Sunday, December 5, 2010

Natural Finance for Income Property ventures

Rental/hotel income property owners typically try to maximize leverage.  They use established real-estate lending facilities led by banks, and larger collectors of properties are able to structure as a REIT (real estate investment trust) which provides investors with a shareholder stake of property price increases as well as regular distributions of property income.  Natural Finance can supplement traditional mortgages, and replace REIT structures.

Investing in Mortgages can be more attractive than bonds because cashflow yield is higher (principal repaid along with interest monthly), and investing in REITs can be more attractive than stocks for its balanced cashflow and share of potential property appreciation.

For an income property investor, finding the first 70-80% of investment through a bank mortgage is hopefully easy.  Funding all of the rest with other people's money is difficult because the smaller investment stake of the owner, the greater the risk to investors that the property value might fall below the purchase price and be abandoned by the owners. When gathering remaining funds from several junior/minority investors (either in equity or loan form), these investors should have concerns over auditing standards and ponzi/madoff schemes.   Such investors both require high returns to invest and are scared off by the suspiciousness of high promised returns.

 Natural finance is both compatible with traditional mortgages as a supplement, and superior to them.  They offer the same general philosophy as stock investment in that payments to investors are based on the availability of surpluses and cashflow.  They are far superior alternative for stock investors, because a natural finance corporation is obligated to ask for more money for future projects instead of hoarding surpluses, and corrupting them for management discretion.  Distributing surpluses fully is a typical promise of real estate income investments, and so formalizing a real estate corporation under natural finance principles provides investors with the assurance of following through on those promises.

There are 3 entrepreneurial monetization ambitions:  operating income, management fees, and capital appreciation.  NF in addition to separating ownership and capital can also facilitate the separation of the 3 interests.  First, mortgages and natural finance queued soft loans are each primary claims on the operating income of the venture.  Mortgages are a hard claim in that they are owed regardless of whether the income is generated.  Queued soft loan bidding process allows each investor to bid according to his confidence in the sustainability of the operating income, but such investment remains a bet primarily on the eventuality and sustainability of that income.  In a recent post on open partnership mechanics I showed how and why entrepreneurs might transform their enterprises into an egalitarian partnership (commune) using set or democratic entry prices for members.  Since entrepreneurial drive generally involves sometimes irrational need for control, a founder's reluctance to allow open membership can be overcome by binding the partnership to a management services contract (for a set term) for his services prior to opening membership acceptances.  The management and operations services company can also be a natural financed commune if the entrepreneur chooses it to be, and thus all 3 monetization ambitions can be marketed independently to investors and partners, depending on which area which investors are most interested/confident/hopeful.

While providing financing more cheaply and within the flexibility of actual cashflows of an enterprise while simultaneously providing better returns for investors are important and sufficient benefits,  independent comptrolling of the enterprise is especially valuable for minority shareholders in private enterprises.  An independent comptroller is better security for investors than independent accounting audit.  Transactions are monitored and approved live, and funds and accounts secured, rather than the auditing process which provides an after-the-fact tracing of events and transactions by a firm that is essentially under a revocable employment-services contract and that is willing to provide all permissible favourable-to-management interpretation of transactions.

The benefits to enterprise of an independent comptroller is that first, it attracts investors and you can pay them less if you provide them with more security.  Second, its less expensive than the regulatory compliance and auditing costs of public companies.  Third, an independent comptroller allows the enterprise to use debt (QSLs) as currency with all of its stakeholders, allowing it to defer compensation and payments, without forcing its recipient-partners to rely on the entrepreneur's faithful loyalty to his contracts, or personally conducting the due diligence necessary to ascertain the value of promised securities.

For monthly income property ventures specifically, the comptrollership function is less time consuming (expensive) than most other businesses, since financing transactions are generally few and large, valuation of projects is very predictable, and little to no mediation and consulting on projects and agreements is necessary.  The comptrollership function in an income property venture is primarily limited to ensuring funds stay where they are supposed to, funds are paid when they are supposed to, and executing operations are being done dutifully (generally easier for income properties), including verifying the existence of buildings and renters.

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