Theory and Practice 7th Edition Terrence M. Clauretie G. Stacy Sirmans REAL ESTATE FINANCE Theory and Practice 7th Edition Terrence M. Clauretie G. Stacy Sirmans © OnCourse Learning

Finance and Real Estate Chapter 1 Finance and Real Estate © OnCourse Learning

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 © OnCourse Learning

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. © OnCourse Learning

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 © OnCourse Learning

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. © OnCourse Learning

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 © OnCourse Learning

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. © OnCourse Learning

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 © OnCourse Learning

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. © OnCourse Learning

The Environment of Real Estate Finance © OnCourse Learning

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 © OnCourse Learning

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 © OnCourse Learning

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 © OnCourse Learning

Primary Mortgage Market The market where mortgages are originated Originators either hold mortgages in portfolio or sell them into the secondary mortgage market © OnCourse Learning

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. © OnCourse Learning

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. © OnCourse Learning