Lesson 1

COMM 405 REAL ESTATE FINANCE „ LESSON 1

Instructor: Larry Wosk

1

WHAT IS FINANCE? „ FINANCE IS THE STUDY OF THE

PROCESS, INSTITUTIONS, MARKETS, AND INSTRUMENTS USED TO TRANSFER MONEY AND CREDIT BETWEEN INDIVIDUALS, BUSINESSES AND GOVERNMENTS.

2

SUB-DISCIPLINES OF FINANCE „ There are several disciplines such as: „ „

3

1

REAL ESTATE FINANCE „ A VERY BROAD CATEGORY INCLUDING: „ THE STUDY OF INSTITUTIONS, MARKETS,

AND INSTRUMENTS USED TO TRANSFER MONEY AND CREDIT FOR THE PURPOSE OF DEVELOPING OR ACQUIRING REAL PROPERTY

4

REAL ESTATE TRANSACTIONS „ THE TRADING OF OWNERSHIP OF

INTERESTS IN LAND

5

REAL ESTATE FINANCE INCLUDES „ THE STUDY OF: „ „ „

6

2

RELATIONSHIP BETWEEN CREDIT vs. FUTURE SAVINGS „ CREDIT IS AN ADVANCE OF FUTURE

SAVINGS OR PURCHASING POWER AS IT SUBSTITUTES FOR CAPITAL YET TO BE ACCUMULATED

7

BORROWING ON INCOME PRODUCING PROPERTIES „ EVEN IF YOU HAVE THE FINANCIAL

LIQUIDITY TO PURCHASE AN INCOME PRODUCING PROPERTY OUTRIGHT IT MAY BE PREFERRABLE TO BORROW PART OF THE PURCHASE PRICE ANYWAY „ WHY?

8

FINANCIAL MARKETS „ MONEY MARKET „ CAPITAL MARKET

9

3

FINANCIAL INTERMEDIARIES „ FINANCIAL INSTITUTIONS THAT

CHANNEL FUNDS FROM THE SURPLUS INCOME UNITS TO THE DEFICIT INCOME UNITS.

10

LARGEST POOLS OF CAPITAL IN CANADA – FINANCIAL INTERMEDIARIES „ CHARTERED BANKS „ LIFE INSURANCE COMPANIES „ TRUST COMPANIES

11

PRIMARY & SECONDARY MARKETS „ PRIMARY MARKETS „ SECONDARY MARKETS

12

4

INTEREST „ “RENTAL” PAYMENT FOR THE USE OF

CAPITAL THE LENDER HAS INVESTED

13

INTEREST ON MORTGAGES „ FROM A LENDER’S VIEWPOINT

14

DETERMINING THE LOAN RATE THERE A SEVERAL KEY ELEMENTS TO BE CONSIDERED WHEN SETTING THE RATE

15

5

MORTGAGE MARKET „ SUPPLY SIDE „ DEMAND SIDE

16

MOVEMENT OF INTEREST RATES „ TEND TO MOVE WITH FLUCTUATIONS IN

THE NATIONAL ECONOMY

17

GENERAL LEVEL OF INTEREST RATES START OFF WITH A “RISKLESS” BOND „ ISSUER WILL MEET ALL INTEREST AND PRINCIPAL PAYMENTS WITH CERTAINTY „ INSTRUMENT CAN BE SOLD INSTANTLY FOR CASH AT A STATED PRICE „ NO EXPECTATION OF INFLATION (DEFLATION) AT ANY TIME IN THE FUTURE

18

6

RISK CHARACTERISTICS „ DEFAULT „ CALLABILITY „ MATURITY „ MARKETABILITY (LIQUIDITY)

19

YIELD CURVE „ A GRAPHICAL REPRESENTATION

THAT RELATES MATURITY AND YIELD ON BONDS OF THE SAME GRADE AT A POINT IN TIME

20

NORMAL YIELD CURVE 7 6 5 4 Yield (%)

3 2 1 0 1

5

10

20

21

7

INVERTED YIELD CURVE 7 6 5 4 YIELD (%)

3 2 1 0 1

5

10

15

20

25

22

HUMPED YIELD CURVE 7 6 5 4 Yield (%)

3 2 1 0 1

5

10

20

30

23

3 PRINCIPAL THEORIES RESPONSIBLE FOR THE SHAPE OF THE YIELD CURVE „ LIQUIDITY PREMIUM THEORY „ MARKET SEGMENTATION THEORY „ EXPECTATIONS THEORY

24

8

LIQUIDITY THEORY „

LONG-TERM RATES TEND TO BE HIGHER THAN SHORT-TERM RATES BECAUSE A PREMUIM MUST BE PAID TO INVESTORS WHO ARE RELUCTANT TO TIE UP THEIR FUNDS FOR LONG PERIODS OF TIME

25

MARKET SEGMENTATON THEORY „ THIS GROUP BELIEVES THAT THERE IS

NOT ONE CONTINUOUS BOND MARKET, BUT SEVERAL DISCRETE SEGMENTS, WITH DIFFERENT PLAYERS IN EACH SEGMENT.

26

EXPECTATIONS THEORY „ THIS APPROACH SUGGESTS THAT THE

YIELD CURVE IS A PICTURE OF WHAT PEOPLE EXPECT RATES TO BE IN THE FUTURE.

27

9

SOURCES: „ Baxter, D., Hamilton,S.W., & Ulinder, D.D. Real Estate Finance

in a Canadian Context (1998) UBC Real Estate Division „ Clauretie, T.M. & Sirmans,G.S. Real Estate Finance, Theory &

Practice (2003) Mason, Ohio: Thomson Southwestern „ Croft, R. Yield Curves and what they mean Retrieved Sept 9,

2004 http://www.canada.etrade.com/yieldcurves.shtml

28

10