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
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
2. Land Development: Land development means preparing raw land for the
construction of improvements. It is somewhat easier to finance that land
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
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