Chapter 12: Principles of Real Estate Financing

Basic Valuation Concepts

*   The central idea of valuation: the present value of the anticipated future benefits

*   Market value is the price a typical buyer would pay (value in exchange)

*   Investment value is the price a particular person (investor) would pay (value in use)

*   Interest is the payment for the use of money.

Present Value of Anticipated Future Benefits Based Upon:

*   Magnitude of anticipated benefits (cash flows)

*   Timing of anticipated benefits (cash flows)

*   Likelihood of the realization of the anticipated benefits (riskiness)

Risk/Return Tradeoff

The Time Value of Money


The Basic Relationships

*   Most problems can be solved with four of the five factors:

*   The appropriate number of periods

*   The appropriate interest rate

*   The initial present value

*   The magnitude of the annuity if any

*   The expected future value

*   In most problems you can break down the more complicated larger problems into smaller ones which contain the above five items.


The Future Value of a Lump Sum

Present Value of Lump Sum

Future Value of an Annuity

Present Value of an Annuity

Tables, Calculators, Equations, and Spreadsheets

*   Tables preceded modern calculators/computers

*   Tables pre-calculated results for equations

*   Most calculations today done by calculators or computers

*   Calculators and computers merging


*   Constant memory

*   Multiple functions of keys

*   Algebraic or Reverse Polish Notation

*   Clearing the calculator

*   Changing Sign

*   Financial Tour

Calculator Financial Tour

*   n

*   I/Yr

*   PV

*   PMT

*   FV

*   P/Yr

*   xP/Yr

Basic Calculator Calculations

*   FV of lump sum

*   PV of lump sum

*   FV of annuity

*   PV of annuity

Solving for Other Factors

*   n

*   number of years

*   I/Yr

*   PMT

*   Loan payment (mortgage payment)

*   Sinking fund

Special Applications

*   Loan amortization

*   Remaining balance

*   APR

*   Net present value

*   IRR (NPV=0)

Review of Mortgage Mathematics

*   Impact of interest rates and amortization term

*   Discount points

*   Buydowns

*   Balance outstanding

The Residential Lending Process
Pre-loan Process

*   Contract to purchase

*   Selection of lender

*   Mortgage application

*   Mortgage Underwriting

*   Property Appraisal

*   Title Quality Appraisal

*   Repayment assessment

*   Loan Commitment

The Residential Lending Process
Post-loan Process

*   Closing

*   Note Signed

*   Lien Given

*   Proceeds Advanced

*   Loan Repayment

*   Release of Mortgage or Satisfaction Piece (stamp)

State Control of Property Laws

*   English common law

*   Spanish law

*   Title theory (Usually non-judicial sale)

*   Lien theory (Judicial sale states)

*   Hybrid theory--Deed of trust

The Mortgage and Promissory Note

*   Mortgage pledges the property as collateral

*   Note actually promises to pay

*   Note W/O mortgage

*   Mortgage W/O note

Clauses Commonly Found in Mortgage Instruments

*   Principal amount due; Amortization method; Estoppel letter

*   Prepayment

*   Allows prepayment (while the contract may not allow prepayment, other laws may in many states)

*   May specify a penalty

*   Acceleration

*   Avoids foreclosure on each payment

*   Used upon default

*   Special forms

*   Due upon sale, alienation, "Paragraph 17"

*   Sleeper

*   Insurance

*   Hazard

*   Flood Insurance

*   Taxes

Mortgage Takeovers

*   Mortgage assumption--joins in liability

*   Subject to the mortgage--avoids personal liability

Land Contracts

*   Also known as a contract for deed

*   "Buyer" pays on property for the specified number of years.

*   At the end of the period, the "buyer" gets the deed.


*   Limits equity of redemption

*   Begins statutory right of redemption

Steps in Foreclosure Action

*   Notice

*   To borrower

*   To other creditors

*   Hearing (Judicial sale states)

*   Order of sale (Judicial sale states)

*   Public sale

*   Absolute sale

*   Upset Bidding

*   Upset Pricing

Priority of Liens

*   Primary mortgage

*   Junior mortgage

*   Wrap-around mortgage

*   Purchase money mortgage

*   Deficiency judgment

Alternatives to Foreclosure

*   Ignore the breach

*   Work-out schedule

*   Deed in lieu

*   Conversion to equity interest

*   Recasting the loan