WO2007111928A2 - Real estate derivative financial products, index design, trading methods, and supporting computer systems - Google Patents
Real estate derivative financial products, index design, trading methods, and supporting computer systems Download PDFInfo
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- WO2007111928A2 WO2007111928A2 PCT/US2007/007094 US2007007094W WO2007111928A2 WO 2007111928 A2 WO2007111928 A2 WO 2007111928A2 US 2007007094 W US2007007094 W US 2007007094W WO 2007111928 A2 WO2007111928 A2 WO 2007111928A2
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- G—PHYSICS
- G06—COMPUTING; CALCULATING OR COUNTING
- G06Q—INFORMATION AND COMMUNICATION TECHNOLOGY [ICT] SPECIALLY ADAPTED FOR ADMINISTRATIVE, COMMERCIAL, FINANCIAL, MANAGERIAL OR SUPERVISORY PURPOSES; SYSTEMS OR METHODS SPECIALLY ADAPTED FOR ADMINISTRATIVE, COMMERCIAL, FINANCIAL, MANAGERIAL OR SUPERVISORY PURPOSES, NOT OTHERWISE PROVIDED FOR
- G06Q40/00—Finance; Insurance; Tax strategies; Processing of corporate or income taxes
- G06Q40/06—Asset management; Financial planning or analysis
Definitions
- the present invention relates to a new alternative between buying/selling and the renting of real estate property.
- the homeowner either waits to sell his house when the real estate markets recover and the homeowner can make a profit on the sale, or if forced to move due to job changes or other relocation pressures, the homeowner sells at a loss. This is in contrast to the situation for other means to protect his investment, such as traditional insurance policies that cover destruction or damage to the house from a variety of causes.
- TRS and PRS were originally borrowed from the OTC equity swaps market.
- the TRS and PRS have many deficiencies. Due to the diverse regional or de-centralized nature of the real estate markets within many countries as well as the relatively unsophisticated nature of these residential real estate asset class owners as compared to the more financially savvy participants in the equity markets, it became apparent that the property markets definitely need new, more innovative derivatives instruments, new index design, and new business methods to address these issues properly. In addition, treating real estate properties simply as equities which typically have uncertain future variable yields in the form of dividends are not sufficient to develop more sophisticated derivatives markets such as forwards and options.
- a typical trade quote for a TRS is that one party is willing to offer a counter-party the total return (composed of price return calculated based on an index during the contract period and an income stream paid usually quarterly during the same contract period) while receiving from the counterparty a quarterly floating rate such as 3-month LIBOR plus a "spread".
- a quarterly floating rate such as 3-month LIBOR plus a "spread”.
- An example of a "spread" could be 250 basis points annually as an arbitrary example.
- TRS and PRS themselves from a professional and technical standpoint are very basic swapping instruments to exchange the return on one asset with a variable future yield to the return of another asset also with variable future yield.
- TRS and PRS do not offer many hedging functions traditionally offered by derivatives on many other asset classes, such as forwards and options. The economic functions they provide are simply synthetic spot trading, spot hedging or asset re-allocation, even with a forward starting date. Therefore there exists a need for newer trading instruments that will provide the true hedging functions of forwards and options for real estate.
- TRS and PRS are like spot trading or spot hedging: spot trading or hedging are ineffective to a corporate hedger or institutional investors who have hedging needs. They need over-the- counter FX forward contracts and FX options contracts to do so. Therefore, there exists a need to develop the true forwards and options equivalents in the property derivatives market. In addition, instead of simply talking about them as wish list hems, there exists a need to invent a systematic methodology to create the "no arbitrage" pricing for both the forwards and options contracts that could provide economic value and convenience for the hedgers as well as the internal risk management capabilities for the financial institutions who act as middlemen and product providers.
- real estate derivative financial products, .index design, trading methods, and supporting computer systems are provided for property owners and investors to temporarily swap their respective economic interests in owning/disowning an underlying property for a certain period of time, directly or through some middlemen. Therefore, in addition to the traditional ways of either buying/selling or renting property, the property owner could consider a third new way of dealing with a property.
- the present invention provides a very straightforward way to enable property owners to protect the gains or prevent further losses in their property equity value.
- the present invention also allows investors to establish an exposure in a potential property equity appreciation or depreciation in a particular neighborhood.
- Figure 1 is a schematic representation of an example real estate index derivative product in accordance with the principles of the present invention.
- Figures 2a and 2b are schematic representations of example real estate index options in accordance with the principles of the present invention.
- Figure 3 is a schematic representation of example property or home equity locking and future value choice mortgage products in accordance with the principles of the present invention.
- Figure 4 is a schematic representation of an example property index linked note or real estate index linked deposit in accordance with the principles of the present invention.
- Figure 5 shows a non- limit ing example of a network hardware infrastructure hardware infrastructure that can be used to run the system of the present invention.
- Figure 6 shows a flow chart of a non-limiting example a method in accordance with the principles of the present invention.
- Figure 7 is a schematic representation of an exemplary industry structure that incorporates the real estate index derivative products of the present invention. DETAILED DESCRIPTION OF THE INVENTION
- novel methods and financial products are provided that are neither a purchase and sale nor a renting of real estate property.
- the present invention provides a straightforward way for property owners to protect gains in their property equity value, thereby avoiding price fluctuations of the property for a short or long period of time.
- the property owners do not need advanced knowledge or education in derivatives or other sophisticated institutional capital markets instruments.
- the present invention comprises consumer-oriented methods and financial products that can be offered directly to property owners/customers.
- the present invention also enables investors to establish exposure in potential real estate equity appreciation or depreciation in a particular neighborhood by creating synthetic long positions in real estate without requiring the real cash traditionally required to do so.
- property owners and investors could be enabled to make transactions with each other or through a middleman or several layers of middlemen, and a marketplace could be created for these new types of transactions.
- a synthetic "rent” or more technically “yield” is created to represent a proxy for property owners to economically switch from owning a property to "renting” a property instead without the attendant costs of a sale and lease-back transaction.
- the quoted term “rent” refers to this synthetic "rent” or “yield”.
- Property owners can make a payment for "renting” their own property for a certain period of time and therefore achieve the objective of not incurring a potential loss or gain in their property value in that same time period, while continuing the existing legal ownership.
- financial institutions such as banks, mortgage lenders or home equity lenders can be engaged to either act as middlemen between the property owners and investors or simply as guarantors of the credit exposures associated with such transactions.
- the financial institutions could in turn manage the credit exposure for themselves by using many existing banking products such as collaterals, liens, and mortgages in a home equity line of credit (HELOC).
- HEOOC home equity line of credit
- the methods and financial products of the present invention incorporate the traditional superior advantages of derivative instruments over their cash equivalents, but financial institutions will be able to offer them to the unsophisticated property owners without having to call them derivative instruments, especially in the form of new property value linked mortgage products with these real estate index derivative instruments built in.
- the real estate index derivative products of the present invention are designed to hedge or invest in a parallel market to the underlying real estate market.
- the underlying market is called a "cash market" for real estate properties.
- investors can utilize real estate index derivative products of the present invention to establish a synthetic long position. But if hedgers are not brought into the market, there will not be volume and liquidity.
- OTC over-the-counter
- hedgers who already own an underlying real estate property can utilize a real estate index derivative product of the present invention of equal notional amount in order to hedge the price risk of their properties.
- Supply and demand will drive the market for real estate index derivative products of the present invention in a similar way supply and demand drive the underlying cash market for real estate properties.
- the two markets real estate index derivative products and underlying cash market
- the market may steer towards more selling (paying the synthetic "rent” like a quasi “tenant”) or more buying (receiving the synthetic "rent” like a quasi “landlord”) depending on the particular market sentiments, but all-in-all the market will establish an equilibrium point to prevent risk-less profitable arbitrage opportunities.
- the property owner will pay a synthetic "rent” of the real estate index derivative products while an investor will receive the synthetic "rent” of the real estate index derivative products so that price fluctuations based on an index will be transferred to the investor.
- the real estate index derivative products of the present invention that are traded will reflect more than just a conventional rent concept; the synthetic "rent" of the real estate index derivative products of the present invention will incorporate the aggregation of yield derived from the actual rents (if any), risk premium of holding property equity, transaction costs, tax considerations, and overall supply and demand sentiments at a particular point in time.
- this traded synthetic "rent” will have no direct, straightforward relationship with the actual rent yield that the property owner may have been able to collect.
- the difference could be like what a coupon (actual rent) is to a fixed rate bond of certain maturity versus what the current term structure yield level (synthetic rent) is to similar bonds of similar maturities traded in the capital markets.
- the property owner/hedger will receive a funding cost that for example can be expressed as a floating rate such as 3-month or 6-month London Inter-Bank Offered Rate (LIBOR) calculated based on London fixing at the settlement dates or a fixed rate such as the swap rate from the interest rate swap market for a maturity that matches the duration of the real estate index derivatives products of the present invention.
- LIBOR London Inter-Bank Offered Rate
- An investor who takes the opposite position will receive the price changes expressed through the settlement of the difference in property value during the holding period in addition to receiving the synthetic "rent” of the real estate index derivative products of the present invention.
- An arbitrage opportunity may exist if the synthetic "rents" are priced out of line and, therefore, market equilibrium could be achieved as explained above. For example, if by paying the synthetic "rent” based on the index of a particular like kind property neighborhood for the notional amount of a particular buy-to-let condo that a property owner actually owns in that neighborhood, an almost no-risk arbitrage profit could be made by simply physically renting out the buy-to-let condo and collecting a real rent, if the real rent is much higher than the synthetic "rent".
- real estate index derivative products and the related derivative instruments of the present invention will increase liquidity as they offer a much closer hedge for property owners.
- the real estate index derivative products and the related derivative instruments of the present invention will increase liquidity as they create a much closer proxy for owning a real underlying property for the potential real estate investors than other methodologies proposed currently by other academics and practitioners.
- the market for real estate index derivative products and related derivative instruments of the present invention will make it possible for traditional institutional investors such as corporate pension funds and insurance companies for example to treat property equity as a separate and distinct investment asset class, especially in the case of residential real estate properties which has never been properly treated as such in the past.
- real estate index derivative products of the present invention can be created based on real estate indices, as described in detail below.
- the indicated bids and offers could be matched and cleared based on an exchange format; alternatively, the indicated bids and offers could be just an indication of interest for both buyer and seller in a brokerage format in order for them to privately negotiate the final price and settlement details.
- these details can be based on an ISDA-like documentation convention.
- the ISDA refers to the International Swaps and Derivatives Association, which is a financial trade association with offices at 360 Madison Avenue, 16th Floor, New York, New York 10017.
- a real estate index derivative product of the present invention could be designed to correspond to the specific underlying index.
- the real estate index derivative products of the present invention can be offered in various maturities such as for example 1, 2 , 3, ... 5 and upwards to 10, 20 years or longer.
- indexes could be at the neighborhood or town levels or even regional levels for less populated area. Examples are Upper East Side Manhattan, New York; Gold Coast Chicago, Illinois; South Beach Miami, Florida; 90210, California; Newport Beach, California; Orange County, California or Western Montana etc.
- the size of the real estate index derivative product could be one square foot.
- Trading hours could be established such as for example between 10:00 a.m. to 2:00 p.m. PST or for any time during any or the entire 24 hour a day.
- orders could be initiated via phones, faxes or through a wide area network such as the Internet or a local area network such as an intranet. Trades could be electronically matched or privately negotiated.
- a typical bid/offer example could be something like 3.75%/3.5% for ZIP code area 90210 in the U.S. and for postal code area WlK 2HP for the U.K. with a corresponding per square foot weighted average or median price of $750 or a per square foot and weighted average or median price of £50.
- Credit collateral could include cash, treasury securities for investors, a home equity line or the new mortgage products of the present invention property owners/hedgers described in detail below.
- collateral requirements and other risk management methodologies can preferably be according to existing industry practice for OTC transactions.
- the collateral of a real estate index derivative product account for investors could be the deposit money for establishing a speculative position (similar to initial margin concept, could be 5, 10 or 20% for example).
- the positions could be marked-to-market on for example a daily, weekly, monthly or quarterly basis by for example the daily moving average or monthly settled indices.
- the gains or losses can be added to or offset by the value of the collateral.
- the account holders can be requested to top up their collateral to a level which will be enough to cushion the volatilities of the next mark-to- market exercise.
- a property owner's credit risk exposure could be better handled through new mortgage products of the present invention described in detail below.
- an investor's credit risk exposure could be better handled through new structured investment products of the present inventions described in detail below.
- the pricing of the real estate index derivative products of the present invention will be determined by the market itself to prevent risk-less arbitrage opportunities as explained above.
- the synthetic fixed or floating "rent" component of the real estate index derivative products of the present invention can be conveniently expressed as an annualized percentage yield number to represent income similar to how 3-month LIBOR or a fixed two-year swap rate is expressed as an annualized percentage interest rate number to represent a financing cost. For any real estate properties, within a particular holding period (with +/- signs from an investor's perspective),
- the synthetic "rent” represents the yield component of the present invention and can be expressed or referred to as a brand name such as for example as the non- limiting "SwapRent SM " of the present invention.
- the synthetic "rent” could be quoted in fixed yield format for the entire product maturity or it could be quoted as floating yield format for a particular floating period such as a 3-month reset, a 6-month reset or an annual reset within the entire product maturity. For practical purpose a fixed "rent” market will provide important information for the further development of the implied forwards and options markets.
- the mortgage funding cost could be expressed either in floating interest rates or fixed interest rates for any particular currency. Floating interest rates and fixed interest rates are interchangeable through the interest rate swap market in that particular currency.
- the synthetic "rents" of the present invention will be able to derive the crucial synthetic fixed "rent” information of different maturities of groups of properties represented by a particular neighborhood or region (like the yield curve term structure concept of interest rate products)
- the synthetic floating "rent” information could also be derived in a similar way by a slight modification of simply specifying the synthetic "rents" to be traded to express a particular floating period, say 3-month, 6-month or annual periods.
- the synthetic floating "rents” thus created in the present invention will be able to connect to the existing Total Return Swaps (TRS) market conventions should a TRS market be developed on these lower level, granular property indices as well.
- TRS Total Return Swaps
- a typical example might involve a property owner who bought a house three years ago for $500,000.
- the current market value of that house is about $800,000.
- the property owner could utilize the present invention in which the property owner will pay an investor a synthetic "rent", say annually 2% of the house value, for the next two years while the property owner will be protected from the ups and downs of the house value for that two years period.
- the investor will receive the "rent" payment and pay the property owner a mortgage funding cost based on, as an example, a floating rate such as the 3-month or 6-month London Inter-Bank Offered Rate (LIBOR) or more often than not, a fixed rate.
- LIBOR London Inter-Bank Offered Rate
- An example could be a fixed annual rate of 5% for the two-year product period.
- the actual payments of the synthetic "rent" of the real estate index derivative product of the present invention that is expressed as an annualized percentage of 2% (the same way as the fixed mortgage funding cost of 5%) could be determined by multiplying the house value and prorating to arrive at a weekly, bi-weekly, monthly or quarterly actual payment amounts (in the same way as the funding cost).
- the property owner's payments and the mortgage funding cost payments could be offset and be netted against each other, so only a netted payment is to be paid either to the property owners or the investors each week, each bi-weekly period, each month or each quarter, depending on the local market preferences.
- the starting and ending values of the house could be determined based on a preset mutual agreement such as for example either through real appraised values or as weighted average or median price per square foot in a particular neighborhood using the index described more in detail below. If the property value has risen to $ 1,000,000 at the end of period, the gain of $200,000 will belong to the investor and the property owner will have to cash settle it by for example borrowing further from, as a non-limiting example the HELOC, on the house and paying the amount to the investor.
- the financial institution could also either simply increase the original mortgage amount by the mortgage products of the present inventions as explained below or simply view it as a further drawdown of the property owner's HELOC if one has already been set up already.
- the property owner will be paid by the investor for the $200,000 difference ($800,000 minus $600,000) and therefore achieve the objective of property equity value protection.
- the property owner could enter into another new real estate derivative financial product of the present invention for another say 3 or 5 year period with another investor or alternatively the property owner could decide to sit tight on it for the time being without further any further hedging activities.
- the financial institution may have asked the investor along the way to put up more collateral so that to ensure by the settlement date of the real estate derivative financial product of the present invention the investor will have the necessary cash to payout to the property owner.
- the predictive evolution of the tax treatment for the tax authority in the future in this example is as follows (subject to future tax ruling): if the property value has risen to $1 ,000,000 at the end of period, then the property owner's cost basis for tax purpose could be increased to $700,000 (instead of the original cost basis of $500,000) after the cash settlement payment at the end of the product period. If the house value drops down to $600,000 at the end of the period, then the property owner's cost basis for tax purpose could be decreased down to $300,000 and, the property owner would continue to own the house with a then current market value of $600,000.
- the financial institution may have asked the investor along the way to put up more collateral so that to ensure by the settlement date the investor will have the necessary cash to pay out to the property owner should the house value drop.
- This practice is analogous to that of a share margin trading account or a foreign exchange margin trading account that has been widely accepted by investors.
- the synthetic "rent" rates utilized in the present invention expressed and quoted for example as an annual percentage number per each neighborhood such as ZIP code or postal code neighborhoods, towns or cities throughout the country, can be quoted and traded on an Internet portal site such as SwapRent.com and REIDeX.com. described below
- GSR "Rent” DP “Rent” + AG “Rent” - MFC
- GSR is a "first generation" real estate derivative financial product of the present invention
- AG is a short “appreciation give-up” financial product of the present invention
- DP is a long “depreciation protection” financial product of the present invention, with all nomenclature referred to from the property owner's perspective
- MFC is the mortgage funding cost. This is comparable to the put-call parity of the conventional understanding of the option market.
- the trading level of a synthetic "rent” of a short appreciation give-up financial product or a long depreciation protection financial product itself will determine the value of the call or put option premium based on the same notional amount of the property value expressed as a percentage of the property value.
- how the trading levels of the synthetic "rents" of "first generation" real estate derivative financial products of the present invention will usually behave is based on how particular market sentiments is perceived. They would typically be driven by the market supply/demand and expectation factors.
- the mortgage funding cost is at 5% (fixed interest rate as an example) and the synthetic "rent" of the "first generation" real estate derivative financial product of the present invention is trading at 2% (in fixed yield format as an example) of the property value.
- the property owner who has entered into a financial product of the present invention for two years will receive $40,000 (5% of $800,000) every year (perhaps divided in monthly cash flow exchange) from the investor and will pay $16,000 (2% of $800,000) to the investor.
- the property owner will have a positive cash in-flow of $24,000 every year (say, $2,000 per month).
- a preferred application of the appreciation give-up financial products of the present invention is that it could be an improvement or replacement for the current Shared Equity Mortgage (SEM), Shared Appreciation Mortgage (SAM), and the Reverse Mortgage (RM) or the Home Equity Conversion Mortgage (HECM) markets. It should be recognized that in the U.K., these carry different names such as Home Reversion Scheme, Life Time Mortgages and Home Income Plan, etc.
- the trading level of the synthetic "rent" of the depreciation protection financial products of the present invention could understandably be traded at a relatively high level, say 10%.
- This -5% of property value cash out-flow could be considered the cost of owning a long put option premium for the property owner.
- a preferred application of the depreciation protection financial products of the present invention is for those risk-averse conservative and wealthy property owners who will treat their property not just as a shelter but also as a financial asset that they own and therefore may be more willing to pay to buy protection against the potential financial loss. They are usually high income-earners who are able, and therefore more likely interested in doing so. As will be made clear by detailed explanations below, this cost of acquiring the downside protection insurance could easily be financed through some simple combination strategies where both appreciation give-up financial products of the present invention and downside protection financial products of the present invention are employed simultaneously again.
- the appreciation give-up notional amount and the depreciation protection notional amount do not have to be the same.
- the property value is worth $1,000,000
- the notional amount for an appreciation give-up financial product could be for $400,000 and the notional amount for a depreciation protection financial product could be for $800,000 or vice versa.
- the appreciation give-up starting/maturity date and the depreciation protection starting/maturity date do not have to be the same.
- the appreciation give-up financial product may start immediately and end in 3 years and the depreciation protection financial product could start in one year and end in 5 years or vice versa. Again, other combinations are also possible.
- the appreciation give-up starting value (strike price) and the depreciation protection starting value (strike price) do not have to be the same.
- the appreciation give-up financial product could start giving up the value from 25% above (or 10% below) the current or future starting value and the depreciation protection financial product could start protecting only from 20% below (or 5% above) the current or future starting value.
- Other combinations are also possible.
- These property values could be determined by an index such as described below, for example.
- a trading forum can be provided for the "first generation" real estate derivative financial products, the appreciation give-up financial products, and the depreciation protection financial products of the present invention as well as other generic swaps, forwards, options, and swaptions contracts on real estate indices.
- an Internet portal site serves as an on-line exchange that offers price indications and execution capabilities for buyers and sellers of the real estate index derivative products of the present invention.
- the trading forum can be run on the network hardware infrastructure example described in conjunction with Figure 5, below.
- Tables 2-5 set forth non-limiting examples of such an on-line exchange that offers price indications for buyers and sellers of the real estate index derivative products of the present invention.
- Table 2 sets forth a non-limiting example listing for "standard” real estate index derivative products of the present invention for Los Angles, California. The listing includes the designated area, an index settlement (in U.S. Dollars) for the area, and the bid/offer for various terms of the "first generation" real estate index derivative financial products.
- Table 3 sets forth a non- limiting example listing for depreciation protection financial products of the present invention for Hong Kong. Again, the listing includes the designated area, an index settlement (in Hong Kong Dollars) for the area, and the bid/offer for various terms of the depreciation protection financial products.
- Table 4 sets forth a non- limiting example listing for appreciation give-up financial products of the present invention for London. Again, the listing includes the designated area, an index settlement (in British Pounds) for the area, and the bid/offer for various terms of the appreciation give-up financial products.
- Table 5 sets forth a non-limiting example listing for "standard" real estate index derivative products of the present invention for commercial properties in New York.
- the listing includes the designated property type (apartment, hotel, industrial, office, retail, etc.), an index settlement (in U.S. Dollars) for the area, and the bid/offer for various terms of the real estate index derivative products.
- a information forum can also be provided with price displays of the various last trades information of the "first generation" real estate derivative financial products, the appreciation give-up financial products, and the depreciation protection financial products of the present invention as well as other generic swaps, forwards, options, and swaptions contracts on real estate indices.
- an Internet portal site serves as an on-line forum that offers last trades information of the real estate index derivative products of the present invention.
- the information forum can be run on the network hardware infrastructure example described in conjunction with Figure 5, below.
- the information forum of the present invention will have the special ability to attract eye balls since property owners around the world would be interested to know where the synthetic "rent" levels are currently traded in their neighborhoods for a variety of reasons. Equally, the index settlement information is also important to know in order to find out the current value of their properties in their neighborhoods. Therefore, the information forum of the present invention is suitable to be run as a stand alone ad-based Internet e-commerce business. The ad revenue will primarily come from the various middlemen such as banks, brokers and real estate agents and other information providers who are involved in the new industry created by the present inventions. PELM - Property Equity Locking Mortgage or HELM - Home Equity Locking Mortgage
- new mortgage products can be provided for financial institutions to offer to residential property owners or to commercial real estate property owners.
- the new mortgage products of the present invention will help provide flexible financing; therefore, new mortgage products of the present invention will allow property owners to lock in their equity value in the property they own for the duration of the property equity locking period established either through a derivative transaction such as a forward, an option, a total return swap (TRS), a price return swap (PRS), also called a capital appreciation swap (CAS), a real estate index derivative product of the present invention or combinations thereof .
- TRS total return swap
- PRS price return swap
- CAS capital appreciation swap
- the property owner agrees to give up the equity gain in the property through a derivative transaction (such as a TRS, a PRS, a forward, an option or a real estate index derivative product of the present invention).
- a derivative transaction such as a TRS, a PRS, a forward, an option or a real estate index derivative product of the present invention.
- the property value-gain which has to be paid out to the derivatives counterparty/investor will be reflected as an automatic increase of the borrowing amount.
- the borrower/property owner gives the lending financial institution a permission to let the financial institution treat the borrower's net equity in his/her property as the collateral for putting on such a property derivative transaction.
- the property owner will also be paid by the property value loss amount by the derivatives counterparty/investor. This amount received will also be used to automatically reduce the property owner's borrowing amount.
- the borrowing amount will fluctuate automatically up and down in tandem with the asset value of the property.
- the frequency of marking-to- market update could be decided by the financial institutions to be either annually, quarterly, monthly, weekly or even daily given the capabilities of the index employed in the products.
- the gearing ratio or leverage ratio will behave opposite to the traditional way and will never exceed 100% as what would normally happen in a traditional mortgage when there is a significant property value decline.
- This feature of "positive Delta” (and its associated Gamma) of LTV versus property value as compared to those of the conventional mortgages will provide financial institutions improved credit risk management features.
- the LTV will increase when the property value declines and therefore could be considered to possess "negative Delta”.
- the mortgage products of the present invention will diversify the credit risks in financial institution's entire mortgage loan portfolios. Up until now financial institutions have not been able to manage their credit risks properly in a real estate downturn or collapse.
- the mortgage products of the present invention will open new possibilities of options of risk management tools and strategies for financial institutions to utilize in order to remain healthy and sound. The savings from the reduced amount of regulatory risk capital required to back-up the credit risk or the lending portfolio will also be substantial in certain jurisdictions.
- the new generation mortgage products of the present invention will be especially popular when the traditional real estate market is near its peak cycle. So far there have not been any other financial lending products offered to borrowers where in a declining real estate market both the borrowers and the lenders (if the lender does not act as the real estate index derivative product counterparty itself and continues to retain that particular exposure instead of laying it off to other counterparties either individually or on a portfolio basis) benefit from an actual decline or even collapse of the real estate property markets.
- the house value could either be $ 1 ,000,000 or $600,000, for example.
- the property owner's cost basis for tax purpose may be increased to $700,000 (subject to future tax rulings) instead of the original cost basis of $500,000.
- the property owner's cost basis will be decreased down to $300,000 (subject to future tax rulings) in this case and the property owner will continue to own the house with a then current market value of $600,000.
- the property owner could enter into another new real estate index derivative product, forward, option, TRS or PRS, together with a simultaneous extension of the existing new mortgage products of the present invention for another say 3 or 5 year period with the same financial institution, another financial institution or another investor directly.
- the property owner could decide to sit on it for the time being without further real estate index derivative product, forward, option, TRS or PRS.
- the new mortgage products of the present invention could either be "switched off” and stay on and act just like a traditional mortgage again or it could be refinanced into another traditional mortgage.
- the mortgage products of the present invention could be designed in a variety of different ways.
- the monthly mortgage payments could be selected by the property owner to change to interest only when the property asset value increases as the borrowing amount has automatically increased with the increase in property asset value.
- Even negative amortization could be a possible way to bring down the monthly debt service cash flow amount in this extreme case.
- the monthly payment could be activated as to include an amortization amount back again.
- This variation example is to make the monthly payments smoother and more stable regardless of how the asset value of the property itself fluctuates through the borrowing period.
- the mortgage products of the present invention could be used either to support a property equity locking transaction such as the real estate index derivative product, forward, option, TRS or PRS, or they could be offered directly from financial institutions to the property borrowers.
- the financial institutions could manage the property equity exposure as they normally manage their other treasury or capital markets exposure in a dedicated dealing desk.
- the mortgage products of the present invention itself will assume the property equity protection function to the property owners. This means the property owners do not necessarily have to source the equity locking of the real estate index derivative product, forward, option, TRS or PRS on their own, but rather rely on financial institutions to offer both financing and property equity protection at the same time through the mortgage products of the present invention.
- the real estate index derivatives transactions could be considered built into the mortgage products of present invention. All the property owners need to know is what kind of economic benefits they want by specifying directly in the mortgage products themselves that are offered by the financial institutions without any need to learn a whole new set of derivatives languages. As will be made clear below, in one embodiment as an example, the property owners can make a request to their lending banks that they would prefer to convert their existing mortgage into a new mortgage product of the present invention temporarily for a period of time, during which they would like to give up 50% of the upside appreciation potential from the current property value for the next two years in order to receive an 80% of the downside depreciation protection from the current value of the property for the next three years. All this could be done with zero upfront costs and without any subsequent cost required.
- the financial institutions can decide to keep those property equity positions which are extracted out from these mortgages they issued to make potential speculative profit, trade them away with other institutional dealers/investors as explained above or distribute either the property exposures alone or the mortgages themselves to other retail outlets through many other capital market means such structured investment products or mortgage securitization.
- the mortgage products of the present invention do not need to be offered at the same amount of the approved LTV. That means the mortgage products of the present invention could be offered to cover only part of the approved LTV amount in conjunction with another more traditional mortgage on the same property. Another way of looking at it is that the notional amount of the property equity protection part of the new mortgage of the present invention does not need to cover the entire 100% of property or the starting mortgage borrowing amount: the notional amount could be just a fraction of it.
- the real estate index of the present invention described below provides a transparent relationship that the combined granular smaller indices could be related to one larger broad level index. This helps the design for the related derivative instruments of the present invention.
- the retail short hedging interest exposures extracted from 200 or 300 index linked mortgage products of the present invention could be fungible or offset-able from the property value risk perspective with very little basis risk by one large long interest in a broad level index of trading real estate index derivative products of the present invention.
- the appreciation give-up notional amount and the depreciation protection notional amount do not have to be the same. For example, if the property value is $1,000,000 the appreciation give-up mortgage product could be for $400,000 and the depreciation protection mortgage product could be for $800,000 or vice versa. Other combinations are possible.
- the appreciation give-up starting/maturity date and the depreciation protection starting/maturity date do not have to be the same.
- the appreciation give-up mortgage product may start immediately and end in 5 years and the depreciation protection mortgage product could start in three years and end in 10 years or vice versa. Other combinations are possible.
- the appreciation give-up starting property value and the depreciation protection starting property value do not have to be the same.
- the appreciation give-up mortgage product could start giving up the value from 25% above (or 10% below) the starting property value and the depreciation protection mortgage product could start protecting only from 20% below (or 5% above) the starting property value.
- Other combinations are possible.
- the small geographical neighborhood indexing approach such as postal code-based, scale-able indexing described below may be a better choice since it could avoid the moral hazard typically involved in an insurance policy.
- the various real estate index options passed on through the financial institutions could be traded on a centralized Internet portal exchange or simply on an OTC basis conducted through phone calls, faxes, postal mails and emails similar to the trading of real estate index derivative products since both share the same postal code-based neighborhood indices.
- the real estate index derivative product transactions could be combined together with the various trading/investment strategies within an appreciation give- up or depreciation protection mortgage product.
- property or real estate index linked notes, bonds or deposits can be provided. These structured investment products could be created for incurring property value risk and return exposures using "first generation" real estate derivative financial products, appreciation give-up financial products, and depreciation protection financial products of the present invention or combination of part or all of the above.
- Structured investment products can be created with the real estate index derivatives of present inventions, forwards, options, TRS, PRS and real estate index options discussed above as follows. First the netted differentials between the synthetic "rent" payments and the mortgage funding cost are added to the current market interest rates, yields or coupon for a note, bond or a deposit on an annual basis. Then, the price return pay-off result of the real estate index derivatives of the present inventions, forwards, options, TRS, PRS and real estate index options are linked to the principal redemption amount of the note, bond or deposit.
- the structured investment products of the present invention could apply to any capital market in any currency around the world.
- Coupon [Depo Rate + (2 - 5)]% Principal Redemption
- the structures could be further leveraged in order to create more property price change impact to the degree that the principal amount will not be entirely eroded by marking- to-market during the holding period for prudent risk management practice by issuers.
- the risks inherent in property or real estate index linked notes, bonds or deposits could be hedged off through outright real estate index derivative product trading.
- outright trading "first generation" real estate derivative financial products, appreciation give- up financial products, and/or depreciation protection financial products of the present invention with counter-party as well as forwards, options, TRS or PRS. This will be one way to hedge the component risks. Otherwise, the property or real estate index linked notes, bonds or deposits could simply be traded in the secondary market to lay off the position risks.
- the structured notes could be created for incurring property value risk and return exposures using appreciation give-up financial products and depreciation protection financial products of the present invention.
- a one-year maturity of non-leveraged structured note is used as non-limiting examples below, assuming the following additional current market conditions:
- Property or real estate index linked notes, bonds or deposits could be marketed to both institutional and retail investors or to speculators with a view on the property or real estate markets either in a particular neighborhood, towns, cities, states, regions or countries depending on the indices used, as described below.
- Property or real estate index linked notes, bonds or deposits could also be marketed either to long hedgers (anticipatory hedge) who may be current renters in a particular neighborhood or to short hedgers who are currently already property owners in a particular neighborhood in a certain country.
- the real estate index of the present invention provides a transparent relationship that the combined granular smaller indices could be related to one larger broad level index. This helps the design for the related derivative instruments of the present invention.
- one long interest of a broad level index built into an index linked structured investment products such as the property or real estate index linked notes, bonds or deposits of the present invention could be fungible or offset-able from the property value risk perspective with very little basis risk by the many retail short hedging interest exposures extracted from 200 or 300 index linked mortgage products of the present invention based on more granular lower level indices.
- the short hedging interests could also come from other similar structured investment products holding the opposite views and therefore short interest exposures on the more granular lower level indices either directly or in combinations.
- real estate index for pricing real estate index derivative products of the present invention can be provided.
- a preferred, though not necessary, real estate index can also be provided that can be utilized for example in property index linked mortgages and structured investment products business.
- real estate indices of the present invention will be able to provide the lower level granular indices which offer higher hedging correlation normally required by the property owners and the higher level broad indices that are more convenient for derivatives trading and the index linked structured products created for investors and speculators.
- the real estate indices of the present invention will apply to both residential and commercial real estates.
- the real estate index of the present invention provides a transparent relationship that the combined granular smaller indices could be related to one larger broad level index. This will make the index more suitable for index derivatives trading. This will also help the design for the real estate index derivative products and the related derivative instruments of the present invention.
- the real estate index derivative product could be based on indices which are comprised of per square area weighted average or median price information for each combination of postal code regions.
- the real estate index of the present invention will be able to drill down to the small homogeneous groups or neighborhoods of like kind properties that could be defined either by ZIP code in the US, postal codes in many other countries, or housing developments or suburbs in other countries.
- the real estate index of the present invention could also be able to drill down other smaller possible neighborhood elements defined by other unconventional methodologies such as census collection districts, electoral council area and satellite geo- spatial image area of like kind property structures, etc.
- the real estate index of the present invention could also be easily scaled up to a larger broad level index by combining smaller indices and simply going through the same transparent weighted average relationship in order to cover much larger geographical area with more number of properties.
- the real estate indices of the present invention could be determined as a rolling moving average price to avoid potential manipulation or extraordinary events. More sophisticated statistical methods could also be employed if enough data points are available to further smooth the data to provide the more relevant indicative power of such indices.
- This rolling moving average method can also provide a more frequently updated index level for derivatives trading as well as for the daily settlements of index linked mortgage products and index linked investment structured products. Therefore, these property derivatives trading and structured mortgage or investment products could easily be marked-to-market on a daily basis which will be very useful for the required risk management practice of banks or other investment funds. This feature will greatly promote the popularity of use and hence the liquidity of these indices based financial products.
- the ZIP (Zone Improvement Plan) codes are a developed and convenient form of describing neighborhoods for the postal service.
- the ZIP code methodology has been well accepted in various parts of our daily life.
- the most important value of using ZIP code oriented index is that it is easily understood and accepted by property owners as they can identify which neighborhoods they belong to by the ZIP codes.
- comparable postal codes, housing developments or suburbs to which property owners relate can be utilized.
- a much bigger region can be scaled up and expanded to by simply including more than one ZIP code (postal code) in the same weight averaging relationship.
- Examples of potential broad indices are U.S.A., East Coast, New York Tri-State, California, Bay Area, SoCaI or going down to more specific lower levels, Newport Beach Single Family Houses, Santa Monica Condos or even ZIP code specific indices, 90210, 92879, etc. if the more precise single ZIP code neighborhood have enough potential users for the real estate index derivative products of the present invention or other structured derivative contracts.
- each of the popular indices created in accordance with the present invention will be composed of more than one ZIP code and most likely it could be at a town level composed of 5 to 10 ZIP codes of neighborhoods.
- the desirable index size for the real estate index derivative products of the present invention or other property derivatives trading could be determined by a balance between the requirement for hedge ratio by the hedging property owners and the commercially viability of liquidity concerns for such derivatives products and the index linked structured mortgage or index linked investment products. Examples for commercial properties could be Office Mid-town Manhattan, Apartment West Los Angeles, Hotel Miami, Warehouse Chicago, Retail Metropolitan NYC, etc.
- construction of the real estate indices of the present invention could be based on a weighted average of per square area (foot, meter, etc.) prices adjusted by property attributes within the neighborhood. This weighting can be based on the square area to produce the capital value of the like-kind properties selected in the smallest defined neighborhood area. Once the smallest identifiable neighborhood areas are defined and determined, the larger area indices can be created using the same weighted averaging methodology without further adjustment in a bottom-up approach to reach the higher broader levels and all the way up to a national level index.
- the real estate indices of the present invention could be determined on a rolling moving average basis, as the new transactions happen each day, even with a time delay to account for the official recording and registration process, the indices will be able to provide a new value each day on a rolling basis, unless there are no new transactions during the entire sequential days used for the moving average calculation within the defined neighborhood or region. In that extreme case the index for that neighborhood can simply stay unchanged for that day.
- representative properties will be selected to represent that particular neighborhood. As much as possible the data will be comprehensive to cover the stable properties in a neighborhood, but unstable outliers could be excluded so that less index revision will be necessary in the future. As new housing developments are established and old neighborhoods are destroyed by fire or other natural disasters within the neighborhood, the new properties can be either added or deleted accordingly in future index revisions.
- the captured changes in transaction prices of the properties within a neighborhood can be adjusted for by its quantified property attributes.
- the property attributes could be as broad as characteristics such as the types of properties (for example condos, town homes, single family houses, etc.) if there are not enough to be treated separately in another defined neighborhood of like-kind properties, or down to other individual property characteristics such as for example square footage, year built, number of bedrooms/bathrooms, number of garages/swimming pools, lot sizes, views, ocean/lake front, high floors/low floors, distance to shopping centers and school districts, crime statistics, etc.
- a property attributes adjustment process can smooth the changes in the individual neighborhood index between time periods to account for the fact that different properties with different attributes may have different volatility than the rest in a rising or a declining market. This way the index created for the smallest defining neighborhood will be an index that can reflect a group of quasi-homogeneous properties without disturbances of either uneven volatilities between properties with different attributes or the compositional changes through time in the neighborhood.
- the real estate index of the present invention provides a transparent relationship that the combined granular smaller indices could be related to one larger broad level index. This helps the design for the related derivative instruments of the present invention.
- the retail short hedging interest exposures extracted from 200 or 300 index linked mortgage products of the present invention could be fungible or offset- able from the property value risk perspective with very little basis risk by one large long interest in a broad level index of trading real estate index derivative products of the present invention.
- the smallest neighborhood of like-kind properties could be defined as groups of offices, retails shops, apartment complexes, industrial warehouses, and hotels in a specific area of a city.
- the real estate indices of the present invention for commercial properties could be very similar to the real estate indices of the present invention for residential properties.
- a hedger For a 3000 square foot house, a hedger needs 3000 real estate index derivative products. Assume one year later the cash indices are 92879 at 115; 92860 at 125; and 90210 at 655. The 3 month LIBOR could be trading at 4% in August 2003. The bid and offer for a 1-year real estate index derivative product could be quoted as SRl : 3.8% / 3.6%. For ZIP code area 92879, the sample transactions for the hedger would be:
- revenue could be generated from spread between bid and offer of products traded, in these examples, using a non-limiting minimum 20 basis point profit on each initial and unwinding trade (in and out):
- FIG. 5 a non-limiting example of a network hardware infrastructure that can be used to run the real estate derivative financial products, index design, and trading methods of the present invention is seen.
- the architecture conforms to a distributed Internet-based architecture using object oriented principles useful in carrying out the methods of the present invention.
- a central controller 100 has a plurality software and hardware components and is embodied as a mainframe computer or a plurality of workstations.
- the central controller IOO is preferably located in a facility that has back-up power, disaster-recovery capabilities, and other similar infrastructure, and is connected via telecommunications links I I O with via a TI cable modem 120, an intranet VPN 130, a wide area network such as the Internet 140, wireless communication 150, and the like.
- Signals transmitted using telecommunications links 110 can be encrypted by public and private key encryption.
- Other telecommunications links, such as radio transmission are known to those of skill in the art.
- a property owner or investor can use for example a desktop computer 160.
- the computers used by property owner or investor can be run on a PC having a minimum of Windows 98 or higher (e.g., Windows2000 or WindowsXP), the equivalent of a Pentium IH processor available from Intel Corporation, 2200 Mission College Boulevard, Santa Clara, California or higher, and a speed of 600 MHz or faster.
- Windows 98 or higher e.g., Windows2000 or WindowsXP
- Pentium IH processor available from Intel Corporation, 2200 Mission College Boulevard, Santa Clara, California or higher
- a property owner or investor can also use a notebook computer 170, personal digital assistant 180, a mobile phone 190, personal digital assistant 200, and the like.
- the real estate derivative financial products, index design, and trading methods of the present invention can form the basis for development of a new industry.
- the different pieces of the industry could be truncated and each of the businesses could be run by different entities.
- the index compiler/publisher, the commercial banks, the investment banks, the IDBs, the RJEIDeX.com, and the SwapRent.com each can be a different participant in the new industry.
- FIG. 5 a flow chart of one preferred, non-limiting example of a method of the creation of such an industry in accordance with the principles of the present invention is seen.
- This method can be implemented on for example the non-limiting example of network hardware infrastructure described above.
- a real estate index can be provided as described in detail above with conjunction to the section entitled 'The Index Construction".
- the basic smallest definable neighborhood element of like kind properties such as a ZIP code (or postal code in countries other than US) or a housing development project can be used to create the per square foot (or meter) property weighted average price information.
- this basic neighborhood element represents too small of a geographic area, then a bigger region can be scaled up and expanded to by simply including more than one smallest definable neighborhood of the like kind properties such as a ZIP code (postal code) or a housing development project in the same weight averaging relationship.
- real estate derivative financial products can be provided. These can include "first generation" real estate derivative financial products as described in detail above with conjunction to the section entitled “SwapRent SM ". Again, these may be offered by a different entity from the real estate index of the present invention.
- new mortgage products can be provided as described in detail above with conjunction to the sections entitled "PELM”, “HELM”, and “FVCM”. Again, these may be offered by a different entity from the real estate index, the "first generation” real estate derivative financial products, the "REIO” and the “OTC Options and Forwards” of the present invention. Additionally, structured investment products can be provided for incurring property value risk and return exposures as described in detail above with conjunction to the section entitled “PILN” and "REILD”.
- a trading forum can be provided as described in detail above with conjunction to the section entitled "REIDeX.com”.
- An Internet portal site can serves as an on-line exchange that offers price indications and execution capabilities for buyers and sellers of the real estate index derivative products of the present invention.
- on-line trading of the present invention may be offered by a different entity from the real estate index, the "first generation” real estate derivative financial products, the "REIO”, the “OTC Options and Forwards", the "PELM”, the “HELM”, the “FVCM”, the “PILN”, and the "REILD of the present invention.
- an information forum can be provided as described in detail above with conjunction to the section entitled "SwapRent.com”.
- the information forum can display price information of the various last trade information of the "first generation" real estate derivative financial products, the appreciation give-up financial products, and the depreciation protection financial products of the present invention as well as other generic swaps, forwards, options, and swaptions contracts on real estate indices.
- an Internet portal site can serve as an online forum that offers last trades information of the real estate index derivative products of the present invention.
- on-line trading information of the present invention may be offered by a different entity from the real estate index, the "first generation” real estate derivative financial products, the "REIO”, the “OTC Options and Forwards", the "PELM”, the “HELM”, the “FVCM”, the “PILN”, the “REILD and the on-line trading of the present invention.
Abstract
Description
Claims
Priority Applications (3)
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CA002647364A CA2647364A1 (en) | 2006-03-26 | 2007-03-22 | Real estate derivative financial products, index design, trading methods, and supporting computer systems |
AU2007231601A AU2007231601A1 (en) | 2006-03-26 | 2007-03-22 | Real estate derivative financial products, index design, trading methods, and supporting computer systems |
EP07753700A EP2008233A2 (en) | 2006-03-26 | 2007-03-22 | Real estate derivative financial products, index design, trading methods, and supporting computer systems |
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US76740606P | 2006-03-26 | 2006-03-26 | |
US60/767,406 | 2006-03-26 | ||
US80597006P | 2006-06-27 | 2006-06-27 | |
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US80647606P | 2006-07-02 | 2006-07-02 | |
US60/806,476 | 2006-07-02 | ||
US80679006P | 2006-07-09 | 2006-07-09 | |
US60/806,790 | 2006-07-09 | ||
US82959706P | 2006-10-16 | 2006-10-16 | |
US60/829,597 | 2006-10-16 | ||
US88661707P | 2007-01-25 | 2007-01-25 | |
US60/886,617 | 2007-01-25 |
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WO2007111928A2 true WO2007111928A2 (en) | 2007-10-04 |
WO2007111928A3 WO2007111928A3 (en) | 2008-02-21 |
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EP (1) | EP2008233A2 (en) |
AU (1) | AU2007231601A1 (en) |
CA (1) | CA2647364A1 (en) |
SG (1) | SG170769A1 (en) |
TW (1) | TW200818050A (en) |
WO (1) | WO2007111928A2 (en) |
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TWI512652B (en) * | 2009-06-04 | 2015-12-11 | Yung Yeung | System and methods of conducting business-to-business operations by registered sellers and buyers using an internet accessible platform |
Citations (4)
Publication number | Priority date | Publication date | Assignee | Title |
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US6237096B1 (en) * | 1995-01-17 | 2001-05-22 | Eoriginal Inc. | System and method for electronic transmission storage and retrieval of authenticated documents |
US20040111358A1 (en) * | 1999-07-21 | 2004-06-10 | Jeffrey Lange | Enhanced parimutuel wagering |
US20050075961A1 (en) * | 2003-09-09 | 2005-04-07 | Mcgill Bradley J. | Real estate derivative securities and method for trading them |
US20050119908A1 (en) * | 2003-08-25 | 2005-06-02 | Hippe Russell H. | Systems, methods, and computer program products for managing real estate transactions |
-
2007
- 2007-03-22 EP EP07753700A patent/EP2008233A2/en not_active Withdrawn
- 2007-03-22 WO PCT/US2007/007094 patent/WO2007111928A2/en active Application Filing
- 2007-03-22 SG SG201102123-5A patent/SG170769A1/en unknown
- 2007-03-22 AU AU2007231601A patent/AU2007231601A1/en not_active Abandoned
- 2007-03-22 CA CA002647364A patent/CA2647364A1/en not_active Abandoned
- 2007-03-23 TW TW96110156A patent/TW200818050A/en unknown
Patent Citations (4)
Publication number | Priority date | Publication date | Assignee | Title |
---|---|---|---|---|
US6237096B1 (en) * | 1995-01-17 | 2001-05-22 | Eoriginal Inc. | System and method for electronic transmission storage and retrieval of authenticated documents |
US20040111358A1 (en) * | 1999-07-21 | 2004-06-10 | Jeffrey Lange | Enhanced parimutuel wagering |
US20050119908A1 (en) * | 2003-08-25 | 2005-06-02 | Hippe Russell H. | Systems, methods, and computer program products for managing real estate transactions |
US20050075961A1 (en) * | 2003-09-09 | 2005-04-07 | Mcgill Bradley J. | Real estate derivative securities and method for trading them |
Also Published As
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EP2008233A2 (en) | 2008-12-31 |
CA2647364A1 (en) | 2007-10-04 |
WO2007111928A3 (en) | 2008-02-21 |
AU2007231601A1 (en) | 2007-10-04 |
TW200818050A (en) | 2008-04-16 |
SG170769A1 (en) | 2011-05-30 |
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