Ch. 16 MORTGAGE ANALYSIS IN REAL ESTATE PRACTICE

IMPACT OF FINANCING ON REAL ESTATE TRANSACTIONS

-Where the financing is beneficial to the purchaser, this can create additional value that adds to the package of what the vendor is selling

-rather than selling a parcel of land with a house on it, the vendor is also including beneficial financing; selling the borrower an opportunity to save on future interest payments

-Where a purchaser is receiving a benefit, the purchaser should expect to pay for it – and it is this potential added value that is at the heart of mortgage analysis.

Cash-Equivalent Price or Market Value of an Offer

-Cash-equivalent price: a mathematical tool that can be used to partially explain these potential benefits.

-Mortgage rate is BELOW market → Discount

-buyers arre getting House + valuable cheap financing

-discount: where an offer to purchase is sold for less than the face value of the loan

-Mortgage rate is ABOVE market → Bonus

-buyers are getting House − disadvantage of expensive financing

-bonus: where an offer to purchase is sold for more than the face value of the loan; the portion of the face value of a mortgage loan that exceeds the funds actually received by the borrower and is intended as additional compensation for the lender

*Purchase price = real estate + value (or cost) of the financing

*Cheap mortgage = buyer gets an extra benefit → subtract it from the purchase price.

*Expensive mortgage = buyer takes an extra burden → add it back to the purchase price.

Market value (of an offer)

the cash down payment plus the present value of the mortgage loan discounted at the market rate, i.e., the market value of the mortgage

Market value (of a mortgage)

the present value of future mortgage payments (and outstanding balance, if applicable) calculated at the market rate of interest

Discounting

the process of expressing expected future income in terms of a present value

Vendor-Supplied (Take-Back) Mortgage

-Vendor financing is often used as a non-price sale incentive

-For example, consider a developer who needs to promote the slow sales of building lots. Rather than lowering the price, the developer might instead offer a no-interest or low-interest loan to spur demand → typically be for a short term and would often be re-sold

-Vendor financing could also be used to facilitate sales in situations where purchasers cannot obtain conventional financing.

-Consider a vendor attempting to sell a residential property in a depressed market, with high unemployment. Purchasers may not be able to qualify for conventional loans, so to sell a property, the vendor may need to consider accepting some cash up front and then have the remainder paid back over time → this vendor is effectively being asked to act as a lender.

-In determining what this discount or bonus might be, the first task is to calculate the cash-equivalent price or market value of that offer.

Appraisal and Vendor Financing

In relying on a sale comparable that involves non-market financing, the appraiser must isolate the value attributed to the financing and adjust the sale price accordingly.

Pesent value calculations provide only a starting point to determine the worth of this financing benefit

the real impact of this in the transaction is determined by negotiations among the parties involved.

-Mathematically, the purchaser is receiving a $77,386 benefit, but the actual benefit received will depend on how the parties value this benefit and how they act accordingly in negotiating the sale.