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Lecture 5


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York University
Administrative Studies
ADMS 3810

LECTURE 5: REAL ESTATE FINANCE Three Types of Financial Markets: 1. Primary Financial Markets – a business that raises capital by selling newly issued securities to the general public or the Canadian government selling a new issue of bonds. 2. Secondary Financial Markets – the Stock and Bond Exchanges. 3. Secondary Mortgage Markets – This market broadens the capital pool for financing real estate allowing many new types of savers and financial intermediaries to invest in real estate. GOVERNMENT ROLE IN REAL ESTATE FINANCE • Banking Regulation • Insurance Regulation • Capital Market Regulation Mortgage – an instrument or agreement used to make real estate security for a debt. It is a two-party instrument between a mortgagor and a mortgagee. Mortgage Amortization – the period in years over which a mortgage debt is paid. Full amortization exists when payments are sufficient to liquidate the loan within the amortization period. Negative amortization occurs if loan payment cover less than principal and interest. Loan Amortization Alternatives: • No Amortization loans; • Negative amortization; • Fully amortizing loans; • Partially amortized loans; Mortgage Term – the period of time for which a specific mortgage interest rate is guaranteed. Mortgage Principal – the amount of money borrowed by way of a mortgage. Mortgage Interest – the rate charged by a mortgage lender. Interest represents a return on the lender’s investment. Principle repayment represents a return of the investment capital. The total lender return is represented by the debt service and is a function of the interest rate and the maturity of the loan. Mortgage Constant – represents the amount of debt service expressed as a percentage of the original loan, necessary to pay the contract rate of interest and entire principle in equal period installments over the term of the loan. THE REAL ESTATE FINANCING CYCLE 1. Land Acquisition or Land Lease: Since raw land generates no cash flow, loan to finance its acquisition are considered the most risky and frequently are avoided. Therefore, an owner might lease the land for a long time rather than selling it. 2. Land Development: Land development means preparing raw land for the construction of improvements. It is somewhat easier to finance that land acquisition. 3. Construction: Real Estate construction finance is a specialized process in which the commercial banks play a dominant role. Usually run from 6 month to 2 years, and the actual loan funds are disbursed in stages as construction proceeds. 4. Gap Financing: Serves to bridge the gap between completion of construction and lease-up or sale especially if tenant improvements are required. 5. Permanent Loan Commitment: The source of repayment of the construction loan is the permanent loan. • Ownership and Use: Now a lender can anticipate a long period cash flow from the property to service a loan, and so it is at this point that a long-term loan can be funded. 6. Secondary Financing: Consists of any additional mortgages beyond the first mortgage taken ob by a property owner. Prior to the maturity of the original mortgage, the owner may: 1. Renegotiate its terms with the original lender; 2. Increase the loan amount; or 3. Pay off the existing mortgage and obtain a new mortgage. In general, refinancing is done for one of three reasons: • To increase the property’s sale potential by making the financing more attractive to a buyer. • To generate tax-free cash for the owner by increasing the existing debt; or • To decrease the existing debt so as to reduce the monthly debt service and increase the cash flow to the owner. MAJOR UNDERWRITING CONSIDERATIONS The lender must be sure the borrower has good title to the real estate. This will involve an examination of title. Market Analysis: Next, the lender will
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