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Date Created: 12/20/15
Concord Eastridge, Inc. Finance Presentation Lesson #2 1 Copyright © 2013 Robert Paul Ellentuck Sources of Real Estate Returns • Sources of returns from • Sources of returns from investment in real investment in estate mortgages – Cash flow from – Periodic (monthly) property operations payments of interest – Proceeds of sale of – Repayment of property principal (monthly and/or at maturity) 3 What is Real Estate Equity? • Equity-money that is invested in a property Represents ownership of the property – Participates in the operating and financial risks of property ownership – Shares in the profits and losses of property operations and proceeds of property sale 4 What is Real Estate Debt? • Debt (Mortgage) Capital – Money loaned to owner, developer or investor in exchange for promise to repay specified current return for the use of the funds (interest) for a specific period of time (term) • savers and borrowersintermediaries, linking • Lenders view a mortgage loan as a fixed income investment that is repaid over a long period of time 5 Characteristics of Real Estate Mortgage Market • Source of real estate loan determined by term of the loan – Lenders seek to match assets and liabilities, thereby creating a “matched book” • Short-term loans generally used for planning through construction stages (until permanent long-term financing funded) – Loan sourced from lenders who raise funds in the “Money Markets” • Long-term loans used for operation/ownership stage – Loan sourced from lenders who raise funds in the “Capital Markets” 6 Structural Characteristics of Mortgage Loans • Non-recourse • Secured • Specified term-when it must be repaid • Interest-calculated based upon fixed or variable rates • Amortization-how principal will be repaid (self-amortizing/balloon) • Prepayment – When and if available – Cost to prepay (penalties) 7 Balloon and Fully Amortizing Mortgage Loans Non-Amortizing ("Balloon") Loan Self-Amortizing Loan $1,000 $1,000 $900 $900 $700 $700 $600 $600 $500 $500 $400 $400 $300 $300 $100 $100 $0 $0 200202026020201202026020202202025 2002020260202012020120202202024025 Loan Balancethly Payment Loan Balancethly Payment 8 Mortgage Constant • The mortgage constant represents the annualized debt service payment (principal amortization, if any, plus mortgage interest) on a loan – It is usually calculated via computer, financial calculator, or by reference to a pre-calculated table – It is calculated on the basis of $1.00 of mortgage principal amount and the resulting mortgages then applied to the amount of the – period required to amortize the loan, thehe interest rates, and the frequency with which debt service payments are made 9 Components of the Private Real Estate Capital Markets • Commodity debt: – Low volatility, many lenders, and efficient pricing – Income (interest) return drives total expected return on investment • Equity: – Higher volatility, first loss position – Appreciation component drives total expected return • Mezzanine Investors: – High yield return, high volatility – Income/appreciation return drives total expected return 10 Lender’s Underwriting Decision, Method I • Adequacy of value of property as collateral for loan – Test # 1- Loan-to-Value (LTV) Ratio – LTV is an absolute standard; “no loans in excess of 75% of market value” – Example: Market value = $1,250,000 x 75% LTV ratio = $937,500 loan – At 75% LTV ratio, maximum loan is $937,500 11 Lender’s Underwriting Decision, Method II • Adequacy of value of property as collateral for loan – Test # 2 – debt service coverage (DSC) ratio – Ratio of dollar of NOI per dollar of debt service – DSC is an absolute standard; “no loans without minimum debt service coverage of 1.2 x 1 • Example: NOI = $125,000 / 1.2 = $104,167– amount of NOI available to pay debt service • To calculate amount of loan, divide amount available for debt service by loan constant –$104,167 / 10.5% = $992,063 • At 1.2 x 1 DSC, maximum loan is $992,063 12 What Would You Loan the Borrower? Why? • Loan-to-Value Ratio $937,500 • Debt Service Coverage Ratio $992,063 13 Review of Debt Service Formulas • Annual Debt Service = Loan Amount x Mortgage Constant • Debt Service Coverage Ratio = Net Operating Income/ Debt Service • Maximum Loan Amount = Maximum $ Available for Debt Service*/ Required Mortgage Constant * Maximum $ Available for Debt Service = Net Operating Income/ Debt Service Coverage Ratio 14 Sources of Debt Financing • Commercial banks • Insurance companies • Savings and loan association • Non-bank financial institutions (credit companies) • Securitized lenders (CMBS or Conduits) • Mortgage REITs • Pension funds • Government sponsored entities (i.e. FNMA) 15 16 Income and Expense Statement: Projected 2005 17 Debt Underwriting – “Back of the Envelope” Borrower Retail Center LLC Acquisition, development or refinance Development Acquisition: In contract Are equity and/or mezzanine in-place Development: Is developer ready to start constructiSeptember 2008 Refinance: Does borrower need to refinance immediately Property Characteristics: Property Type Shopping Center Major Tenants, (sq. ft., lease exp., rent, % GLA, credit ratings, etc.) Supermarket 51,674 sf 25Y $9.68/sf. 93.98% BBB Subway 2,500 sf 5Y $20.00/sf 2.73% BB Dry Cleaners 1,808 sf 10Y $15.00/sf 3.29% NR Square Feet/Rooms/Units 54,982 sf % Occupied/Pre leased/Pre sold 100% 18 Debt Underwriting – “Back of the Envelope” Story/Loan Structure Excellent location, great sponsor, good anchor, appropriate inline space, excellent demographics, and good contractor GMP. Proposed Capitalization: Acquisition/Development Cost $7,146,524 Closing Costs $0 Other $0 Capital Expenditures $0 TOTAL $7,146,524 Debt $ 5,717,200 80 % Mezzanine $ % Equity $ 1,429,324 20 % 19 Debt Underwriting – “Back of the Envelope ” Underwriting: Cash Flow: NOI (before TILC) $581,599 Percentage Rent [50% if prepay histor$39,520 Vacancy allowance % of Gross Revenue $5,720 (10 % of inline space) Management Fee % of Gross Revenue 3% of EGI FF&E Reserve % of Gross Revenue NA Franchise Fee % of Gross Revenue NA Structural Reserve $ PSF/$Unit $.25 psf GLA TILC Reserve $ PSF $3.00 psf GLA of inline space Underwritten NOI (after TILC) $554,930 Return on Cost 7.77 % 20 Debt Underwriting – “Back of the Envelope” Loan Sizing: Fixed Rate or Floating Rate Fixed DSCR 1.20 X Spread/Base Rate 1.50 % over 10Y USTN 4.90 % Floor Rate/Actual Rate 6.40% Amortization/Mortgage Constant 30Y 7.506 % Minimum Constant & DSCR LTV & Est. Cap Rate 75 % 7.0 % LTC 80.0 % DSCR Loan Amount $6,160,960 Minimum Constant Loan Amount $ LTV Loan Amount $5,945,679 LTC Loan Amount $5,717,200 21
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