Real Estate Finance and Investments

Cover
Real Estate Finance and Investments
Preface
Brief Contents
Table of Contents
PART ONE: OVERVIEW OF REAL ESTATE FINANCE AND INVESTMENTS
	Chapter 1: Real Estate Investment: Basic Legal Concepts
		Property Rights and Estates
			Definition of Estate
			Two General Classifications of Estates
			Examples of Freehold Estates
			Estates Not Yet in Possession (Future Estates)
			Examples of Leasehold Estates
		Interests, Encumbrances, and Easements
		Assurance of Title
			The Meaning of Title
			Deeds
		Methods of Title Assurance
			Abstract and Opinion Method
			The Title Insurance Method
		Recording Acts
		Limitations on Property Rights
	Chapter 2: Real Estate Financing: Notes and Mortgages
		Notes
		The Mortgage Instrument
			Definition of a Mortgage
			Relationship of Note to Mortgage
			Interests That Can Be Mortgaged
			Minimum Mortgage Requirements
			Important Mortgage Covenants
		Assumption of Mortgage
		Acquiring Title “Subject to” a Mortgage
			Property Covered by a Mortgage
			Junior Mortgages
			Recording of Mortgages
		Other Financing Sources
			Seller Financing
		Land Contracts
		Default
			What Constitutes Default?
		Alternatives to Foreclosure: Workouts
			Restructuring the Mortgage Loan
			Transfer of Mortgage to a New Owner
			Voluntary Conveyance
			Friendly Foreclosure
			Prepackaged Bankruptcy
			Short Sale
		Foreclosure
			Judicial Foreclosure
			Redemption
			Sales of Property
			Effect of Foreclosure on Junior Lienors
			Deficiency Judgment
			Taxes in Default
		Bankruptcy
			Chapter 7 Liquidation
			Chapter 11
			Chapter 13
PART TWO: MORTGAGE LOANS
	Chapter 3: Mortgage Loan Foundations: The Time Value of Money
		Compound Interest
		Compound or Future Value
			Calculating Compound Interest Factors
		Using Financial Functions: Calculators and Spreadsheets
		Present Value
			A Graphic Illustration of Present Value
			Expanding the Use of Calculators for Finding Present Values
		Compound or Future Value of an Annuity
			Use of Compound Interest Factors for Annuities
		Present Value of an Annuity
			Use of the Present Value of an Annuity Factors
		Accumulation of a Future Sum
		Determining Yields, or Internal Rates of Return, on Investments
			Investments with Single Receipts
			Yields on Investment Annuities
			Equivalent Nominal Annual Rate (ENAR): Extensions
			Solving for Annual Yields with Partial Periods: An Extension
	Chapter 4: Fixed Interest Rate Mortgage Loans
		Determinants of Mortgage Interest Rates: A Brief Overview
			The Real Rate of Interest: Underlying Considerations
			Interest Rates and Inflation Expectations
			Interest Rates and Risk
			A Summary of Factors Important in Mortgage Loan Pricing
		Understanding Fixed Interest Rate Mortgage (FRM) Loan Terms
		Calculating Payments and Loan Balances—Fixed Interest Rate Loans
			The Importance of Accrued Interest and Loan Payments
			Loan Amortization Patterns
			Fully Amortizing, Constant Payment Mortgage (CPM) Loans
			Partially Amortizing, Constant Payment Mortgage (CPM) Loans
			Zero Amortizing, or Interest-Only—Constant Payment Mortgage (CPM) Loans
			Negative Amortizing, Constant Payment Mortgage (CPM) Loans
		Summary and Comparisons: Fixed Interest Rate, Constant Payment Mortgage (CPM) Loans with Various Amortization Patterns
			Determining Loan Balances
			Finding Loan Balances—Other Amortization Patterns
			Loan Closing Costs and Effective Borrowing Costs
			Loan Fees and Early Repayment: Fully Amortizing Loans
			Charging Fees to Achieve Yield, or When “Pricing” FRMs
		Financing Loan Fees and Other Closing Costs
		Other FRM Loan Patterns—Declining Payments and Constant Amortization Rates
			Amortization Schedules and Callable Loans
			“Reverse Mortgages”
		Appendix Inflation, Mortgage Pricing, and Payment Structuring
	Chapter 5: Adjustable and Floating Rate Mortgage Loans
		The Price Level Adjusted Mortgage (PLAM)
			PLAM: Payment Mechanics
			ARMs and Floating Rate Loans: An Overview
			Variations: ARM and Floating Rate Loans
			Risk Premiums, Interest Rate Risk, and Default Risk
			Expected Yield Relationships and Interest Rate Risk
			More Complex Features
			ARM Payment Mechanics
			Expected Yields on ARMs: A Comparison
	Chapter 6: Mortgages: Additional Concepts, Analysis, and Applications
		Incremental Borrowing Cost
			Early Repayment
			Origination Fees
			Incremental Borrowing Cost versus a Second Mortgage
			Relationship between the Incremental Cost and the Loan-to-Value Ratio
			Differences in Maturities
		Loan Refinancing
			Early Repayment: Loan Refinancing
			Effective Cost of Refinancing
			Borrowing the Refinancing Costs
			Other Considerations
		Early Loan Repayment: Lender Inducements
		Market Value of a Loan
		Effective Cost of Two or More Loans
			Second Mortgages and Shorter Maturities
		Effect of Below-Market Financing on Property Prices
			Assuming a Lower Loan Balance
		Cash Equivalency
		Cash Equivalency: Smaller Loan Balance
		Cash Equivalency: Concluding Comments
		Wraparound Loans
		Buydown Loans
		Appendix After-Tax Effective Interest Rate
PART THREE: RESIDENTIAL HOUSING
	Chapter 7: Single-Family Housing: Pricing, Investment, and Tax Considerations
		Overview
			House Prices
			Income and Employment
			Renting versus Owning
			Analyzing Expected House Prices
			Economic Base Analysis—Location Quotients
		Housing Supply: An Overview
			Submarkets: Neighborhoods/Municipalities
			Capitalization Effects: Price Premiums
			Pricing Property in Specific Submarkets/Locations
		Investing in “Distressed Properties”
			Financial Framework for Analyzing Distressed Properties
			Acquisition Phase
			Holding Period Phase
			Disposition Phase—Exit Strategies
	Chapter 8: Underwriting and Financing Residential Properties
		Underwriting Default Risk
		Classification of Mortgage Loans
			Conventional Mortgage Loans
			Insured Conventional Mortgage Loans
			FHA-Insured Mortgage Loans
			VA-Guaranteed Mortgage Loans
		The Underwriting Process
			Borrower Income
			Verification of Borrower Assets
			Assessment of Credit History
			Estimated Housing Expense
			Other Obligations
			Compensating Factors
		The Underwriting Process Illustrated
			Underwriting Standards—Conventional and Insured Conventional Mortgages
			Underwriting Standards—FHA-Insured Mortgages
			Underwriting Standards—VA-Guaranteed Mortgages
			Underwriting and Loan Amounts—A Summary
		The Closing Process
			Fees and Expenses
			Prorations, Escrow Costs, and Payments to Third Parties
			Statutory Costs
			Requirements under the Real Estate Settlement and Procedures Act (RESPA)
		Settlement Costs Illustrated
			Federal Truth-in-Lending (FTL) Requirements
			Truth-in-Lending Sample Disclosure
			Establishing the APR under Federal Truth-in-Lending Requirements
			ARMs and Truth-in-Lending Disclosure
PART FOUR: INCOME-PRODUCING PROPERTIES
	Chapter 9: Income-Producing Properties: Leases, Rents, and the Market for Space
		Property Types
		Supply and Demand Analysis
			Local Market Studies of Supply and Demand
			Location and User-Tenants
		The Business of Real Estate
		The “Market” for Income-Producing Real Estate
		Income Potential—Real Estate Assets
			Vacancy
			Underwriting Tenants
		General Contents of Leases
			Leases and Rental Income
			Leases and Responsibility for Expenses (Recoveries)
			Comparing Leases: Effective Rent
			Other Financial Considerations
		Developing Statements of Operating Cash Flow
		Case Example: Office Properties
			Rent Premiums and Discounts for Office Space
			Pro Forma Statement of Cash Flow—Office Properties
		Case Example: Industrial and Warehouse Properties
			Pro Forma Statement of Cash Flow—Industrial/Warehouse Properties
		Case Example: Retail Properties
			The Retail Leasing Environment
			CAM Charges—Recoveries
			Pro Forma Statement of Cash Flow—Retail Properties
		Case Example: Apartment Properties
	Chapter 10: Valuation of Income Properties: Appraisal and the Market for Capital
		Introduction
		Valuation Fundamentals
		Appraisal Process and Approaches to Valuation
		Sales Comparison Approach
		Income Approach
			Capitalization Rate
			Capitalization Rates—A Note of Caution
			Discounted Cash Flow Techniques
		Land Values: Highest and Best Use Analysis
			Volatility in Land Prices
			“Highest and Best Use” Analysis—Vacant Site
			“Highest and Best Use” Analysis—Improved Property
		Mortgage-Equity Capitalization
		Reconciliation: Sales Comparison and Income Capitalization Approaches
		Exploring the Relationships between Changing Market Conditions, Cap Rates, and Property Values
		A Closing Note on Cap Rates and Market Conditions
		A Word of Caution—Simultaneous Effects of Real Market Forces and Interest Rates on Property Values
		Leases: Valuation of a Leased Fee Estate
		Cost Approach
		Valuation Case Study—Oakwood Apartments
			RealNex Solution
		Appendix RealNex Inputs and Output for Apartment Analysis
	Chapter 11 Investment Analysis and Taxation of Income Properties
		Motivations for Investing
		Real Estate Market Characteristics and Investment Strategies
			The Real Estate Cycle
			Investment Strategies
		Market Analysis
			Supply of Space
			Market Rents
			Forecasting Supply, Demand, Market Rents, and Occupancy
		Making Investments: Projecting Cash Flows
		Office Building Example
			Base Rent
			Market Rent
			Expense Stops
			Net Operating Income
			Expected Outlays for Replacements and Capital Improvements
			Estimated Sale Price
		Introduction to Investment Analysis
			Internal Rate of Return (IRR)
			Present Value
		Introduction to Debt Financing
			Measures of Investment Performance Using Ratios
			Before-Tax Cash Flow from Sale
			Summary of Investment Analysis Calculations
		Taxation of Income-Producing Real Estate
		Taxable Income from Operation of Real Estate
			Depreciation Allowances
			Loan Points
			Tax Liability and After-Tax Cash Flow
		Taxable Income from Disposal of Depreciable Real Property
		After-Tax Investment Analysis
			After-Tax Cash Flow from Operations
			After-Tax Cash Flow from Sale
			After-Tax IRR
			Effective Tax Rate
		A Note about Passive Losses
			Special Exceptions to PAL Rules
	Appendix A Approaches to Metro Area Market Forecasting
	Appendix B RealNex Office Example
	Chapter 12 Financial Leverage and Financing Alternatives
		Introduction to Financial Leverage
			Conditions for Positive Leverage—Before Tax
			Conditions for Positive Leverage—After Tax
		Break-Even Interest Rate
		Risk and Leverage
		Underwriting Loans on Income Properties
			Market Study and Appraisal
			Borrower Financials
			The Loan-to-Value Ratio
			The Debt Coverage Ratio
		Other Loan Terms and Mortgage Covenants
		Alternatives to Fixed Rate Loan Structures
		Participation Loans
			Lender Motivations
			Investor Motivations
			Participation Example
		Sale-Leaseback of the Land
			Effective Cost of the Sale-Leaseback
		Interest-Only Loans
		Accrual Loans
			Structuring the Payment for a Target Debt Coverage Ratio
		Convertible Mortgages
			Lender’s Yield on Convertible Mortgages
		Comparison of Financing Alternatives
		Other Financing Alternatives
	Chapter 13 Risk Analysis
		Introduction
			Comparing Investment Returns
			Types of Risk
			Due Diligence in Real Estate Investment Risk Analysis
			Sensitivity Analysis
			Partitioning the IRR
			Variation in Returns and Risk
		Retail Case Study—Westgate Shopping Center
			Westgate Shopping Center Scenario Analysis
		Lease Rollover Risk
		Market Leasing Assumptions with Renewal Probabilities
			Market Rent
			Months Vacant
			Leasing Commissions
			Tenant Improvements
		Industrial Case Study—Worthington Distribution Center
		Risk and Leverage
			Monte Carlo Simulation
			Example
			Extensions of Monte Carlo Simulation
			Participation Example
		A “Real Options” Approach to Investment Decisions
			Traditional Approach to Land Valuation
			Real Option Approach to Land Valuation
			Real Options Extensions and Strategy
	Chapter 14 Disposition and Renovation of Income Properties
		Disposition Decisions
			A Decision Rule for Property Disposition
		IRR for Holding versus Sale of the Property
		Return to a New Investor
			Marginal Rate of Return
		Refinancing as an Alternative to Disposition
			Incremental Cost of Refinancing
			Leveraged Return from Refinancing and Holding an Additional Five Years
			Refinancing at a Lower Interest Rate
		Other Disposition Considerations—Portfolio Balancing
		Tax-Deferral Strategies upon Disposition
			Installment Sales
			Tax-Deferred Exchanges
		Renovation as an Alternative to Disposition
		Renovation and Refinancing
		Rehabilitation Investment Tax Credits
			Low-Income Housing
	Chapter 15 Financing Corporate Real Estate
		Lease-versus-Own Analysis
			Leasing versus Owning—An Example
			Cash Flow from Leasing
			Cash Flow from Owning
			Cash Flow from Owning versus Leasing
			Return from Owning versus Leasing
			Importance of the Residual Value of Real Estate
			The Investor’s Perspective
			A Note on Project Financing
			Factors Affecting Own-versus-Lease Decisions
		The Role of Real Estate in Corporate Restructuring
		Sale–Leaseback
		Refinancing
		Investing in Real Estate for Diversification
	Appendix Real Estate Asset Pricing and Capital Budget Analysis: A Synthesis
PART FIVE: FINANCING REAL ESTATE DEVELOPMENT
	Chapter 16: Financing Project Development
		Introduction
		Overview: The Planning and Permitting Process
		The Development of Income-Producing Property
			Market Risks and Project Feasibility
			Project Risks
		Project Development Financing—An Overview
		Lender Requirements in Financing Project Development
			Interest Rates and Fees
		Project Development Illustrated
			Project Description and Project Costs
			Market Data and Tenant Mix
			Pro Forma Construction Costs and Cash Flow Projections
		Feasibility, Profitability, and Risk—Additional Issues
			Profitability before and after Taxes
			Sensitivity Analysis, Risk, and Feasibility Analysis
	Chapter 17: Financing Land Development Projects
		Characterization of the Land Development Business
		The Land Development Process—An Overview
			Acquisition of Land—Use of the Option Contract
			Financing and Development
		Lender Requirements in Financing Land Development
			Detailed Cost Breakdowns
			General Contracts and Subcontracts
		Residential Land Development Illustrated
			Market Conditions and Site Plan
			Estimating Development Cost and Interest Carry
			Estimating Release Prices per Parcel Sold
			Loan Request and Repayment Schedule
		Project Feasibility and Profitability
			Project IRR and Net Present Value
			Entrepreneurial Profits
			Sensitivity Analysis
PART SIX: ALTERNATIVE REAL ESTATE FINANCING AND INVESTMENT VEHICLES
	Chapter 18: Structuring Real Estate Investments: Organizational Forms and Joint Ventures
		Introduction
			Sole Proprietorships
			Partnerships
			Limited Liability Companies
			Corporations
		Joint Ventures
			Organizational Forms
			Profit Sharing
		Initial Capital Contributions
		Sharing Cash Flow from Operations
		Sharing of Cash Flow from Sale
		Summary of Cash Flows Distributed in Each Operating Year
		Cash Flow from Sale
		IRR to Each Joint Venture Party
		Variation on the Preferred IRR—“The Lookback IRR”
		Syndications
		Use of the Limited Partnership in Private and Public Syndicates
		Private Syndication Problem Illustrated
			Financial Considerations—Partnership Agreement
			Operating Projections
			Statement of Before-Tax Cash Flow (BTCF)
			Calculation of Net Income or Loss
			Calculation of Capital Gain from Sale
		Capital Accounts
			Distribution of Cash from Sale of Asset
			Calculation of After-Tax Cash Flow and ATIRR on Equity
		Partnership Allocations and Substantial Economic Effect
		Capital Accounts and Gain Charge-Backs
		Use of the Limited Partnership in Private and Public Syndicates
			Use of Corporate General Partners
			Private versus Public Syndicates
			Accredited Investors—Regulation D
		Regulation of Syndicates
			Investment Objectives and Policies
			Promoters’ and Managers’ Compensation
			Investor Suitability Standards
		Federal and State Securities Authorities
	Chapter 19: The Secondary Mortgage Market:Pass-Through Securities
		Introduction
		Evolution of the Secondary Mortgage Market
			Early Buyers of Mortgage Loans
		The Secondary Market after 1954
			FNMA’s Changing Role
		The Government National Mortgage Association
			Mortgage-Backed Securities and the GNMA Payment Guarantee
		The Federal Home Loan Mortgage Corporation
		Operation of the Secondary Mortgage Market
			Direct Sale Programs
			The Development of Mortgage-Related Security Pools
		Mortgage-Backed Bonds
			Pricing Mortgage-Backed Bonds
			Subsequent Prices
		Mortgage Pass-Through Securities
			Important Characteristics of Mortgage Pools
			Mortgage Pass-Through Securities: A General Approach to Pricing
			Mortgage Pass-Through Payment Mechanics Illustrated
			Prepayment Patterns and Security Prices
			Prepayment Assumptions
		The Effects of Prepayment Illustrated
			Security Prices and Expected Yields
			Market Interest Rates and Price Behavior on Mortgage Pass-Throughs
			A Note on MBBs and MPTs
	Chapter 20: The Secondary Mortgage Market: CMOs and Derivative Securities
		Introduction
		Mortgage Pay-Through Bonds (MPTBs)
		Collateralized Mortgage Obligations
			CMOs Illustrated
			CMO Mechanics
			CMOs: Pricing and Expected Maturities
			CMO Price Behavior and Prepayment Rates
			CMO Tranche Variations
			Subprime Mortgage-Backed Securities
		Derivatives Illustrated
			Yield Enhancement
			IO and PO Strips
			Convexity
		Residential Mortgage-Related Securities: A Summary
		Residential Mortgage-Related Securities: Some Closing Observations
		Commercial Mortgage-Backed Securities (CMBSs)
			Rating Commercial Mortgage-Backed Securities
			Collateralized Debt Obligations (CDOs)
			Mortgage-Related Securities and REMICs
			REMICs: Other Considerations
		Appendix Duration—An Additional Consideration in Yield Measurement
	Chapter 21: Real Estate Investment Trusts (REITs)
		Introduction
			Legal Requirements
			Tax Treatment
			Violation Penalties and Status Termination
			Taxable REIT Subsidiaries
		TYPES of REITs
			Equity REITs
			The Investment Appeal of Equity REITs
			Public Nonlisted REITs
			Importance of FFO (Funds from Operations)
			REIT Expansion and Growth
		Important Issues in Accounting and Financial Disclosure: Equity REITs
			Tenant Improvements and Free Rents: Effects on FFO
			Leasing Commissions and Related Costs
			Use of Straight-Line Rents
			FFO and Income from Managing Other Properties
			Types of Mortgage Debt and Other Obligations
			Existence of Ground Leases
			Lease Renewal Options and REIT Rent Growth
			Occupancy Numbers: Leased Space or Occupied Space?
			Retail REITs and Sales per Square Foot
			Additional Costs of Being a Public Company
		The Investment Appeal of Mortgage REITs
			Financial Analysis of an Equity REIT Illustrated
		Valuing REITs as Investments
			Valuation of Midwestern America Property Trust
PART SEVEN: PORTFOLIO ANALYSIS AND REAL ESTATE FUNDS
	Chapter 22: Real Estate Investment Performance and Portfolio Considerations
		Introduction
		The Nature of Real Estate Investment Data
		Sources of Data Used for Real Estate Performance Measurement
			REIT Data: Security Prices
			Hybrid and Mortgage REITs
			NCREIF Property Index: Property Values
			Data Sources for Other Investments
		Cumulative Investment Return Patterns
		Computing Holding Period Returns
			Comparing Investment Returns
		Risk, Return, and Performance Measurement
			Risk-Adjusted Returns: Basic Elements
		Elements of Portfolio Theory
			Calculating Portfolio Returns
			Portfolio Risk
			Portfolio Weighting: Trading Off Risk and Return
		Real Estate Returns, Other Investments, and the Potential for Portfolio Diversification
			Portfolio Diversification: EREITs and Other Investments
			Public versus Private Real Estate Investments
			Real Estate Performance and Inflation
			Diversification by Property Type and Location
			Global Diversification
			Risks of Global Investment
			Use of Derivatives to Hedge Portfolio Risk
			Example—Swap Office for Retail
			Up Shares and Down Shares
	Chapter 23: Real Estate Investment Funds: Structure, Performance, Benchmarking, and Attribution Analysis
		Investor Goals and Objectives
		General Explanation of Possible Provisions in Fund Offerings
			Reporting Fund Performance
			Measuring and Reporting Investment Returns
			Summary of Major Activity during Quarter
		Calculating Returns
			Calculating Returns at the Property Level
			Comparing Returns: Fund Level versus Property Level
			Returns: Before and After Fees
			Calculating Historical Returns
			Time-Weighted Returns
		Choosing IRR versus TWR for Performance Measurement
			Target Returns and Benchmarks
			Investment Multiple
			Attribution Analysis
			Attribution Analysis Mathematics
			Interpreting Sector Allocation
			Evaluating Risk Differences
			Jensen’s Alpha
Indexes