Sources of Funds for Commercial Real Estate Properties

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Chapter 17

• Sources of Funds for Commercial Real Estate
  Properties

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Chapter 17Learning Objectives
17-1

• Understand the sources of funds that support the
  development and purchase of real estate
• Understand the difference between debt and equity
  sources of funds
• Understand how different institutions specialize
  in either debt or equity financing
• Understand how government regulations affect real
  estate investment decisions

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SOURCES OF RESIDENTIAL MORTGAGE DEBT

• Commercial Banks
• Savings Institutions
• GNMA Mortgage-Backed Securities
• Fannie Mae and Freddie Mac

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FLOW OF DEBT FUNDS

• Institutions either lend directly or purchase
  debt obligations
• Net acquisitions Originations Purchases -
  Sales
• Mortgage brokers originate mortgages solely for
  sale to other investors

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SOURCES OF COMMERCIAL DEBT

• Life Insurance Companies
• Commercial Banks
• Savings Institutions
• Commercial Mortgage-Backed Securities

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COLLATERALIZED MORTGAGE OBLIGATIONS

• Backed by commercial mortgages
• May be backed by a single, large property or by a
  mix of mortgages on different property types in
  different geographical locations
• Provide liquidity through a secondary market
  mechanism

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RISK OF COMMERCIAL CMOS

• Lack of mortgage insurance
• Difficulty in evaluating risk of underlying
  properties
• Financial ratings by Moodys and SP. Quality
  ratings of A, B, C, D or E
• Part of rating is based on economic strength of
  region

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COMMERCIAL LOAN SECURITIZATION

• Key to acceleration is standardization of the
  underlying assets
• Standardized loan documents
• Extended amortization of bullet loans
• Minimum debt service and LTV ratios
• Prohibition of prepayment for some initial years

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TRENDS IN COMMERCIAL DEBT FINANCING

• Recognition that regional economies behave
  differently from the national economy
• ADC loans for large residential developers are
  somewhat restricted
• Public debt (available through publicly traded
  securities) vs. private debt from banks or
  insurance companies

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EQUITY FINANCING OF COMMERCIAL REAL ESTATE

• Equity positions through direct investment or
  indirect investment
• Indirect investment Real estate limited
  partnerships (RELPs) or real estate investment
  trusts (REITs)
• Tax Act of 1986 makes partnerships less attractive

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INSTITUTIONAL INVESTORS IN EQUITY REAL ESTATE

• Life insurance companies
• Primary role is providing debt financing
• Pension Funds
• Defined-contribution vs. defined-benefit plans
• Commingled funds include investments by several
  firms or groups

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PENSION FUND RESTRICTIONS

• Employee Retirement Income Security Act (ERISA)
• Funds must invest as a prudent man
• Funds must diversify their portfolios
• Does not restrict types of real estate

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a prudent man

• The fundamental principle for professional
  money management, stated by Judge Samuel Putnum
  in 1830 "Those with responsibility to invest
  money for others should act with prudence,
  discretion, intelligence, and regard for the
  safety of capital as well as income." Some states
  which don't have specific legal lists require
  fiduciaries to uphold the Prudent Investor Act.

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Prudent Expert Act

• DefinitionRevised version of the prudent man
  rule required by ERISA to guide managers of
  pension and profit sharing portfolios. The main
  addition is that the manager must act as someone
  with familiarity with matters relating to the
  management of money, not just prudence.

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PUBLIC/PRIVATE PARTNERSHIPS

• Local governments provides land, money, grants,
  subsidies, or other resources to private
  developers
• May be low interest loans from tax-free bonds
• Designed to serve community needs
• Some restrictions by federal tax regulations