Real Estate Finance and Investments Real Estate Finance and Investments Fifteenth Edition William B Brueggeman, PhD Corrigan Chair in Real Estate Edwin L Cox School of Business Southern Methodist University Jeffrey D Fisher, PhD Professor Emeritus of Real Estate Kelley School of Business Indiana University President, Homer Hoyt Institute REAL ESTATE FINANCE AND INVESTMENTS, FIFTEENTH EDITION Published by McGraw-Hill Education, Penn Plaza, New York, NY 10121 Copyright © 2016 by McGraw-Hill Education All rights reserved Printed in the United States of America Previous editions © 2011, 2008, and 2005 No part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written consent of McGraw-Hill Education, including, but not limited to, in any network or other electronic storage or transmission, or broadcast for distance learning Some ancillaries, including electronic and print components, may not be available to customers outside the United States This book is printed on acid-free paper QVS/QVS ISBN 978-0-07-337735-3 MHID 0-07-337735-X Senior Vice President, Products & Markets: Kurt L Strand Vice President, General Manager, Products & Markets: Marty Lange Vice President, Content Production & Technology Services: Kimberly Meriwether David Managing Director: James Heine Executive Brand Manager: Charles Synovec Lead Product Developer: Michele Janicek Product Developer: Jennifer Upton Digital Product Developer: Tobi Philips Director, Digital Content: Douglas Ruby Digital Product Analyst: Kevin Shanahan Director, Content Design & Delivery: Linda Meehan-Avenarius Executive Program Manager: Faye M Herrig Content Project Manager: Mary Jane Lampe Buyer: Sandy Ludovissy Content Licensing Specialist: Ann Marie Jannette Cover Designer: Studio Montage Cover Image: ©Erica Simone Leeds Compositor: SPi Global Typeface: 10/12 STIX MathJax Main–Regular Printer: Quad/Graphics All credits appearing on page or at the end of the book are considered to be an extension of the copyright page Library of Congress Cataloging-in-Publication Data Brueggeman, William B    Real estate finance and investments / William B Brueggeman, Ph.D., Jeffrey D Fisher, Ph.D.—Fifteenth edition      pages cm    ISBN 978-0-07-337735-3 (alk paper)   Mortgage loans—United States Real property—United States—Finance I Fisher, Jeffrey D II Title   HG2040.5.U5B78 2016   332.7'2—dc23 2015015605 The Internet addresses listed in the text were accurate at the time of publication The inclusion of a website does not indicate an endorsement by the authors or McGraw-Hill Education, and McGraw-Hill Education does not guarantee the accuracy of the information presented at these sites www.mhhe.com Preface Introduction to Real Estate Finance and Investments This book prepares readers to understand the risks and rewards associated with investing in and financing both residential and commercial real estate Concepts and techniques included in the chapters and problem sets are used in many careers related to real estate These include investing, development financing, appraising, consulting, managing real estate portfolios, leasing, managing property, analyzing site locations, managing corporate real estate, and managing real estate funds This material is also relevant to individuals who want to better understand real estate when making their own personal investment and financing decisions The turmoil in world financial markets during the late 2000s, which was closely tied to events in the real estate market, suggests that investors, lenders, and others who participate in the real estate market need to better understand how to evaluate the risk and return associated with the various ways of investing and lending This requires an understanding of the legal issues that can impact the rights of lenders and investors, the characteristics of the various vehicles for lending and investing in real estate, the economic benefits of loans and investments, and how local economies may affect the investment performance of properties as well as the goals of lenders and investors This book is designed to help both students and other readers understand these many factors so that they can perform the necessary analysis and make informed real estate finance and investment decisions As the book’s title suggests, we discuss both real estate finance and real estate investments These topics are interrelated For example, an investor who purchases a property is making an “investment.” This investment is typically financed with a mortgage loan Thus, the investor needs to understand both how to analyze the investment and how to assess the impact that financing the investment will have on its risk and return Similarly, the lender, by providing capital for the investor to purchase the property, is also making an “investment” in the sense that he or she expects to earn a rate of return on funds that have been loaned Therefore, the lender also needs to understand the risk and return of making that loan In fact, one of the risks associated with making loans secured by real estate is that, if a borrower defaults, the lender may take ownership of the property This means that the lender also should evaluate the property using many of the same techniques as the investor purchasing the property Organization of the Book From the above discussion it should be clear that many factors have an impact on the risk and return associated with property investments and the mortgages used to finance them This is true whether the investment is in a personal residence or in a large incomeproducing investment such as an office building Part I begins with a discussion of the legal concepts that are important in the study of real estate finance and investments Although a real estate investor or lender may rely heavily on an attorney in a real estate transaction, it is important to know enough to be able to ask the right questions We focus only on those legal issues that relate to real estate investment and financing decisions Part II begins with a discussion of the time value of money concepts important for analyzing real estate investments and mortgages These concepts are important because real estate is a long-term investment and is financed with loans that are repaid over time This leads to a discussion of the primary ways that mortgage loans are structured: fixed v rate and adjustable rate mortgage loans vi  Preface Part III considers residential housing as an investment and covers mortgage loan underwriting for residential properties This is relevant for individuals making personal financial decisions, such as whether to own or rent a home, as well as for lenders who are evaluating both the loan and borrower Part IV covers many topics related to analyzing income property investments We provide in-depth examples that include apartments, office buildings, shopping centers, and warehouses Many concepts also may be extended to other property types These topics include understanding leases, demonstrating how properties are appraised, how to analyze the potential returns and risks of an investment, and how taxes impact investment returns We also consider how to evaluate whether a property should be sold or renovated Finally, we look at how corporations, although not in the real estate business per se, must make real estate decisions as part of their business This could include whether to own or lease the property that must be used in their operations, as well as other issues While the first four parts of this book focus on investing or financing existing properties, Part V discusses how to analyze projects proposed for development Such development could include land acquisition and construction of income-producing property of all types to acquisition of land to be subdivided and improved for corporate office parks or for sale to builders of residential communities This section also includes how projects are financed during the development period Construction and development financing is very different from the way existing, occupied properties are financed Part VI discusses various alternative real estate financing and investment vehicles We begin with joint ventures and show how different parties with specific areas of expertise may join together to make a real estate investment We use, as an example, someone with technical development expertise who needs equity capital for a project A joint venture is created with an investor who has capital to invest but doesn’t have the expertise to the development We then provide a financial analysis for the investment including capital contributions from, and distributions to, partners during property acquisition, operation, and its eventual sale In this section, we also discuss how both residential and commercial mortgage loan pools are created We then consider how mortgage-backed securities are (1) structured, (2) issued against such pools, and (3) traded in the secondary market for such securities This also includes a discussion of the risks that these investments pose Part VI also includes a discussion of real estate investment trusts (REITs) These public companies invest in real estate and allow investors to own a diversified portfolio of real estate by purchasing shares of stock in the company Finally, in Part VII, we discuss how to evaluate real estate in a portfolio that also includes other investments such as stocks and bonds This includes understanding the ­diversification benefits of including real estate in a portfolio as well as ways to diversify within the real estate portfolio (including international investment) This is followed by a new chapter on real estate investment funds that are created for high net worth individuals and institutional investors We discuss different fund strategies and structures and how to analyze the performance of the funds relative to various industry benchmarks Wide Audience From the above discussion, one can see that this book covers many topics Depending on the purpose of a particular course, all or a selection of topics may be covered If desired, the course also may emphasize either an investor’s or a lender’s perspective Alternatively, some courses may emphasize various industry segments such as housing and residential real estate, commercial real estate, construction and development, mortgage-backed securities, corporate real estate, or investment funds In other words, this book is designed to allow flexibility for instructors and students to cover a comprehensive range of topics or to focus only on those topics that are most important to them Preface  vii Changes to the Fifteenth Edition In addition to updating material throughout the text, we are particularly proud to introduce a new chapter in this edition Chapter 23 provides extensive coverage of real estate investment funds These funds now play a major role in the ownership of both residential and commercial real estate Typically, these funds are created by professional investment managers and private equity firms that offer opportunities to high net worth investors, pension plan sponsors, and other institutional investors to invest in professionally managed portfolios of real estate How these funds are structured, operated, and evaluated are among the important topics covered in this new chapter Another important addition is a new concept box in Chapter 18 that summarizes the new SEC regulations resulting from the “JOBS Act” which allow for “crowd funding” to raise capital for real estate investments The new regulations now allow the Internet to be used to reach investors which is expected to result in a significant increase in investment from individuals that was not previously available This edition also introduces a new cloud-based, lease by lease, discounted cash flow program It is designed to investment analysis and valuation of real estate income property investments, as discussed below Excel Spreadsheets and REIWise Software This book is rigorous yet practical and blends theory with applications to real-world problems These problems are illustrated and solved by using a blend of financial calculators, Excel spreadsheets, and specialized software designed to analyze real estate income property Excel spreadsheets, provided on the book’s Web site at www.mhhe.com/bf15e, are an aid for students to understand many of the exhibits displayed in chapters throughout the text By modifying these exhibits, students also may solve many end-of-chapter problems without having to design new spreadsheets Students can also register online to get free access to a cloud-based real estate valuation program called REIWise We chose this program for this edition of the book because it is very easy and convenient to use by anyone with an Internet connection (including iPads and other mobile devices) REIWise is used in several chapters to supplement the use of Excel spreadsheets when doing investment analysis and solving valuation problems Once students (or professors) register, they will also have access to data files that replicate examples in the book Students can register at the following website: www.reiwise.com/edu Internet Tools and Assets Making informed real estate investment and financing decisions depends on being able to obtain useful information Such information may include national and local market trends, interest rates, and properties available for acquisition, financing alternatives, and the opinions of experts concerning the outlook for various real estate sectors The Internet provides a rich source of information to real estate investors and lenders Knowing how to find information on the Web is an important part of the “due diligence” that should be done before making any real estate investments This edition includes a number of Web App boxes that provide exercises that require finding relevant information on the Internet These Web App boxes provide practical examples of the types of data and other resources that are available on the Internet The fifteenth edition also contains Web site references that students can use to research various real estate topics In addition to research, these resources provide readers with an opportunity to remain current on many of the topics discussed in the book viii  Preface The book’s Web site, located at www.mhhe.com/bf15e, contains additional helpful materials for students such as Web links, multiple-choice quizzes, Excel spreadsheets, and appendixes to the text Using a password-protected instructor log-in, instructors can find a solutions manual, test bank, and PowerPoint presentations Supplements Several ancillary materials are available for instructor use These include: ∙ Solutions Manual—developed by Jeffrey Fisher and William Brueggeman ∙ Test Bank—developed by Scott Ehrhorn, Liberty University ∙ PowerPoint slides—developed by Joshua Kahr, Columbia University Acknowledgments We would like to thank several people who contributed to recent editions by either being a reviewer or providing feedback to us in other ways that helped improve the current edition: Edward Baryla East Tennessee State University Robert Berlinger, Jr University Institute of Technology Roy T Black Georgia State University Thomas P Boehm University of Tennessee-Knoxville Thomas Bothem University of Illinois at Chicago Wally Boudry University of North Carolina-Chapel Hill Grace Wong Bucchianeri Wharton School, University of Pennsylvania Brad Case NAREIT Ping Cheng Florida Atlantic University Joe D’Alessandro Real Estate Insights Ron Donohue Homer Hoyt Institute John Fay Santa Clara University Michael Fratantoni Georgetown University Eric Fruits Portland State University Deborah W Gregory University of Arizona Arie Halachmi Tennessee State University (USA) Sun Yat-Sen University (China) Barry Hersh NYU-SCPS Real Estate Institute Samuel Kahn Touro College Joshua Kahr Columbia University W Keith Munsell Boston University Michael Schonberger Rutgers University-New Brunswick Tracey Seslen University of Southern California Rui Shi L&B Realty Advisors Carlos Slawson Louisiana State University Jan Strockis Santa Clara University Preface  ix Several people played an important role in providing comments to help revise the current edition Brad Case with the National Association of Real Estate Investment Trusts (NAREIT) and Ron Donohue with the Homer Hoyt Institute helped revise the chapter on real estate investment trusts Joe D’Alessandro and Rui Shi helped with the revision of the new chapter on real estate funds Rhea Thornton with FNMA provided comments on the chapter that discusses underwriting residential loans Susanne Cannon with Megalytics helped with a new insert on Crowd Funding Heather Hofmann helped in the preparation and submission of the manuscript Much of the material in the current edition benefited from many people who provided input into previous editions Youguo Liang at ADIA provided significant input on the structure of joint ventures Charles Johnson and Aaron Temple helped with Web references Jacey Leonard helped prepare the Excel templates for the previous edition that were used in this edition Anand Kumar helped with Web references and spreadsheets Ji’ Reh Kore helped with research on recent trends impacting the real estate finance industry, as well as with the preparation of the Solutions Manual Deverick Jordan and Diem Chau also helped with the Solutions Manual and with chapter exhibits Nathan Hastings helped update the legal chapters and provided input on the ownership structures used for real estate We will miss the late Theron Nelson, who contributed to prior editions of the book, including creating the original version of several of the spreadsheet templates We appreciate his contributions to this book and to the real estate profession Our thanks to the book team at McGraw-Hill Education for their help in developing the new edition: Chuck Synovec, Michele Janicek, Jennifer Upton, Melissa Caughlin, M Jane Lampe, James Heine, Lynn Breithaupt, Douglas Ruby, and Kevin Shanahan We also continue to be ­indebted to people who have contributed as authors to previous editions, especially the late Henry E Hoagland, who wrote the first edition of this book, and the late Leo D Stone, who participated in several editions Finally, we thank all of the adopters of previous editions of the book, who, because of their feedback, have made us feel that we have helped them prepare students for a career in real estate William B Brueggeman Jeffrey D Fisher www.downloadslide.net 800  Index NAREIT Index, 697, 724, 725 See also Portfolio theory; Real; Real estate investment performance NASAA (North American Securities Administrators Association), 615, 617 NASDAQ (National Association of Security Dealers Automated Quotation), 725 National Association of Home Builders (NAHB), 197 National Association of Real Estate Investment Trusts (NAREIT) See also Portfolio theory; Real estate investment performance appeal of equity trusts, 695–697 data sources, 724–725 funds from operations (FFO), 700–702, 719 property types, 694 National Association of Realtors (NAR), 193 National Association of Security Dealers Automated Quotation (NASDAQ), 725 National Council of Real Estate Investment Fiduciaries (NCREIF), 725–727, 729, 731, 741 See also Portfolio theory; Real estate investment performance National Council of Real Estate Investment Fiduciaries (NCREIF) Index, 774, 775 National Housing Act (1934), 224n1 NAV (net asset value), 704, 717–718 NCREIF (National Council of Real Estate Investment Fiduciaries), 725–727, 729, 731, 741 See also Portfolio theory; Real estate investment performance NCREIF Index, 726, 727, 729, 731 See also Portfolio theory; Real estate investment performance Negative amortization in accrual loans, 418–420 adjustable rate mortgage (ARM) loans, 138–140 defined, 116, 126 graduated payment mortgage (GPM) loans, 180–182 in loan underwriting, 232 Negative amortizing loans, 84, 90, 90–91 See also Amortization patterns; Fixed rate mortgages (FRMs) Negative (unfavorable) financial leverage, 397, 397–398 Negotiated markets, 731 Neighborhoods See Submarkets Nelson, Grant S., 7n6, 24n7 Net asset value (NAV), 704, 717–718 Net income from operations, 714 Net leases, 270, 272–275 Net operating income (NOI), 761 See also Discounted present value method capitalization rate, 301–302 defined, 301, 359 forecasts, 305–306 net income from operations vs., 714 projections, apartment example, 329–330 Net present value (NPV), 544–548, 578–579 See also Present value (PV) New York Stock Exchange (NYSE), 692, 725 NOI See Net operating income (NOI) Nominal interest rate, 78, 78–79, 81 See also Equivalent nominal annual rate (ENAR) Nonconforming mortgages, 223 Noncumulative pari passu distribution, 590 Nondilution clauses, 286 “Non-disturbance” clauses, 267 Nonfinite-life REITs, 695 Non-operating expense pass throughs, 269 Nonpossessory interest, Nonrecourse clause, 17, 404, 534 Nonresidential properties, 253, 253–254, 260–261 See also Incomeproducing properties; Leases North American Industry Classification System (NAICS), 195, 379–381 North American Securities Administrators Association (NASAA), 615, 617 Note, promissory, 18 Notes, 16–19 See also Loan(s) NPV (net present value), 544–548, 578– 579 See also Present value (PV) Nuisance calls, 637 Number of payments, 246 NYSE (New York Stock Exchange), 692, 725 O Occupancy dates, 266 Occupancy rates (vacancies) See also Market analysis collection losses, 302 leased vs occupied space, REITs, 710 property acquisition, 263–264 rent forecasting, 252–256, 436 vacancy-collection loss ratio, 542, 543 Occupied vs leased space, REITs, 710 Off-balance-sheet financing, 507–508, 673 Office buildings cash flow projections for, 356–361 demand forecasts for, 379–381 income potential from owning, 262–264 REITs, 694, 695 rent example, 277–281 space per employee in, 349–352 supply and demand for, 257, 351–352 See also Vacancies types of, 253, 254 Office of Federal Housing Enterprise Oversight, 198 Office of Management and Budget, U.S., 195 Open-end diversified core equity (ODCE) Index, 774, 775 Open-end mortgage, 22 Open-ended construction lending, 526 Operating cycles, 303 Operating expense ratio, 543, 544 Operating income, tax on, 367–372 Operating leases, 507 Operations, sharing cash flow from, 590–593, 599–602 Opportunistic investing, 349 Opportunity cost, in incremental borrowing, 150 Opportunity funds, 754–757 Optimal holding period, 467 Optimal size of cities, 198, 198, 200, 200 Option agreements, 556, 556–558 Option contracts, 214–216 Optional delivery program, 627 Ordinary annuity, 57n3 Organizational forms, 583–621 C corporations, 587–588, 694 corporations, 587–588 joint ventures (JVs), 588–596 liability issues, 583–584, 587–588 limited liability companies (LLCs), 586–587 limited liability partnerships (LLPs), 585–586 limited partnerships (LPs), 374, 375, 585, 597 partnerships See Partnerships S corporations, 588 sole proprietorships, 583–584 syndicates, 596–617 terms and exercises, 618–621 types of, 583 Web resources, 607–609, 618 Origination fees, 151, 151–152 Other income, in direct capitalization method, 302 Overage, 442 Overage provisions, 542n10 Overage rent, 268, 284, 284–285 www.downloadslide.net Index  801 Overcollateralization, 650, 653, 673, 678 See also Collateralized mortgage obligations (CMOs) Overdevelopment cycles, 345 Overimprovement, 203 Owner services, 267 See also Leases Owner’s policy, 12 Ownership, 494n2 See also Leaseversus-own analysis; Lessor; Organizational forms Ownership flowchart, legal, Ownership rights, P PAC (planned amortization class) tranches, 664 PAL (passive activity loss limitation), 374–375 Parking ratio, 519 Partially amortizing loans, 84, 88–89, 91–92 See also Amortization patterns; Fixed rate mortgages (FRMs) Participation certificate (PC) program, 633n11, 634 Participations See Equity participation loans Parties to foreclosure suits, 34–35 Partitioning the IRR, 436, 436–437 See also Internal rate of return (IRR) Partnerships, 606–611 See also Organizational forms allocations in, 606 capital accounts and gain chargebacks, 607–609 limited, in private/public syndicates, 609–611 types of, 374–375, 584–586 Passive activity loss limitation (PAL), 374–375 Passive income/loss, 373–374, 373–375 Passive investment, 773n8 Pass-through method, 638, 673, 699 See also Mortgage pass-through securities (MPTs) Pay rate, 83, 418 Payment of loans See also Financing; Loan(s) adjustable rate mortgage (ARM) loans, 125–128, 136–141 amortization See Amortization patterns biweekly, 160–161 early, 150–151, 157–159, 161–163 Federal Truth-in-Lending (FTL) Act impact, 244–249 mortgage pass-through securities (MPTs), 635 notes, 16–18 prepayment See Prepayment RESPA requirements, 240–244 Payment shock, 130, 231n6 Payment-to-income ratio, 221, 228 See also Underwriting Pay-through method, 699 PC (participation certificate) program, 633n11, 634 Peiser, Richard B., 606n12 Penalties, 17 Pending home sales, 193 Pending/threatened matters review, 433 Percentage rent, 268, 442, 541–542, 542 Percentage rent lease, 284, 284–285 Periodic tenancy See Estate from year to year Permanent financing, 526, 534–535, 540, 540 Permits, 517, 518, 520 See also Project development Personal property, Personal property review, 434 Personalty, vs realty, 1–2 Pest inspection certificates, 240 Peter O Dietz, 765n4 PGI (potential gross income), 300, 302 Physical depreciation, 205, 324–326 Physical deterioration, 323, 323 Physical inspections, 434 Pivo, Gary, 742n1 PLAM (price level adjusted mortgage), 122, 122–124 Planned amortization class (PAC) tranches, 664 Plat, 559 Pledge of property (encumbrance), 6–7 PMI (private mortgage insurance), 230 PO strips, 668–671, 669, 672 Points, 95, 188, 369 Police power, 13 Pool factor, 639, 639 Population, 184, 382–383 Porter, David M., 494n1 Portfolio income/loss, 374, 374–375 Portfolio theory, 731–749 See also Real estate investment performance calculating returns, 733 diversification potential See Diversification hedging risk, 748 introduction to, 731–733 risk, 736 risk/return weighting, 736–737 Positive (favorable) financial leverage, 394, 394–400 Possession and estates, 4–7 Potential gross income (PGI), 300, 302 Preferred distribution, 590, 590–591 Preferred equity, 424, 680 Preferred return, 590, 590–591 Premiums, title insurance, 11–12 Prepackaged bankruptcy, 30 Prepayment adjustable rate mortgage (ARM) loans, 126 assumptions, 642–644 collateralized mortgage obligations (CMOs), 656–659, 661–663 Federal Truth-in-Lending (FTL) Act impact, 246 illustration, 644–645 security price affected by, 641 Prepayment penalties defined, 100 in note, 17 reasons for, 100–101 security pricing, 641n16 underwriting, 230 Prepayment risk See also Payment of loans collateralized mortgage obligations (CMOs), 672 commercial mortgage-backed securities (CMBSs), 675 defined, 80 loan pools affected by, 637, 651, 673 penalties, 17, 230 Present value (PV), 49–56 See also Discounted present value method; Net present value (NPV) calculators in finding, 49–52, 54–56 defined, 43 in effective rent calculation, 273, 275–276 illustration, 52–54 in investment analysis, 362 net, 544–548, 578–579 table, 54 Present value of an annuity (PVA), 60, 60–64 Preservation of property, mortgage clause for, 21 Price and pricing collateralized mortgage obligations (CMOs), 659–663 disclosure of, 723–724 fixed rate mortgages (FRMs), 102–103 in foreclosure sales, 32 as investment motivation, 343, 344 land development, 565–567 mortgage pass-through securities (MPTs), 637–639, 641–642, 645–647 mortgage-backed bonds (MBBs), 629–632 multifamily housing, 384 projecting, 360–361 single family housing, 183–184 See also Housing supply Price compression, 646 Price level adjusted mortgage (PLAM), 122, 122–124 www.downloadslide.net 802  Index Prime borrowers, 664 Principal, 84 Principal only tranches, 668–671 Private investments, vs public, 740–741 Private mortgage insurance (PMI), 230 Private offerings, 597, 610, 611 Private REITs, 694 Private syndicates, 610 See also Syndication Profit ratio, 473, 473–476 Profit sharing, 589–590 Profitability, 208, 544–548, 579–580 Project development, 517–553 See also Land development cost and cash flow projections, 541–544 description and cost example, 535–540 financing overview, 525–526 income-producing property, 521–525 interim loan closings, 533–534 land development vs., 554 See also Land development loan contingencies, 530–531 loan disbursement methods, 532 loan interest rates and fees, 533 loan overview, 531–533 loan submission requirements, 528–530 market data and tenant mix, 540–541 permanent loan closings, 534–535 phases of, 521 planning and permitting, 517–520 profitability projections, 544–548 sensitivity and feasibility analyses, 548–549 terminology, 518–520 terms and exercises, 550–553 Web resources, 549, 550 Promissory note, 18 Promote, 591 Proof of ownership, Property See also specific types basic concepts of, covered by mortgages, 23–24 diversification by type of, 741, 743–744 held for resale vs investment, 366–367 See also Disposition income from sale of, 372 investing based on size of, 348 Property rights, 2, 2–6, 13–14 Property survey review, 433 Property taxes See also Tax issues abatement, 519 in default, 36–37 mortgage clauses, 20 proration of, 238–240, 244 Property values, 192, 194, 195, 206, 310–311 See also Housing supply; Single family properties Prorated property taxes, 238, 244 PSA prepayment model, 643, 643–644 Public goods, 197, 198 Public investments, vs private, 740–741 Public non-listed REITs, 694, 697–700 Public offerings, 598n9, 600n11, 610, 611 Public Securities Association, 643–644 Public syndicates, 597–598, 610 Purchase-money mortgages, 18, 25, 167 Purchase-only house price index (HPI), 193 Put options, 404 PV See Present value (PV) PVA (present value of an annuity), 60, 60–64 Q Qualified escrow accounts, 479 Qualified intermediaries, 479 Qualified mortgages, 683 Qualified reserve funds, 683 Qualified trusts, 479 Quarterly compounding intervals, 46 See also Time value of money (TVM) Quitclaim deed, 8, 10 R Radius clauses, 286 RAMs (reverse annuity mortgages), 105, 105–106 Rate of return See also Internal rate of return (IRR); Investment analysis; Returns; Yields comparison of, 429–430 defined, 65 as investment motivation, 343, 344 in lease-versus-own analysis, 498 risk and variable, 437–441 Ratio analysis, 730–731, 733–737 See also Debt coverage ratio (DCR); Loanto-value ratio corporate real estate affecting, 506–507 housing expense ratio, 228 payment-to-income ratio, 221, 228 in portfolio theory, 736–737 profit ratio, 473–476 project development, 542, 543 REITs, 714 risk-adjusted returns, 736–737 Real estate See also specific topics defined, industry characteristics, 344 overview, 1–2, Real estate commission, 240 “Real estate cycle,” 344, 344–346 Real estate investment funds acquisition fees, 759 appraisals, 757–758 benchmarks See Benchmarks calculating returns See calculating returns capital committed vs invested, 760 core funds, 754–757 debt, 758–759 disposition fees, 759 fees based on NOI, 761 full discretion, 756 fund management, 759 funds flow, 763–764 investment advisors, 753 investor goals and objectives, 754 leverage, 758–759 management fees, 759–760 opportunity funds, 754–757 pension plans, 753 performance fees, 761 performance returns report, 762 separate account, 758 strategies for, 752–753 terms and exercises, 784–787 value-added funds, 754–757 Real estate investment performance, 723–751 See also Investment analysis data sources, 724–726 holding period returns, 727–729 nature of data on, 723–724 portfolio theory, 723–751 by property type and location, 744, 745 retail example, 748–749 return patterns, 726, 727 risk-return relationship, 729–731 See also Investment analysis socially responsible, 742–743 terms and exercises, 750–751 Web resources, 741, 743, 750 Real estate investment trusts (REITs), 690–722 capital structure of, 703–704 data sources, 724–725 defined, 690 equity See Equity REITs expansion and growth, 702, 704–706 funds from operations (FFO), 700–702 hybrid, 694 largest U.S., 696 legal requirements, 690–694 limited partnerships in, 597–598 mortgage, 694, 711–713 private, 694, 697, 700 qualification failure, 693 subsidiaries, 693–694 tax treatment, 690–694, 698–699 terms and exercises, 720–722 U.S vs international, 698–699 valuation of, 716–719 Web resources, 719, 720 www.downloadslide.net Index  803 Real estate mortgage investment conduits (REMICs), 673, 682, 682–684 Real estate owned (REO) lists, 208, 208–209 See also Distressed properties Real Estate Review, 365–366, 606n12 Real Estate Settlement and Procedures Act (RESPA, 1974), 240–244 Real options, 452, 452–455 Real property, 2, Real rate of interest, 78, 78–79 Realty, vs personality, 1–2 Recasting mortgages, 27 Recording acts, 11n10, 12, 12–13 Recording fees, 240 Recording requirements, 24, 26 Recourse See “With recourse” (loans) Recoveries, 268–271, 285 Recovery of capital (ROC), 715 Recreational real estate, 254 Redemption, 32 Redevelopment, income from, 702 Referral fees, RESPA on, 241–242 Refinancing See Loan refinancing Regulation D of Securities Act (1933), 610, 617 Rehabilitation investment tax credits, 487–489, 489 See also Renovation Reinstatement, borrower’s right to, 21 Reinvestment rate, 467 REIT Modernization Act (RMA, 1999), 693 REITs See Real estate investment trusts (REITs) REIWise, 385–392 Release fees, 240 Release of lien, 18 Release price, 573, 573–575 Release schedule, 561 Remainder, REMICs (real estate mortgage investment conduits), 673, 682, 682–684 Renewal options, 709–710 Renewal probability, 446, 446–447 Renovation, 484–489 Rent forecasting, 352–356, 446 lease rollover increasing, 709 straight-line, 708 terms of, 266, 268 See also Leases Rent roll analysis, 433 Rentable area, 271, 278 Rental income at full occupancy, 302 Rental properties, 184–191 See also Income-producing properties; Leases REO (real estate owned) lists, 208, 208– 209 See also Distressed properties Repair and maintenance, 302 See also Improvements Replacement cost, 325, 325–326, 360 Repurchase agreements, 678 Required internal rate of return, 306, 306–307 Resale price, 310–311 Reset date, 126, 129 Residential properties See also Incomeproducing properties; Single family properties defined, 252–254 financing See Loan closing income potential from owning, 262–264 in mortgage pools See Mortgage backed securities REITs, 694, 695 supply and demand factors, 257 taxation of, 366 underwriting See Underwriting Residual, 654, 656 Residual equity, 680 Residual income, 233 Residual land value, 312, 312–313 Residual value, 499–501, 500 Resort REITs, 695 RESPA (Real Estate Settlement and Procedures Act, 1974), 240–244 Responsibility for expenses, 261–262, 267 Responsible property investing (RPI), 742–743 Restructuring, 27–28, 509 See also Workouts Retail properties CAM expenses in, 270, 271, 285 forecasting demand for, 382–383 income potential from owning, 262–264 project development example, 535–544 REITs, 694, 695, 710–711 rent example, 283–287 risk analysis case study, 441–445 supply and demand factors, 257 types of, 253, 254 Return on equity, 542, 543 Returns, 729–731, 736–737 See also Rate of return risk-adjusted, 729–731, 736–737 in risk-return comparison, 429–430 variable, 437–441 Revenue, rent based on, 268 Reverse annuity mortgages (RAMs), 105, 105–106 “Reverse Starker” strategy, 478 Reversion, Reversion value, 307, 307–312 Revitalization, urban, 743 Right of entry mortgage clause, 20–21 Right of first refusal, 279 Right to reinstate, 21 Right-of-way line, 518 Rights See Legal concepts and considerations; Property rights Risk amortization patterns and, 92 commercial mortgage-backed securities (CMBSs) ratings, 677–679 contraction, 672 of default See Default; Default risk in effective rent calculation, 273, 275–276 extension, 672, 675 interest rates and, 79–80 See also Interest rate risk joint ventures for sharing, 589 lease renewal, 444, 446 in lease-versus-own decisions, 504 leverage link to, 402–404, 449–452 loans in distributing, 393 in supply and demand analysis, 256–257 types of, 430–432 Risk analysis, 429–455 See also Investment analysis; Market analysis; Supply and demand analysis due diligence in, 432–434 industrial case study, 447–451 investment return comparison, 429–430 market leasing assumptions, 446–447 partitioning the IRR, 436–437 in performance measurement, 729–731 in portfolio theory, 733–737 project development, 524–525, 548–549 real options approach, 452–455 retail case study, 441–445 sensitivity analysis in, 432, 434–436 terms and exercises, 456–458 variable returns in, 437–441 Web resources, 454, 456 Risk premiums, 131–133, 729 Risk-adjusted returns, 729–731, 736–737 Risk-to-reward ratio, 730–731 RMA (REIT Modernization Act, 1999), 693 ROC (recovery of capital), 715 Rockefeller Group, 509 RPI (responsible property investing), 742–743 S S corporations, 588 See also Organizational forms Safe harbor rules, 478–479, 610 Salaries, in direct capitalization method, 302 Sale price, projecting, 360–361 See also Disposition www.downloadslide.net 804  Index Sale-leaseback, 509, 509–512 Sale-leaseback of the land, 414, 414–416, 422–424 Sales comparison approach See also Appraisals defined, 199, 200, 297 income approach vs., 317 process of, 199–206, 297–299 Sales per square foot, 710–711 Sales performance, rent based on, 268 Sales, sharing cash flow from, 591–592, 594, 600–602 Sarbanes-Oxley law of 2002, 697, 711 Scaling, 666, 666–668 Scenarios, 434–436, 435 Seasoned property, 522 Seasoning, of loans, 636 SEC (Securities and Exchange Commission), 600n11, 692, 711 Second homes, taxes on, 188 Second mortgages defined, 24 home equity loans as, 168–169 incremental borrowing vs., 152, 153 shorter maturities on, 166–167 Secondary mortgage market, 622–689 See also Mortgage backed securities CMOs See Collateralized mortgage obligations (CMOs) collateralized debt obligations (CDOs), 665, 679–683 commercial mortgage-backed securities (CMBSs), 674–679 comparison of mortgage-backed securities, 671–674 defined, 622 derivatives, illustrated, 649, 665–671 duration, measurement of, 687–689 federal government influencing, 20, 625–626 history of, 622–624 mortgage pass-through securities (MPTs), 632–647 mortgage pay-through bonds (MPTBs), 649–650, 672–673 operation of, 626–628 payment illustration, 639 and REMICs, 673, 682–684 terms and exercises, 647–648, 684–687 Web resources, 647, 684–685 Section 453 (1), Internal Revenue Code (IRC), 472 Section 1031, Internal Revenue Code (IRC), 477, 477–479 Section 1221, Internal Revenue Code (IRC), 473n4, 477 Section 1231, Internal Revenue Code (IRC), 473n4, 477 Sector investing, 346 Secured interest, 2, 6–7, 18 Securities Act (1933), 610, 617 Securities and Exchange Commission (SEC), 600n11, 612, 614, 692, 711 Securities Commission Act (1934), 711 Securities Exchange Act (1934), 617 Securities, risk from, 430 See also specific securities Security interest, FTL on, 246 Seisin, 19n2 Self storage REITs, 695 Self-liquidating REITs, 695 Seller financing, 24, 24–25, 204, 473 Semiannual compounding intervals, 46 See also Time value of money (TVM) Senior tranches, 674, 674–676 Sensitivity analysis defined, 434, 434 land development, 580 project analysis, 548–549 in risk analysis, 432, 434–436 Separate account, 758 Sequential payout tranche, 652 Service/maintenance agreement review, 433 Services, REIT income from, 705 Servicing fee, 638 Setback/building line, 518 Settlement costs, RESPA on, 240 Settlement of closing statements, 236–237, 241 7/1 hybrid ARM loans, 127–128 SFF (sinking-fund factor), 65 Sharpe ratio, 779, 780 Sheriff’s deed, 10 Shopping Center Development Handbook Series (Urban Land Institute), 542n10 Shopping centers See Retail properties Short sale, 30, 30–31 Signage clauses, 260, 279, 286 Single family properties, 183–219 See also Housing supply; Residential properties distressed properties, 207–215 economic influences on, 184, 257 employment related to, 184–185 expected appreciation of, 191–195 location quotients, 195–196 pricing and valuation, 183–184, 199–206 renting vs owning, 185–190 terms and exercises, 215–219 U.S perception of, 183 Web resources, 193–194, 197, 198, 216 Single net leases, 270 Single receipts, investments with, 65–68 Sinking fund retirements, 632n10 Sinking-fund factor (SFF), 65 Site plans, 519, 565–567 Social equity, 743 Social Investment Forum, 743 Socially responsible investment (SRI), 743 Soft costs, 525, 538, 591n4 Sole proprietorships, 583, 583–584 See also Organizational forms S&P (Standard & Poor’s) 500 Index of Common Stocks, 725–727, 729 S&P Case-Shillerr (CS) Housing Price Index, 194 S&P (Standard & Poor’s) Corporation, 629n4, 629n7 Space per employee, 349, 349–352 Space requirements, in lease-versus-own decisions, 503 Special allocations, 600, 600 Special purpose buildings, 504–505, 505 Special sales tax districts, 519–520 Special warranty deeds, 8, 10, 209 Specialty REITs, 695 “Specified property,” 616 Speculation, and joint ventures, 589 Speculative construction lending, 526 Spread, 126 Spreadsheets, 50, 118n7 SRI (socially responsible investment), 743 Stacking plans, 520 Standard & Poor’s (S&P) 500 Index of Common Stocks, 725–727, 729 Standard & Poor’s (S&P) Corporation, 629n4, 629n7 Standard deviation of the mean return, 439, 728–731 See also Portfolio theory Standby commitments, 529, 529–530 Starker philosophy, 478–479 State Securities Commission, 753n1 Statements of operating cash flow See Cash flow statements Statute of Frauds and Perjuries (1677), 1n1 Statutory costs, 240 Statutory redemption, 32 Step-up rents, 268 Stocks, risk from, 430 Straight-line rent, 708 “Subject to” the mortgage, 23 Subletting, 266 Submarkets, 197, 198, 199, 199–206 See also Housing supply; Single family properties Subordinated tranches, 674, 674–676 Subordination clause, 22 Subprime borrowers, 664–665, 692 Subsidiaries, REIT, 693–694 Substantial economic effect, 606 Substitute basis, in tax-deferred exchanges, 480–481 Sunk costs, 159n9 Super floating rate tranche, 668 Supply and demand analysis, 254–260 See also Investment analysis; Market analysis; Risk analysis www.downloadslide.net Index  805 equilibrium market rental rate, 254–256 income potential and, 262–263 local market, 257–258 See also Metropolitan statistical areas (MSAs) location and user-tenants, 258–260 in property valuation, 317–319 risk implications, 256–257 Supporting industries, 195 Surety bonds, 678 “Swap” program, 633n11 Swaps See Interest rate swaps Syndication, 596–617 See also Organizational forms capital accounts, 602–609 defined, 596 illustration, 598–602 limited partnerships in, 598, 609–611 overview, 596–597 regulation of, 615–617 Synthetic leases, 512 T TAC (targeted amortization class), 664 “Take downs,” reverse annuity mortgages (RAMs), 105–106 Take-out commitments, 526, 529 See also Project development Targeted amortization class (TAC), 664 Taubman Realty, 692 Tax increment financing (TIF), 519 Tax issues See also Internal Revenue Service (IRS) after-tax effective interest rates, 179–182 borrower income assessment, 226 as borrowing motivation, 393–400 corporate, 587, 588 due diligence review, 434 early loan repayment, 163n14 foreclosure and default, 36 home rental vs purchase comparison, 186–190 housing demand affected by, 184 income approach, 302 income-producing properties See Taxation of income-producing properties lease-versus-own decisions, 505 legislation, 370, 373–374 See also Tax Reform Act (1986) limited liability companies (LLCs), 587 low-income housing credits, 489 mortgage clauses, 20, 36–37 partnerships, 584, 586 project development, 544–548 property disposal, 471–476 See also Tax-deferred exchanges property tax abatement, 519 See also Property taxes rehabilitation investment credits, 487–489 REITs, 690–694, 698–699, 714–715 sole proprietorships, 583–584 special sales tax districts, 519–520 syndicates, 600–606 Tax Reform Act (1986) on capital gains vs income, 368, 546n17 on depreciable life, 509 income and loss categories, 373–375 on limited partnerships, 598 low-income housing credits, 489 in own-vs.-lease decisions, 505 on REMICs, 682 Tax Reform Act (1993), 370, 375 Tax sale, 36 Taxable income, 367 Taxable REIT subsidiaries (TRSs), 693–694 Taxation of income-producing properties, 364–379 after-tax analysis, 370–373 as investment motivation, 344 operating income, 367–372 passive losses, 373–375 property sale, 364–376, 369–370 terms and exercises, 376–379 Web resources, 375–377 Tax-deferred exchanges, 477–484 See also Disposition considerations, 477–478 defined, 477 economics of, 482–484 equity balancing, 480 recognized gains, 479–480, 482 time frames, 479 unrecognized gains, 482 Tax-exempt serial bonds, 660n7 Tax-free exchanges, 472, 598 See also Tax-deferred exchanges T-bills See Treasury securities TDR (transfer of development rights), 520 Teaser rate, 127n5, 129–130, 231n6 Technical default, 26 Tenant improvements (TIs), 266, 304, 447, 707 See also Improvements Tenant mix, 540–541 See also Lessee 1031 exchanges; Tax-deferred exchanges Terminal cap rate, 307, 309–310, 361 Termination notices, 267, 286 Threatened matters review, 433 Tilt effect, 112, 112–113, 123–124 Time See also Occupancy dates in lease agreements, 286 See also Occupancy dates in lease-versus-own decisions, 503–504 mortgage yields and, 99–101 in tax-deferred exchanges, 479 Time, Inc., 509 Time value of money (TVM), 42–76 See also Interest rates accumulation of future sum, 64–65 calculators and spreadsheets, 49–51 compound interest, 42–43 compound or future value, 43–49, 56–60 determining investment yields, 65–73 present value, 52–56, 60–64 See also Present value (PV) terms and exercises, 74–76 Web resources, 51, 74 Time-weighted return (TWR), 768–771 TIs (tenant improvements), 266, 304, 447, 707 See also Improvements Title See also Deeds clouded, 10n9, 11, 13 defined, distressed properties, 210–211, 215 due diligence review of, 433 in foreclosure sale, 34 marketable, 211 “subject to” the mortgage, 23 transferring See Loan closing Title assurance, 7–12 attorney’s opinion of title, 8, 11, 240 deeds, defined, insurance policies, 11–12, 240, 241, 563 methods for, 9–11 Title insurance, 11–12, 240, 241, 563 Title insurance method, 11 Title theory of mortgages, 209–210 Title/deed document review, 433 Total of payments, 246 TRA See Tax Reform Act (1986) Tracking error, 779, 781–782 Trade fixtures, 23n6 Traffic counts, 519 Tranches, 651, 663–664, 672 See also Collateralized mortgage obligations (CMOs) Transfer of development rights (TDR), 520 Transfer of mortgage, 28–29, 29 Transfer of property clause, 21 Transfer tax, 240 TransUnion, 229 Treasury securities as adjustable rate mortgage (ARM) loans pricing index, 126 interest rate on, 533 returns data, 725–727, 729 See also Portfolio theory risk from, 430 Treasury, U.S., 625 Treynor ratio, 779, 781 Triparty buy-sell agreements, 534, 534 www.downloadslide.net 806  Index Triple net leases, 270 Trophy properties, 349 TRSs (taxable REIT subsidiaries), 693–694 Trustee’s deed, 10 Trusts See Real estate investment trusts (REITs) Truth-in-Lending Act, Federal (FTL, 1968), 98, 244–249 Turnaround investing, 348 Turnkey basis, 555 Turnover vacancy, 446 TVM See Time value of money (TVM) TWR (Time-weighted return), 768–771 U ULTA (Uniform Land Transactions Act, 1975), 24 Umbrella partnership REIT (UPREIT), 692, 697 Unanticipated inflation, 80, 121 Under improvement, 204n5 Underwriting, 220–251 borrower asset verification, 227 borrower income, 225–227 closing process, 237–249 compensating factors, 228, 230 credit history assessment, 227–229 default risk, 220–221 defined, 220 housing expense estimate, 228 for income-producing properties, 404–406 of lease tenants, 264 loan classifications, 221–225 other obligations review, 228 process illustration, 231–237 terms and exercises, 249–251 Web resource, 234, 250 Unfavorable (negative) financial leverage, 397, 397–398 Uniform Land Transactions Act (ULTA, 1975), 24 Uniform mortgage form, 20 Uniform Residential Appraisal Report, 200, 201 Uniform settlement statement, 242 Unit of comparison, 299 Unleveraged internal rate of return (IRR), 362 Unlike property, in exchanges, 481 Unrealized equity gains, 191 Unrecognized capital gains, in exchanges, 482 Unseen hazards, 11–12 “Unstated interest rule,” 25n8 “Up fitting,” 442n8 UPREIT (umbrella partnership REIT), 692, 697 Upset price, 32 Urban Land Institute, 542n10 U.S Aggregate Bond Index, 725 U.S Bureau of Economic Analysis, 184, 380 U.S Bureau of Labor Statistics, 184, 349 U.S Census Bureau, 184, 197 U.S Department of Commerce, 184, 197, 380 U.S Department of Labor, 195, 379, 380 U.S Federal Reserve, 185, 227 U.S Office of Management and Budget, 195 U.S Securities and Exchange Commission (SEC), 600n11, 692, 711, 753n1 U.S Treasury, 625 U.S Universal Index, 725 Usable area, 278, 279 User-tenant See Lessee; Tenant mix Usury, 20n4 V VA See Veterans Affairs (VA), Department of Vacancies See also Market analysis collection losses, 302 leased vs occupied space, REITs, 710 property acquisition, 263–264 rent forecasting, 352–356, 446 vacation homes, 188 Vacancy-collection loss ratio, 542, 543 Vacant land, valuation of, 313–314 Vacation homes, 188 Valuation See Appraisals; Investment analysis “Value add” strategy, 349 Value, creating, 521 Value investing, 347, 347–348 Value-added funds, 754–757 Variable rate, FTL on, 246 Variation, coefficient of, 440, 728–731, 730 Veterans Affairs (VA), Department of defined, 224–225 loan prepayment, 641n16 other loan types vs., 236–237 role of, 224–225, 233–235 secondary mortgage market role of, 625 See also Secondary mortgage market Voluntary conveyance, 29, 29–30 W WACs (weighted average coupons), 638 Wall Street Journal, 725 Warehouses See Industrial and warehouse properties Waste, 21n5 Wealth effect, 192 Web resources See also Data sources; Inside book cover adjustable rate mortgage (ARM) loans, 143, 144 appraisals, 330–333 corporate real estate, 512, 513 disposition/renovation, 489, 490 Federal Housing Administration (FHA), 234, 250 financial leverage, 424, 425 financing, 19, 40 financing corporate real estate, 512, 513 financing for land development, 579–581 financing for mortgages, 176 financing, for project development, 549, 550 fixed rate mortgage (FRM) loans, 100, 107 housing statistics, 193–194, 197, 198, 216 income-producing properties, 263 investment analysis, 375–377 land development, 579–581 legal concepts and considerations, 11, 15 leverage, financial, 424, 425 mortgage insurance, 155, 176 mortgage-backed securities, 684, 685 mortgages, 176 organizational forms, 607–609, 618 project development, 549, 550 real estate investment performance, 741, 743, 750 REITs, 719, 720 reverse annuity mortgages (RAMs), 106 risk analysis, 454, 456 secondary mortgage market, 647, 685 single family properties, 193–194, 197, 198, 216 time value of money (TVM), 51, 74 underwriting, 234, 250 Weighted average cost of capital, 500n12, 503, 513–514 Weighted average coupons (WACs), 638 Weighted average maturity, 638–639 Werner, Raymond J., 24n7 Whitman, Dale A., 7n6, 24n7 Wilshire and Associates, 725 “With recourse” (loans), 16 Work letters, 266 Workouts, 26–31, 27, 207n8, 207n8 WorldCom, 711 Wraparound loans, 172, 172–176 X XIRR method, 73–74, 765, 766 www.downloadslide.net Index  807 Y Yield maintenance fee (YMF), 407 Yield to maturity See also Internal rate of return (IRR) duration calculation, 687–689 internal rate of return (IRR) vs., 630n8 mortgage pass-through securities (MPTs), 645–646 mortgage-backed securities, 638 Yields See also Internal rate of return (IRR); Rate of return on adjustable rate mortgage (ARM) loans, 133–134, 141–144 on annuities, 68–70 on convertible mortgages, 420–422 defined, 65, 94n6 ENAR, 70, 72 interest rates vs., 67n6 as land development term, 559 loan time outstanding and, 99–101 partial periods, 72–74 with single receipts, 65–68 YMF (yield maintenance fee), 407 Z Zero amortizing loans, 84, 89–90 See also Amortization patterns; Fixed rate mortgages (FRMs) Zero coupon mortgage-backed securities, 631–632, 650 Zoning, 519–520, 559–560, 567 www.downloadslide.net www.downloadslide.net www.downloadslide.net www.downloadslide.net www.downloadslide.net www.downloadslide.net www.downloadslide.net .. .Real Estate Finance and Investments Real Estate Finance and Investments Fifteenth Edition William B Brueggeman, PhD Corrigan Chair in Real Estate Edwin L Cox School... Estate Finance and Investments This book prepares readers to understand the risks and rewards associated with investing in and financing both residential and commercial real estate Concepts and. .. other three estates 6  Part 1   Overview of Real Estate Finance and Investments Estate for Years: Tenancy for Terms An estate for years is the type of leasehold estate investors and lenders