Real Estate Principles: A Value Approach, Seventh Edition
By David C. Ling and Wayne R. Archer
Contents:
Preface viii
Part 1 SETTING THE STAGE 1
1 The Nature of Real Estate and Real Estate Markets 1
Introduction 1
Real Estate: Some Basic Definitions 2
Real Estate: A Tangible Asset 2
Real Estate: A Bundle of Rights 4
Real Estate: An Industry and Profession 5
Real Estate and the Economy 5
Land Use in the United States 6
Real Estate and U.S. Wealth 6
Real Estate Markets and Participants 7
User, Capital, and Property Markets 9
The Role of Government 10
The Interaction of Three Value-Determining Sectors 11
The Production of Real Estate Assets 11
Characteristics of Real Estate Markets 13
Heterogeneous Products 13
Immobile Products 13
Localized Markets 13
Segmented Markets 14
Privately Negotiated Transactions with High Transaction Costs 14
Summary 15
part 2 LEGAL AND REGULATORY DETERMINANTS OF VALUE 18
2 Legal Foundations to Value 18
Introduction 19
The Nature of Property 19
The Nature of Rights 19
Real Property and Personal Property: The Problem of Fixtures 22
The Real Property Bundle of Rights 24
Possessory Interests (Estates) 24
Nonpossessory Interests 27
Forms of Co-Ownership 33
Indirect Co-Ownership Through a Single Entity 33
Direct Co-Ownership 34
Timeshare 38
Rights Related to Water 40
Rights to Oil, Gas, and Minerals 41
Summary 41
3 Conveying Real Property Interests 45
Introduction 46
Deeds 46
Requirements of a Deed 47
Types of Deeds 49
Modes of Conveyance of Real Property 50
Voluntary Conveyance by a Deed 51
Involuntary Conveyance by a Deed 51
Voluntary Conveyance Without a Deed 52
Involuntary Conveyance Without a Deed 53
Real Property Complexity and Public Records 54
The Doctrine of Constructive Notice 55
Statute of Frauds 55
Recording Statutes 55
Actual Notice 55
Title 56
Title Search, Title Abstract, and Chain of Title 56
Evidence of Title 56
Land Descriptions 59
Metes and Bounds 60
Subdivision Plat Lot and Block Number 62
Government Rectangular Survey 62
Summary 66
4 Government Controls and Real Estate Markets 70
Introduction 71
The Power of Government to Regulate Land Use 71
Monopolies, Externalities, and Other Market Distortions 71
Traditional Methods of Land Use Control 74
Building Codes 75
Zoning 75
Subdivision Regulations 77
Zoning and Planning Administration 77
The Revolution in Land Use Controls: Planning, New Tools 78
Comprehensive Planning: The Idea and Elements 78
The Elements of Planning 78
Challenges to Comprehensive Planning 79
Modern Tools of Land Use Control 81
Environmental Hazards 83
Types of Hazardous Materials 83
Implications for Real Estate Investors 83
The Government’s Power of Eminent Domain 84
Public Use or Public Purpose 85
Just Compensation 87
Inverse Condemnation and Regulatory Takings 87
The Power of Government to Tax Real Property 89
Mechanics of the Property Tax 90
Determining a Jurisdiction’s Budget and Tax Rate 90
Tax-Exempt Properties 91
Homestead and Other Exemptions 91
Calculating Tax Liability 91
Special Assessments 92
Nonpayment of Property Taxes 92
Criticisms of the Property Tax 93
Overview of Restrictions on Real Property Ownership 95
Summary 95
part 3 MARKET VALUATION AND APPRAISAL 99
5 Market Determinants of Value 99
Introduction 100
Market Misjudgments in Real Estate 100
Minimizing Market Errors 101
The Creation, Growth, and Decline of Cities 101
Where Cities Occur 101
The Economic Base of a City 102
Resources of a City: The Supply Side of Urban Growth 106
The Shape of a City 108
Demand for Proximity and Bid-Rent Curves 108
Bid-Rent Curves, Urban Land Uses, and Land Value Contours 113
Changing Transportation, Changing Technology, and Changing Urban Form
113
Differing Location Patterns of Urban Land Uses 120
Convenience “Goods” and Central Place Patterns 120
Comparison Goods and Clustering 121
Industry Economies of Scale and Clustering 121
The Role of Urban Analysis in Real Estate Decisions 123
Summary 124
6 Forecasting Ownership Benefits and Value: Market
Research 129
Introduction 130
Market Research: Slipperiest Step in Real Estate Valuation 130
Market Segmentation 131
Real Estate Market Research as Storytelling 131
The Beginning Point: A Market-Defining Story 132
Initial Collection of Data 133
First Analysis 133
Refining the Research 133
A Reverse to Conventional Market Research 133
Three Important Techniques in Market Analysis 133
Three Examples of Market Research 135
Market Research Example 1: Elysian Forest, a Planned Unit Development 135
Market Research Example 2: Palm Grove Office Complex 140
Market Research Example 3: Plane Vista Apartments 142
Some Final Notes on the Process of Market Research 151
Improving One’s Capacity in Real Estate Market Research 151
Market Projections and Real Estate Cycles 151
Some Tools of Market Research 153
Geographical Information Systems (GIS) 153
Psychographics 154
Survey Research 155
Summary 157
7 Valuation Using the Sales Comparison and Cost
Approaches
160
Introduction 160
Market Value, Investment Value, and Transaction Prices 162
The Appraisal Process 163
Identify the Problem 165
Determine the Scope of Work 165
Collect Data and Describe Property 165
Perform Data Analysis 165
Determine Land Value 166
Apply Conventional Approaches to Estimate Market Value 166
Reconcile Indicated Values from Three Approaches 167
Report Final Value Estimate 167
Traditional Sales Comparison Approach 168
Comparable Sales Data 169
Sources of Market Data 169
Adjustments to Comparable Property Transaction Prices 170
Types of Adjustments 173
Sequence of Adjustments 174
A Note on the Selection of Comparables and Adjustments 177
Reconciliation to an Indicated Value Estimate 177
The Cost Approach 178
Estimating Cost 178
Accrued Depreciation 179
Final Reconciliation 181
Summary 185
8 Valuation Using the Income Approach 190
Introduction 190
Direct Capitalization Versus Discounted Cash Flow 191
Estimating Net Operating Income 192
Potential Gross Income 193
Effective Gross Income 195
Operating Expenses 196
Capital Expenditures 197
Net Operating Income 198
Using Direct Capitalization for Valuation 199
Abstracting Cap Rates from the Market 199
Understanding Capitalization Rates 201
Income Multipliers 203
Using Discounted Cash Flow Analysis for Valuation 204
A Word of Caution 205
Estimating Future Sale Proceeds 206
Valuing Future Cash Flows 207
Other Approaches 207
Final Reconciliation 208
Valuing Partial and Other Interests 209
Summary 210
part 4 FINANCING HOME OWNERSHIP 214
9 Real Estate Finance: The Laws and Contracts 214
Introduction 215
The Note 215
Interest Rate and Interest Charges 215
Adjustable Rates 216
Payments 218
Term 219
Right of Prepayment 219
Prepayment Penalties 220
Late Fees 220
Personal Liability 220
Demand Clause 221
Inclusion of Mortgage Covenants by Reference 221
The Mortgage or Deed of Trust 221
Description of the Property 222
Insurance Clause 222
Escrow Clause 222
Acceleration Clause 223
Due-on-Sale Clause 223
Hazardous Substances Clause and Preservation and Maintenance Clause
223
Deed of Trust 223
When Things Go Wrong 224
Default 224
Nonforeclosure Responses to Default 224
Foreclosure 226
Deficiency Judgment 227
The Effect of Default on the Borrower 227
Judicial Foreclosure Versus Power of Sale 228
Bankruptcy and Foreclosure 229
Acquiring a Property with an Existing Debt 230
Real Estate Debt Without a Mortgage 231
Regulation of Home Mortgage Lending 233
Equal Credit Opportunity Act 233
Truth-in-Lending Act 233
Real Estate Settlement Procedures Act 234
Home Ownership and Equity Protection Act 235
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
235
Other Laws Regulating Discrimination in Home Mortgage Lending 236
Summary 236
10 Residential Mortgage Types and Borrower Decisions
241
Introduction 242
The Primary and Secondary Mortgage Markets 242
Prime Conventional Mortgage Loans 243
Forms of Prime Conventional Mortgages 243
Private Mortgage Insurance 245
Adjustable Rate Mortgages 246
Government-Sponsored Mortgage Programs 247
FHA-Insured Loans 247
VA-Guaranteed Loans 249
Other Mortgage Types and Uses 251
Purchase-Money Mortgage 251
Home Equity Loan 252
Reverse Mortgage 252
Home Mortgage Adventurism 255
Interest-Only Mortgage and Balloon Mortgages 255
Hybrid ARM 256
Option ARM 256
Subprime and Alt-A Loans 257
Subprime Loans 257
Alt-A Loans 257
Qualified Mortgages 257
The Borrower’s Mortgage Loan Decisions 258
Mortgage Choice 258
Loan Size 259
The Refinancing Decision 260
The Default Decision 263
Summary 264
11 Sources of Funds for Residential Mortgages 269
Introduction 270
The Market for Home Mortgage Loans 270
The Revolution in Home Mortgage Finance 271
The Rise of a World Economy and The Demise of the Thrifts 272
The Transformation of Commercial Banks 273
Mortgage Banking and Mortgage Brokerage 274
Mortgage Banking 275
Mortgage Brokers 279
The Secondary Market for Residential Mortgages 279
Mortgage-Backed Securities 280
Purchasers of Residential Mortgages in the Secondary Market 282
Ginnie Mae (GNMA) 282
Fannie Mae 283
Freddie Mac 283
The Importance and Status of Fannie Mae and Freddie Mac 285
Private Conduits 286
Federal Home Loan Banks 286
Other Secondary Market Purchasers 286
The Big Picture of Home Mortgage Lending: Four Different Channels 288
Where Does a Borrower Find a Home Loan? 290
The Lender’s Mortgage Loan Decisions 291
Traditional Home Mortgage Underwriting 291
Modern Home Mortgage Underwriting 293
Ability-to-Repay Standard 294
Cash Down Payment Requirement 295
Recent Underwriting Failures 295
Home Financing for Marginal Borrowers 295
Affordable Housing Loans 296
Subprime Lending 296
Summary 297
part 5 BROKERING AND CLOSING THE TRANSACTION 301
12 Real Estate Brokerage and Listing Contracts 301
Introduction: Brokerage—The Best-Known Type of Real Estate Business 302
Real Estate Brokers as Market Facilitators 302
Economic Rationale for Employing a Broker 302
Law of Agency 304
Types of Agents 304
Fiduciary Responsibilities 304
Real Estate Agents 305
Problems in Real Estate Agency Relationships and Disclosures 307
Transaction Brokers 308
Licensing of Real Estate Brokers and Salespersons 309
Brokerage Licensing Administration 310
How to Obtain a Real Estate License 311
License Law Infractions 312
Designations in Real Estate Sales and Brokerage 312
The Marketing Function 312
Market Segmentation and Specialization and Service 312
Commercial Brokerage 313
Residential Brokerage 313
International Aspects of Brokerage 317
Listing Contracts 317
Types of Listing Contracts 319
Open Listing 319
Exclusive Agency Listing 319
Exclusive Right of Sale Listing 319
Innovations in Brokerage 320
Buyer Brokerage 320
New Listing Services and “Discount” Brokerage 320
Listing Contract Provisions 321
Termination of a Listing Contract 323
Splitting the Commission 323
Summary 332
13 Contracts for Sale and Closing 336
Introduction: The Most Important Document in Real Estate 336
Rights and Obligations of Sellers and Buyers 337
Requirements of a Contract for Sale 337
Competency of the Parties to Act 338
Lawful Intent of the Parties 338
An Offer and an Acceptance 338
Consideration 339
No Defects to Mutual Assent 339
A Written Real Estate Contract 340
Proper Description of the Property 340
Legal Title Versus Equitable Title 340
The Form of the Contract for Sale 341
Simple Contract 341
Standard Form Contracts 342
Components of a Form Contract 357
Contracts with Contingencies 358
Assignment 358
Remedies for Nonperformance 359
Escrow 359
Closing and Closing Statements 360
Electronic Documents 360
Role of the Brokers 361
Role of the Lenders 361
RESPA, TILA, and the Dodd–Frank Act 361
Preparation of Closing Statements 362
The Continuing Story of a Sale 365
Loan Estimate 365
Steps before Closing 366
Steps at Closing and the Closing Disclosure 371
Summary 378
part 6 TIME, OPPORTUNITY COST, AND VALUE DECISIONS 382
14 The Effects of Time and Risk on Value 382
Introduction 382
The Time Value of Money 383
The Timeline 384
Terminology 385
Equations, Calculators, and Spreadsheets 385
Compounding Operations 386
Discounting Operations 391
Yields and Internal Rates of Return 396
Value and Risk 398
Determining Required Returns 399
Comparing Investment Values to Acquisition Costs 401
Summary 403
15 Mortgage Calculations and Decisions 407
Introduction 407
Basic Computations 408
Payments 408
Loan Balance 409
Lender’s Yield 410
Effective Borrowing Cost (EBC) 411
Up-Front Costs, Holding Period, and Effective Borrowing Cost 413
Fixed-Rate Mortgages 416
Level-Payment, Fully Amortized Mortgages 416
The Choice of Loan Term: A Question of Present Value 416
Alternative Amortization Schedules 418
Adjustable Rate Mortgages 419
The Mechanics of Adjustable Rate Mortgages 419
Initial Adjustment Periods 420
Rate Caps 421
Other Options 423
Summary 423
part 7 FINANCING AND INVESTING IN COMMERCIAL REAL ESTATE 428
16 Commercial Mortgage Types and Decisions 428
Introduction 428
Loan Documents and Provisions 429
The Note 429
The Mortgage 430
Common Types of Permanent Mortgages 431
Balloon Mortgages 431
Restrictions on Prepayments 433
Alternative Financing Arrangements 434
Floating-Rate Loans 434
Loan Syndications 435
Second Mortgages and Mezzanine Financing 436
Bridge Loans 437
Government-Sponsored Programs 438
The Borrower’s Decision-Making Process 439
Typical Loan Terms 439
Loan Size 440
Financial Risk 441
Increased Variability of Equity Returns from Leverage 441
The Prepayment and Default Decisions 441
The Permanent Loan Application and Approval Process 442
Loan Submission Package and Application 443
From Loan Application to Closing 444
Maximum Loan Amount 445
Land Acquisition, Development, and Construction Financing 447
Summary 448
17 Sources of Commercial Debt and Equity Capital 453
Introduction 453
How Large Is the U.S. Commercial Real Estate Market? 454
Forms of Ownership for Pooled Equity Investments 455
General Partnership 456
Limited Partnership 456
C Corporation 457
S Corporation 458
Limited Liability Company 458
Optimal Ownership Form 459
Ultimate Equity Investors in Commercial Real Estate 459
Direct Investment in Commercial Real Estate 459
Investment in Commercial Real Estate through Intermediaries 461
Institutional Versus Noninstitutional Properties and Investors 464
Real Estate Investment Trusts 465
Sources of Commercial Real Estate Debt 467
Advantages and Disadvantages of the Five Primary
Sources of CRE Debt 468
Development and Construction Lending 469
A Closer Look at Real Estate Investment Trusts 470
The Importance of Public Real Estate Markets 470
REIT Management 472
Measuring REIT Income 473
REIT Valuation 473
REIT Investment Performance 474
Summary 475
18 Investment Decisions: Ratios 479
Introduction 479
Investment Decision Making 480
Centre Point Office Building Example 480
Treatment of Capital Expenditures 481
Effects of Debt Financing on Property Cash Flows 483
Why Do Investors Borrow? 483
Effect on Initial Equity Investment 483
Effect on Cash Flows from Annual Operations 484
Evaluating the Cash Flow Estimates 485
Partnerships and Other Direct Forms of Ownership 486
Effects of Income Taxes 486
Single-Year Return Measures and Ratios 488
Profitability Ratios 488
Multipliers 490
Financial Risk Ratios 491
Operating Expense Ratio 491
Loan-to-Value Ratio 491
Debt Coverage Ratio 492
Debt Yield Ratio 492
Limitations of Ratio Analysis 494
Summary 495
19 Investment Decisions: NPV and IRR 499
Introduction 499
Investment Valuation Versus Market Valuation 500
Investment Valuation Using Discounted Cash Flow Models 501
Centre Point Office Building Example 501
Levered Versus Unlevered Cash Flows 503
Effect of Leverage on Cash Flow from Sale 504
Net Present Value 504
Internal Rate of Return 506
Comparing Net Present Value and the Internal Rate of Return 507
Equity Multiple 508
The Impact of Leverage on Expected Returns 508
The Impact of Leverage on Risk 509
Income Taxes and Investor Cash Flows 512
Effect of Taxes on Discount Rates 513
Effect of Taxes on Net Present Value and the Internal Rate of Return 513
More Detailed Cash Flow Projections 514
Varying the Assumptions 516
Summary 517
20 Income Taxation and Value 521
Introduction 521
Objectives and Implementation of U.S. Tax Law 522
Comparing the Taxation of Individuals and Corporations 522
Four Classes of Real Property 523
Income Subject to Taxation 524
Income Tax Rates 525
Estimating Tax Liabilities from Operations 526
Cash Calculation versus Tax Calculation 527
Operating Expenses versus Capital Improvements 528
Costs of Mortgage Financing 528
Depreciation Deductions 529
Tax Credits 533
Centre Point Office Building: Taxes from Operations 535
What Is a Tax Shelter? 536
Estimating Tax Liabilities from Sale 537
Fully Taxable Sale 537
Centre Point Office Building: Taxes Due on Sale 542
Net Benefits of Tax Depreciation 543
Effect of Taxes on Values and Returns 544
Complications Caused by Alternative Ownership Forms 546
Tax Deferral Strategies 546
Tax Factors Affecting Homeowners 548
Summary 549
part 8 CREATING AND MAINTAINING VALUE 554
21 Enhancing Value Through Ongoing Management
554
Introduction 554
Owners as Managers 555
Functions of a Property Manager 556
Marketing the Property 556
Selecting Tenants 558
Signing Leases 560
Collecting Rent 561
Complying with Landlord–Tenant Laws 561
Maintaining Tenant Relations 562
Communicating with Owners 562
Repairing and Maintaining the Premises 563
Property Management Agreements 565
Management Fees 567
Professional Associations and Designations 568
Asset Management 568
Asset Management Functions 569
Performance Evaluation and Compensation 570
A Closer Look at the Decision to Improve or Alter a Property 571
Abandonment, Demolition, and Reuse 573
Managing Corporate Real Estate Assets 573
Summary 574
22 Leases and Property Types 578
Introduction 578
Essential Elements of a Lease 579
Negotiated Lease Provisions 579
Use of the Premises 580
Lease Term 580
Rental Payments 581
Responsibility for Operating Expenses 582
Concessions 583
Alterations and Improvements 583
Assignment and Subletting 583
Lease Options 584
Other Common Clauses 585
Effective Rent 586
Broader Lease Considerations 587
Residential Rental Properties and Leases 589
Common Lease Provisions of Residential Rental Properties 590
Office Properties and Leases 591
Defining Rentable Space in Office Properties 591
Common Lease Provisions of Office Properties 592
Retail Properties and Leases 594
Defining Leasable Area in Retail Properties 595
Common Lease Provisions of Retail Properties 595
Industrial Properties and Leases 597
Common Lease Provisions of Industrial Properties 598
Hospitality Properties 598
Specialty Property Types 599
Ground Leases 599
Summary 599
23 Development: The Dynamics of Creating Value 603
Introduction 603
The Process of Development 604
Establishing Site Control 605
Feasibility Analysis, Refinement, and Testing 606
Obtaining Permits 607
Design 610
Financing 613
Construction 617
Marketing and Leasing 618
Operation 621
The “Numbers” of Development 621
What Is It Like to Be a Developer? 624
What Does It Take to Enter Development? 626
Summary 626
Glossary 630
Index 643