banking, Borrowing, finance, financial engineering, foreclosure, interest rates, intermediation, investing, investment, Real estate, real-estate, real-estate law, renting, subletting, term occupancy, time-value of money
Many fortunes are made in real estate. And, lured by those stories of success, lots of people have tried their hand at real-estate investing as well, with highly variable results. Meanwhile, many people who cannot buy homes of their own decide to rent instead.
But the present rental market has a lot of flaws in its structure. Take, for example, a common strategy used by new investors who don’t want to sink a lot of capital into a house. They will instead rent a place, perhaps for a long term to bring down their monthly rent, and then turn around and sublet it out to someone else for a higher price.
Now, these people are certainly providing a service of some kind. They are providing income to the owner of the property; if they chose a longer rental term, they are also providing a guarantee of long-term occupancy. But the eventual renter is paying a higher rate for his home than the owner is receiving. It’s possible that the renter has low credit and would not otherwise qualify, or perhaps would not have heard about the apartment without the marketing efforts of the investor-renter; but still, it seems that there ought to be more opportunities for mutual benefit.
One thing that’s always struck me about renting is that most landlords do not allow you to prepay your rent. There are good legal reasons for this, but it still seems to be a missed opportunity. The typical landlord carries a mortgage with an interest rate of more than 5%, sometimes much more. By contrast, 10-year Treasury notes are yielding around 1.6%. If a renter could sink extra cash into prepaying rent, with an annualized discount of (let’s say) 3%, and the landlord used the extra cashflow to pay down the mortgage, it would benefit both sides. All that is necessary is to create the appropriate legal structure.
When you think about the components of a property’s value, you could break it down into two parts: the right to live in a place for a given time, and the actual ownership of the property. Suppose you actually broke them into separate pieces. For example, I could have a house I wanted to rent out, but I wasn’t interested in collecting a rent check every month. Instead, I created a product: the right to live in my house for ten years. I then assigned that product a value, just like a piece of real estate. Say the house itself is worth $100,000; I then value ten years of use at, say, $40,000. If I find a buyer, I can get all that cash upfront and not have to worry about collecting rent every month. At the end of the term, I still own the house and can benefit from its price appreciation, tax depreciation, and so on.
Now suppose I’m a renter, or investor-renter. Buying a ten-year lease gives me a discounted price, compared to having to pay for it month by month. It also lets me lock in the price for the entire term, giving me stability. Plus, since I don’t actually own the house, I don’t have to worry about property taxes. But how might I come up with all that cash up front? If this becomes the norm, it ought to be easy to borrow that money from the bank—especially when you consider that a ten-year rental term is an asset like property is, and can be used to sublet the house in turn, or repossessed by the bank if necessary.
It would be easier for a bank to repossess rental rights than a full property, meanwhile. At all times, there is an actual owner who is interested in maintaining the value of the property, as opposed to home foreclosures that often sit vacant and get trashed, destroying massive amounts of value. And it is easier to rent a property than to sell it, and lots of managers that the bank can call upon to fill up their newly-repossessed asset. Finally, it ought to be easier to appraise use-rights than the actual underlying property, making underwriting easier. So from the bank’s perspective, this might be an attractive asset class.
Subletting a rental-agreement house will provide more gains from trade, in this scenario. I, the investor-renter, have provided the benefits of upfront capital, allowing me to get a good price. I can then sublet to a traditional renter, who does not have to provide upfront capital but can still pay a price comparable to the going rate. I make money from the difference between my discounted upfront payment, and the month-by-month payments of the renter, without having to “overcharge” as subletting investors must do today.
This all will need fleshing out, of course. Navigating the legal minefields alone will be an effort, not one that I care to undertake right now, and people would have to work out the practical problems involved with any new asset class. And this kind of structure will not be appropriate in many cases. Still, its mere existence would cause ripple effects out into the market that would benefit everyone. And perhaps someone more enterprising can see this idea and make use of it.