Real Estate Finance

© JR DeLisle, Ph. D.

Lecture 1: Introduction to Real Estate Finance

byJames R. DeLisle, Ph.D.

January 5, 2010

Real Estate Finance

© JR DeLisle, Ph. D.

Lecture Overview

• Course Organization• Critical Thinking• The Economic Problem: an Example in Critical Thinking• Other Real Estate Trends/Issues

• Real Estate Process Review

Real Estate Finance

© JR DeLisle, Ph. D.

Course Overview

• Course Background– Course Objectives– Timetable– Computer and Technology Requirements– Grading Strategy and Policy– Project Decision: Rationale and Alternatives

• Organization of Real Estate Finance 2010– Part 1: Residential Finance– Part 2: Commercial Property Finance– Part 3: Capital Markets– Part 4: Institutional Finance

Real Estate Finance

© JR DeLisle, Ph. D.

Course Objectives

• Foster Creative thinking and Problem-solving– Helping students Systematically think about financial decisions related to real estate– Develop ability to model a variety of financial decisions

• Develop Understanding of Real Estate Financial Markets– Market fundamentals: products and processes– Market Decision-making: players and market drivers– Residential Finance & Income Property Finance– Construction and Development Finance

• Cultivate Appreciation for Capital Markets– Sources and Uses of Capital– Capital Flows to Real Estate– Private Market– Public Market

• Develop Individual and Team-based Problem solving skills– Emerging Trends: class discussion of emerging issues and trends– Financial modeling: team-based modeling and application of appropriate tools

• Excel Modeling• Argus Decision-support

Real Estate Finance

© JR DeLisle, Ph. D.

Finance and Investments Text

• Hard Copy– Brueggeman and Fisher, Real Estate Finance and Investments,

13th Edition, Irwin, (2008)• On-line Resources

– General Resources• Excel Spreadsheet with selected examples from Chapter problems.• Argus Data Files & Argus Free Trial Link

– Chapter Resources• New Articles and Weblinks. A listing of Internet resources• Quizzes. A series of 10 questions per chapter with automatic

grading.• PowerPoint Presentations.

Real Estate Finance

© JR DeLisle, Ph. D.

Supplemental Materials

• Cases and Review material from Real Estate Process– Time Value of Money & Primer on Mathematics of Real Estate Finance,” (DeLisle)– Case 1: Building Envelope– Case 2: Total Replacement Cost– Case 3: Frontdoor/Backdoor Analysis– Case 4: Alternative Use Analysis– Case 5: Discounted Cash Flow

• Problems in Real Estate Finance (hyperlinked files)– Problem Set 1: Basic Time Value of Money– Problem Set 2: Basic Mortgage Finance– Problem Set 3: Intermediate Mortgage Finance– Problem Set 4: Basic Corporate Real Estate Decisions

• Argus Guides/Portfolio Case Studies– A Guide to Argus– Case Study in Argus

• Glossary of Real Estate Finance Terms

Real Estate Finance

© JR DeLisle, Ph. D.

Course Organization: Grading Policy

• Grading Philosophy– Basis: curved– Emphasis: achievement vs. process/speed

• Metrics– 4 Multiple Choice/Matching Quizzes & calculated quizzes on fundamentals of real estate

finance– 2 Mortgage Spreadsheet Modeling: fixed rate and variable rate mortgages– 2 DCF Modeling: Enhancement to Excel model with rent roll, partnerships and portfolio

integration– 2 Argus Cases. Argus Model for an individual project and a portfolio project.– 1 Final Exam. Individual paper in which students explore a contemporary issue in real

estate finance

•  Grading Components– Quizzes 4 24%– Financial Modeling: Mortgages 2 20%– DCF Modeling 2 30%– Argus/Portfolio Decision Support 2 20%– Final Exam 1 10%– Class Participation and Forum 6%

 

 

Real Estate Finance

© JR DeLisle, Ph. D.

Course Objectives

• Develop a conceptual understanding of:– Real estate market at the macro and micro levels,– Linkages between the spatial and capital markets,– Integration of property, asset and portfolio management, and– Roles, drivers, and decision-making processes of major classes of space users,

producers, and investors.

• Cultivate an appreciation for:– Sustainable development, operation, transaction and investment, and– Integrate related disciplines to support real estate decision-making with the

appropriate breadth and depth of inquiry.

• Be able to make decisions drawing on:– Industry best practices, academic and theoretical concepts, and an– Understanding of basic technical and analytical tools.

Real Estate Finance

© JR DeLisle, Ph. D.

How we Got Where we Are?

Real Estate Finance

© JR DeLisle, Ph. D.

Critical Thinking

Real Estate Finance

© JR DeLisle, Ph. D.

Feasibility Analysis: Critical Problem Solving

Real Estate Finance

© JR DeLisle, Ph. D.

Legal Elements of Real Estate

Real Estate Process

© JR DeLisle, Ph. D.

Legal Description: Irregular Shapes

Real Estate Process

© JR DeLisle, Ph. D.

Legal Description by Metes & Bounds

N 0o0” E100’

ThenceS 0o0: 120’

ThenceE 0o0: 140’Thence to

POB

Marker

Real Estate Finance

© JR DeLisle, Ph. D.

Players and Perspectives

Space Producers

Space Consumers

Infrastructure Providers

Linkages

Environment

Static

S…. E….. L ….

Real Estate Process

© JR DeLisle, Ph. D.

Which Market Segments?

Upscale City Singles

Major Market Core

Metro Fringes

Second City Leaders

Affluent Suburbia

AnomolousLifestyles

Real Estate Process

© JR DeLisle, Ph. D.Interdisciplinary Spectrum: A Life Cycle Approach

Time

$

Portfolio Mgmt.Asset Mgmt.LeasingTenant ImprovementsTenant Relations

Property Mgmt.Accounting/ReportingEngineeringFinancial Mgmt.

Construction Mgmt.Quality ControlsProject Mgmt.Architectural OversightCost Mgmt.Construction FinancingInspectionsPre-leasingReleasesFinal Inspection

orSourcing if Existing

FeasibilityMarketabilityAppraisalEngineeringArchitecturalEnvironmentalLegalCost EstimationNegotiations

Hold/Sell AnalysisMarketingValuationBuyer SelectionBroker ManagementNegotiationsClosing

Planning Acquisition/Production

Operation

Disposition/Redevelop

Real Estate Finance

© JR DeLisle, Ph. D.

Land Use Controls

Real Estate Process

© JR DeLisle, Ph. D.

Land Use Controls: Taking vs. Police Power

Land Use Controls

Eminent Domain

LUC

Taking

Partial Taking

Public Good vs. Private Loss

Safety, health & welfare

Real Estate Process

© JR DeLisle, Ph. D.

Building Envelopes: A Modular Approach

• Site Size

• Lot Coverage Ratio (LCR)

• Height Restrictions

• Parking Requirements– Parking Index– SF/Stall

• Floor Area Ratio (FAR)

Real Estate Finance

© JR DeLisle, Ph. D.

Parcel Research

Real Estate Finance

© JR DeLisle, Ph. D.

TRCm

Real Estate Finance

© JR DeLisle, Ph. D.

Money-Time Dimension of Real Estate Value

Real Estate Process

© JR DeLisle, Ph. D.Backdoor Model: Reverse Engineered

Land

Hard & Soft Costs

TRCj

Value

Income

/ Rate

* NIRGross Income

Market

RCR=Budget to Real Estate

Real Estate Process

© JR DeLisle, Ph. D.Frontdoor Model: Sequence

Land

Hard & Soft Costs

TRCm

Value

Income

* Rate

/ NIR

Gross Income

Real Estate Finance

© JR DeLisle, Ph. D.

Frontdoor Model

Real Estate Process

© JR DeLisle, Ph. D.Frontdoor Model: Sequence

Land

Hard & Soft Costs

TRCm

Value

Income

* Rate

/ NIR

Gross Income

Real Estate Finance

© JR DeLisle, Ph. D.

Backdoor Model

Real Estate Process

© JR DeLisle, Ph. D.Backdoor Model: Reverse Engineered

Land

Hard & Soft Costs

TRCj

Value

Income

/ Rate

* NIRGross Income

Market

RCR=Budget to Real Estate

Real Estate Finance

© JR DeLisle, Ph. D.

Social Responsibility

Irretrievable CommitmentOf Scarce Resources

Real Estate Finance

© JR DeLisle, Ph. D.

Appraisal Objective and Process

Real Estate Finance

© JR DeLisle, Ph. D.

Appraisal Theory and Application

Real Estate Finance

© JR DeLisle, Ph. D.

Market Analysis

Real Estate Finance

© JR DeLisle, Ph. D.

Market Segmentation & Product Stratification

Real Estate Finance

© JR DeLisle, Ph. D.

Alternative Uses

Real Estate Finance

© JR DeLisle, Ph. D.

H&B Use and Most Fitting Use

Real Estate Finance

© JR DeLisle, Ph. D.

TMV

Real Estate Finance

© JR DeLisle, Ph. D.

Risk Management

Real Estate Finance

© JR DeLisle, Ph. D.

Mortgage Cycle

Real Estate Process

© JR DeLisle, Ph. D.

Mortgage Life Cycle Management

Planning/Application

Acquisition

Operation

Disposition

Mortgagee’s Concerns• Probability of Default• Severity of Default

Real Estate Process

© JR DeLisle, Ph. D.

Mortgage Risks: Acquisition Stage

• Borrower Underwriting– Will to pay– Ability to pay

• Property & Value– Due Diligence: collateral integrity, quality and quantity– Appraisal: value of underlying asset

• Claim– Collateral Commitment: clear title, deed, – Priority of Claim; no intervening liens, recording– Title Assurance/Insurance

Planning/Application

Acquisition

Operation

Disposition

Real Estate Process

© JR DeLisle, Ph. D.

Mortgage Risks: Operation Stage

• Administration– Loan Processing: collection, posting, record-keeping– Loan Servicing: disperse payments of taxes, insurance

• Property– Periodic Inspection: property maintained– covenants honored

• Borrower– Additional Encumbrances– Liens; restriction, disclosure

Planning/Application

Acquisition

Operation

Disposition

Real Estate Process

© JR DeLisle, Ph. D.

Mortgage Risks: Disposition Stage

• Timing– Duration: actual term vs. contract term– Prepayment Penalties: yield maintenance

• Transfer– Loan assumption: timing, risk– Borrower substitution

• Foreclosure– Monitor– manage and pursue/protect claims

Planning/Application

Acquisition

Operation

Disposition

Real Estate Finance

© JR DeLisle, Ph. D.

Mortgage Loans

Real Estate Finance

© JR DeLisle, Ph. D.Traditional Mortgage Amortization Patterns

Real Estate Finance

© JR DeLisle, Ph. D.Traditional Mortgage Assumptions

PP* LV

Pi

PMT

INT PRIN

Interest vs. Principal Share of Payments

0%

20%

40%

60%

80%

100%

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29

Term

Tot

al P

aym

ent

INT vs. PRIN Total Payment

Amortization Schedule

$0

$50,000

$100,000

$150,000

$200,000

$250,000

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30

Time

Dol

lars

Principal Balance

Amortization Schedule

$0

$50,000

$100,000

$150,000

$200,000

$250,000

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30

Time

Dol

lars

Principal Balance Total Payment Interest

Real Estate Finance

© JR DeLisle, Ph. D.

DCF

Real Estate Finance

© JR DeLisle, Ph. D.

Leases as Risk Management

Real Estate Finance

© JR DeLisle, Ph. D.

Capital Market

Real Estate Finance

© JR DeLisle, Ph. D.

REITs and CMBS

Real Estate Finance

© JR DeLisle, Ph. D.

Portfolio Management

Real Estate Finance

© JR DeLisle, Ph. D.

Development

Real Estate Finance

© JR DeLisle, Ph. D.

Timetable: Part 1

Timetable as of 1/5/2010

Wk Date Topic Chapter Readings/Cases Quizzes/Projects Out Problem Sets/Due Dates

1 1/5 Course Overview and Process Review

Ch 1: RE Finance Overview

DeLisle, No Bottom, No NetGraaskamp, Finance Educ. & Risk Management

Review Cases: located inMoodle Process Review

1/7 Capital Markets & Real Estate

Ch 2: Money, Credit and Rates; Ch 3: Finance Theory & RE

2010 Emerging Trends; DeLisle: RE Asset Class or Sector?

Prob Set1: Basic Time Value of Money

2 1/12 Financing Notes & Mortgages

Ch 4: History of Res Finance; Ch 5: Postwar Residential Finance

DeLisle, Primer 1: Res. Mortgage pgs 1-48.

Mortgage Project 1 Base Mtgs. Out; Quiz 1 Out

1/14 Residential Mortgage Loans

Ch 6: Alternative Mortgages

DeLisle: Primer 1: Alt Mortgages pgs 48-72.

Prob Set 2: Intro to Mortgage FinanceMortgage Project 1 Due

3 1/19 Residential Finance; Housing Affordability

Ch 7: Financing and Property Value; Ch 8-9 Federal Housing

DeLisle, Housing Affordability Cost Study

Quiz 2 OutProject 2 Alt Mtgs. Out

Prob Set 3: Intermediate Mtg Fin; Quiz 1: Due

1/21 Underwriting Residential Property

Ch 13: Loan Orig; Ch 14: Mortgage Ins, Title Insurance

4 1/26 Discounted Cash Flow;Investment Analysis

Ch 19: Perm Financing Case 1: FD/BD AnalysisCase 2: DCF Analysis DCF Enhanced

Mortgage Project 2 Due

1/28 Introduction to Income Property & Leases

To be assigned Primer 2: Rent Roll Modeling in Excel

Project 3: DCF Leases Out

Quiz 2: DueProb Set 4: Intro Corp RE

5 2/2 Valuation of Income Property

To be assigned

2/4 Financial Leverage & Alt. Financing

Ch 15 Value, Leverage Prob Set 5: Adv Corp RE

Real Estate Finance

© JR DeLisle, Ph. D.

Timetable: Part 2

Wk Date Topic Chapter Readings/Cases Quizzes/Projects Out

Problem Sets/Due Dates

6 2/09 Risk Analysis Ch 12: Controlling Risk;

2/11 Disposition/RenovationCorporate RE Finance

To be assignedQuiz 3: Out Project 3: DCF Leases Due

7 2/16 Financing & Land Development

Ch 18: ADC LoansArgus Model Tutorial

2/18 Real Estate Portfolio Management

Ch 21: RE in a Portfolio Context

DeLisle, “A Holistic RE Portfolio Mgmt.”

8 2/23 To be assigned Primer 3: Argus Project Analysis

Proj. 4: Argus RR-DCF Out

2/25 JVs, Syndications, Partnerships,

Ch 20: Ownership Proj. 5 Argus Portfolio: Out

Project 4: Argus RR-DCF

9 3/02 Public Equity Market

Ch 17: Sources of Funds

Quiz 4: Out

3/04 Secondary Market: Pass-Throughs

Ch 10: Secondary Market

10 3/9 Secondary Market: CMOs, CMBSs

Ch 11: Valuation of RE Securities

Primer 4: Argus Portfolio Analysis

Final Out

3/11 Issues in RE Finance

Ch 22: Liability, Fraud and Ethics.

Project 5 Argus: Due Quiz 3: Due

11 3/15 Finals Week Final Exam Final Due 3/21