PHILIPPINE ASSOCIATION OF
REAL ESTATE BOARDS, INC (PAREB)
Gensan-Sarangani REB
REAL ESTATE FINANCING
by Maya Bandolon-Cartojano, REC, REA, REB
REAL ESTATE FINANCING
TOPIC AREAS 4hrs
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Debt Financing
Time Value of Money
Cash Flow Analysis
Financing Terminologies
HDMF/PAGIBIG Financing, Principles and Guidelines
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
REAL ESTATE FINANCING
Debt Financing for Real Estate
O Discussion Outline
O Why Investors Use Leverage
O Behavioral Effects of Financing
O Types of Loans
O Legal Issues in Real Estate Finance
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
Why Borrow Against
Real Estate?
O Decrease Equity Exposure
O Extend limited resources in a capital intensive asset class
O Limit risk exposure to any single asset
O Tax Deductibility of Interest
O Reduce taxable income
O Positive Leverage
O Before and after tax returns to equity are greater with than
without debt
O As long as debt costs less than equity, it takes less than its
proportionate share of a propertys cash flow
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
How Debt Affects Real
Estate Investment Behavior
O Influences value at the margin
O Increases focus on operational efficiency
O Lengthens holding periods by reducing
liquidity
O Increases risk of loss of investment capital
O Causes tax driven behaviors
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
REAL ESTATE FINANCE TERMS
Mortgages borrowed money, considered capital
instruments because payback periods are usually
more than 10 years
Equity buyers contribution, usually downpayment
Original Loan Amount face amount of loan
Amortization monthly payments over a specified
time period to retire a mortgage. Consist of
PRINCIPAL + INTEREST
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
REAL ESTATE FINANCE
Interest money earned for the right to use the
capital. Usually compound interest method
Payment or Debt Service comprise both interest
and principal
Annual Constant ratio of mortgage payment to
the original loan amount (MP/OLA)
Loan to Value Ratio percentage of the original
loan amount to the value of the property (OLA/PV).
BSP allows LTV ratio up to 80%.
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
Debt and Market Liquidity
O Structure and terms of most long term debt
increases holding periods, illiquidity in the
market
O Loans are structured to lock in lender yields
O Prepayment prohibitions, penalties
O Features compensate lenders for risks of
extending credit
O Default loss of principal
O Prepayment potential opportunity cost of lost yield
O Interest rate risk loss of value due to changes in the yield
curve
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
Debt and Equity
Principal Risk
O Debt has legal priority over equity ownership
O Equity owners must balance the benefits of
positive leverage with the risk of foreclosure
and loss of capital
O Equity often accepts lower levered returns for reduced
risk (ie, REITs, core investment funds)
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
Debt and Taxes
O Deductibility of interest expense enhances
the tax shield already in place from
depreciation
O Tax impact is generally an individual issue
O Private markets hold real estate primarily in flow
through vehicles (partnerships, etc.)
O Tax motivated investors may structure deals for
maximum tax benefit
O Typically, does not effect pricing at the margin
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
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Is Inflation Good for
Levered Real Estate?
O In inflationary times, leverage benefits real
estate equity returns
O Debt principal is paid in the future with pesos that
are worth less
O Holds true only in hyper-inflationary
periods
O Loan pricing reflects the yield curve
O Should have inflationary expectations built in
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
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Residential vs.
Commercial Lending
OResidential lending:
O Smaller in size
O Non-recourse to the borrower
O Totally dependent on market value of home for collateral
O Fully pre-payable at any time
O High percentage of prepayments at any given time
O government heavily involved in pricing and
structuring
O Loan terms largely standardized, un-negotiable
O Widely disseminated pricing information
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
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Residential vs.
Commercial Lending
OCommercial Lending
O Dominated by private sources of capital
O A relationship business
O Increasingly influenced by the public
O Highly dependent on local market information
O Lender specialization by loan type
O Source of funding, market knowledge
O Terms and conditions highly negotiable
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
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Setting Loan Terms
O Determining a loan amount
O Based on ratio tests, collateral value
O Debt coverage ratio
O Loan to value ratio
O Setting the terms and conditions
O Pricing based on underlying cost of funds
O plus premiums for default, inflation, and
prepayment
O Reps and warranties, performance covenants
O Determination of sufficiency of collateral
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
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Alternative Loan Structures
O Loan structures reflect a trade off of risk and
return between lender and borrower
O Lender evaluates borrower capacity (ie., more
risk) for greater return
O Borrower evaluates more or less debt proceeds
versus
O Timing and security of cash flows
O The financial leverage effect
O Current return (less risk) vs. residual return (more
risk)
O Cost of incremental debt versus additional equity
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
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Fixed, Floating and
Interest Only Loans
O Fixed rate loans are the standard
O Floating rate loans
O Construction and mini-perms
O Acquisition lines of credit
O Interest only loans
O balloon or bullet payment at maturity
O Used for:
O Construction
O Acquisition lines of credit
O Structured finance transactions
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
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Participating Loans
O Lender trades risk for higher potential
returns
O Reduces LTV coverage
Increases loan amount
O Takes a percentage of after debt service cash
flows
O Structured as additional interest
O Total of fixed payment and percentage
interest creates higher total yield on loan
dollars invested
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
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More on Participating Loans
O Borrower benefits:
O Greater loan proceeds
O Often cheaper than equity which might have to be raised
from outside sources
O Lower fixed debt payments
O Less pressure on short term NOI
O Borrower decision:
O What is the incremental cost of borrowing the extra
loan amount, vs. cost of equity?
O If the deal IRR is weighted toward the residual, the
lenders participation in the residual is probably
less than an equity investors would be
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
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More Alternatives
OLand Sale Leaseback
O Financing land separately from improvements
O Higher total loan proceeds
O Finances 100% of land value, vs. LTV if included
in typical loan calculation
O 100% of payments are tax deductible
O Vs. only interest portion if financed by loan
O Risk is in subordination provisions
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
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Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
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More Alternatives
OAccrual Loans
O Pay rate < stated interest rate
O Negative amortization situation
O Tax benefits:
O Creates greater tax shield deductible interest
is based on the accrued rate, not the pay rate
O More risk to the lender WHY?
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
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More Alternatives
OConvertible Loans
O Lender has an option to convert ie, swap loan
proceeds for partial equity ownership
O Would convert if the equity value of the interest
exceeds the mortgage balance at conversion date
O Borrower benefits
O Lower interest rate, greater current cash flow in
exchange for potential loss of equity value in the
future
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
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TYPES OF LOANS
Fixed Rate Mortgages interest is fixed for the
term of the loan. Some fixed for 5-7 years, then
readjusted for the remainder of term.
Adjustable Rate Mortgages interest is based
on a certain index (eg TBills) plus spread
Buydowns variation of FRM & ARM, but
interest is prepaid to lower payments in the
early years of the term. Prepaid interest usually
by developers
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
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FORMS OF MORTGAGES
Conventional Mortgages most common,
secured by RE collateral, available through
bankers, banks and savings & loan institutions.
Usually safe instruments to trade in Secondary
Market for Morgages
Insured Loans include guarantee or insurance
to protect the lender in case of default by the
borrower
Blanket Mortgage secured by group of
properties or number of lots
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
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FORMS OF MORGAGES
Chattel Mortgages loan for personal
property and secured by personal property
Package Mortgages loan on both real and
personal property. (eg. Factory can be
mortgaged on the land, improvements and
equipments)
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
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Legal Considerations In
Real Estate Financing
O Real estate cash flows can be legally allocated
to different interest holders via the capital
structure
O The PV of each of these streams = value of the
interests claimed by each layer of capital
O The legal system also establishes control over
other, non-monetary interests
O Equity owners dont necessarily get 100% of the value
of real estate interests
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
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Possessory Interests
OPossessory (current or potential)
interest is a right to control some of
the rights through some form of
financial consideration
O Fee simple ownership interest
O Tenants leasehold interest
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
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Non- Possessory Interests
O Non-possessory interest is a right to use real
estate without ownership or financial
consideration
O Most pervasive form is the easement
O Provides a right to use, but not legally own, an interest
O Power lines, fire access
O Some easements may be irrevocable
O An easement can affect value
+ Right of way to reach the street
- Power line running down the center of property
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
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REAL ESTATE
FINANCING
O SPOT CASH
O DEFERRED CASH PAYMENT
O LONG TERM FINANCING
Each type of financing scheme has its own
advantages and disadvantages. To
determine which one is appropriate to you,
it is best to start looking at your own
budget and financial capabilities
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
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BANK FINANCING SAMPLE
COMPUTATIONS
O *Let's say Bank Loan interest is 9.25% and the loan
term is 12 years -- therefore the Amortization Factor
(based on the table) is .0116637. There are many
websites that provide an automated Mortgage
Calculator
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
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SAMPLE COMPUTATIONS
Given:
Actual Value of Property: P1,000,000
Borrower's Equity: 30%
Loanable Amount: 70%
Bank Loan interest: 9.25%
How much monthly amortization?
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
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MONTHLY AMORTIZATIONS PROBLEMS
SELLING
PRICE/PROPERTY VALUE
less:
DOWNPAYMENT
BALANCE
multiply:
MONTHLY AMORTIZATION FACTOR*
MONTHLY AMORTIZATION
* Factor is usually given in the problem or a factor table is provided.
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
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SAMPLE COMPUTATIONS
Given:
Actual Value of Property: P1,000,000
Borrower's Equity: 30%
Loanable Amount: 70%
Bank Loan interest: 9.25%
Amortization Factor: .0116637.
How much monthly amortization?
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
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SAMPLE COMPUTATIONS
Given:
Actual Value of Property: P1,000,000
Borrower's Equity: 30%
Loanable Amount: 70%
Bank Loan interest: 9.25%
Amortization Factor: .0116637.
How much monthly amortization?
MONTHLY AMORTIZATION
Contract Price:
less Equity: 30%
Balance
multiply Factor:
Monthly Amortization
= P1,000,000
300,000
700,000
0.0116637
P8,164.59
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
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Real Estate Finance Tools:
Present Value and Mortgage
Mathematics
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
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Major Topics
Time value of money calculations
Present value of a single sum or annuity payment
Future value of a single sum or annuity
Mortgage loan constants
Mortgage balance calculations
Point charges and their effects on borrowing costs or yields
Annual Percentage Rate
Effective Cost of Borrowing
Net present value and IRR calculations
Refinancing decisions
Adjustable Rate Mortgage or ARM Calculations
Price Level Adjusted Mortgage
Reverse Annuity Mortgages (Future Value of Annuity)
Supportable mortgage calculations
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
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Introduction to the Time
Value of Money
A peso today is worth more than a peso
received in future
In most economies we expect a return
on money or capital related to the
productivity of things capital can buy
This is the fundamental source of the
real returns (not just inflationary
increases)
The required returns are cumulatively
known as the opportunity cost of
capital
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
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Present & Future Value of a Single Sum
PV = FV / (1+r)
FV = PV (1+r)
PV is the present value
FV is future value
r is the total expected rate of return
r includes the risk free and risk
premium rates
r is called discount rate when solving
for PV
r is called rate of return when solving
for FV
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
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PV & FV over Multiple
Periods of Time
General formula for PV and FV across
multiple periods:
PV = FV / (1+r)N
FV = PV (1+r)N
N is the number of periods between FV and
PV
If FV and PV are known the rate of return
can be found by the formula:
r = (FV/PV)
1/N
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
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PV of an Annuity
Annuity: stream of regular payments of equal
amounts
E.g.: monthly rental payments, mortgage
payments
1 1/(1+r)N
PV = PMT -----------------
PMT is the equal amount of payments occurring
at end the of each consecutive equal length
period of time
N is the number of payments
r is the interest rate per period to time,
compounded at the end of each period
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
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PV of Annuity
For payments in advance the PV formula
changes to:
1 1/(1+r)N
PV = PMT (1+r) --------------r
Expressed in simple interest annual rate
terms, the annuity formula assumes the
forms:
1 1/(1 + i/m)(Tm)
PV = PMT ----------------------------
i/m
i/m
PMT = PV ----------------------------
1 1/(1 + i/m)(Tm)
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
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Mortgage Constant
MMC is the monthly mortgage constant
It is the monthly payment per dollar of loan and it
includes both interest and principal amortization
--
r
MMC = ---------------1 1/(1+r)N
Here N & r are in months
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
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Calculating a Loan Balance
Outstanding Loan Balance (OLB) equals
the present value of the remaining loan
payments
Original mortgage was for T years at a
rate of i
If q payments have been made, the
formula will be:
1 1/(1 + i/m)(mT-q)
OLB = PMT ---------------------------i/m
1 1/(1 + i/12)(12T-q)
OLB = PMT ---------------------------i/12
(with m=12)
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
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Calculating the Principal and Interest
Separation of a Mortgage
Example: A P150,000 30yr mortgage at 9%
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
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Future Value of an Annuity
The FV of an annuity is the result of equal
payments compounding over time at a given
interest rate
Used in RAM (Reverse Annuity Mortgage)
Formula:
N 1
(1+r)
FV = PMT -----------------
r
PMT is the annuity paid every month
r is the interest per period (month)
n is the number of months
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
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Calculating Yields or Borrowing Costs
Recap of terms:
Contract interest rate
Index
Spread
Prime
Prime Rate of Interest
Discount Rate
Carry cost
Effective or true cost of borrowing
Effective yield
Contract rate
Points
Yield
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
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More Mortgage Calcs on a
Financial Calculator
Inputs:
PV =
I=
N=
$240,000
8%
360
(Amount of Loan)
(divide by 12)
(30 year loan x 12
months/year)
Solve for PMT
Result
PMT = (P1,761.03)
O The payment is based on the annuity
that equates to a present value of the
mortgage loan when discounted at the
contract rate of interest
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
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Effective Yield Calculation
Loan Amount is P240,000 with 1.5 points and
prepayment expected in 10 years without
penalty
Step 1: Calculate actual loan amount
Loan Amount Disbursed
= P240,000 1.5%(240,000)
= P236,400 net
Step 2: Calculate loan balance due at end of 10
years
PMT = (P1,761.03)
I = 8% (convert to monthly)
N = 240 (Months Remaining on the loan)
Compute
PV = P(210,539) (Use as FV input)
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
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Effective Yield Calculation
Step 3: Calculate the lender's yield on the
amount disbursed, considering early
repayment
Enter PV = P 236,400
Enter PMT = P(1,761.03)
Enter
N = 120 (The expected time until
prepayment)
Enter FV = P (210,539)
Compute I = 8.23%
This is the effective cost of borrowing
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
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Annual Percentage Rate (APR)
When loans are held over full amortization term
the effective borrowing costs are based on
APR for annual percentage rate
Truth in lending Act
If there are no point charges, APR is equal to
effective borrowing costs
APR is the yield which brings the future
payment stream back to present value such
that it exactly equals the net cash disbursed
by the lender
PV = Mortgage Points = [1-{1/(1+APR12)N}/APR/12]* PMT
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
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Points A tool to increase Yield
Lenders perspective: Decrease contract
rate (looks attractive to borrower) and
increase points to compensate for it
Question: How many points are needed to
bring a mortgage yield up given the
contract rate is lower than required yield?
Steps (using business calculator)
Find monthly payment and input as PMT
Find mortgage balance (considering
payout) input as FV
Input monthly interest rate (Required
yield/12)
Input the number of periods
Compute for PV
Loan amount PV will give the points
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
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Mortgage Pricing
Which loan is best for a borrower depends on
the expected tenure or time they expect to
hold the loan
The 7.5% loan with 7 points is better if the
borrower is fairly certain they will hold the
loan for more then 10 years and if they dont
believe rates will come down allowing them
to refinance before 10 years
If the borrower is uncertain about holding
periods or future rates, the 8.6% loan is the
best choice with the lowest cost for anything
under a 10 year hold
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
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ARM and FRM
Fixed Rate Mortgage (FRM), where the
rate of interest charged remains
constant throughout the term
Adjustable Rate Mortgage (ARM),
where the rate of interest and hence
the mortgage payment is variable due
to the link with an index
Spread is the amount above the index
that is added to determine the new
contract rate of interest
Typically ARMs are priced at
significantly lower interest rates as
much of the future interest rate risk is
borne by the borrower
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
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ARM and FRM
Annual rate caps is the maximum increase in
the rate that is possible per year
Life time caps is the maximum total increase
in the rate that is possible during the loan
term
A 1.0% to 2.0% annual rate cap is common
To calculate the new payment we first need
the balance of the loan and then we use this
balance over the remaining term or N to
calculate payments at the new rate
Typical life caps are 5% or 6% over the
course of the loan, so a loan that starts at 6%
can never be higher then 11% if the life cap is
5%
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
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Choosing b/w FRMs and ARMs
FRM interest rate risk is borne by lender
Borrowers who are just able to qualify for the
mortgage with little excess in their budget for
the risk of higher payments will often opt for the
FRM, while wealthier borrowers with few
liquidity concerns will often opt for the ARMS
Rather than lower aspirations many households
will start to consider taking on the risk of an
ARM as rate rise and the spread in the market
between FRMs and ARMs increases
With ARMs much of the interest rate risk is
borne by the borrower
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
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Refinancing
Refinancing can save borrower money if
there is a drop in mortgage interest rates
Situations when refinancing is not advisable:
Remaining term of the loan is short or
expected tenure with new loan is short
Mortgage rates are expected to further
drop
Prepayment penalties are higher than
benefits
Deciding whether refinancing is profitable or
not:
NPV of expected savings exceeds the
cost of refinancing then it is advisable
and vice-versa
Real Estate Finance by Maya Cartojano REC, REA, REB
12/17/2015
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