Topic 1: Introduction to Real Estate Finance
(Suggested textbook reading: Chapter 1)
We can define economics as the allocation of scarce resources. We can define finance as the applied branch of economics that focuses on:
· Claims on value with different characteristics (debt, equity)
· Maximizing equity values;
· Cash-flow based analysis;
· Intertemporal transfers of funds (time value of money);
· Analysis of, and adjustment for, risk.
We can define real estate finance as the application of financial concepts to the real estate markets. More specifically, we can view real estate finance as relating to the direction of funds from entities with surplus savings to those with savings deficits, but who wish to purchase:
· Unimproved land
· Improved land
· Land and the inputs to make improvements
Who (what) are these savings deficit entities that wish to borrow?
· Businesses (As users, as developers)
· Households (As users, as investors)
Value of U.S. housing stock is more than $17 trillion, commercial property almost $12 billion. Total owed on U.S. residential mortgage loans is approximately $10 trillion. Approximately 2/3 of US households had mortgage loans as of mid 2013.
· Governments (Indirect real estate borrowers; they issue bonds and then buy the real estate they need)
Who (what) are these savings surplus entities that wish to lend?
· Commmercial Banks
· Thrifts
Savings and Loans (massive failures of mid/late 1980s)
Savings Banks
Credit Unions (common bond issue still creates controversies)
· Investment Companies
REITs
Mutual Funds (buy GNMAs and other mtg-backed securities)
· Insurance Companies
Lend directly on commercial property
Lend indirectly on homes (by buying MBSs)
· Pension Funds
Lend indirectly on real estate (by buying MBSs)
Expected to play a growing role
· Private parties
Property sellers
Investors (e.g., charitable foundations; also third-party individual investors in zero-down payment cases)
· Governments
Make some direct loans
Federal: agricultural
Local: low & moderate income housing
Their greater role is often in providing guarantees
In what markets does real estate lending occur?
Money vs. Capital Markets
· Money (short-term) lending market: some acquisition, development, & construction (ADC) loans
· Capital (long-term) lending market: most real estate loans, including take-out loans that replace ADC loans
Primary vs. Secondary Mortgage Markets
· Primary mortgage market: new mortgage loans are created
· Secondary mortgage market: liquidity is provided
Residential mortgage-backed security values total more than $7 trillion and commercial mortgage-backed security values are another $2 trillion. (Amounts owed on U.S. corporate bonds total only $8 trillion).
Improved real estate has some features that make it attractive as the basis for financial transactions: fills important human needs (not a passing fad), long life, can not be hidden or stolen. Yet real estate itself trades in markets that are inefficient and highly segmented (localized, and by property type).
Real estate finance, on the other hand, has become an integrated national (even worldwide) market. In real estate finance, we can enjoy market efficiencies and take advantage of real estate’s attractive financial features because of standardized instruments (which follow, to some extent, from guarantees and other participation by government and quasi-government agencies, especially “Fannie Mae” and “Freddie Mac”).
FIL 360/Trefzger