Real Estate Investments - Cal Polyppatel29/IntroductionBUS435Winter2015.pdf · What are real estate investments? | The Big Picture 10 ... (MBS, CMBS), Derivative securities (IOs,

Real Estate Investments

Pratish Patel

Winter 2015 — Lecture Notes

California Polytechnic University Pratish Patel Winter 2015

Learning Objectives

• What are real estate investments?

• Syllabus

• Topics to be covered

• Physical and Financial Market

• Real Estate size

California Polytechnic University Pratish Patel Winter 2015 1

What are real estate investments? — The Big Picture

10

Exhibit 2Exhibit 2--2: The 2: The ““Real Estate SystemReal Estate System””: Interaction of the Space Market, Asset Market, & Development I: Interaction of the Space Market, Asset Market, & Development Industryndustry

SPACE MARKET

SUPPLY(Landlords)

DEMAND(Tenants)

RENTS&

OCCUPANCY

LOCAL&

NATIONALECONOMY

FORECASTFUTURE

ASSET MARKET

SUPPLY(Owners

Selling)

DEMAND(InvestorsBuying)

CASHFLOW

MKTREQ’D

CAPRATE

PROPERTYMARKETVALUE

DEVELOPMENTINDUSTRY

ISDEVELPT

PROFITABLE?

CONSTRCOSTINCLULAND

IFYES

ADDSNEW

CAPITAL MKTS

= Causal flows.

= Information gathering & use.California Polytechnic University Pratish Patel Winter 2015 2

Physical property market

Physical property market includes

• Hotels, warehouses, apartments, condos

• Specialized buildings that focus on Bio Tech Labs for example

• Retirement homes

The economics of investment in physical property markets depends on traditionaleconomic factors such as demand of rental space, supply of rental space, regulations,forecasted operating cashflows.


Capital markets

In order to buy or develop a real estate property, the decision maker needs toborrow:

• We need to understand who they are borrowing from? Sources of Funds

• We need to understand what are they borrowing? Financial Instruments

• We need to understand how they are borrowing? Market Infrastructure

1. Sources of funds

• Capital market investors (including mutual funds) for both debt (mortgage)and equity (REIT) instruments.


• Financial intermediaries (Commercial banks, Thrift institutions, Insurancecompanies, Pensions funds.

• Government Sponsored Enterprises (GSEs, i.e. Fannie/Freddie).

2. Financial Instruments

• Mortgages (whole loans),• Mortgage backed securities (MBS, CMBS),• Derivative securities (IOs, POs, Floaters, etc.) ,• REIT equity.

3. Market infrastructure

• Legal structure including land ownership, mortgage recording, foreclosure andeviction laws, and tax law.


Secondary Market?

Suppose you took out a mortgage by approaching Bank of America. Your loanis considered to be primary market.

Bank of America in turn sells your loan to others.

• “Others” make up the secondary market.

• The process is called Securitization.

• A lot of players are involved in this process and some of them have conflictingincentives.


© 2009 Dwight Jaffee and Nancy Wallace, Slide 41 41

Whole Mortgages vs. Mortgage Backed Securities (MBS)

The MBS Pool

Principal and Interestfrom Mortgages

Final Investors

All Cash Flowfrom MBS Pool

Simple Pass Throughor Tranches

Lender Mortgages

Lender can just hold

whole mortgages

Often better to sell

mortgages as a pool

Each investor gets a

prorated % of the pool



US Secondary Mortgage Market

InvestorsHold

IssuedMortgages

ThriftsBanksInsurance Co.Pension FundsMortgage Banks Mortgage REITs

SecondaryMarket

TransfersOwnership

GSEs (MBS)Private MBS/CMBSMortgage InsurersServicersLawyersRating Agencies

PrimaryMarket

Originates Mortgages

Banks & ThriftsInsurance Co.Pension FundsMutual FundsIndividualsGSEs


What is this class about?

Real Estate Investments is

Investment in apartments, condos, buildings, warehouses, etc so that you havea right to cash flows from the real estate property

+ Investment in financial instruments that are collateralized by real estate property


What is the size of the real estate related financial instruments?


RESEARCH QUARTERLY RESEARCH REPORT | 3Q | 2013

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Treasury(1) Federa l Agency(1) Municipal(1) Mortgage-Related Asset-Backed Corporate(1) Equity

$ Billions

(1) Includes long-term issuance onlySource: Thomson Reuters, U.S. Treasury, U.S. Federal Agencies

Issuance in U.S. Capital MarketsYTD 2012 vs. YTD 2013

YTD 2012

YTD 2013

Issuance Highlights - Year-Over-Year

$ Billions 2013:Q3 2012:Q3Y-o-Y %

Change* 2013 YTDTreasury (1) 640.0 544.0 17.6% 1,618.0Federal Agency (1) 96.5 197.0 -51.0% 347.3Municipal (1) 72.0 87.7 -17.9% 251.1Mortgage-Related 469.2 535.1 -12.3% 1,602.4Asset-Backed 45.0 51.7 -13.0% 142.5Corporate (1) 359.2 347.1 3.5% 1,087.4Equity 63.0 88.6 -28.9% 231.4* Percent change between 2013:Q3 and 2012:Q3

Quarter-Over-Quarter

$ Billions 2013:Q3 2013:Q2Q-o-Q % Change*

Treasury (1) 640.0 539.0 18.7%Federal Agency (1) 107.1 116.1 -7.7% Municipal (1) 72.0 95.0 -24.2% Mortgage-Related 469.2 552.5 -15.1% Asset-Backed 45.0 48.4 -7.1% Corporate (1) 359.2 350.2 2.6% Equity 63.0 79.8 -21.1% * Percent change between 2013:Q3 and 2013:Q2(1) Includes long-term issuance only

CAPITAL MARKETS OVERVIEW Total Issuance Falls in Third Quarter 2013 Long-term securities issuance totaled $1.74 trillion in the third quarter of 2013, a 2.0 percent decrease quarter-over-quarter (q-o-q) and a 5.7 percent decrease year-over-year (y-o-y). Increases in U.S. Treasuries and corporate bond issuance were offset by declines in federal agency debt, municipal debt, asset-backed securities, and mortgage-related issuance.

Total gross issuance of Treasury bills and coupons, including cash manage-ment bills (CMBs), was $1.97 trillion in 3Q’13, a 1.4 percent increase from $1.95 trillion issued in 2Q’13 and a 0.5 percent increase from 3Q’12’s issuance of $1.96 trillion. On net basis, in 3Q’13 the U.S. Treasury issued $142.3 billion in securities a much different outcome than the previous quarter’s net redemp-tion of $10.7 billion and $234.3 billion issued in 3Q’12.

Federal agency long-term debt issuance was $96.5 billion in the third quarter compared to $110.7 billion in 2Q’13. Fannie Mae’s 3Q’13 gross debt issuance, both STD and LTD, totaled $72.9 billion, down 14.3 percent from 2Q’13 ($85.1 billion); STD issuance increased to $48.8 billion, a 4.9 percent increase q-o-q while LTD issuance decreased to $24.2 billion.

Long-term municipal issuance volume, including taxable and tax-exempt issu-ance, totaled $68.0 billion in the third quarter of 2013, a decline of 21.3 percent from the prior quarter ($88.6 billion) and a decline of 18.7 percent y-o-y.

Issuance of mortgage-related securities, including agency and non-agency passthroughs and collateralized mortgage obligations, totaled $469.2 billion in the third quarter, a 13.4 percent decline from 2Q’13 ($541.5 billion) and a 13.2 percent decline y-o-y ($540.4 billion).

Asset-backed securities issuance totaled $45.0 billion in the third quarter, a de-cline of 7.1 percent and 13.0 percent, respectively, q-o-q ($48.4 billion) and y-o-

y ($51.71 billion).

Corporate bond issuance totaled $359.3 billion in 3Q’13, 5.8 percent up from the $339.4 billion issued last quarter and 3.5 percent above the $347.1 billion issued in 3Q’12.

Equity underwriting declined to $63.0 billion in the third quarter, 21.1 percent below the $79.8 bil-lion in 2Q’13 and 28.9 percent below the $88.6 billion in 3Q’12. Secondary market issuance de-creased to $44.0 billion on 245 deals from $47.7 billion on 218 deals in 2Q’13 (a decrease of 7.8 percent in volume but an increase of 12.4 percent in number of deals). “True” initial public offer-ings, which exclude closed-end mutual funds, decreased in 3Q’13 to $11.5 billion on 56 deals, a 17.8 percent decrease from $14.0 billion and an 8.2 percent decrease from 61 deals in the previous quar-ter.

2



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2012 20132004 2005 2006 2007 2008 2009 2010 2011 2012 YTD

$ Billions

1Excludes maturities of one year or less* Beginning in 2004, Sallie Mae has been excluded due to privatization

Sources: Thomson Reuters

Long-Term Federal Agency Debt Issuance1

2004 - 2013:Q3

Fannie Mae, $18.0B

Farmer Mac, $0.0B

Federal Farm Credit, $13.5B

Federal Home Loan Banks,

$44.3B

Freddie Mac, $20.8B

Long-Term Federal Agency Debt Issuance by Agency2013:Q3

* Beginning in 2004, Sallie Mae has been excluded due to privatizationSources: FHLB, FNMA, FHLMC, SLMA, TVA, FCS

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2

4

6

8

10

12

14

Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13

$ Billions

Source: FINRA

Average Daily Trading Volume of Federal Agency SecuritiesOct. 2011 - Sep. 2013

Other FHLB

FNMA FHLMC

FEDERAL AGENCY DEBT MARKET Federal agency long-term debt (LTD) issuance was $96.5 billion in the third quarter compared to $110.7 billion in 2Q’13. Overall, average daily trading volume of agency securities in the third quarter was $5.1 billion, down 31.4 percent from $7.5 billion traded in 2Q’13.

The 12 Federal Home Loan Banks issued $84.5 billion in LTD in the third quarter, a decrease of 4.9 percent q-o-q but an increase from the 3Q’12 amount of $70.0 billion. A little more than $727.6 billion in short-term debt (STD) was issued in 3Q’13, decreases of 20.1 percent q-o-q and 24.2 percent from 3Q’12.

Total FHLB LTD outstanding was $485.5 billion at quarter-end, up slightly from the $483.1 billion outstanding at the end of the second quarter and up 6.2 percent y-o-y from $457.1 billion. Discount notes increased to $235.2 bil-lion at the end of 3Q’13 from $221.4 billion in 2Q’13and from $217.3 billion in 3Q’12.

Fannie Mae’s 3Q’13 gross debt issuance, both STD and LTD, totaled $72.9 billion, down 14.3 percent from 2Q’13 ($85.1 billion); STD issuance increased to $48.8 billion, a 4.9 percent increase q-o-q while LTD issuance decreased to $24.2 billion. Fannie Mae had $77.8 billion in STD outstanding in 3Q’13, down from $102.8 STD outstanding as of 2Q’13, and $492.3 billion LTD outstand-ing, a slight decrease from $505.6 billion in 2Q’13.

Freddie Mac’s third quarter gross debt issuance totaled $92.6 billion, an 18.1 percent decrease from 2Q’13 ($113.1 billion). As of quarter-end, Freddie Mac had $133.1 billion STD and $390.3 billion LTD outstanding, relatively flat from the $132.8 billion STD and $395.6 billion in LTD in the prior quarter.

Total Farm Credit System gross debt issuance year to date totaled $327.4 bil-lion. Total debt outstanding ended the third quarter at $197.9 billion, of which $15.4 billion was short-term and $184.5 billion was long-term.

Primary dealers polled by SIFMA in the Third Quarter Government Forecast survey expected gross coupon issuance for the four largest Federal agencies (FHLB, Fannie Mae, Freddie Mac, and the Farm Credit Systems) to reach $96.6 billion in the fourth quarter of 2013.7 By agency, gross coupon issuance was expected to be $18.0 billion for Fannie Mae, $20.8 billion for Freddie Mac, $44.3 billion for the FHLBs, and $13.5 billion for the Farm Credit System.

7 See SIFMA’s U.S. Government Forecast 4Q’13.

6


http://www.clevelandfed.org/research/trends/2013/1013/01houcon-3.gif[12/26/2013 7:48:13 PM]




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2012 20132006 2007 2008 2009 2010 2011 2012 YTD

$ Billions

Source: Thomson Reuters, SIFMA

Issuance of Asset-Backed Securities2005 - 2013:Q3

Auto, $21.9B

Credit Cards, $10.5B

Equipment, $4.4B

Home Equity, $1.9B

Manufactured Housing, $0.0B

Other, $3.1B

Student Loans, $3.1B

ABS Issuance by Major Types of Credit2013:Q3

Source: Thomson Reuters, SIFMA

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1.0

1.2

1.4

1.6

3Q'11 4Q'11 1Q'12 2Q'12 3Q'12 4Q'12 1Q'13 2Q'13 3Q'13

$ Billions

Source: FINRA Trace

Asset-Backed Securities Average Daily Trading Volume2011:Q3 - 2013:Q3

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3,500.0

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

$ Billions

Source: Bloomberg, Thomson Reuters Eikon, SIFMA

Asset Backed Securities Outstanding2004:Q1 - 2013:Q3

USD-denominated CDO

Consumer ABS

ASSET-BACKED SECURITIES Asset-Backed Market Issuance Declines In Third Quarter Asset-backed securities (ABS) issuance totaled $45.0 billion in the third quarter, a decline of 7.1 percent and 13.0 percent, respectively, q-o-q ($48.4 billion) and y-o-y ($51.7 billion). The auto sector continued to lead issuance totals with $21.9 billion (48.8 percent of total issuance in 3Q’13), followed by credit cards ($10.5 billion, or 23.3 percent) and equipment ($4.4 billion, or 9.9 percent).

Issuance declined in all categories with the exception of credit cards, equip-ment, and other, which experienced a 56.2 percent, a 43.9 percent, and a 12.4 percent increase, respectively, q-o-q.

Outstandings continued to decline, with $1.62 trillion outstanding at the end of the third quarter, compared to $1.63 trillion in 2Q’13 and $1.67 trillion in 3Q’12. As in the prior quarter, only auto, equipment, and other outstandings grew in the third quarter, increasing by 10.6 percent, 17.1 percent, and 1.1 per-cent respectively, from 2Q’13. Auto outstanding growth was driven by the growth in prime, near-prime, and subprime auto loans. In the ‘other’ category, several insurance linked securities (ILS) deals were done in the third quarter; notably a deal from the NY Metropolitan Transportation Authority (MTA) for storm surges in the NYC area. In addition to ILS deals, several timeshare and transportation deals were also issued in the third quarter.

In the remainder of the ABS sectors excluding CDOs, however, outstandings continued to decline. Quarterly declines were most pronounced in manufac-tured housing (12.8 percent) and home equity (8.9 percent).

Trading Activity Increases Daily average trading activity in ABS increased in the third quarter to $1.06 billion daily, an increase of 12.1 percent and 4.4 percent, respectively, q-o-q and y-o-y.

Global Collateralized Debt Obligations (CDO) Issuance Rises According to Thomson Reuters, global funded CDO issuance totaled $16.1 billion in 3Q’13, a decline of 19.1 percent q-o-q ($19.9 billion) but an increase of 10.6 percent from 3Q’12 ($18.0 billion). U.S. CLO issuance continued to drive most of new global CDO volume in 2013, although several European collateralized loan obligation (CLO) deals were also issued.

10



0

500

1,000

1,500

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2,500

2012 20132005 2006 2007 2008 2009 2010 2011 2012 YTD

$ Billions

Sources: Federal Agencies, Thomson Reuters

Issuance of Mortgage-Related Securities2005 - 2013:Q3

Agency - Other

Agency MBS/CMO

Non-Agency MBS

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100

200

300

400

500

600

700

800

2012 20132005 2006 2007 2008 2009 2010 2011 2012 YTD

$ Billions

Sources: Bloomberg, Thomson Reuters

Issuance of Non-Agency Mortgage-Backed Securities2005 - 2013:Q3

RMBS CMBS

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500

1,000

1,500

2,000

2,500

2005 2006 2007 2008 2009 2010 2011 2012 2013 Q3

$ Billions

Sources: Loan Performance, Fitch Ratings, Moody's, S&P, SIFMA, Thomson Reuters

U.S. Non-Agency Securities Outstanding2005 - 2013:Q3

RMBS

CMBS

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2012 20132005 2006 2007 2008 2009 2010 2011 2012 Q3

$ Billions

Sources: Federal Reserve Bank of NY (pre-2011), FINRA Trace (2011 onward); 2011 data is a daily average beginning May 15, 2011 as Trace data starts May 2011.

Average Daily Trading Volume of Agency Mortgage-Related Securities 2005 - 2013:Q3

TBA

Agency CMO

Agency MBS

MORTGAGE-RELATED SECURITIES Issuance in Mortgage-Related Market Declines Issuance of mortgage-related securities, including agency and non-agency passthroughs and collateralized mortgage obligations (CMOs), totaled $469.2 billion in the third quarter, a 13.4 percent decline from 2Q’13 ($541.5 billion) and a 13.2 percent decline y-o-y ($540.4 billion). The decline in issuance q-o-q was primarily due to a slight decline in agency issuance, although non-agency volumes also declined due to the drop off in residential agency mortgage-backed securities (RMBS) issuance. Overall, the agency share of issuance de-clined slightly to 97.1 percent in 3Q’13 from 98.1 percent in the prior quarter.

According to Freddie Mac, average rates on conventional 30-year mortgages began rising at the end of June to a high of 4.58 percent midway through the third quarter, before declining to 4.32 percent at the end of September. The average rate in 3Q’13 (4.42 percent) was 75 basis points higher than the average rate in 2Q’13 (3.67 percent).

Agency Issuance and Outstanding Agency mortgage-related issuance totaled $455.4 billion in 3Q’13, a decline of 14.3 percent and 14.5 percent, respectively, q-o-q and y-o-y. Agency MBS out-standings increased by 1.2 percent in 3Q’13, with Ginnie Mae growing the fast-est q-o-q (2.7 percent).

Agency Risk Sharing Deals The two agencies, Freddie Mac and Fannie Mae, debuted their new risk sharing securitizations in the third and fourth quarter of 2013. Freddie Mac debuted its Structured Agency Credit Risk (STACR) securities in July, followed by an addi-tional deal in November, while Fannie Mae debuted in October with their Connecticut Avenue Securities (CAS) deal. Both deals partially transfer the credit risk of an underlying reference pool of mortgages to private investors. Unlike agency MBS, cashflows do not flow from the reference pool, nor are principal and interest guaranteed; unlike the agency debentures, the risk sharing deals are structured and have credit exposure to the referenced mortgage pool. Both agencies sold mezzanine and junior tranches of their respective deals and retained the senior unfunded portion.

Non-Agency Issuance and Outstanding Non-agency issuance totaled $13.8 billion in 3Q’13, a decline of 34.9 percent from 2Q’13 ($21.2 billion) but a 76.9 percent increase from 3Q’12 ($7.8 bil-lion). Non-agency RMBS issuance fell to $0.5 billion in 3Q’13, a decline of 85.7 percent q-o-q but an increase of 179.9 percent y-o-y.

Non-agency outstandings continued to decline, with $1.2 trillion outstanding end-September, down 3.0 percent from 2Q’13, comprising $625.5 billion in non-agency CMBS (a decline of 1.4 percent q-o-q) and $543.7 billion in non-agency RMBS (a decline of 4.7 percent q-o-q). Year-over-year, the non-agency sector has declined 9.8 percent, with the non-agency RMBS sector falling faster (16.8 percent).

Trading Activity and Rates Daily trading volumes for mortgage-related securities, both agency- and non-agency, plummeted in the third quarter, partly on seasonal slowdown but also in part on speculation over an early end to bond buying from the Fed. Average

daily trading volume of agency mortgage-related securities, including passthroughs, CMOs, and TBA, was $203.3 billion in 3Q’13, a decline of 20.3 percent from 2Q’13. Average daily trading vol-umes of non-agency CMBS and RMBS in 2Q’13 were $1.8 billion and $1.6 billion, respectively, a

8







Securitization Rates for Home Mortgages(Source: Inside Mortgage Finance)

0%

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20%

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110%

120%

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

FHA/VA Conventional Conforming

Jumbo Subprime

Total



Documents

Real Estate Investments - Cal Polyppatel29/IntroductionBUS435Winter2015.pdf · What are real estate investments? | The Big Picture 10 ... (MBS, CMBS), Derivative securities (IOs,