’s do it with SwapRent, HELM and FARM so that we could get to examine their fundamental economic value propositions again.

The various new advantages of using SwapRent contracts to introduce the new economic owning and renting concepts could add a whole new dimension to the conventional legal structures of owning a real estate property, hence the “flexible” and “reversible” features for the homeowners in the new FARM product. It will also offer much better risk management capabilities for the provider banks than the conventional mortgage products by the lending banks.

A SwapRent transaction will allow property owners to efficiently and effectively switch between owning and renting at any time at a very low cost. Therefore all the “shared appreciation” or “downside hedging” objectives could be automatically realized when they simply do the switch between owning and renting of the property in question. There would be no need to resort to other conventional complicated financial derivatives of puts, calls and swaps or to struggle with the very inefficient SAM and SEM anymore.

As a new concept and methodology the SwapRent transaction will only function as a tool to help property owners realize their investment views and face their monthly income reality. It will not alter the original reasons why people may want to switch or may be forced to switch between owning and renting. It will only facilitate it and make it more possible since the transaction cost is drastically lower as compared to buying and selling the conventional legal ownership in a real estate property.

On the investment views of the real estate market, SwapRent is again, just an financial instrument that allows people to efficiently and effectively express a view in a low cost way. From a historical perspective, it would be much easier to think of the invention of a SwapRent contract to a property as the invention of a stock certificate to a company. A Generic SwapRent contract allows other investors to own the economic exposures expressed in future financial gains and losses of a portion of the real estate property that a homeowner occupies and uses, in a similar way that a share or a stock certificate entitles an investor to a portion of the future gains and losses of a corporation’s equity that is managed and owned by many other people. When those other existing owners of the company’s shares let you buy a few shares of the company, they are indeed similarly letting you share part of the future appreciation of the company with them, in exactly the same way that homeowners could let other people to share a part of the future appreciation of the property they occupy through the use of the SwapRent contracts.

REIDeX, the marketplace to efficiently trade SwapRent contracts could therefore be considered similar to a stock exchange where people can go to trade shares of companies. It does not matter what the homeowners or the investors may think of on whether the future directions of the real estate market is going up or down. Everybody may have his/her own unique views. Few people would actually agree. That is why and how REIDeX could offer its economic value by allowing people to expressed their own views of the property’s financial future through buying and selling SwapRent contracts, just like how a stock exchange would function to allow people to express a view on a company’s financial future.

Since the existence of a secondary marketplace is vitally important to realize all these new economic benefits, many more dedicated research efforts had specifically gone into creating a standardized and systematic way for trading the three basic SwapRent contracts (i.e. Generic, AG and DP) at in order to offer price discovery, risk transference, capital regeneration functions, … etc. for the potential users of the SwapRent contracts.

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