Real estate finance and investments part 2

www.downloadslide.net Chapter 12 Financial Leverage and Financing Alternatives In Chapter 6, we introduced a number of issues related to analyzing financing alternatives Important concepts from that chapter include the effective cost of borrowing (before and after tax) and the incremental cost of borrowing additional funds We also discussed how to evaluate whether a loan should be refinanced when interest rates decline Although this discussion focused on residential property, all of the above concepts also apply to the analysis of income property The three preceding chapters have dealt with analyzing investment returns and risk on income property In that analysis, we introduced financing and alluded to its effect on the before- and after-tax cash flow to the equity investor The purpose of this chapter will be to extend the discussion of debt from the earlier chapters in three additional ways First, we consider how the level of financing affects the investor’s before- and after-tax IRR Second, we consider important underwriting procedures used by lenders when financing is sought by investors Third, we consider several different financing alternatives that are used with real estate income property Since it is impossible to discuss all the varieties of loans that are used in practice, we will concentrate on the primary alternatives and focus our discussion on concepts and techniques that you can apply to any type of financing alternative that you might consider Introduction to Financial Leverage Why should an investor use debt? One obvious reason is simply that the investor may not have enough equity capital to buy the property On the other hand, the investor may have enough equity capital but may choose to borrow anyway and use the excess equity to buy other properties Because equity funds could be spread over several properties, the investor could reduce the overall risk of the portfolio A second reason to borrow is to take advantage of the tax deductibility of mortgage interest, which amplifies tax benefits to the equity investor The third reason usually given for using debt is to realize the potential benefit ­associated with financial leverage Financial leverage is defined as benefits that may result for an investor who borrows money at a rate of interest lower than the expected rate of return on total funds invested in a property If the return on the total investment invested in a property is greater than the rate of interest on the debt, the return on equity is magnified To examine the way financial leverage affects the investor’s rate of return, we consider investment in a small commercial property with the following assumptions: 393 www.downloadslide.net 394  Part 4  Income-Producing Properties Purchase price    Building value    Land value Total value Loan assumptions    Loan amount   Interest rate   Term Income assumptions   NOI Income tax rate* Depreciation Resale price Holding period $ 85,000 15,000 $100,000 $ 80,000 10.00% Interest only $12,000 per year (level) 28.00% 31.5 years (straight line)† $100,000 years Used to illustrate this example only Tax rates are subject to change * Recall from Chapter 11 that the Tax Act of 1993 allows residential property to be depreciated over 27.5 years and nonresidential property to be depreciated over 39 years These rates are subject to change, however, and we use 31.5 years in this example for illustration only † Using those assumptions, we obtain the cash flow estimates shown in Exhibit 12–1 Exhibit 12–2 shows the cash flow summary and IRR calculations for the cash flows in Exhibit 12–1 From Exhibit 12–2 we see that the before-tax IRR (BTIRR) is 20 percent and the after-tax IRR (ATIRR) is 15.40 percent with an 80 percent loan We now consider how these returns would be affected by a change in the amount of debt Exhibits 12–3 and 12–4 show the cash flow and return calculations for the example assuming that no loan is used From Exhibit 12–4 we see that both the BTIRR and ATIRR have fallen That is, both ­returns are higher with debt than without debt When this occurs, we say that the investment has positive (favorable) financial leverage We now examine the conditions that ­result in positive financial leverage more carefully To so, we first look at the conditions for positive leverage on a before-tax basis (the effect of leverage on BTIRR) Later, we examine the relationship on an after-tax basis (the effect of leverage on ATIRR) Conditions for Positive Leverage—Before Tax In the example when no debt was used, the BTIRR was 12 percent We will refer to this as the unleveraged BTIRR, since it equals the return when no debt is used In the case where 80 percent debt was used, the BTIRR increased to 20 percent Why does this increase ­occur? It occurs because the unleveraged BTIRR is greater than the interest rate paid on the debt.1 The interest rate on the debt was 10 percent, which is less than the 12 percent ­unleveraged BTIRR We could say that the return on investment (before debt) is greater than the rate that has to be paid on the debt This differential (12% vs 10%) means that positive leverage exists that will magnify the BTIRR on equity This relationship is formalized in a formula that estimates the return on equity, given the return on the property and the mortgage interest rate2: BTIRRE  BTIRRP  (BTIRRP  BTIRRD) (D/E) More precisely, the unleveraged IRR is greater than the effective cost of the loan Recall that the effective cost of a loan reflects points, prepayments, and other factors that affect the borrower This is an approximation when the ratio of debt to equity changes over time www.downloadslide.net Chapter 12  Financial Leverage and Financing Alternatives  395 EXHIBIT 12–1   Cash Flow Estimates for Commercial Building Estimates of Cash Flow from Operations Year 3 4 5 A Before-tax cash flow: Net operating income (NOI) Less debt service (DS) $12,000 $12,000 $12,000 $12,000 $12,000 8,000 8,000 8,000 8,000 8,000 Before-tax cash flow B Taxable income or loss: Net operating income (NOI) Less interest Depreciation $12,000 $12,000 $12,000 $12,000 $12,000 8,000 8,000 8,000 8,000 8,000 2,698 2,698 2,698 2,698 2,698 Taxable income (loss) Tax $ C After-tax cash flow: Before-tax cash flow (BTCF ) Less tax $ 4,000 $ 4,000 $ 4,000 $ 4,000 $ 4,000 364 364 364 364 364 After-tax cash flow (ATCF ) $ 3,636 $ 4,000 $ 4,000 1,302 364 $ 1,302 364 $ 3,636 $ 4,000 $ 1,302 364 $ 3,636 $ 4,000 $ 1,302 364 $ 3,636 $ 4,000 $ 1,302 364 $ 3,636 Estimates of Cash Flows from Sale in Year Sale price Less mortgage balance $100,000 80,000 Before-tax cash flow (BTCFs ) Taxes in year of sale   Sale price    Original cost basis $100,000    Less accumulated depreciation 13,492 $ 20,000 $100,000   Adjusted basis 86,508    Capital gain $ 13,492    Tax from sale 3,778 After-tax cash flow from sale (ATCFs ) $ 16,222 where BTIRRE  Before-tax IRR on equity invested BTIRRP  Before-tax IRR on total investment in the property (debt and equity) BTIRRD  Before-tax IRR on debt (effective cost of the loan considering points) D/E  Ratio of debt to equity Using the numbers for our example, we have BTIRRE  12.00%  (12.00%  10.00%)  (80%  20%)  20.00% This formula indicates that as long as BTIRRP is greater than BTIRRD, the BTIRRE will be greater than BTIRRP This situation is referred to as favorable, or positive, leverage www.downloadslide.net 396  Part 4  Income-Producing Properties EXHIBIT 12–2 Cash Flow Summary and IRR End of Year 2 3 4 5 Before-tax cash flow After-tax cash flow $20,000 $4,000 $4,000 $4,000 $4,000 24,000 20,000 3,636 3,636 3,636 3,636 19,858 Before-tax IRR (BTIRR)  20.00% After-tax IRR (ATIRR)  15.40% EXHIBIT 12–3   Cash Flow Estimates (No Loan) Estimates of Cash Flow from Operations Year 3 4 5 A Before-tax cash flow: Net operating income (NOI) Less debt service (DS) $12,000 $12,000 $12,000 $12,000 $12,000 0 0 0 0 Before-tax cash flow B Taxable income or loss: Net operating income (NOI) Less interest Depreciation $12,000 Taxable income (loss) Tax 9,302 $ 2,604 C After-tax cash flow: Before-tax cash flow (BTCF ) Less tax $12,000 $12,000 $12,000 $12,000 $12,000 2,604 2,604 2,604 2,604 2,604 After-tax cash flow (ATCF ) $ 9,396 $12,000 $12,000 $12,000 $12,000 $12,000 $12,000 $12,000 $12,000 $12,000 0 0 2,698 2,698 2,698 2,698 2,698 9,302 $ 2,604 $ 9,396 9,302 $ 2,604 $ 9,396 9,302 $ 2,604 $ 9,396 9,302 $ 2,604 $ 9,396 Estimates of Cash Flows from Sale in Year Sale price $100,000 Less mortgage balance Before-tax cash flow (BTCFs) $100,000 Taxes in year of sale Sale price $100,000 Original cost basis $100,000 Less accumulated depreciation 13,492 Adjusted basis 86,508 Capital gain $ 13,492 Tax from sale 3,778 After-tax cash flow from sale (ATCFs ) $ 96,222 Whenever leverage is positive, the greater the amount of debt, the higher the return to the equity investor From this result many investors conclude that they should borrow as much as possible (We will see later that this conclusion is not necessarily valid when risk is considered.) The graph in Exhibit 12–5 illustrates the effect of different loan-to-value ratios on the IRR for our example www.downloadslide.net Chapter 12  Financial Leverage and Financing Alternatives  397 EXHIBIT 12–4 Cash Flow Summary and IRR (No Loan) Cash Flow Summary End of Year Before-tax cash flow After-tax cash flow 2 3 4 5 $100,000 $12,000 $12,000 $12,000 $12,000 $112,000 100,000 9,396 9,396 9,396 9,396 105,618 Before-tax IRR (BTIRR)  12.00% After-tax IRR (ATIRR)  8.76% EXHIBIT 12–5 21 Before- and AfterTax Positive Leverage 20 19 IRR on equity (%) 18 17 Before tax 16 15 14 13 After tax 12 11 60 10 25.00 45.00 65.00 85.00 Loan-to-value ratio (%) While the relationships in Exhibit 12–5 are relatively straightforward, the amount of debt that may be used is limited What are the limits? First, for various amounts of debt, the debt coverage ratio may exceed the lender’s limits, as discussed in Chapter 11 Because the NOI does not change when more debt is used, increasing the amount of debt increases the debt service relative to the NOI Second, at higher loan-to-value ratios and declining debt coverage ratios, risk to the lender increases As a result, the interest rate on additional debt will also increase Indeed, at some point BTIRRP may no longer exceed BTIRRD (leverage will no longer be positive) Third, additional borrowing has additional risks for the equity investor We will deal with the effect of leverage on risk more formally later in this chapter However, we can point out now that leverage works both ways in the sense that it can magnify either returns or losses That is, if the loan offers negative (unfavorable) financial leverage, or ATIRRD  BTIRRP, the use of more debt will magnify losses on equity i­nvested in the property We saw earlier that BTIRRP must exceed BTIRRD for the leverage to be favorable Suppose that the interest rate is 14 percent instead of 10 percent This results in negative leverage because the unlevered BTIRRE (12%) is now less than the 14 percent cost of debt Exhibit 12–6 illustrates the effect that different loan-to-value ratios will have on the beforeand after-tax IRRs Note that when BTIRRP is less than BTIRRD , the BTIRRE is also less than BTIRRD and declines even further as the amount borrowed (debt-to-equity ratio) increases The next section develops this relationship more formally www.downloadslide.net 398  Part 4  Income-Producing Properties EXHIBIT 12–6 12 Before- and AfterTax Negative Leverage 11 10 Before tax IRR on equity (%) After tax 61 25.00 45.00 65.00 85.00 Loan-to-value ratio (%) Conditions for Positive Leverage—After Tax Looking at the after-tax IRR (ATIRR) in Exhibits 12–2 and 12–4, we see that ATIRRP (on total investment) is 8.76 percent and ATIRR on equity invested is 15.4 percent Thus, the ­investor has favorable, or positive, leverage on an after-tax basis That is, the expected aftertax IRR is higher if we can borrow money at a 10 percent rate as assumed in the example How can leverage be favorable if the unlevered ATIRR (8.76%) is less than the cost of debt (10%)? The reason is because interest is tax deductible; hence, we must consider the aftertax cost of debt Because there are no points involved in this example, the ­after-tax cost of debt is equal to the before-tax cost times (1  t), where t is the tax rate Thus, the after-tax cost of debt is 10(1  28)  7.2% In the previous section we showed a formula to estimate the return on equity, given the ­return on the property and the mortgage interest rate That formula can be modified to consider taxes as follows: ATIRRE  ATIRRP  (ATIRRP  ATIRRD) (D/E) where ATIRRE  After-tax IRR on equity invested ATIRRP  After-tax IRR on total funds invested in the property ATIRRD  After-tax IRR on debt (effective after-tax cost of the loan) D/E  Ratio of debt to equity Using the above equation, we have ATIRRE  8.76%  (8.76%  7.2%) (80%  20%)  15.00% www.downloadslide.net Floating Interest Rate Loans and Swaps Concept Box 12.1 Our example in Exhibit 12–7 assumes that the mortgage loan is made at a fixed rate of interest As seen in Chapter 5, there are many transactions that are financed with floating interest rate loans These loans are frequently made when financing commercial real estate However, should borrowers not want a floating rate, interest rate swaps may be used to achieve the equivalent of a fixed interest rate Banks that are willing to make only a floating rate loan are usually willing to execute a swap transaction for the borrower for a fee The market for interest rate swaps is very large and involves many participants In our example, the borrower seeks to swap a floating rate for a fixed rate with a counterparty who is seeking to swap a fixed rate for a floating rate Typically, the borrower selects a notional amount (in our example, $80,000) and pays a fee to the bank plus the spread (price) at which a counterparty with a similar credit rating is willing to execute the swap with the borrower The amount is notional in the sense that it is only used to calculate what the interest would be based on this amount.* This transaction is referred to as a “swap” because, in essence, the two parties to the swap trade payments The borrower with the fixed rate mortgage pays a floating rate, and the counterparty with the floating rate pays a fixed rate In actuality, only the difference in interest rates is exchanged between the parties This transaction is usually referred to as a “plain vanilla swap” because it is the most frequent type of swap transaction We also should point out that there is some probability that each party to the swap could default on their obligation or enter bankruptcy Either or both parties can insure against default by the counterparty by purchasing a credit default swap, or “insurance.” In addition to interest rate swaps, foreign currency swaps for real estate development in other countries and other more complex transactions may be executed in the market for swaps Finally, in addition to swaps, other alternatives may be used for hedging floating interest rate loans, such as buying and selling interest rate futures and/or options on futures However, the latter strategies usually involve U.S government securities with risk that is not directly correlated with commercial real estate risk As a result, these transactions usually provide less efficient hedges than swaps * The swap in our example may be executed in amounts greater or less than $80,000 To the extent that it is lower, the borrower is underhedged and is bearing some risk, and to the extent that it is greater, the borrower is overhedged and may be expecting to profit, should interest rates increase Hence, the approximation is 15 percent versus the actual ATIRR of 15.40 percent, as shown in Exhibit 12–2 The formula is an approximation because the debt-to-equity ratio increases over the holding period That is, although the initial debt-to-equity ratio is 4.0 ($80,000  $20,000), when the property is sold, the debt is still $80,000, but the equity is $16,222 (ATCFS of $96,222 less the loan of $80,000), resulting in a debt-to-equity ratio of 4.93 Thus, the average D/E for the holding period is greater than the initial D/E of that we used in the formula However, using the initial D/E is still a good approximation And the pivotal point for leverage is still the after-tax cost of debt That is, for leverage to be favorable on an after-tax basis, the after-tax return on total funds invested must exceed the after-tax cost of the debt For example, in our illustration, if the ATIRRP was less than 7.2 percent, leverage would be unfavorable It is useful to summarize the various IRR calculations we have made for the office ­example Exhibit 12–7 shows the before- and after-tax IRR with and without a loan It is important to understand the difference between each of these returns When using the term return (or IRR), it is obviously very important to specify whether that return is before tax or after tax, and whether it is based on having a loan (a leveraged return) or not having a loan (an unleveraged return) 399 www.downloadslide.net 400  Part 4  Income-Producing Properties EXHIBIT 12–7 Summary IRR Measures BTIRRE ATIRRE No loan* 80% loan 12.00% 20.00% 8.76% 15.40% *Note that IRRE  IRRP when there is no loan Break-Even Interest Rate In the previous discussion, we saw that the relationship between the after-tax IRR on the property (before debt) and the after-tax cost of debt determines whether leverage is favorable or unfavorable It is sometimes useful to determine the maximum interest rate that could be paid on the debt before the leverage becomes unfavorable This is referred to as the break-even interest rate and represents the interest rate at which the leverage is neutral (neither favorable nor unfavorable) By examining the after-tax leverage equation in the previous section, we see that the point of neutral leverage can be expressed as follows: ATIRRD  ATIRRP Based on this relationship, we want to know the interest rate that will result in an after-tax cost of debt that is equal to the after-tax IRR on total funds invested in the property In general, ­recall from Chapter that the after-tax cost of debt, ATIRRD, can be estimated as follows: ATIRRD  BTIRRD (1  t) Solving this for the before-tax cost of debt, we have BTIRRD ATIRRD t Because the break-even point for leverage occurs when ATIRRD  ATIRRP, we can substitute ATIRRP for ATIRRD in the above equation and obtain a break-even interest rate: BTIRRD ATIRRp t For our example, the break-even interest rate (BEIR) would be 8.76% 28 12.17% This means that regardless of the amount borrowed or the degree of leverage desired, the maximum rate of interest that may be paid on debt and not reduce the return on equity is 12.17 percent To demonstrate this concept further, Exhibit 12–8 shows the after-tax IRR for ­interest rates ranging from 10 percent to 16 percent for three different loan-to-value ratios Note that for interest rates above the break-even interest rate of 12.17 percent, the after-tax IRR for an equity investor (ATIRRE) is less than the after-tax IRR on total investment (ATIRRP), which is 8.76 percent Conversely, for interest rates below the break-even interest rate, the after-tax IRR for the equity investor is greater than the after-tax IRR on the property Exhibit 12–9 graphs the information in Exhibit 12–8 and shows the break-even interest rate Again note that the break-even interest rate remains 12.17 percent regardless of the amount borrowed (i.e., 60%, 70%, or 80% of the property value) If an investor borrowed funds at an effective interest rate that was just equal to the break-even interest rate, leverage would be neutral; that is, it would not be unfavorable or favorable However, at the break-even interest rate ATIRRP is exactly equal to ATIRRD www.downloadslide.net Chapter 12  Financial Leverage and Financing Alternatives  401 EXHIBIT 12–8 Effect of Interest Rates on the AfterTax IRR on Equity ATIRRE (%) Loan to Value Interest Rate (%) 10.00 10.50 11.00 11.50 12.00 12.50 13.00 13.50 14.00 14.50 15.00 15.50 16.00 EXHIBIT 12–9 60% 10.83 10.36 9.89 9.41 8.92 8.44 7.95 7.45 6.95 6.45 5.95 5.44 4.92 70% 80% 11.86 11.16 10.45 9.73 9.01 8.27 7.53 6.79 6.03 5.27 4.50 3.73 2.94 13.73 12.61 11.48 10.32 9.16 7.98 6.78 5.57 4.34 3.10 1.85 0.58 0.70 14 After-Tax IRR versus Interest Rates 12 60% loan After-tax IRR (%) 10 70% loan 80% loan 10.00 Break-even interest rate 12.00 14.00 16.00 Interest rate (%) (by definition), which means that ATIRRE will exactly equal ATIRRD That is, the investor earns the same ­after-tax rate of return as a lender in the same project But borrowing at the break-even interest rate will not provide a risk premium for the equity investor Equity ­investors normally require a risk premium because they bear the risk of variations in the performance of the property We will show this situation more formally below, in the section titled “Risk and Leverage.” Leverage and the Incremental Cost of Debt As mentioned earlier in this chapter, as the amount of debt increases, lenders may charge a higher interest rate to obtain additional financing Recall that in Chapter we discussed the concept of the incremental cost of debt, which involves determining the actual cost of additional financing (e.g., getting a 90% loan instead of an 80% loan) In the example we have been using in this chapter, an 80 percent loan was available at a 10 percent interest rate Because this rate was less than the unleveraged return of 12 percent, we had favorable leverage, which resulted in a leveraged return of 15.4 percent www.downloadslide.net 402  Part 4  Income-Producing Properties Now suppose that the investor can obtain an 85 percent loan as an alternative to the 80 percent loan, but at a 10.25 percent interest rate instead of a 10 percent rate Should the investor obtain the additional financing? First, it might be noted that the 10.25 percent rate is still less than the 12 percent unleveraged return Thus, there is still favorable leverage on all the funds being borrowed But are the additional funds obtained from the 85 percent loan versus the 80 percent loan contributing to the favorable leverage? Or are these funds making it less favorable than it would have been with the 80 percent loan? To get some insight into this, let us first calculate the incremental cost of the 85 percent loan This is an interest-only loan, so the calculation of the incremental cost is fairly simple Interest on the 85 percent loan is 1025  $85,000, or $8,712.50 Interest on the 80 percent loan is 10  $80,000, or $8,000 Thus, we have to pay an additional $712.50 in order to borrow an additional $5,000 Since it is interest only, we can simply divide the $712.50 by $5,000 to obtain the incremental cost of 14.25 percent Thus, additional funds cost 14.25 percent But what we compare this to? It is important to realize that we are now comparing the 85 percent loan with the 80 percent loan As noted above, with the 80 percent loan we have a leveraged return of 15.4 percent for the example we have been analyzing It is this return that the additional leverage is being applied to That is, we are earning 15.4 percent before borrowing the additional money To have favorable leverage on this additional money, the incremental cost of this additional money has to be less than 15.4 percent (not the original unleveraged return of 12%) Since the return before borrowing the additional money (15.4%) is greater than the incremental cost of debt (14.25%), there is positive leverage on the incremental funds Thus, the leveraged return should increase even more if the additional funds are borrowed The reader should verify that using an 85 percent loan with a 10.25 percent interest rate results in a leveraged IRR of 21.92 percent, which is higher than the original 20 percent leveraged return with the 80 percent loan at a 10 percent interest rate (A good way to this is to use the Excel spreadsheet provided with the book, which includes a tab with the leverage example.) As we will discuss in the next section, the risk also increases as we borrow additional money But at least we know that the additional leverage is positive If it was not, then the investor might be better off just getting the 80 percent loan, since the additional funds would be reducing the leverage Because the additional funds still contribute to positive leverage, the question is whether the additional return is a sufficient compensation for the additional risk Risk and Leverage We have seen how favorable financial leverage can increase BTIRRE and ATIRRE We also have seen that increasing the amount of debt magnifies the effect of leverage It is no wonder that many people conclude that they should borrow as much as possible (look at the number of “no money down” seminars and advocates of using “OPM,” or other people’s money) The point of the following discussion is to emphasize that there is an implicit cost associated with the use of financial leverage This cost comes in the form of higher risk To illustrate, consider the following ­investment opportunity: Total project costs (land, improvements, etc.) will be $1 million In our initial example, the investor does not use debt to finance the project Three possible scenarios for a project are as follows: Pessimistic—NOI will be $100,000 the first year and decrease percent per year over a five-year holding period The property will sell for $900,000 after five years www.downloadslide.net 800  Index NAREIT Index, 697, 724, 725 See also Portfolio theory; Real; Real estate investment performance NASAA (North American Securities Administrators Association), 615, 617 NASDAQ (National Association of Security Dealers Automated Quotation), 725 National Association of Home Builders (NAHB), 197 National Association of Real Estate Investment Trusts (NAREIT) See also Portfolio theory; Real estate investment performance appeal of equity trusts, 695–697 data sources, 724–725 funds from operations (FFO), 700–702, 719 property types, 694 National Association of Realtors (NAR), 193 National Association of Security Dealers Automated Quotation (NASDAQ), 725 National Council of Real Estate Investment Fiduciaries (NCREIF), 725–727, 729, 731, 741 See also Portfolio theory; Real estate investment performance National Council of Real Estate Investment Fiduciaries (NCREIF) Index, 774, 775 National Housing Act (1934), 224n1 NAV (net asset value), 704, 717–718 NCREIF (National Council of Real Estate Investment Fiduciaries), 725–727, 729, 731, 741 See also Portfolio theory; Real estate investment performance NCREIF Index, 726, 727, 729, 731 See also Portfolio theory; Real estate investment performance Negative amortization in accrual loans, 418–420 adjustable rate mortgage (ARM) loans, 138–140 defined, 116, 126 graduated payment mortgage (GPM) loans, 180–182 in loan underwriting, 232 Negative amortizing loans, 84, 90, 90–91 See also Amortization patterns; Fixed rate mortgages (FRMs) Negative (unfavorable) financial leverage, 397, 397–398 Negotiated markets, 731 Neighborhoods See Submarkets Nelson, Grant S., 7n6, 24n7 Net asset value (NAV), 704, 717–718 Net income from operations, 714 Net leases, 270, 272–275 Net operating income (NOI), 761 See also Discounted present value method capitalization rate, 301–302 defined, 301, 359 forecasts, 305–306 net income from operations vs., 714 projections, apartment example, 329–330 Net present value (NPV), 544–548, 578–579 See also Present value (PV) New York Stock Exchange (NYSE), 692, 725 NOI See Net operating income (NOI) Nominal interest rate, 78, 78–79, 81 See also Equivalent nominal annual rate (ENAR) Nonconforming mortgages, 223 Noncumulative pari passu distribution, 590 Nondilution clauses, 286 “Non-disturbance” clauses, 267 Nonfinite-life REITs, 695 Non-operating expense pass throughs, 269 Nonpossessory interest, Nonrecourse clause, 17, 404, 534 Nonresidential properties, 253, 253–254, 260–261 See also Incomeproducing properties; Leases North American Industry Classification System (NAICS), 195, 379–381 North American Securities Administrators Association (NASAA), 615, 617 Note, promissory, 18 Notes, 16–19 See also Loan(s) NPV (net present value), 544–548, 578– 579 See also Present value (PV) Nuisance calls, 637 Number of payments, 246 NYSE (New York Stock Exchange), 692, 725 O Occupancy dates, 266 Occupancy rates (vacancies) See also Market analysis collection losses, 302 leased vs occupied space, REITs, 710 property acquisition, 263–264 rent forecasting, 252–256, 436 vacancy-collection loss ratio, 542, 543 Occupied vs leased space, REITs, 710 Off-balance-sheet financing, 507–508, 673 Office buildings cash flow projections for, 356–361 demand forecasts for, 379–381 income potential from owning, 262–264 REITs, 694, 695 rent example, 277–281 space per employee in, 349–352 supply and demand for, 257, 351–352 See also Vacancies types of, 253, 254 Office of Federal Housing Enterprise Oversight, 198 Office of Management and Budget, U.S., 195 Open-end diversified core equity (ODCE) Index, 774, 775 Open-end mortgage, 22 Open-ended construction lending, 526 Operating cycles, 303 Operating expense ratio, 543, 544 Operating income, tax on, 367–372 Operating leases, 507 Operations, sharing cash flow from, 590–593, 599–602 Opportunistic investing, 349 Opportunity cost, in incremental borrowing, 150 Opportunity funds, 754–757 Optimal holding period, 467 Optimal size of cities, 198, 198, 200, 200 Option agreements, 556, 556–558 Option contracts, 214–216 Optional delivery program, 627 Ordinary annuity, 57n3 Organizational forms, 583–621 C corporations, 587–588, 694 corporations, 587–588 joint ventures (JVs), 588–596 liability issues, 583–584, 587–588 limited liability companies (LLCs), 586–587 limited liability partnerships (LLPs), 585–586 limited partnerships (LPs), 374, 375, 585, 597 partnerships See Partnerships S corporations, 588 sole proprietorships, 583–584 syndicates, 596–617 terms and exercises, 618–621 types of, 583 Web resources, 607–609, 618 Origination fees, 151, 151–152 Other income, in direct capitalization method, 302 Overage, 442 Overage provisions, 542n10 Overage rent, 268, 284, 284–285 www.downloadslide.net Index  801 Overcollateralization, 650, 653, 673, 678 See also Collateralized mortgage obligations (CMOs) Overdevelopment cycles, 345 Overimprovement, 203 Owner services, 267 See also Leases Owner’s policy, 12 Ownership, 494n2 See also Leaseversus-own analysis; Lessor; Organizational forms Ownership flowchart, legal, Ownership rights, P PAC (planned amortization class) tranches, 664 PAL (passive activity loss limitation), 374–375 Parking ratio, 519 Partially amortizing loans, 84, 88–89, 91–92 See also Amortization patterns; Fixed rate mortgages (FRMs) Participation certificate (PC) program, 633n11, 634 Participations See Equity participation loans Parties to foreclosure suits, 34–35 Partitioning the IRR, 436, 436–437 See also Internal rate of return (IRR) Partnerships, 606–611 See also Organizational forms allocations in, 606 capital accounts and gain chargebacks, 607–609 limited, in private/public syndicates, 609–611 types of, 374–375, 584–586 Passive activity loss limitation (PAL), 374–375 Passive income/loss, 373–374, 373–375 Passive investment, 773n8 Pass-through method, 638, 673, 699 See also Mortgage pass-through securities (MPTs) Pay rate, 83, 418 Payment of loans See also Financing; Loan(s) adjustable rate mortgage (ARM) loans, 125–128, 136–141 amortization See Amortization patterns biweekly, 160–161 early, 150–151, 157–159, 161–163 Federal Truth-in-Lending (FTL) Act impact, 244–249 mortgage pass-through securities (MPTs), 635 notes, 16–18 prepayment See Prepayment RESPA requirements, 240–244 Payment shock, 130, 231n6 Payment-to-income ratio, 221, 228 See also Underwriting Pay-through method, 699 PC (participation certificate) program, 633n11, 634 Peiser, Richard B., 606n12 Penalties, 17 Pending home sales, 193 Pending/threatened matters review, 433 Percentage rent, 268, 442, 541–542, 542 Percentage rent lease, 284, 284–285 Periodic tenancy See Estate from year to year Permanent financing, 526, 534–535, 540, 540 Permits, 517, 518, 520 See also Project development Personal property, Personal property review, 434 Personalty, vs realty, 1–2 Pest inspection certificates, 240 Peter O Dietz, 765n4 PGI (potential gross income), 300, 302 Physical depreciation, 205, 324–326 Physical deterioration, 323, 323 Physical inspections, 434 Pivo, Gary, 742n1 PLAM (price level adjusted mortgage), 122, 122–124 Planned amortization class (PAC) tranches, 664 Plat, 559 Pledge of property (encumbrance), 6–7 PMI (private mortgage insurance), 230 PO strips, 668–671, 669, 672 Points, 95, 188, 369 Police power, 13 Pool factor, 639, 639 Population, 184, 382–383 Porter, David M., 494n1 Portfolio income/loss, 374, 374–375 Portfolio theory, 731–749 See also Real estate investment performance calculating returns, 733 diversification potential See Diversification hedging risk, 748 introduction to, 731–733 risk, 736 risk/return weighting, 736–737 Positive (favorable) financial leverage, 394, 394–400 Possession and estates, 4–7 Potential gross income (PGI), 300, 302 Preferred distribution, 590, 590–591 Preferred equity, 424, 680 Preferred return, 590, 590–591 Premiums, title insurance, 11–12 Prepackaged bankruptcy, 30 Prepayment adjustable rate mortgage (ARM) loans, 126 assumptions, 642–644 collateralized mortgage obligations (CMOs), 656–659, 661–663 Federal Truth-in-Lending (FTL) Act impact, 246 illustration, 644–645 security price affected by, 641 Prepayment penalties defined, 100 in note, 17 reasons for, 100–101 security pricing, 641n16 underwriting, 230 Prepayment risk See also Payment of loans collateralized mortgage obligations (CMOs), 672 commercial mortgage-backed securities (CMBSs), 675 defined, 80 loan pools affected by, 637, 651, 673 penalties, 17, 230 Present value (PV), 49–56 See also Discounted present value method; Net present value (NPV) calculators in finding, 49–52, 54–56 defined, 43 in effective rent calculation, 273, 275–276 illustration, 52–54 in investment analysis, 362 net, 544–548, 578–579 table, 54 Present value of an annuity (PVA), 60, 60–64 Preservation of property, mortgage clause for, 21 Price and pricing collateralized mortgage obligations (CMOs), 659–663 disclosure of, 723–724 fixed rate mortgages (FRMs), 102–103 in foreclosure sales, 32 as investment motivation, 343, 344 land development, 565–567 mortgage pass-through securities (MPTs), 637–639, 641–642, 645–647 mortgage-backed bonds (MBBs), 629–632 multifamily housing, 384 projecting, 360–361 single family housing, 183–184 See also Housing supply Price compression, 646 Price level adjusted mortgage (PLAM), 122, 122–124 www.downloadslide.net 802  Index Prime borrowers, 664 Principal, 84 Principal only tranches, 668–671 Private investments, vs public, 740–741 Private mortgage insurance (PMI), 230 Private offerings, 597, 610, 611 Private REITs, 694 Private syndicates, 610 See also Syndication Profit ratio, 473, 473–476 Profit sharing, 589–590 Profitability, 208, 544–548, 579–580 Project development, 517–553 See also Land development cost and cash flow projections, 541–544 description and cost example, 535–540 financing overview, 525–526 income-producing property, 521–525 interim loan closings, 533–534 land development vs., 554 See also Land development loan contingencies, 530–531 loan disbursement methods, 532 loan interest rates and fees, 533 loan overview, 531–533 loan submission requirements, 528–530 market data and tenant mix, 540–541 permanent loan closings, 534–535 phases of, 521 planning and permitting, 517–520 profitability projections, 544–548 sensitivity and feasibility analyses, 548–549 terminology, 518–520 terms and exercises, 550–553 Web resources, 549, 550 Promissory note, 18 Promote, 591 Proof of ownership, Property See also specific types basic concepts of, covered by mortgages, 23–24 diversification by type of, 741, 743–744 held for resale vs investment, 366–367 See also Disposition income from sale of, 372 investing based on size of, 348 Property rights, 2, 2–6, 13–14 Property survey review, 433 Property taxes See also Tax issues abatement, 519 in default, 36–37 mortgage clauses, 20 proration of, 238–240, 244 Property values, 192, 194, 195, 206, 310–311 See also Housing supply; Single family properties Prorated property taxes, 238, 244 PSA prepayment model, 643, 643–644 Public goods, 197, 198 Public investments, vs private, 740–741 Public non-listed REITs, 694, 697–700 Public offerings, 598n9, 600n11, 610, 611 Public Securities Association, 643–644 Public syndicates, 597–598, 610 Purchase-money mortgages, 18, 25, 167 Purchase-only house price index (HPI), 193 Put options, 404 PV See Present value (PV) PVA (present value of an annuity), 60, 60–64 Q Qualified escrow accounts, 479 Qualified intermediaries, 479 Qualified mortgages, 683 Qualified reserve funds, 683 Qualified trusts, 479 Quarterly compounding intervals, 46 See also Time value of money (TVM) Quitclaim deed, 8, 10 R Radius clauses, 286 RAMs (reverse annuity mortgages), 105, 105–106 Rate of return See also Internal rate of return (IRR); Investment analysis; Returns; Yields comparison of, 429–430 defined, 65 as investment motivation, 343, 344 in lease-versus-own analysis, 498 risk and variable, 437–441 Ratio analysis, 730–731, 733–737 See also Debt coverage ratio (DCR); Loanto-value ratio corporate real estate affecting, 506–507 housing expense ratio, 228 payment-to-income ratio, 221, 228 in portfolio theory, 736–737 profit ratio, 473–476 project development, 542, 543 REITs, 714 risk-adjusted returns, 736–737 Real estate See also specific topics defined, industry characteristics, 344 overview, 1–2, Real estate commission, 240 “Real estate cycle,” 344, 344–346 Real estate investment funds acquisition fees, 759 appraisals, 757–758 benchmarks See Benchmarks calculating returns See calculating returns capital committed vs invested, 760 core funds, 754–757 debt, 758–759 disposition fees, 759 fees based on NOI, 761 full discretion, 756 fund management, 759 funds flow, 763–764 investment advisors, 753 investor goals and objectives, 754 leverage, 758–759 management fees, 759–760 opportunity funds, 754–757 pension plans, 753 performance fees, 761 performance returns report, 762 separate account, 758 strategies for, 752–753 terms and exercises, 784–787 value-added funds, 754–757 Real estate investment performance, 723–751 See also Investment analysis data sources, 724–726 holding period returns, 727–729 nature of data on, 723–724 portfolio theory, 723–751 by property type and location, 744, 745 retail example, 748–749 return patterns, 726, 727 risk-return relationship, 729–731 See also Investment analysis socially responsible, 742–743 terms and exercises, 750–751 Web resources, 741, 743, 750 Real estate investment trusts (REITs), 690–722 capital structure of, 703–704 data sources, 724–725 defined, 690 equity See Equity REITs expansion and growth, 702, 704–706 funds from operations (FFO), 700–702 hybrid, 694 largest U.S., 696 legal requirements, 690–694 limited partnerships in, 597–598 mortgage, 694, 711–713 private, 694, 697, 700 qualification failure, 693 subsidiaries, 693–694 tax treatment, 690–694, 698–699 terms and exercises, 720–722 U.S vs international, 698–699 valuation of, 716–719 Web resources, 719, 720 www.downloadslide.net Index  803 Real estate mortgage investment conduits (REMICs), 673, 682, 682–684 Real estate owned (REO) lists, 208, 208–209 See also Distressed properties Real Estate Review, 365–366, 606n12 Real Estate Settlement and Procedures Act (RESPA, 1974), 240–244 Real options, 452, 452–455 Real property, 2, Real rate of interest, 78, 78–79 Realty, vs personality, 1–2 Recasting mortgages, 27 Recording acts, 11n10, 12, 12–13 Recording fees, 240 Recording requirements, 24, 26 Recourse See “With recourse” (loans) Recoveries, 268–271, 285 Recovery of capital (ROC), 715 Recreational real estate, 254 Redemption, 32 Redevelopment, income from, 702 Referral fees, RESPA on, 241–242 Refinancing See Loan refinancing Regulation D of Securities Act (1933), 610, 617 Rehabilitation investment tax credits, 487–489, 489 See also Renovation Reinstatement, borrower’s right to, 21 Reinvestment rate, 467 REIT Modernization Act (RMA, 1999), 693 REITs See Real estate investment trusts (REITs) REIWise, 385–392 Release fees, 240 Release of lien, 18 Release price, 573, 573–575 Release schedule, 561 Remainder, REMICs (real estate mortgage investment conduits), 673, 682, 682–684 Renewal options, 709–710 Renewal probability, 446, 446–447 Renovation, 484–489 Rent forecasting, 352–356, 446 lease rollover increasing, 709 straight-line, 708 terms of, 266, 268 See also Leases Rent roll analysis, 433 Rentable area, 271, 278 Rental income at full occupancy, 302 Rental properties, 184–191 See also Income-producing properties; Leases REO (real estate owned) lists, 208, 208– 209 See also Distressed properties Repair and maintenance, 302 See also Improvements Replacement cost, 325, 325–326, 360 Repurchase agreements, 678 Required internal rate of return, 306, 306–307 Resale price, 310–311 Reset date, 126, 129 Residential properties See also Incomeproducing properties; Single family properties defined, 252–254 financing See Loan closing income potential from owning, 262–264 in mortgage pools See Mortgage backed securities REITs, 694, 695 supply and demand factors, 257 taxation of, 366 underwriting See Underwriting Residual, 654, 656 Residual equity, 680 Residual income, 233 Residual land value, 312, 312–313 Residual value, 499–501, 500 Resort REITs, 695 RESPA (Real Estate Settlement and Procedures Act, 1974), 240–244 Responsibility for expenses, 261–262, 267 Responsible property investing (RPI), 742–743 Restructuring, 27–28, 509 See also Workouts Retail properties CAM expenses in, 270, 271, 285 forecasting demand for, 382–383 income potential from owning, 262–264 project development example, 535–544 REITs, 694, 695, 710–711 rent example, 283–287 risk analysis case study, 441–445 supply and demand factors, 257 types of, 253, 254 Return on equity, 542, 543 Returns, 729–731, 736–737 See also Rate of return risk-adjusted, 729–731, 736–737 in risk-return comparison, 429–430 variable, 437–441 Revenue, rent based on, 268 Reverse annuity mortgages (RAMs), 105, 105–106 “Reverse Starker” strategy, 478 Reversion, Reversion value, 307, 307–312 Revitalization, urban, 743 Right of entry mortgage clause, 20–21 Right of first refusal, 279 Right to reinstate, 21 Right-of-way line, 518 Rights See Legal concepts and considerations; Property rights Risk amortization patterns and, 92 commercial mortgage-backed securities (CMBSs) ratings, 677–679 contraction, 672 of default See Default; Default risk in effective rent calculation, 273, 275–276 extension, 672, 675 interest rates and, 79–80 See also Interest rate risk joint ventures for sharing, 589 lease renewal, 444, 446 in lease-versus-own decisions, 504 leverage link to, 402–404, 449–452 loans in distributing, 393 in supply and demand analysis, 256–257 types of, 430–432 Risk analysis, 429–455 See also Investment analysis; Market analysis; Supply and demand analysis due diligence in, 432–434 industrial case study, 447–451 investment return comparison, 429–430 market leasing assumptions, 446–447 partitioning the IRR, 436–437 in performance measurement, 729–731 in portfolio theory, 733–737 project development, 524–525, 548–549 real options approach, 452–455 retail case study, 441–445 sensitivity analysis in, 432, 434–436 terms and exercises, 456–458 variable returns in, 437–441 Web resources, 454, 456 Risk premiums, 131–133, 729 Risk-adjusted returns, 729–731, 736–737 Risk-to-reward ratio, 730–731 RMA (REIT Modernization Act, 1999), 693 ROC (recovery of capital), 715 Rockefeller Group, 509 RPI (responsible property investing), 742–743 S S corporations, 588 See also Organizational forms Safe harbor rules, 478–479, 610 Salaries, in direct capitalization method, 302 Sale price, projecting, 360–361 See also Disposition www.downloadslide.net 804  Index Sale-leaseback, 509, 509–512 Sale-leaseback of the land, 414, 414–416, 422–424 Sales comparison approach See also Appraisals defined, 199, 200, 297 income approach vs., 317 process of, 199–206, 297–299 Sales per square foot, 710–711 Sales performance, rent based on, 268 Sales, sharing cash flow from, 591–592, 594, 600–602 Sarbanes-Oxley law of 2002, 697, 711 Scaling, 666, 666–668 Scenarios, 434–436, 435 Seasoned property, 522 Seasoning, of loans, 636 SEC (Securities and Exchange Commission), 600n11, 692, 711 Second homes, taxes on, 188 Second mortgages defined, 24 home equity loans as, 168–169 incremental borrowing vs., 152, 153 shorter maturities on, 166–167 Secondary mortgage market, 622–689 See also Mortgage backed securities CMOs See Collateralized mortgage obligations (CMOs) collateralized debt obligations (CDOs), 665, 679–683 commercial mortgage-backed securities (CMBSs), 674–679 comparison of mortgage-backed securities, 671–674 defined, 622 derivatives, illustrated, 649, 665–671 duration, measurement of, 687–689 federal government influencing, 20, 625–626 history of, 622–624 mortgage pass-through securities (MPTs), 632–647 mortgage pay-through bonds (MPTBs), 649–650, 672–673 operation of, 626–628 payment illustration, 639 and REMICs, 673, 682–684 terms and exercises, 647–648, 684–687 Web resources, 647, 684–685 Section 453 (1), Internal Revenue Code (IRC), 472 Section 1031, Internal Revenue Code (IRC), 477, 477–479 Section 1221, Internal Revenue Code (IRC), 473n4, 477 Section 1231, Internal Revenue Code (IRC), 473n4, 477 Sector investing, 346 Secured interest, 2, 6–7, 18 Securities Act (1933), 610, 617 Securities and Exchange Commission (SEC), 600n11, 612, 614, 692, 711 Securities Commission Act (1934), 711 Securities Exchange Act (1934), 617 Securities, risk from, 430 See also specific securities Security interest, FTL on, 246 Seisin, 19n2 Self storage REITs, 695 Self-liquidating REITs, 695 Seller financing, 24, 24–25, 204, 473 Semiannual compounding intervals, 46 See also Time value of money (TVM) Senior tranches, 674, 674–676 Sensitivity analysis defined, 434, 434 land development, 580 project analysis, 548–549 in risk analysis, 432, 434–436 Separate account, 758 Sequential payout tranche, 652 Service/maintenance agreement review, 433 Services, REIT income from, 705 Servicing fee, 638 Setback/building line, 518 Settlement costs, RESPA on, 240 Settlement of closing statements, 236–237, 241 7/1 hybrid ARM loans, 127–128 SFF (sinking-fund factor), 65 Sharpe ratio, 779, 780 Sheriff’s deed, 10 Shopping Center Development Handbook Series (Urban Land Institute), 542n10 Shopping centers See Retail properties Short sale, 30, 30–31 Signage clauses, 260, 279, 286 Single family properties, 183–219 See also Housing supply; Residential properties distressed properties, 207–215 economic influences on, 184, 257 employment related to, 184–185 expected appreciation of, 191–195 location quotients, 195–196 pricing and valuation, 183–184, 199–206 renting vs owning, 185–190 terms and exercises, 215–219 U.S perception of, 183 Web resources, 193–194, 197, 198, 216 Single net leases, 270 Single receipts, investments with, 65–68 Sinking fund retirements, 632n10 Sinking-fund factor (SFF), 65 Site plans, 519, 565–567 Social equity, 743 Social Investment Forum, 743 Socially responsible investment (SRI), 743 Soft costs, 525, 538, 591n4 Sole proprietorships, 583, 583–584 See also Organizational forms S&P (Standard & Poor’s) 500 Index of Common Stocks, 725–727, 729 S&P Case-Shillerr (CS) Housing Price Index, 194 S&P (Standard & Poor’s) Corporation, 629n4, 629n7 Space per employee, 349, 349–352 Space requirements, in lease-versus-own decisions, 503 Special allocations, 600, 600 Special purpose buildings, 504–505, 505 Special sales tax districts, 519–520 Special warranty deeds, 8, 10, 209 Specialty REITs, 695 “Specified property,” 616 Speculation, and joint ventures, 589 Speculative construction lending, 526 Spread, 126 Spreadsheets, 50, 118n7 SRI (socially responsible investment), 743 Stacking plans, 520 Standard & Poor’s (S&P) 500 Index of Common Stocks, 725–727, 729 Standard & Poor’s (S&P) Corporation, 629n4, 629n7 Standard deviation of the mean return, 439, 728–731 See also Portfolio theory Standby commitments, 529, 529–530 Starker philosophy, 478–479 State Securities Commission, 753n1 Statements of operating cash flow See Cash flow statements Statute of Frauds and Perjuries (1677), 1n1 Statutory costs, 240 Statutory redemption, 32 Step-up rents, 268 Stocks, risk from, 430 Straight-line rent, 708 “Subject to” the mortgage, 23 Subletting, 266 Submarkets, 197, 198, 199, 199–206 See also Housing supply; Single family properties Subordinated tranches, 674, 674–676 Subordination clause, 22 Subprime borrowers, 664–665, 692 Subsidiaries, REIT, 693–694 Substantial economic effect, 606 Substitute basis, in tax-deferred exchanges, 480–481 Sunk costs, 159n9 Super floating rate tranche, 668 Supply and demand analysis, 254–260 See also Investment analysis; Market analysis; Risk analysis www.downloadslide.net Index  805 equilibrium market rental rate, 254–256 income potential and, 262–263 local market, 257–258 See also Metropolitan statistical areas (MSAs) location and user-tenants, 258–260 in property valuation, 317–319 risk implications, 256–257 Supporting industries, 195 Surety bonds, 678 “Swap” program, 633n11 Swaps See Interest rate swaps Syndication, 596–617 See also Organizational forms capital accounts, 602–609 defined, 596 illustration, 598–602 limited partnerships in, 598, 609–611 overview, 596–597 regulation of, 615–617 Synthetic leases, 512 T TAC (targeted amortization class), 664 “Take downs,” reverse annuity mortgages (RAMs), 105–106 Take-out commitments, 526, 529 See also Project development Targeted amortization class (TAC), 664 Taubman Realty, 692 Tax increment financing (TIF), 519 Tax issues See also Internal Revenue Service (IRS) after-tax effective interest rates, 179–182 borrower income assessment, 226 as borrowing motivation, 393–400 corporate, 587, 588 due diligence review, 434 early loan repayment, 163n14 foreclosure and default, 36 home rental vs purchase comparison, 186–190 housing demand affected by, 184 income approach, 302 income-producing properties See Taxation of income-producing properties lease-versus-own decisions, 505 legislation, 370, 373–374 See also Tax Reform Act (1986) limited liability companies (LLCs), 587 low-income housing credits, 489 mortgage clauses, 20, 36–37 partnerships, 584, 586 project development, 544–548 property disposal, 471–476 See also Tax-deferred exchanges property tax abatement, 519 See also Property taxes rehabilitation investment credits, 487–489 REITs, 690–694, 698–699, 714–715 sole proprietorships, 583–584 special sales tax districts, 519–520 syndicates, 600–606 Tax Reform Act (1986) on capital gains vs income, 368, 546n17 on depreciable life, 509 income and loss categories, 373–375 on limited partnerships, 598 low-income housing credits, 489 in own-vs.-lease decisions, 505 on REMICs, 682 Tax Reform Act (1993), 370, 375 Tax sale, 36 Taxable income, 367 Taxable REIT subsidiaries (TRSs), 693–694 Taxation of income-producing properties, 364–379 after-tax analysis, 370–373 as investment motivation, 344 operating income, 367–372 passive losses, 373–375 property sale, 364–376, 369–370 terms and exercises, 376–379 Web resources, 375–377 Tax-deferred exchanges, 477–484 See also Disposition considerations, 477–478 defined, 477 economics of, 482–484 equity balancing, 480 recognized gains, 479–480, 482 time frames, 479 unrecognized gains, 482 Tax-exempt serial bonds, 660n7 Tax-free exchanges, 472, 598 See also Tax-deferred exchanges T-bills See Treasury securities TDR (transfer of development rights), 520 Teaser rate, 127n5, 129–130, 231n6 Technical default, 26 Tenant improvements (TIs), 266, 304, 447, 707 See also Improvements Tenant mix, 540–541 See also Lessee 1031 exchanges; Tax-deferred exchanges Terminal cap rate, 307, 309–310, 361 Termination notices, 267, 286 Threatened matters review, 433 Tilt effect, 112, 112–113, 123–124 Time See also Occupancy dates in lease agreements, 286 See also Occupancy dates in lease-versus-own decisions, 503–504 mortgage yields and, 99–101 in tax-deferred exchanges, 479 Time, Inc., 509 Time value of money (TVM), 42–76 See also Interest rates accumulation of future sum, 64–65 calculators and spreadsheets, 49–51 compound interest, 42–43 compound or future value, 43–49, 56–60 determining investment yields, 65–73 present value, 52–56, 60–64 See also Present value (PV) terms and exercises, 74–76 Web resources, 51, 74 Time-weighted return (TWR), 768–771 TIs (tenant improvements), 266, 304, 447, 707 See also Improvements Title See also Deeds clouded, 10n9, 11, 13 defined, distressed properties, 210–211, 215 due diligence review of, 433 in foreclosure sale, 34 marketable, 211 “subject to” the mortgage, 23 transferring See Loan closing Title assurance, 7–12 attorney’s opinion of title, 8, 11, 240 deeds, defined, insurance policies, 11–12, 240, 241, 563 methods for, 9–11 Title insurance, 11–12, 240, 241, 563 Title insurance method, 11 Title theory of mortgages, 209–210 Title/deed document review, 433 Total of payments, 246 TRA See Tax Reform Act (1986) Tracking error, 779, 781–782 Trade fixtures, 23n6 Traffic counts, 519 Tranches, 651, 663–664, 672 See also Collateralized mortgage obligations (CMOs) Transfer of development rights (TDR), 520 Transfer of mortgage, 28–29, 29 Transfer of property clause, 21 Transfer tax, 240 TransUnion, 229 Treasury securities as adjustable rate mortgage (ARM) loans pricing index, 126 interest rate on, 533 returns data, 725–727, 729 See also Portfolio theory risk from, 430 Treasury, U.S., 625 Treynor ratio, 779, 781 Triparty buy-sell agreements, 534, 534 www.downloadslide.net 806  Index Triple net leases, 270 Trophy properties, 349 TRSs (taxable REIT subsidiaries), 693–694 Trustee’s deed, 10 Trusts See Real estate investment trusts (REITs) Truth-in-Lending Act, Federal (FTL, 1968), 98, 244–249 Turnaround investing, 348 Turnkey basis, 555 Turnover vacancy, 446 TVM See Time value of money (TVM) TWR (Time-weighted return), 768–771 U ULTA (Uniform Land Transactions Act, 1975), 24 Umbrella partnership REIT (UPREIT), 692, 697 Unanticipated inflation, 80, 121 Under improvement, 204n5 Underwriting, 220–251 borrower asset verification, 227 borrower income, 225–227 closing process, 237–249 compensating factors, 228, 230 credit history assessment, 227–229 default risk, 220–221 defined, 220 housing expense estimate, 228 for income-producing properties, 404–406 of lease tenants, 264 loan classifications, 221–225 other obligations review, 228 process illustration, 231–237 terms and exercises, 249–251 Web resource, 234, 250 Unfavorable (negative) financial leverage, 397, 397–398 Uniform Land Transactions Act (ULTA, 1975), 24 Uniform mortgage form, 20 Uniform Residential Appraisal Report, 200, 201 Uniform settlement statement, 242 Unit of comparison, 299 Unleveraged internal rate of return (IRR), 362 Unlike property, in exchanges, 481 Unrealized equity gains, 191 Unrecognized capital gains, in exchanges, 482 Unseen hazards, 11–12 “Unstated interest rule,” 25n8 “Up fitting,” 442n8 UPREIT (umbrella partnership REIT), 692, 697 Upset price, 32 Urban Land Institute, 542n10 U.S Aggregate Bond Index, 725 U.S Bureau of Economic Analysis, 184, 380 U.S Bureau of Labor Statistics, 184, 349 U.S Census Bureau, 184, 197 U.S Department of Commerce, 184, 197, 380 U.S Department of Labor, 195, 379, 380 U.S Federal Reserve, 185, 227 U.S Office of Management and Budget, 195 U.S Securities and Exchange Commission (SEC), 600n11, 692, 711, 753n1 U.S Treasury, 625 U.S Universal Index, 725 Usable area, 278, 279 User-tenant See Lessee; Tenant mix Usury, 20n4 V VA See Veterans Affairs (VA), Department of Vacancies See also Market analysis collection losses, 302 leased vs occupied space, REITs, 710 property acquisition, 263–264 rent forecasting, 352–356, 446 vacation homes, 188 Vacancy-collection loss ratio, 542, 543 Vacant land, valuation of, 313–314 Vacation homes, 188 Valuation See Appraisals; Investment analysis “Value add” strategy, 349 Value, creating, 521 Value investing, 347, 347–348 Value-added funds, 754–757 Variable rate, FTL on, 246 Variation, coefficient of, 440, 728–731, 730 Veterans Affairs (VA), Department of defined, 224–225 loan prepayment, 641n16 other loan types vs., 236–237 role of, 224–225, 233–235 secondary mortgage market role of, 625 See also Secondary mortgage market Voluntary conveyance, 29, 29–30 W WACs (weighted average coupons), 638 Wall Street Journal, 725 Warehouses See Industrial and warehouse properties Waste, 21n5 Wealth effect, 192 Web resources See also Data sources; Inside book cover adjustable rate mortgage (ARM) loans, 143, 144 appraisals, 330–333 corporate real estate, 512, 513 disposition/renovation, 489, 490 Federal Housing Administration (FHA), 234, 250 financial leverage, 424, 425 financing, 19, 40 financing corporate real estate, 512, 513 financing for land development, 579–581 financing for mortgages, 176 financing, for project development, 549, 550 fixed rate mortgage (FRM) loans, 100, 107 housing statistics, 193–194, 197, 198, 216 income-producing properties, 263 investment analysis, 375–377 land development, 579–581 legal concepts and considerations, 11, 15 leverage, financial, 424, 425 mortgage insurance, 155, 176 mortgage-backed securities, 684, 685 mortgages, 176 organizational forms, 607–609, 618 project development, 549, 550 real estate investment performance, 741, 743, 750 REITs, 719, 720 reverse annuity mortgages (RAMs), 106 risk analysis, 454, 456 secondary mortgage market, 647, 685 single family properties, 193–194, 197, 198, 216 time value of money (TVM), 51, 74 underwriting, 234, 250 Weighted average cost of capital, 500n12, 503, 513–514 Weighted average coupons (WACs), 638 Weighted average maturity, 638–639 Werner, Raymond J., 24n7 Whitman, Dale A., 7n6, 24n7 Wilshire and Associates, 725 “With recourse” (loans), 16 Work letters, 266 Workouts, 26–31, 27, 207n8, 207n8 WorldCom, 711 Wraparound loans, 172, 172–176 X XIRR method, 73–74, 765, 766 www.downloadslide.net Index  807 Y Yield maintenance fee (YMF), 407 Yield to maturity See also Internal rate of return (IRR) duration calculation, 687–689 internal rate of return (IRR) vs., 630n8 mortgage pass-through securities (MPTs), 645–646 mortgage-backed securities, 638 Yields See also Internal rate of return (IRR); Rate of return on adjustable rate mortgage (ARM) loans, 133–134, 141–144 on annuities, 68–70 on convertible mortgages, 420–422 defined, 65, 94n6 ENAR, 70, 72 interest rates vs., 67n6 as land development term, 559 loan time outstanding and, 99–101 partial periods, 72–74 with single receipts, 65–68 YMF (yield maintenance fee), 407 Z Zero amortizing loans, 84, 89–90 See also Amortization patterns; Fixed rate mortgages (FRMs) Zero coupon mortgage-backed securities, 631–632, 650 Zoning, 519–520, 559–560, 567 www.downloadslide.net www.downloadslide.net www.downloadslide.net www.downloadslide.net www.downloadslide.net www.downloadslide.net www.downloadslide.net ... $ 12, 000 $ 12, 000 $ 12, 000 $ 12, 000 $ 12, 000 $ 12, 000 $ 12, 000 $ 12, 000 $ 12, 000 0 0 2, 698 2, 698 2, 698 2, 698 2, 698 9,3 02 $ 2, 604 $ 9,396 9,3 02 $ 2, 604 $ 9,396 9,3 02 $ 2, 604 $ 9,396 9,3 02 $ 2, 604 $ 9,396... $106,090 $109 ,27 3 $1 12, 551 80 ,27 5 80 ,27 5 80 ,27 5 80 ,27 5 80 ,27 5 Cash flow before participation Participation Before-tax cash flow 19, 725 22 , 725 25 ,815 28 ,998 32, 276 1,500 3,045 4,636 6 ,27 5 $   19, 725 $... 32, 727 32, 727 32, 727 32, 727 7,976 11,443 15,043 18,779 22 ,661 $  2, 233 $ 3 ,20 4 $    4 ,21 2 $  5 ,25 8 $    6,345 C After-tax cash flow: Before-tax cash flow (BTCF ) Less tax $    35,411 2, 233