19th May 2012
My favourite thing at the moment is the Real Estate Investment Trust. Of course, as the founder of one I am biased but just as an engineer sees opportunities in new tools so do I. For me, it is the instrument that will help people stay in their homes and simultaneously provide a solid return for institutional investors.
Since the financial crash, banks have been dealing with bad mortgage debts on a massive scale. Initial forbearance was discouraged by a series of regulatory moves as the crisis deepened. The result has been foreclosures and wholesale sale of defaulted stock into a depressed market. The perfect financial storm.
But why not use my new favourite tool to solve the problem?
If we take, as an example, a couple with a £75,000 mortgage against an original valuation of £110,000. When one of them lost their job, it became difficult to repay it and they sought help from an interest-only solution. Things go from bad to worse and they begin to miss payments.
In normal circumstances this would begin a process that could ultimately lead to repossession and eviction. Moreover the couple would also lose the 35,000 they had put in as deposit. However, by using a REIT model, the banks now have an alternative: They can offer to transfer the asset at its current valuation to a REIT in exchange for shares. The allocation of the shares would be based on the level of debt outstanding on the mortgage. To use our example: The house has a current value of £100,000 (carrying a £10,000 loss) and the outstanding mortgage is £75,000. The allocation of shares is therefore 75% to the bank and 25% to the couple.
To move forward, the couple enter into a tenancy agreement for the rent which equates to the interest paid to all shareholders – the tenants’ share dividends off-sets the rent. While the rent itself will not be less than the interest payments, it is supportable under the housing benefit system (with the correct amendment*). That means that the couple can receive help with the cost. However, if they did have to move they would then simply surrender the tenancy and walk away with some of their deposit money. The house can then be re-let. On the other hand, should the couple encounter happier times and find themselves in a position to pay down their mortgage, they could have the option of buying shares (subject to limits) in the REIT until the interest they receive from shares equals the rent charge.
By using a REIT the couple wins. What about your bank? Let’s remember that banks don't lend money with a view to repossession or even early payment. Their success is predicated on people servicing borrowing. Foreclosures and the sale of assets into a depressed market makes poor financial sense too.
And there is more to come for the banks. If I read the regulations correctly, the bank can convert an impaired asset into an investment that qualifies as tier one capital during the transition. This is the benchmark against which all banks have to perform; the shortage of which reduces their ability to lend (the aim is 15% tier one capital).
This approach costs nothing and the structure is already in place for transfers to begin as Royal Assent is given to the Finance Bill this summer. So which bank will be first?
* This may not be required as shared ownership is already dealt with in regulations
By Phil Shanks, Chief Executive, Houses4Homes