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)

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.

DRAW A TIME LINE

The Future Value of a Lump Sum

Present Value of Lump Sum

Future Value of an Annuity

Present Value of an Annuity

Tables preceded modern calculators/computers

Tables pre-calculated results for equations

Most calculations today done by calculators or computers

Calculators and computers merging

Calculators

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

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

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.

Foreclosure

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