BUSI 221: Real Estate Finance in a Canadian Context ... · BUSI 221: Real Estate Finance in a Canadian Context 2 Webinar Seminar 1: Chapters 1-6. REAL ESTATE DIVISION Introduction

Real Estate Division

BUSI 221: Real Estate

Finance in a Canadian

Context

2

Webinar Seminar 1: Chapters 1-6

REAL ESTATE DIVISION

Introduction

• Webinar Presenter: Sharon Gulbranson

• B Comm 1986 and MBA 1990 from UBC

• Consultant for UBC since 1990

• Marker, lecturer, editor

• Focus on Real Estate Math

• Currently mark BUSI 100, 221, and 442

3


Agenda

• Course Content

• Ch 1: Intro to Mtg Finance-Past and Present

• Ch 2: Mtg Finance Mkt Participants

• Ch 3: RE Finance and Gov’t Policy

• Ch 6: Mtg Math Review

• Next time: Thursday, February 3rd

• Questions?

4


Course Content

• History (Ch. 1)

• Participants (Ch. 2)

• Government Policy (Ch. 3)

• Property and Contract Law (Ch. 4)

• Mortgage Law (Ch. 5)

• Mortgage Math Review (Ch. 6)

5


Course Content

• Mortgage Underwriting and Res’l Borrower Qualification (Ch. 7)

• Comm’l Mortgage Underwriting (Ch. 8)

• Mortgage Loan Repmt Plans (Ch. 9)

• Loan Mgmt and Refinancing Options (Ch.10)

• Development Financing (Ch.11)

• Leasehold Finance (Ch.12)

6


Ch. 1: Introduction to Mtg

Finance: Past and Present

• Why use debt?

• History of Canadian mortgages

• Financial, money, and capital markets

• Interest rates

• Mortgage market

• Characteristics of mortgage loans as investments

UNIVERSITY OF BRITISH COLUMBIA 7


Role Of Financing In Real Estate

Transactions

• Most purchasers borrow funds to purchase real estate (use of debt financing)

• Why?

• largely due to the high capital price relative to income

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9

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Multiple Choice Question 1

Why might investors in income-producing properties use debt to finance a purchase?

• (1) Use equity for other activities

• (2) Financial leverage

• (3) Hedge against inflation

• (4) All of the above

11


History of Mortgage Financing in

Canada (1900 – late 1920s)

• long-term interest only loans

• period of stable interest rates, low inflation and stable property values

• satisfactory for both parties until depression

12


Depression Years (late 1930s –

early 1940s)

• individuals with little income (forced to live off savings), depreciated property values principal risk

• blended payment mortgage

• long-term fully amortized mortgage

13


Post World War II Period

• mtg default insurance: introduced to get lender’s to supply mortgage $ by reducing lender’s loss

• Borrowers paid insurance fees into a fund to compensate lenders if default occurred at a later date

• Combo of insurance, expansion in economy, slow inflation, and slow growth in interest rates little change in mtgloans between 1950s to lates 1960s

14


Late 1960s to Mid 1980s

• period of rapid inflation and rising consumer demands (and increasing interest rates)

• interest rate risk: risk for lenders being locked into LT loans at below market rates

• as a result, partially amortized mortgages were introduced

15


1980s

• Peak in interest rate in 1981, from mid 1980s to mid 1990s, decline in interest rates

• Mtg Rate insurance program introduced in 1984 to protect borrowers against extraordinary increases in interest rates

• Introduction of MBS in 1986

• Changes to traditional sources of mtgs

16


Mortgage-Backed Securities

(MBS)

• Mortgage Backed Securities (MBS): An undivided interest in a pool of insured residential mortgages (NHA insured)

• a very secure investment, guaranteed by CMHC, guaranteeing the investor a specified income flow even if the borrower defaults

• MBS are created by an issuer who brings together a pool of NHA insured mortgages

17

$0

$50,000

$100,000

$150,000

$200,000

$250,000

$300,000

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

Mortgage-Backed Securities ($millions)

Mortgage-Backed Securities ($millions)


1990s to Present

• relatively low inflation, low interest rate environment

• Technological and market changes impacted structure of mtg finance

• increasingly competitive market—innovative options by lenders

• Increased role of mtg brokers

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20

The Financial Market

Households

Business

Government

Business

Government

Direct

Investments

Brokers

Financial Institutions

Secondary

Investments

$ INCOME SAVINGSSPENDING

$ BORROWING



Which of the following item is treated as a money market item?

• (1) long-term bonds

• (2) equity (common shares)

• (3) treasury bills

• (4) mortgages

21


Mortgage Interest Rates

• while the overall level of interest rates are set by supply and demand, there is a structure of relative rates within the financial markets

• rates vary mainly due to risk (increased risk increased rate required to attract investors) and term structure

22

23

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00

18.00

20.001951

1953

1955

1957

1959

1961

1963

1965

1967

1969

1971

1973

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

Average 5 Year Mortgage Rate1951-2009

Average 5 Year Mortgage Rate

24


Mortgage Market: Supply

• Key suppliers are the financial institutions

• Volume depends on the amount available in the form of savings and the competitive position of mortgages compared to other investments.

• Supply is also influenced by the monetary and fiscal policies of the Federal Government and the Bank of Canada.

25


Mortgage Market: Demand

• a “derived” demand from the demand for housing

• influenced by interest rates, price of housing, other economic factors (employment, income and inflation), demographics (population growth, family formation and size), and specific policies and programs

26



Which of the following best represents the characteristics of mortgage loans as investments?

(1) illiquidity, short repayment term, simple administration

(2) illiquidity, long repayment term, complex administration

(3) liquid investment, long repayment term, simple administration

(4) liquid investment, short repayment term, complex administration

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Ch. 2: Mortgage Finance and

Market Participants

• Identify and describe key players: chartered banks, credit unions, trusts and insurance companies

• Mortgage brokers and mortgage fraud



Major Suppliers

• Chartered Banks

• Trusts and Mortgage Loan Companies

• Insurance Companies

• Credit Unions and Caisse Populaires

• Mtg Investors and Dealers

• NHA Mtg-Backed Securities

• Pension funds, private lenders, and mtgbrokers

29


Major Suppliers of Mtg Loans

• Chartered Banks: single largest source, yet smaller % of their assets

• Trust Co/Mtg Loan Co: mtg specialists; used to be separate

• Life Co: used to be important, today much smaller role

• Credit Unions: steady contribution, high % of assets in mtgs

• Pension Funds: small % of market

• MBS: increasingly larger role

30



Chartered banks:

• (1) have always been the most important source of mtg funds.

• (2) are governed by the Bank Act.

• (3) are not limited to the maximum 80% loan-to-value ratio for uninsured residential loans.

• (4) withdrew from the mtg mortgage in 1954 when interest rates exceeded 6%.

31


Ch. 3: Real Estate Finance and

Government Policy

• History of Housing Policy in Canada

• Dominion Housing Act

• National Housing Act

• CMHC Act

• Mortgage Loan Insurance

• Mortgage Rate Insurance



Government Role in Housing

Market

• As the federal government is precluded from direct intervention in housing markets (by the separation of powers under the Constitution),

• federal policies and programs affecting housing and residential mortgage financing have been extremely limited

• TRUE STATEMENT?

33


History of Federal Government

Lending Programs

• Pre 1935: one mortgage lending program

• Dominion Housing Act (1935): joint lending, constant blended payments, property taxes in payment

• National Housing Act (1938/44): changes in joint mortgages, encourage lending in remote areas; prepay with penalty

34


History of Federal Government

Lending Programs

• CMHC Act (1945): Crown corporation set up to administer federal participation in housing, make direct loans

• National Housing Act (1954): insured loans replaced joint lending, chartered banks able to lend on NHA mortgages, secondary mkt set up

• NHA Act and CMHC Act (1999): align CMHC’s legislation with other government legislation; also clarified CMHC’s right to enter public and private partnerships of a commercial nature

35


Canada Mortgage and Housing

Corporation (CMHC)

• Federal government’s most direct tool for implementing housing policy

• Four divisions: affordable and sustainable housing, aboriginal housing, securitization, and mortgage insurance

• Programs: Home Adaptations for Seniors’ Independence (HASI), Residential Rehabilitation Assistance Program (RRAP), Shelter Enhancement Program (SEP)

36



The Home Buyer’s Plan:

• (1) was introduced by the federal government in 1992

• (2) allows Canadians to withdraw up to $35,000 tax-free from the RRSP’s

• (3) amts withdrawn remain tax-exempt if repaid within 25 years

• (4) is no longer available

37


Mortgage Loan Insurance

• provides for reimbursement to the lender in the event of borrower default

• Uninsured (conventional) mtgsmaximum loan-to-value of 80%

• with insured mtgs, maximum loan-to-value up to 95%

38


History of Mortgage Loan Insurers

• 1954-1963: CMHC NHA approved mtgs

• 1963-1972: MICC entered the market

• 1993: MICC left market

• 1995: GE Capital Mortgage Insurance entered market (now Genworth Financial Canada)

• 2006: AIG United Guaranty entered the market

• April 2010: AIG United Guaranty sold to Canada Guaranty Financial Corp in April 2010

39



What are the benefits of mortgage loan insurance (to borrower)?

(1) increased equity requirement

(2) investment protection should borrower default

(3) avoids legal and other costs of a second mortgage

(4) property less saleable

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Ch. 6: Mortgage Math Review

• Interest rates, payment, OSB

• Interest accrual loans

• Annuities: definitions and calculations

• P/I split: one payment and over time

• NPV, IRR, Profitability Index (PI)

• Mtg constant and final payments



Important Financial Operations

and Formulation

• Use of calculator steps

• Use of formulation—for example

PV = PMT x a[[N, jm]] + FV(1 + i)-N

FV = PMT x s[[N, jm]]

43


Interest Accrual Loans (Lump

Sum Problems)

PV (1 + i)n = FV and

FV(1 + i)-n = PV

PV = present value of the loan

i = periodic interest rate

n = number of compounding periods

FV = amount owed at end of loan, the future value

44


Nominal and Periodic Rates

• Nominal interest rates: annual interest rate with a stated compounding frequency (jm)

• Periodic interest rates: interest rate per compounding period (i)

• Periodic interest rate = nominal interest rate divided by compounding frequency

• j/m = periodic rate

• i x m = nominal rate

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If Joanne deposited $5,000 in bank today and was able to earn j1=6%, how much will she save at the end of 5 years?

• (1) $7,068.58

• (2) $6,744.25

• (3) $7,220.64

• (4) $6,691.13

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Calculator Steps

6 I/YR

1 shift P/YR

5000 PV0 PMT5 N

FV -6,691.127888

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Interest Rate Conversions

• Based on the premise of equivalence

• (1 + ida)365 = (1 + imo)12 = (1 + iq)4 =

(1 + isa)2 = (1 + ia)1 = (1+iwk)52

48


Interest Rate Conversions using

HP10BII

• Enter STATED nominal rate NOM%

• Enter STATED compounding frequency P/YR

• Calculate the effective annual rate EFF%

• Enter the DESIRED compding freq P/YR

• Calculate the equivalent nominal rate NOM%

49



Calculate the annual rate, compounded monthly (j12) equivalent for a rate of 6% per annum, compounded semi-annually (j2 = 6%)?

(1) 0.49386220312%

(2) 6.07550187875%

(3) 0.506291823%

(4) 5.92634643744%

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Calculator Steps

6 shift NOM%

2 shift P/YR

shift EFF% 6.09

12 shift P/YR

shift NOM% 5.92634643744

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Annuities

Compounding

Periods and

Payment

Periods are:

PMTS occur at: Same (Simple) Different

(General)

Beginning of

period

SIMPLE

ANNUITY DUE

GENERAL

ANNUITY DUE

End of period ORDINARY

SIMPLE

ANNUITY

ORDINARY

GENERAL

ANNUITY


Formula for PV of Ordinary

Annuities

PV = PMT x [1 – (1 + i)-n]

i

where: [(1+i)-1 +(1+i)-2 + … + (1+i)-n]

= [1 – (1 + i)-n]

i

Formula is pre-programmed into calculator

PV = PMT x a [[n, jm]]

53


Formula for FV of Ordinary

Annuities

FV = PMT x [(1 + i)n – 1]

i

where[(1+i)n-1 +(1+i)n-2 + … + (1+i)1 + (1+i)0] =

[(1 + i)n – 1]

i

Formula pre-programmed into calculator:

FV = PMT x s[[n, jm]]

54



Given a purchase price of $350,000 and a $87,500 down payment, calculate the size of the monthly payment, assuming a rate of j12 = 5.25% amortized over 25 years.

• (1) $2,097.37

• (2) $2,097.36

• (3) $1,573.03

• (4) $1,573.02

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Calculator Steps

5.25 I/YR

12 shift P/YR

350000 – 87500 =

262500 PV

300 N

0 FV

PMT -1,573.02525232

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Outstanding Balances (OSB)

• Definition: how much is owing on a loan at a particular point in time

• Partially amortized loans will have OSBs

• Calculated at the end of term or at any point during the term

• 2 preprogrammed functions to solve

57



Borrow $130,000 at j12 = 12% for a 20 year amortization period and a 2 year term. Payments are monthly. Calculate the amount of the monthly payment and the outstanding balance at the end of the term.

• (1) $1,431.42; $126,455.15

• (2) $1,369.20; $128,133.67

• (3) $1,427.66; $127,445.89

• (4) $1,399.65; $129,312.09

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Calculator Steps

12 I/YR

12 shift P/YR

130000 PV

240 N

0 FV

PMT -1,431.41197364

1431.42 +/- PMT

24 INPUT shift AMORT = = = 126,455.147249

24 N FV -126,455.147249

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Next time: 221 Webinar 2

• Review Mortgage Finance

• Chapters 7 and 8

• Project 1 preparation

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Questions?

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Documents

BUSI 221: Real Estate Finance in a Canadian Context ... · BUSI 221: Real Estate Finance in a Canadian Context 2 Webinar Seminar 1: Chapters 1-6. REAL ESTATE DIVISION Introduction