Real Estate Finance and Investments, Sixteenth Edition PDF by Jeffrey D Fisher and William B Brueggeman

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Real Estate Finance and Investments, Sixteenth Edition
by Jeffrey D Fisher and William B Brueggeman
Real Estate Finance and Investments, Sixteenth Edition

Table of Contents

Preface iii
PART ONE
OVERVIEW OF REAL ESTATE FINANCE
AND INVESTMENTS
Chapter 1
Real Estate Investment: Basic Legal
Concepts 1
Property Rights and Estates 2
Definition of Estate 4
Two General Classifications of Estates 4
Examples of Freehold Estates 4
Estates Not Yet in Possession (Future Estates) 5
Examples of Leasehold Estates 5
Interests, Encumbrances, and Easements 6
Assurance of Title 7
The Meaning of Title 7
Deeds 9
Methods of Title Assurance 9
Abstract and Opinion Method 11
The Title Insurance Method 11
Recording Acts 12
Limitations on Property Rights 13
Chapter 2
Real Estate Financing: Notes and
Mortgages 16
Notes 16
The Mortgage Instrument 18
Definition of a Mortgage 18
Relationship of Note to Mortgage 18
Interests That Can Be Mortgaged 19
Minimum Mortgage Requirements 19
Important Mortgage Covenants 20
Assumption of Mortgage 22
Acquiring Title “Subject to” a Mortgage 23
Property Covered by a Mortgage 23
Junior Mortgages 24
Recording of Mortgages 24
Other Financing Sources 25
Seller Financing 25
Land Contracts 25
Default 26
What Constitutes Default? 26
Alternatives to Foreclosure: Workouts 27
Restructuring the Mortgage Loan 27
Transfer of Mortgage to a New Owner 29
Voluntary Conveyance 29
Friendly Foreclosure 30
Prepackaged Bankruptcy 30
Short Sale 31
Foreclosure 31
Judicial Foreclosure 31
Redemption 32
Sales of Property 32
Effect of Foreclosure on Junior Lienors 35
Deficiency Judgment 35
Taxes in Default 36
Bankruptcy 37
Chapter 7 Liquidation 37
Chapter 11 38
Chapter 13 39

 
PART TWO
MORTGAGE LOANS
Chapter 3
Mortgage Loan Foundations: The Time
Value of Money 42
Compound Interest 42
Compound or Future Value 43
Calculating Compound Interest Factors 47
Using Financial Functions: Calculators and
Spreadsheets 49
Present Value 52
A Graphic Illustration of Present Value 52
Expanding the Use of Calculators for Finding Present
Values 54
Compound or Future Value of an Annuity 56
Use of Compound Interest Factors for Annuities 58
Present Value of an Annuity 60
Use of the Present Value of an Annuity Factors 61
Accumulation of a Future Sum 64
Determining Yields, or Internal Rates of
Return, on Investments 65
Investments with Single Receipts 65
Yields on Investment Annuities 68
Equivalent Nominal Annual Rate (ENAR): Extensions 70
Solving for Annual Yields with Partial Periods: An
Extension 72
Chapter 4
Fixed Interest Rate Mortgage Loans 78
Determinants of Mortgage Interest Rates: A Brief
Overview 78
The Real Rate of Interest: Underlying Considerations 79
Interest Rates and Inflation Expectations 79
Interest Rates and Risk 80
A Summary of Factors Important in Mortgage Loan
Pricing 82
Understanding Fixed Interest Rate Mortgage (FRM)
Loan Terms 82
Calculating Payments and Loan Balances—Fixed
Interest Rate Loans 84
The Importance of Accrued Interest and Loan Payments 84
Loan Amortization Patterns 84
Fully Amortizing, Constant Payment Mortgage (CPM)
Loans 85
Partially Amortizing, Constant Payment Mortgage (CPM)
Loans 89
Zero Amortizing, or Interest-Only—Constant Payment
Mortgage (CPM) Loans 90
Negative Amortizing, Constant Payment Mortgage
(CPM) Loans 91
Summary and Comparisons: Fixed Interest Rate,
Constant Payment Mortgage (CPM) Loans with
Various Amortization Patterns 92
Determining Loan Balances 94
Finding Loan Balances—Other Amortization
Patterns 95
Loan Closing Costs and Effective Borrowing Costs 96
Loan Fees and Early Repayment: Fully Amortizing Loans 99
Charging Fees to Achieve Yield, or When “Pricing”
FRMs 103
Financing Loan Fees and Other Closing Costs 104
Other FRM Loan Patterns—Declining Payments
and Constant Amortization Rates 104
Amortization Schedules and Callable Loans 105
“Reverse Mortgages” 106
Appendix
Inflation, Mortgage Pricing, and Payment
Structuring 113
Chapter 5
Adjustable and Floating Rate Mortgage
Loans 122
The Price Level Adjusted Mortgage (PLAM) 124
PLAM: Payment Mechanics 124
ARMs and Floating Rate Loans: An Overview 126
Variations: ARM and Floating Rate Loans 129
Risk Premiums, Interest Rate Risk, and Default
Risk 133
Expected Yield Relationships and Interest Rate
Risk 135
More Complex Features 136
ARM Payment Mechanics 138
Expected Yields on ARMs: A Comparison 143
Chapter 6
Mortgages: Additional Concepts, Analysis,
and Applications 150
Incremental Borrowing Cost 150
Early Repayment 152
Origination Fees 153
Incremental Borrowing Cost versus a Second
Mortgage 154
Relationship between the Incremental Cost and the
Loan-to-Value Ratio 154
Differences in Maturities 157
Loan Refinancing 158
Early Repayment: Loan Refinancing 159
Effective Cost of Refinancing 161
Borrowing the Refinancing Costs 161
Other Considerations 162
Early Loan Repayment: Lender Inducements 164
Market Value of a Loan 165
Effective Cost of Two or More Loans 166
Second Mortgages and Shorter Maturities 168
Effect of Below-Market Financing on Property Prices 169
Assuming a Lower Loan Balance 172
Cash Equivalency 172
Cash Equivalency: Smaller Loan Balance 173
Cash Equivalency: Concluding Comments 174
Wraparound Loans 174
Buydown Loans 177
Appendix
After-Tax Effective Interest Rate 181

 
PART THREE
RESIDENTIAL HOUSING
Chapter 7
Single-Family Housing: Pricing, Investment,
and Tax Considerations 185
Overview 185
House Prices 185
Income and Employment 186
Renting versus Owning 187
Analyzing Expected House Prices 193
Economic Base Analysis—Location Quotients 197
Housing Supply: An Overview 198
Submarkets: Neighborhoods/Municipalities 199
Capitalization Effects: Price Premiums 199
Pricing Property in Specific Submarkets/Locations 201
Investing in “Distressed Properties” 209
Financial Framework for Analyzing Distressed
Properties 210
Acquisition Phase 210
Holding Period Phase 214
Disposition Phase—Exit Strategies 218
Chapter 8
Underwriting and Financing Residential
Properties 222
Underwriting Default Risk 222
Classification of Mortgage Loans 223
Conventional Mortgage Loans 223
Insured Conventional Mortgage Loans 224
FHA-Insured Mortgage Loans 226
VA-Guaranteed Mortgage Loans 226
The Underwriting Process 227
Borrower Income 227
Verification of Borrower Assets 229
Assessment of Credit History 229
Estimated Housing Expense 230
Other Obligations 230
Compensating Factors 230
The Underwriting Process Illustrated 232
Underwriting Standards—Conventional and Insured
Conventional Mortgages 233
Underwriting Standards—FHA-Insured
Mortgages 234
Underwriting Standards—VA-Guaranteed
Mortgages 235
Underwriting and Loan Amounts—A Summary 237
The Closing Process 239
Fees and Expenses 239
Prorations, Escrow Costs, and Payments to Third
Parties 240
Statutory Costs 242
Requirements under the Real Estate Settlement and
Procedures Act (RESPA) 242
Settlement Costs Illustrated 244
Federal Truth-in-Lending (FTL) Requirements 246
Truth-in-Lending Sample Disclosure 247
Establishing the APR under Federal Truth-in-Lending
Requirements 247
ARMs and Truth-in-Lending Disclosure 248

 
PART FOUR
INCOME-PRODUCING
PROPERTIES
Chapter 9
Income-Producing Properties: Leases, Rents,
and the Market for Space 254
Property Types 254
Supply and Demand Analysis 256
Local Market Studies of Supply and Demand 259
Location and User-Tenants 260
The Business of Real Estate 262
The “Market” for Income-Producing Real Estate 263
Income Potential—Real Estate Assets 264
Vacancy 265
Underwriting Tenants 266
General Contents of Leases 266
Leases and Rental Income 270
Leases and Responsibility for Expenses
(Recoveries) 270
Comparing Leases: Effective Rent 273
Other Financial Considerations 275
Developing Statements of Operating Cash Flow 278
Case Example: Office Properties 279
Rent Premiums and Discounts for Office Space 279
Pro Forma Statement of Cash Flow—Office
Properties 282
Case Example: Industrial and Warehouse
Properties 283
Pro Forma Statement of Cash Flow—Industrial/
Warehouse Properties 284
Case Example: Retail Properties 285
The Retail Leasing Environment 285
CAM Charges—Recoveries 287
Pro Forma Statement of Cash Flow—Retail
Properties 288
Case Example: Apartment Properties 290
Chapter 10
Valuation of Income Properties: Appraisal
and the Market for Capital 297
Introduction 297
Valuation Fundamentals 297
Appraisal Process and Approaches to Valuation 298
Sales Comparison Approach 299
Income Approach 301
Capitalization Rate 303
Capitalization Rates—A Note of Caution 306
Discounted Cash Flow Techniques 307
Land Values: Highest and Best Use Analysis 314
Volatility in Land Prices 315
“Highest and Best Use” Analysis—Vacant Site 315
“Highest and Best Use” Analysis—Improved
Property 316
Mortgage-Equity Capitalization 317
Reconciliation: Sales Comparison and Income
Capitalization Approaches 319
Exploring the Relationships between Changing Market
Conditions, Cap Rates, and Property Values 319
A Closing Note on Cap Rates and Market
Conditions 324
A Word of Caution—Simultaneous Effects of
Real Market Forces and Interest Rates on Property
Values 324
Leases: Valuation of a Leased Fee Estate 324
Cost Approach 325
Valuation Case Study—Oakwood Apartments 329
RealNex Solution 331
Appendix
RealNex Inputs and Output for Apartment
Analysis 341
Chapter 11
Investment Analysis and Taxation of Income
Properties 348
Motivations for Investing 348
Real Estate Market Characteristics and Investment
Strategies 349
The Real Estate Cycle 349
Investment Strategies 351
Market Analysis 354
Supply of Space 356
Market Rents 358
Forecasting Supply, Demand, Market Rents, and
Occupancy 359
Making Investments: Projecting Cash Flows 361
Office Building Example 361
Base Rent 362
Market Rent 362
Expense Stops 363
Net Operating Income 364
Expected Outlays for Replacements and Capital
Improvements 365
Estimated Sale Price 365
Introduction to Investment Analysis 367
Internal Rate of Return (IRR) 367
Present Value 367
Introduction to Debt Financing 368
Measures of Investment Performance Using Ratios 369
Before-Tax Cash Flow from Sale 369
Summary of Investment Analysis Calculations 370
Taxation of Income-Producing Real Estate 371
Taxable Income from Operation of Real Estate 372
Depreciation Allowances 372
Loan Points 374
Tax Liability and After-Tax Cash Flow 374
Taxable Income from Disposal of Depreciable Real
Property 374
After-Tax Investment Analysis 375
After-Tax Cash Flow from Operations 375
After-Tax Cash Flow from Sale 377
After-Tax IRR 377
Effective Tax Rate 378
A Note about Passive Losses 378
Special Exceptions to PAL Rules 380
Appendix A
Approaches to Metro Area Market Forecasting 384
Appendix B
RealNex Office Example 390
Chapter 12
Financial Leverage and Financing
Alternatives 398
Introduction to Financial Leverage 398
Conditions for Positive Leverage—Before Tax 399
Conditions for Positive Leverage—After Tax 403
Break-Even Interest Rate 405
Risk and Leverage 407
Underwriting Loans on Income Properties 409
Market Study and Appraisal 409
Borrower Financials 409
The Loan-to-Value Ratio 410
The Debt Coverage Ratio 410
Other Loan Terms and Mortgage Covenants 411
Alternatives to Fixed Rate Loan Structures 413
Participation Loans 414
Lender Motivations 414
Investor Motivations 415
Participation Example 415
Sale-Leaseback of the Land 419
Effective Cost of the Sale-Leaseback 421
Interest-Only Loans 421
Accrual Loans 423
Structuring the Payment for a Target Debt Coverage
Ratio 423
Convertible Mortgages 425
Lender’s Yield on Convertible Mortgages 425
Comparison of Financing Alternatives 427
Other Financing Alternatives 429
Chapter 13
Risk Analysis 433
Introduction 433
Comparing Investment Returns 433
Types of Risk 434
Due Diligence in Real Estate Investment Risk
Analysis 436
Sensitivity Analysis 436
Partitioning the IRR 440
Variation in Returns and Risk 441
Retail Case Study—Westgate Shopping Center 445
Westgate Shopping Center Scenario Analysis 448
Lease Rollover Risk 448
Market Leasing Assumptions with Renewal
Probabilities 450
Market Rent 450
Months Vacant 450
Leasing Commissions 451
Tenant Improvements 451
Industrial Case Study—Worthington Distribution
Center 451
Risk and Leverage 453
Monte Carlo Simulation 456
Example 458
Extensions of Monte Carlo Simulation 459
Participation Example 459
A “Real Options” Approach to Investment Decisions 461
Traditional Approach to Land Valuation 462
Real Option Approach to Land Valuation 462
Real Options Extensions and Strategy 463
Chapter 14
Disposition and Renovation of Income
Properties 467
Disposition Decisions 467
A Decision Rule for Property Disposition 468
IRR for Holding versus Sale of the Property 469
Return to a New Investor 472
Marginal Rate of Return 472
Refinancing as an Alternative to Disposition 476
Incremental Cost of Refinancing 476
Leveraged Return from Refinancing and Holding an
Additional Five Years 477
Refinancing at a Lower Interest Rate 479
Other Disposition Considerations—Portfolio
Balancing 480
Tax-Deferral Strategies upon Disposition 480
Installment Sales 481
Tax-Deferred Exchanges 486
Renovation as an Alternative to Disposition 493
Renovation and Refinancing 496
Rehabilitation Investment Tax Credits 496
Low-Income Housing 498
Chapter 15
Financing Corporate Real Estate 503
Lease-versus-Own Analysis 504
Leasing versus Owning—An Example 504
Cash Flow from Leasing 505
Cash Flow from Owning 505
Cash Flow from Owning versus Leasing 507
Return from Owning versus Leasing 507
Importance of the Residual Value of Real Estate 508
The Investor’s Perspective 510
A Note on Project Financing 511
Factors Affecting Own-versus-Lease Decisions 512
The Role of Real Estate in Corporate
Restructuring 518
Sale–Leaseback 518
Refinancing 521
Investing in Real Estate for Diversification 521
Appendix
Real Estate Asset Pricing and Capital Budget Analysis:
A Synthesis 524
PART FIVE
FINANCING REAL ESTATE
DEVELOPMENT
Chapter 16
Financing Project Development 526
Introduction 526
Overview: The Planning and Permitting Process 526
The Development of Income-Producing Property 530
Market Risks and Project Feasibility 531
Project Risks 532
Project Development Financing—An Overview 534
Lender Requirements in Financing Project
Development 535
Interest Rates and Fees 541
Project Development Illustrated 541
Project Description and Project Costs 541
Market Data and Tenant Mix 546
Pro Forma Construction Costs and Cash Flow
Projections 547
Feasibility, Profitability, and Risk—Additional Issues 551
Profitability before and after Taxes 551
Sensitivity Analysis, Risk, and Feasibility Analysis 555
Chapter 17
Financing Land Development Projects 561
Characterization of the Land Development
Business 561
The Land Development Process—An Overview 563
Acquisition of Land—Use of the Option Contract 563
Financing and Development 565
Lender Requirements in Financing Land
Development 568
Detailed Cost Breakdowns 570
General Contracts and Subcontracts 570
Residential Land Development Illustrated 571
Market Conditions and Site Plan 572
Estimating Development Cost and Interest Carry 574
Estimating Release Prices per Parcel Sold 582
Loan Request and Repayment Schedule 582
Project Feasibility and Profitability 583
Project IRR and Net Present Value 585
Entrepreneurial Profits 586
Sensitivity Analysis 587

 
PART SIX
ALTERNATIVE REAL ESTATE
FINANCING AND INVESTMENT
VEHICLES
Chapter 18
Structuring Real Estate Investments:
Organizational Forms and Joint
Ventures 590
Introduction 590
Sole Proprietorships 590
Partnerships 591
Limited Liability Companies 593
Corporations 594
Joint Ventures 595
Organizational Forms 596
Profit Sharing 596
Initial Capital Contributions 597
Sharing Cash Flow from Operations 597
Sharing of Cash Flow from Sale 598
Summary of Cash Flows Distributed in Each
Operating Year 599
Cash Flow from Sale 601
IRR to Each Joint Venture Party 601
Variation on the Preferred IRR—“The Lookback
IRR” 602
Syndications 603
Use of the Limited Partnership in Private and Public
Syndicates 604
Private Syndication Problem Illustrated 605
Financial Considerations—Partnership
Agreement 606
Operating Projections 607
Statement of Before-Tax Cash Flow (BTCF) 608
Calculation of Net Income or Loss 608
Calculation of Capital Gain from Sale 609
Capital Accounts 609
Distribution of Cash from Sale of Asset 610
Calculation of After-Tax Cash Flow and ATIRR on
Equity 611
Partnership Allocations and Substantial Economic
Effect 613
Capital Accounts and Gain Charge-Backs 614
Use of the Limited Partnership in Private and Public
Syndicates 616
Use of Corporate General Partners 617
Private versus Public Syndicates 617
Accredited Investors—Regulation D 618
Regulation of Syndicates 622
Investment Objectives and Policies 623
Promoters’ and Managers’ Compensation 623
Investor Suitability Standards 624
Federal and State Securities Authorities 624
Chapter 19
The Secondary Mortgage Market:
Pass-Through Securities 629
Introduction 629
Evolution of the Secondary Mortgage Market 629
Early Buyers of Mortgage Loans 630
The Secondary Market after 1954 630
FNMA’s Changing Role 631
The Government National Mortgage Association 631
Mortgage-Backed Securities and the GNMA Payment
Guarantee 632
The Federal Home Loan Mortgage Corporation 633
Operation of the Secondary Mortgage Market 633
Direct Sale Programs 634
The Development of Mortgage-Related Security
Pools 634
Mortgage-Backed Bonds 635
Pricing Mortgage-Backed Bonds 636
Subsequent Prices 638
Mortgage Pass-Through Securities 639
Important Characteristics of Mortgage Pools 641
Mortgage Pass-Through Securities: A General Approach
to Pricing 644
Mortgage Pass-Through Payment Mechanics
Illustrated 646
Prepayment Patterns and Security Prices 648
Prepayment Assumptions 649
The Effects of Prepayment Illustrated 651
Security Prices and Expected Yields 652
Market Interest Rates and Price Behavior on Mortgage
Pass-Throughs 653
A Note on MBBs and MPTs 654
Chapter 20
The Secondary Mortgage Market:
CMOs and Derivative Securities 657
Introduction 657
Mortgage Pay-Through Bonds (MPTBs) 657
Collateralized Mortgage Obligations 658
CMOs Illustrated 659
CMO Mechanics 661
CMOs: Pricing and Expected Maturities 667
CMO Price Behavior and Prepayment Rates 669
CMO Tranche Variations 671
Subprime Mortgage-Backed Securities 672
Derivatives Illustrated 673
Yield Enhancement 676
IO and PO Strips 676
Convexity 679
Residential Mortgage-Related Securities: A
Summary 679
Residential Mortgage-Related Securities:
Some Closing Observations 681
Commercial Mortgage-Backed Securities
(CMBSs) 682
Rating Commercial Mortgage-Backed Securities 685
Collateralized Debt Obligations (CDOs) 687
Mortgage-Related Securities and REMICs 690
REMICs: Other Considerations 691
Appendix
Duration—An Additional Consideration in Yield
Measurement 695
Chapter 21
Real Estate Investment Trusts (REITs) 698
Introduction 698
Legal Requirements 698
Tax Treatment 702
Violation Penalties and Status Termination 702
Taxable REIT Subsidiaries 702
TYPES of REITs 703
Equity REITs 703
The Investment Appeal of Equity REITs 704
Public Nonlisted REITs 706
Importance of FFO (Funds from Operations) 709
REIT Expansion and Growth 711
Important Issues in Accounting and Financial
Disclosure: Equity REITs 715
Tenant Improvements and Free Rents: Effects
on FFO 716
Leasing Commissions and Related Costs 716
Use of Straight-Line Rents 717
FFO and Income from Managing Other
Properties 717
Types of Mortgage Debt and Other Obligations 718
Existence of Ground Leases 718
Lease Renewal Options and REIT Rent Growth 718
Occupancy Numbers: Leased Space or Occupied
Space? 719
Retail REITs and Sales per Square Foot 719
Additional Costs of Being a Public Company 720
The Investment Appeal of Mortgage REITs 720
Financial Analysis of an Equity REIT Illustrated 722
Valuing REITs as Investments 725
Valuation of Midwestern America Property
Trust 725
PART SEVEN
PORTFOLIO ANALYSIS AND REAL
ESTATE FUNDS
Chapter 22
Real Estate Investment Performance and
Portfolio Considerations 732
Introduction 732
The Nature of Real Estate Investment Data 732
Sources of Data Used for Real Estate Performance
Measurement 733
REIT Data: Security Prices 733
Hybrid and Mortgage REITs 733
NCREIF Property Index: Property Values 734
Data Sources for Other Investments 735
Cumulative Investment Return Patterns 735
Computing Holding Period Returns 736
Comparing Investment Returns 738
Risk, Return, and Performance Measurement 738
Risk-Adjusted Returns: Basic Elements 739
Elements of Portfolio Theory 740
Calculating Portfolio Returns 742
Portfolio Risk 742
Portfolio Weighting: Trading Off Risk and Return 745
Real Estate Returns, Other Investments, and
the Potential for Portfolio Diversification 747
Portfolio Diversification: EREITs and Other
Investments 747
Public versus Private Real Estate Investments 749
Real Estate Performance and Inflation 750
Diversification by Property Type and Location 750
Global Diversification 753
Risks of Global Investment 754
Use of Derivatives to Hedge Portfolio Risk 756
Example—Swap Office for Retail 757
Up Shares and Down Shares 757
Chapter 23
Real Estate Investment Funds: Structure,
Performance, Benchmarking, and
Attribution Analysis 761
Investor Goals and Objectives 763
General Explanation of Possible Provisions in Fund
Offerings 763
Reporting Fund Performance 771
Measuring and Reporting Investment Returns 771
Summary of Major Activity during Quarter 772
Calculating Returns 774
Calculating Returns at the Property Level 776
Comparing Returns: Fund Level versus Property
Level 777
Returns: Before and After Fees 778
Calculating Historical Returns 778
Time-Weighted Returns 779
Choosing IRR versus TWR for Performance
Measurement 782
Target Returns and Benchmarks 783
Investment Multiple 784
Attribution Analysis 785
Attribution Analysis Mathematics 787
Interpreting Sector Allocation 788
Evaluating Risk Differences 790
Jensen’s Alpha 794
INDEXES 800

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