Real Estate Finance Final Exam

Gross Potential Rents

Gross Potential Rents

the maximum amount of rent you can collect if you rented out 100% of the unit 100% of the time; however, you don’t usually rent out 100% of the building 100% of the time

Vacancy Loss

estimate of the units we’re not gonna collect rent on; expressed as percentage; have to understand it based on where you're located- UES will be lower vs. Camden, NJ

Net Rent

the amount that you as a landlord arrive at after subtracting every expense from the gross operating income

Operating Expenses

Those expenses you're going to incur which are necessary to operate the building; ex: Utilities, repair and maintenance, real estate tax, landscaping, snow removal, payroll (for super or doorman), payroll taxes, union benefits, permits/dues/fees, management fee, garbage, property, liability insurance- all diff types, advertising/commissions; Depreciation and annual debt services do NOT COUNT

Net Operating Income

=Net rent- operating expenses; what you're putting in your pocket; When you're buying a piece of property you're buying this cash flow

Market Value/Capitalization Rate

MV=NOI/Cap Rate and represents how much you're willing to pay for the building; cap rate= the interest rate, Youre gonna invest x dollars and demand a certain amount in interest because you want to get a certain amount of cash each year, The higher the cap the higher the return

Loan-to-Value

amount of money lender will give you relative to value; Usually expressed as %

loan constant

k%= ADS/ Original loan amount; Telling you how much you're paying in amortization on a loan; Real estate investor wants to pay the least amount possible in amortization; it changes for a given interest rate and amortization but it does NOT CHANGE based on how much you borrow

debt coverage ratio

=net operating income/debt service; Amount of cash to pay debt obligations; they put this as a condition in a loan contract so if your NOI falls below this, you become in default of your loan

maximum allowable loan

total amount you are allowed to borrow as a real estate company

lending

in commercial real estate is credit that is created to finance or refinance commercial property; When borrowing money from bank and wanna get a loan on the property the bank will appraise the building to see how much money you really need; ex: Banks, Insurance companies, Pensions plans

salvage value (real estate)

The value of the underlying land; want low value so you can depreciate more; Land is not depreciable- Need to subtract the value of the land to get annual depreciation

financial leverage

the use of debt to invest in assets; The use of debt will either increase or decrease your return; If your cost of borrowing is less than your cap rate you have positive leverage; If your cost of borrowing is more than your cap rate you have a negative leverage; Positive leverage= driving return up; Cost of borrowing= k% loan constant; Negative leverage- driving return down

underwriting loans

the process of your lender verifying your income, assets, debt, credit and property details to issue final approval on your loan application.

mortgage covenants

clauses in the agreement that require the borrower to do or avoid doing certain things and are often tied to the business' financial performance; ex. Notify bank of intentions with the property such as capital improvements

lockout clause

You cannot prepay that loan for a certain period of time;

prepayment penalty

You can prepay it but it has to be in increments and you have to pay a penalty; Usually in commercial loan

types of risk

interest rate, legislative, liquidity, credit, market, inflation, environmental

due diligence

Process that prospective purchases goes through when looking at a property; Look at rent roll; Look through leases; Look at service and maintenance agreements; Pending litigation; Review title and deed; Property survey; Make sure building is in governmental compliance; Do physical inspection; once its done and you  sign your contract you're hard in your contract- Typically during this period you have the opportunity to not go through with it

renewal leasing assumptions

Tenants in commercial buildings want these; Typically gives the tenant the right to extend out their lease after its initial expiration

market value

what a willing seller is willing to sell it at and a willing buyer is willing to buy it at

appraisal

An estimate of market value at a given point in time

appraisal process

If you wanna buy a property they appraise it to make sure its worth the price; Usually Done by a third party not yourself; They're going to describe the physical attributes of the property in their report; Give you legal description of the property- Called the metes and bounds; Identify the property rights being appraised- Evaluating the fee simple of the property, Identify a leasehold interest in the property, Valuing partnership interest; Tell you date of appraisal;

Purpose of the appraisal for lending- When borrowing money from bank and wanna get a loan on the property the bank will appraise the building to see how much money you really need

Appraiser gathers all relevant info and uses it to come of w appraised value of the property; Apply methods of valuation to the property and then choose the best method of appraisal

methods of valuation

sales comparison approach, income approach, cost approach

sales comparison approach

Method is trying to come up with value of your property relative to other properties similar to yours; Wanna look at buildings around your area; Building sold at a similar time near your building is a good comp; When you don't have similar properties within a close radius you might have to go other places to look

income approach

Basically taking NOI/CAP rate to come up w values but appraiser is not gonna do just that; Appraiser takes discounted cash flow and project out rents and terminal values; Terminal value: Sales value at some point in time; Apply cap rate to discounted value

cost approach

valuation of vacant land plus construction costs; How much bulk can you build on this property?Looking for the value of your property; You have to think opposite of sales comparison approach because you're coming up with your value; many examples of this in notes**

why invest in real estate?

For a return on your equity/investment!; To accrue assets; depreciation- you shelter part of your income through depreciation- This is the beauty of real estate- explained in notes**; Tax benefits- You don't necessarily pay taxes on a capital gain on the year you get it; For diversification- Wealthy and have money in bonds and equities and real estate; For capital appreciation- Buy building for 54 mil and wanna sell it for 80 mil

investment styles

core properties, sector investing, contrarian investing, value investing, turn around situations or special situation, trophy investing, development

taxation of incoming producing properties

IRC Section 1031 is a like-kind exchange; provides an exception and allows you to postpone paying tax on the gain if you reinvest the proceeds in similar property as part of a qualifying like-kind exchange. Gain deferred in a like-kind exchange under IRC Section 1031 is tax-deferred, but it is not tax-free.

IRC section 121- If you sell your personal residence Exclude 600k Capital gain if you're single and 500k if you're married; Have to lived in the house two out of the last 5 years to qualify

Financing costs- Those costs amortize over the term of the loan; ex. The legal bill you pay to attorney point you bill to loan

economic influences on housing

Interest rates- As interest rates go up more people get pushed out of the market, As they go down more people can afford going into the market;

Inflation- High inflation pushes up price of housing;

Unemployment or employment- If employment is increasing then housing prices will rise, There's nothing in wyoming so housing prices are low cuz there's not much work;

Population growth or decline-If an area is Experiencing a growth it increases demand and prices, If experiencing a decrease it may have a negative affect on housing;

Taxes- As taxes increase that has a negative effect on housing you have less disposable income to spend on housing

benefits of home ownership

Building equity, capital appreciation; Could have collateral in the house if you pay off mortgage or could have a reverse mortgage; Building credit; Tax incentives-Deductibility of real estate taxes That you pay to municipality, Mortgage interest: If you take out a loan to purchase a house the interest you pay on that loan can be deductible on your tax return; Pride of ownership- You take care of it because you own it, When its not yours you don’t care as much

rent versus buy

Typically people tend to move from renting into buying when the net cost of buying is lower than the cost of renting

ex. Rent is 1500 on apartment but if you buy a house your mortgage and taxes are 1800 but when you factor in the tax benefits you lower it to 1400 so for roughly the same amount of money you can own instead of rent

residential mortages

Ppl. typically get loan from banks; Can get government loans or gov. Insured loans- Loans originated by a bank but guaranteed by some governmental agency, ex. VA loan meant for veterans; Some loans geared towards 1st time home buyers and they don't have 20% to put down they only have 5%- Programs that will give you the loan that most banks won't

underwriting criteria

When going to buy house they ask for:

Credit score- Your overall debt vs. the debt you can take on, Not necessarily based on income; Assets vs. liabilities- Show us how wealthy you are or are not; Employment verification- See that you're an employee; Income- Show us W2 and tax return can you afford the loan

Look at these things to see if you should be given the money

closing process

Typically face to face but now can be done remotely nowadays; pay all your fees and expenses; Bank will want an appraisal and you have to pay the appraisal fee; Bank will want a survey-Survey is outlining a piece of property you're buying and whats on that property; Prepare loan documents- Promissory note, loan documentation respiration fee

closing fees and expenses

Bank charges you a loan application fee, a credit report fee, You may have to pay an origination fee on the loan-A % amount of the amount you're borrowing, You're gonna pay for the banks legal-They have a lot of paperwork pay for the banks attorney, your attorney fee, Bank will want an appraisal and you have to pay the appraisal fee, loan documentation respiration fee, Pay bank discount points- Points are prepaid interest

prorations

splitting an expense between the buyer and seller; Real estate taxes, common charges, HOA fees, etc. get prorated; In commercial real estate prepaid salaries get prorated; Insurance does not get prorated; Gas, water, electricity, insurance don't get prorated; The buyer of the house owes the seller and they can do this for wages, fuel oil, and others; ex. in notes**

holding period

typical amount of time an investor hold on to a piece of real estate; Depends on personal investor and what they are looking to accomplish; Some people their philosophy is to hold it forever; Some is to hold it a few years and dispose it

refinancing

When you've owned your house for a while and its value has gone up, you can do this to get a new loan based on its current value; This lets you tap into the equity you've built up; And pull out cash

ex. Purchased for 10mil

• Debt on property of 7mil

• Equity on property of 3mil

• Current market value is 18mil

• Can get debt on property of 12mil 

  • New loan 

  • Get 5mil in your pocket

• If CFads is 1.3mil and original return was 8% then return on equity is infinity

  • Because you have no cash investment in the property anymore 

  • 1.3mil/0= infinity

renovation

you have an old property that you can turn around; after you do that you can sell it or refinance it or raise rents

ex. Put 1mil in renovs in hopes to raise rents and increase value of property to something greater than 1mil; If u had 250unit building and spent 1mil on reno cuz You believe you’ll be able to increase the rents by $100/month- continued in notes**

joint venture

2 or more people or entities coming together each with their own expertise; Doing a development and maybe one person knows how to build a building and the other has the money and they build the building; Very often the money guy will put the money in but he wants a preferred return of 12% of my money and full equity back before you get a dime, Then after i get paid we split the profits in a certain percentage whatever our agreement is

syndication

Where someone is buying a piece of property and they ask investors to put their money up; Syndicator is putting in little of their own money and going out to group of investors to get the money and they're gonna run it; See this a lot in restaurants and bars and type of wendy's things and real estate you see it too

Ex. sebastian has a deal and he needs $10mil and he goes to 10 of his nearest friends and asks for $1mil each and hell give them a 9% ownership interest on what he's doing like buying apartment building and He gets $10mil

types of partnerships

general, limited, c corp, sole proprietorship, limited liability companies (LLC)

evolution of the secondary mortgage market

the primary mortgage market-You go to the bank and the bank originates the loan; Most banks sell those loans into the this mortgage market; Wallstreet buys these loans and bundles them up and they sell it at a premium cuz they're not gonna lose money; Decreases the interest rate; It exists to replenish the funds for a lender-The put 1bil out in loans and need cash back in so they sell theses loans and get the cash back so they can lend that money; Gives investors a method to invest in this product which they might not of otherwise done

federal national mortgage association (FNMA)

purchases loans from primary mortgage lenders and turns them into Mortgage Backed Securities; Lender is originating the loan on Freddy paper or franny paper; guidelines- What happens is chase bank will originate the loan and that loan is not on chase’s books even tho they service it- freddie mac or fannie mae is guaranteeing that loan to the books; Typically rates are a little lower but their pretty onerous these loans

Government National Mortgage Association (GNMA)

guarantee timely payment of principal and interest to investors who purchase government Mortgage Backed Securities; does primarily single family homes

Federal home loan mortgage corporation (FHLMC)

purchases loans from primary mortgage lenders and turns them into Mortgage Backed Securities; Lender is originating the loan on Freddy paper or franny paper; guidelines- What happens is chase bank will originate the loan and that loan is not on chase’s books even tho they service it- freddie mac or fannie mae is guaranteeing that loan to the books; Typically rates are a little lower but their pretty onerous these loans

Mortgage backed bonds

Where you have a pool of mortgages- residential and commercial, bonds are issued against these pools of mortgages

mortgage pass-through securities

a claim to a share of the cash flows from a pool of mortgage loans. These securities are created when mortgage lenders bundle together individual mortgage loans and sell interest in the pool to investors.; Similar to bond but you have undivided interest in the mortgage; You may have fractional interest in fund and if a loan defaults then you feel it- If they don't make monthly payment you lose money

collateralized mortgage obligations

pooling together various types of debt obligations, such as mortgages, corporate loans, or bonds, and repackaging them into discrete tranches with different levels of risk and return. These tranches are then sold to investors;

Debt obligation collateralized by the mortgagers; You have the security of the mortgage whereas bond you dont have security of mortgage

what is a REIT?

Real Estate Investment Trusts; are Either publicly traded or privately-If publicly they are on the stock exchange; They aren't taxed at a corporate level and that goes down to shareholders; Fairly decent returns; Dividend yield is greater than other corporations; they must meet all requirements

Ex. SL Green Realty- mostly office buildings in NY, Simon properties, Ventas, Ronato, Blackrock, Blackstone

REIT asset requirements

Must have at least 75% of the value invested in real estate or mortgages something related to real estate

REIT income requirements

95% of their income must be generated from real estate activity- Rental income, mortgage income

REIT distribution requirements

90% of taxable income must be distributed to their shareholders

REIT stock and ownership requirements

Must be set up as a taxable corporation- a C Corp.; Must have a board of directors; Shares must be fully transferable- I can sell my stock or buy it at any time; Shares must be held by a minimum of 100 people; No more than 50% of the shares can be held by fewer than 5 individuals- They don't want me to get 100 people together and i own 95% of the shares and everyone else owns 5%

REIT types of REIT’s

Invest in nursing homes, timber, warehouses, cell antennas, mobile home parks, you name it there's probably one out there that's setup to own this type of asset

interest rate risk

The risk that interest rates might go against you

legislative risk

Legislation meaning law goes against you; ex. rent control, Local and tax laws, Zoning laws

liquidity risk

Real estate is illiquid; You can't convert real estate into cash quickly and If you do then you pay a price- Need to sell it for less its value to get that money quickly; Cash is liquid real estate is not

credit risk

More when your tenants aren't paying you if they have bad credit

market risk

Ex. Buying a apartment building out in wyoming, cuz market says everyones gonna move there and people don't then you gave the risk of it being too outside of civilization

inflation risk

Lock in rent for 10-15 years with a tenant and inflation takes off it might not be a good deal for you anymore

environmental risk

Pretty big today in the industry; toxic waste, oil, lead, aspetos; Pollution insurance: Regular property insurance excludes lead paint and this is what you use for environmental risks

core properties investing

Properties that have stable cash flow, Low vacancy

Ex: A multifamily apartment building in nyc

sector investing

Investing in a specific type of property ie. industrial, retail commercial office building, multi family housing , garden style, nursing homes, storage facilities ,etc.; Most real estate people tend to concentrate on a few sectors; Hard to be knowledgeable about all diff aspects of real estate- Running nursing home is diff than running an apartment building

contrarian investing

Investing in assets class that everyone else is getting out of

ex. Back in the 70’s “the bronx is burning”; Burn the buildings down they couldn't pay off; Getting out of the bronx its not the place to invest in; If you're this type of investor you'd be buying as everyone is fleeing here

value investing

Purchasing assets that are overlooked by the marketplace; Investing in assets that are undervalued

ex. Lots of new construction in the bronx and williamsburg- this investor would have bought that land

Turn around situations or special situation investing

Buying a property that's been neglected for some reason; Could be absentee ownership or the owner hasn't put money into it; You come in and spruce it up and turn it around and invest in it; Some people call it value add

trophy investing

Buildings that like blue chip buildings; Buying probs at low cap rate and buying for like bragging rights; Buying the empire state building just to say you own it; See in this country many foreign investors come and go and they are buying these properties

development investing

You're actually building the property from the ground up; Developer will buy or lease the land and build something on top of it; Getting construction loan typically which accrues and you're not getting any cash; Rewards can be good but results can also be disastrous; Not for the faint of heart; Is a very risky proposition

general partnership

All partners have unlimited liability, which means they can come after you; To get away from this you have to have liability insurance and you should buy it; Real estate was owned mostly like this

Ex. pregnant lady gets hit and killed by building roof and the husband sues and gets judgment of $50mil and he chases after everyone in the partnership; They go after insurance and then building and then personal assets and it doesn't go away until its paid off

limited partnership

have general partners who own and limited partners who have limited liability; if there's an investor who invests 100k, you lose your investment in the entity that's it

c corp

how most corporations are; Can't come after you personally they come after corporation which is limited liability; Problem of owning real estate in this is double taxation; As building makes money you pay corp tax and when you pay dividend you pax tax on dividend

sole proprietorship

unlimited liability on the sole proprietor one person who owns it

ex. Barber owns the barbershop and he doesn't have an LLC and then hes personally liable if something happens on his property

Limited liability companies (LLC)

best of c corp and best of general partnership; There are diff forms of ownership but most common is this; Have the limited liability of c corp but no double taxation- Profits and losses flow directly through the partners; Law firms have limited liability partnerships; In nyc most businesses are this