REAL ESTATE FINANCETheory and Practice7th Edition

Terrence M. ClauretieG. Stacy Sirmans

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Chapter 1Finance and Real Estate

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Chapter 1 Learning Objectives Understand the relationship between finance and real

estate Understand how financial markets work Learn, which major financial institutions direct the

flow of funds

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What is Finance? The study of the process, institutions, markets, and

instruments used to transfer money and credit between individuals, businesses, and governments

Applied economics Economics is the study of the allocation of resources for the

purpose of producing goods and services for various members of society.

The study of how the flow of money and credit facilitates that production and allocation.

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What is Finance? Considers time value of money (TVM) and

implications of interest rates on TVM and financing decisions:

Focuses on cash flows, not profits Makes extensive use of the concept of risk

Risk – the possibility that the actual result will differ from the expected outcome

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What is Real Estate Finance? The study of the institutions, markets, and

instruments used to transfer money and credit for the purpose of developing or acquiring real property. Real property - the rights, powers, and privileges

associated with the use of real estate. Real estate - land and all fixed and immovable

improvements on it.

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What is Real Estate Finance?

Includes the study of: Residential and commercial properties Terms of residential and property leases Appraisal of residential and commercial properties Financing of residential and commercial real estate Valuation of mortgages Real estate taxation issues Primary and secondary mortgage markets Securitization of mortgages

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The Environment of Real Estate Finance

Financial instruments are used to transfer money and credit for the purpose of developing and acquiring real property.

The institutions that create and purchase those instruments and the markets within which they are transferred constitute the environment of real estate finance.

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Real Estate as Portion of the Financial System

Table 1-1 Current-Cost Net Stock of Fixed Assets and Consumer Durable Goods (billion USD)

Source: Bureau of Economic Analysis

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Savings-Investment Cycle An identity, whereby the amount of savings equals the

total amount invested Three groups of savings: by individuals, businesses, and the

government Investment considers amount invested in new plan

construction, equipment and real property

The financial marketplace is the system whereby savings are transferred from what are termed surplus income units to what are termed deficit income units.

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The Environment of Real Estate Finance

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Financial Intermediaries Financial intermediaries are financial institutions that

channel funds from the surplus income units to the deficit income units. Commercial Banks – accept demand and time deposits Thrift Institutions – S&L associations; mutual savings banks;

credit unions Investment Companies – pool the funds of savers and invest

the funds in a portfolio of assets

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Financial Intermediaries (Cont.) Insurance Companies - receive periodic or lump-sum

payments from individuals or organizations in return for a promise to make future payments if certain events occur

Pension Funds - pool the contributions of employees and invest the funds similarly to insurance companies

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Direct Financing When the flow of funds takes place without the use of

intermediaries E.g. when a home seller grants a note to the home buyer

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Primary Mortgage Market The market where mortgages are originated Originators either hold mortgages in portfolio or sell

them into the secondary mortgage market

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Secondary Mortgage Market Major secondary market participants are the Federal National

Mortgage Association (FNMA, or Fannie Mae), the Federal Hole Loan Mortgage Corporation (FHLMC or Freddie Mac), the Government National Mortgage Association (GNMA, or Ginnie Mae), the Federal Home Loan Bank Board

The secondary mortgage market agencies and firms purchase mortgages from other intermediaries or brokers that deal with surplus income units, using funds raised though sales of securities they create Issue mortgage-related securities (MRSs) using mortgage pools as

collateral

A large and active secondary market makes securities more liquid.

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Money and Capital Markets Financial markets can be divided into two categories:

money markets and capital markets. Money markets deal in short-term securities (maturities of 1

year or less) Capital markets deal in long-term securities (over 1 year in

maturity).

Most real estate financing takes place in the capital markets.

Mortgages are long-term securities.

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