1. REAL ESTATE FINANCING
9/11/2018
Dr.P.S, MBFS, V Unit

2. Major Topics Mortgage Terms and Clauses Sources of Real Estate Finance
Mortgage Money in the Context of the Capital Market
Primary and Secondary Mortgage Markets
Commercial Mortgage Backed Securities
Economic of Interest Rates
Impact of the Federal Reserve
Trends in Real Estate Finance
9/11/2018
Dr.P.S, MBFS, V Unit

3. Introduction
Real estate finance is traditionally the process of borrowing or lending, most often involving a third party that is neither the buyer nor seller of the property in question
From the borrower’s point of view a loan is a debt and liability, while from the lender’s point of view a loan is an investment and an asset with the property serving as collateral for the loan
Financing a real estate transaction involves significant risk to both the owner of the real estate (the borrower) and to the lender
9/11/2018
Dr.P.S, MBFS, V Unit

4. Important to have relationship documented
What is a Mortgage Loan?
The combination of Equity and Debt used to buy a property is known as the capital structure of the property
When debt involves real estate as collateral security for the loan it is referred to as a Mortgage
A mortgage loan is a contractual agreement between the mortgagor and the mortgagee
Important to have relationship documented
9/11/2018
Dr.P.S, MBFS, V Unit

5. Promissory Note
A promissory note is a written document containing the contract terms between the borrower and the lender
Legally, the promissory note provides evidence of the debt between borrower and lender since a mortgage cannot be enforced unless the mortgagor owes a debt to the mortgagee
Practically, the promissory note documents the agreement between the borrower and the lender and contains the financial and legal details of the transaction
9/11/2018
Dr.P.S, MBFS, V Unit

6. Clauses contained in “the note”
Loan Amount
Method of Repayment
Interest Rate
Term
Acceleration Clause
Prepayment Provisions
Late Payment Provisions
Due on Sale Clause
Escrow for Property Taxes/ Insurance
Maintenance of Property
Default
Loan Guarantees
9/11/2018
Dr.P.S, MBFS, V Unit

7. Mortgage Markets and the Role of Intermediaries
Financial Markets bring together savers who have surplus income to invest and borrowers who have a need for funds beyond their current cash holdings
Financial Intermediaries bring together those who use borrowed funds and those who have surplus funds to lend or invest
Play an extremely important role in financial markets because they absorb many of the risks associated with lending by and provide important services to both savers and borrowers
9/11/2018
Dr.P.S, MBFS, V Unit

8. 9/11/2018
Dr.P.S, MBFS, V Unit

9. Uses of Mortgage Money
9/11/2018
Dr.P.S, MBFS, V Unit

10. Primary Sources of Mortgage Money
Single Family Housing
Dominant secondary market players, Freddie Mac and Fannie Mae
Multifamily Mortgage Loans
Commercial banks followed by Federally related agencies, Fannie Mae, Ginnie Mae etc.
Commercial Mortgages
For office and industrial property, commercial banks, followed far behind by life insurance companies and the larger savings and loan associations
Commercial mortgage backed securities market (CMBS) becoming important
9/11/2018
Dr.P.S, MBFS, V Unit

11. CMBS
9/11/2018
Dr.P.S, MBFS, V Unit

12. Primary Suppliers of Mortgage Funds
Savings and Loans
Commercial Banks
Mortgage Bankers/ Mortgage Companies
Life Insurance Companies
Pension Funds
Individuals
9/11/2018
Dr.P.S, MBFS, V Unit

13. Other Sources of Debt Capital
Mortgage and Hybrid REITS (Real Estate Investment Trusts)
Credit Unions Companies and Private Personal Finance Agencies especially important for home equity second mortgages.
Investment Banking Firms through Commercial Mortgage Backed Securities or Direct Placements of larger loans ($100 million plus).
The Government Agencies such as the Farmers Home Administration
Bank Trust Departments
9/11/2018
Dr.P.S, MBFS, V Unit

14. Impact of the RTC
RTC had to establish standard procedures and rating criteria in order to dispose of much of the real estate held by the failed institutions
As a result, these procedures have been used by investment bankers as a way of structuring commercial financing transactions on performing properties that can be securitized and sold in the secondary markets
9/11/2018
Dr.P.S, MBFS, V Unit

15. Impact of the CRA
CRA requires that each insured depository institution's record to meet credit needs of its entire community be evaluated periodically
As a result of CRA more loans are made to disadvantaged areas, often at below market rates, as part of the community oriented policies of local financial institutions
9/11/2018
Dr.P.S, MBFS, V Unit

16. Influences on Mortgage Interest Rates
Generally, the interest rate on any investment consists of several components:
The real risk free rate of interest
Expected inflation over a given term
A risk premium for interest rate risk and liquidity concerns,
Risk premiums for default and loss of principal risk
Other risk premiums such as political risks, currency risks, or other factors that may influence investment return volatility or safety
9/11/2018
Dr.P.S, MBFS, V Unit

17. Yield Curves
All real estate loans are affected by yields on Treasury securities
These yields on Treasury securities are used by economists and financial market reporters to construct what is called a term structure Yield Curve
Most yield curves are upward sloping
Tend to flatten out or even become downward sloping just before and during economic recessions
9/11/2018
Dr.P.S, MBFS, V Unit

18. Yield Curves
9/11/2018
Dr.P.S, MBFS, V Unit

19. The Real Risk Free Rate of Interest and Expected Inflation Levels
Nominal risk free returns were theorized to have a real component and expected inflation component by Ernest Fisher:
nominal rate = (1+ real rate)(1+ expected inflation) – 1
Using this same relationship, if we know expected inflation and nominal rates, we can estimate real rates:
real rate = (nominal rate + 1)/(1 + expected inflation) – 1
The level of expected inflation also has an important influence on fixed rate mortgage payments through the tilt effect
9/11/2018
Dr.P.S, MBFS, V Unit

20. Yield Curve (Contd.)
Real risk free rates in the United States have run about .5% to 1.5% for short term investments and 1.5% to 4% for longer term investments over the last few decades
9/11/2018
Dr.P.S, MBFS, V Unit

21. Impact of Global Capital Markets on Mortgage Rates
Real interest rates are ultimately driven by the opportunity costs of capital, not just domestically but globally
If sufficient mechanisms evolve for foreign capital investment in rapid growth countries in Asia, Eastern Europe etc., they will be able to pay greater real rates of return than anything provided in more developed countries
9/11/2018
Dr.P.S, MBFS, V Unit

22. Impact of Federal Reserve
The overall mission of the Federal Reserve is to keep the economy stable by balancing the total amount of money available in the economy with the economy’s growth and productivity
The three tools that the Federal Reserve uses to accomplish this goal are as follows:
Open-market Operations
Discount Rate
Reserve Requirements
9/11/2018
Dr.P.S, MBFS, V Unit

23. Other Risk Premia added on Mortgages
Default Risk
Prepayment and Interest Risk
Liquidity Risk
9/11/2018
Dr.P.S, MBFS, V Unit

24. Trends in Real Estate Finance
The days of purely relationship borrowing are gone, although many commercial banks still rely heavily on relationship based marketing
Today we continue to see an increasing prevalence of securitizing all types of mortgages
Securitization is the process of converting an individual mortgage into a security, often is pooled form where many similar mortgages are combined, that is then sold to investors in secondary markets
9/11/2018
Dr.P.S, MBFS, V Unit

25. THANK YOU
9/11/2018
Dr.P.S, MBFS, V Unit