Mortgage Yield
Return the lender receives from originating the loan
ECB
cost of the loan to the borrower
Zero - Sum Game
lenders yield is the same as borrowers expense
fees and expenses are
not paid to the lender, increase the borrowers costs but not the lenders yield
History of Mortgage Contracts
Primary: FRM
70s and 80s: alternative types- high inflation
inflation up - portfolios value down
need for shorter duration mortgages
Floating Rate Loans
Mostly commercial loans
One month LIBOR rate to calc debt service
Simplest IO floating rate mortgage
Residential: also has amortizing floating rate loans
Interest Only Floating Rate Mortgage
Sized with DSCR
restriction against loan that is below DSCR level and above LTV ratio
One month LIBOR with monthly DS pmts changing depending on LIBOR
Rate used to calc payment is a fixed margin over LIBOR rate
Lower caps and upper caps as bounds
prepayme
Fully amortizing floating rate loans
Mostly residential loans
1,3,5 year treasury rates as index
fixed margin added to index
often stipulates the rate change period
Negative amortizing floating rate loans
rare in commercial loans - home
implies that loan balance can increase over time rather than decrease
occur if there are interest rate caps
high default rate, less favorable for lender
Bridge Loans
allows owners to perform certain tasks (reno, liquidation, new tenants)
6mo-1yr, extension fees of .5-2 points for 6mo-1yr extension
Higher rates than permanent loan rates
Rarely prepayment penalties or lock-out clauses
Construction Bridge Loans
interim mortgage which allows developer to take out the often expensive construction loan before structuring a permanent loan
often construction cannot qualify for permanent loans bc no historical performance
later replaced by a min-perm which amortizes o
Hard Money Loans
for borrowers with poor credit rating for unprofitable real estate companies
higher points than normal banks - last resort lender
collateral is property, 1-3 yr maturity
exit fees which require payments regardless of if loans are paid on time
late fess on
Third Party Reports and Lender Term Sheet
appraisals and toxic reports
borrowers reluctant to pay for these reports without first getting loan approval and lenders would approve without reports
borrower can request a term sheet - conditional commitment letter which is a proposal of loan originati
Land Development Loan
finance improvements to convert raw land/unimproved parcels into construction ready sites
subdividing, bringing sewers and highways (horizontal improvements)
Mezzanine Load
secured by membership interest of limited liability company that owns a commercial property
Preferred Equity
allows borrower to recapture equity often occurring after a period of property appreciation
For when first lender prohibits secondary financing or expensive to refinance(defeasance)
Has equity stake and is paid a promised return
Lower Debt Service Payments
When borrowing rates decline, refinance or replace loan
Benefit - lower payments!
Cons - costs (points, fees, etc.)
Equity Extraction or Cash Out
value increased, refinance and cash out some of he equity accumulated from appreciation
can use equity extraction for next project
will entail increasing the mortgage debt on the existing building
Prepayment Provisions
conduit loans have some form of prepayment penalty
Fixed
Yield Maintenance
Scheduled Principal and Interest
When is the lockout period for prepayment NOT valid?
Default (Penalty = PV of all interest until end of lockout + regular penalty)
Condemnation (city appropriation of land)
Casualty (fire)
if full principal is paid to lender
Fixed Penalties
not common today
% of unpaid balance
sometimes low interest rates are still worth refinancing
Yield Maintenance
penalty based on PV of the difference between the old loan payment and new payment if the refinance is at a lower rate (benefit component)
eliminates interest rate motivated prepayment behavior
2 methods to calculate:
Scheduled principal and interest
Inte
Scheduled Principal and Interest
most common
penalty = PV of future scheduled payments - balance outstanding
penalty must be 1%+ of the outstanding
Interest Rate Differential
determine the PV over remaining loan maturity of the interest rate differential between the note rate and treasury rate
Prepayment Penalties over time are the least for? most for?
Yield maintenance is the least over time
Defeasance is the most over time
Lock Out Period
provisions of securitized loans often have a period and then a defeasance period till some maturity date
no prepayment allowed (3-5 yrs typically)
after this is the defeasance phase
Defeasance
Most common prepayment penalty
submission of a portfolio of treasury securities whose cash flow matches the scheduled mortgage payments of the loan being defeased
price is the price of the coupon-matching portfolio of treasury securities
Participating Loan
lender gets equity cash flows in exchange for lower interest rate or other lending concessions
Ways to structure a participating loan
Lender % of yearly income (% GI, % NOI, % BTCF)
Lender % of Sales Price and Before Tax Reversion
or a combo of the two
Mezzanine Financing
junior or second mortgage
lender receives the ability to cure default before foreclosure
lender can protect their interest
Mezz financing is used when:
first mortgage is... High DCR, low LTV or hard to take out or good terms you want to leave in place
Combo of mezz and first is lower ECB
lender will securitize the loan
Wraparound Mortgage
junior or second mortgage
entire DS(first + second payments) is paid to second mortgage holder, many times the seller of property
secont holder continues to make payments on the first mortgage using the proceeds from the wrap borrower
Structuring a Wrap Loan
Contact a wrap lender to structure a wrap loan for the needed funds and the underlying first mortgage which equals the wrap lending rate
Wraps are used:
to take advantage of low interest rate on a existing first mortgage
when the existing has a lockout provision
to facilitate the sale of property at higher price for someone having difficulty qualifying for a loan orrrrr a property with a higher LTV ratio
Portfolio Selection Criteria
Returns: change in price of asset, compensate for risk, illiquidity, term premium
Risk: price or return volatility, standard deviation
Diversification: ability to reduce risk in portfolio
Protection against undesirable states of nature:
Measures of RE performance
appraisal based returns
REIT performance
Concensus
Appraisal based returns
most common
NCREIF index
prices change of commercial RE held by tax exempt financial institutions
REIT performance
traded share price reflect prices of underlying investment
problem is that prices are also a function of other factors and not a pure measure of performance
Consensus
ask an expert!
Survey of real estate investors and determine their return experience for real estate
Appraisal Smoothing
measuring RE performance is problematic since commercial RE trades infrequently
index based on appraisals is smoothed - underrep of risk and true volatility
Alternative
more accurate appraisals over longer holding periods
compare long term real estate returns with stock returns
Hotel Performance
absorb inflation risk with short term leases
Why refinance?
lower debt service payments
equity extraction
Securitization
process by which illiquid financial assets and liabilities are transformed into capital market instruments
Commercial Mortgage Backed Securities
allows commercial real estate lending sector to tap into the bond markets for funds
resulted in commercial lending sector being better integrated with the domestic and global capital markets
Consequences of CMBS?
new lending source
more competitive lending environment
default risk is spread across bond investors
with structured CMBS bonds, risk is sold to those who can manage it
LOWER BORROWING COSTS
What gets securitized?
conduit loans are designed to meet rating agency and securitization criteria
- pool of diversified types, geography, source and borrowers
- typically 100 - 200 loans per mortgage pool
- sizes rang 1 mill to 25 mill
- LTV 70 - 75%
DCR - 1.35 to 1.45
How does a pool work?
groups of commercial mortgages with common theme are pooled together by investment bank, formed into bonds and sold to several investors
What is a conduit?
pipeline for lending capital
- finance commercial borrowers, offset credit risk via securities markets
Benefits: exposure to commercial RE, diversification through pooling, balances supply-demand in RE
Buy low, sell high! means...
AAA yields lower than rates on collateral
Weighted average bond rates lower than collateral mortgage rate
Buy low bonds, sell high originate mortgages
Structure will work so long as the average bond yields are lower than rates on commercial mortgages
What affects the CMBS market
integration with global capital markets
global events
global crises leading to flight to quality can dry up funding
Special Servicer
retains the first-loss subordinate bond, make advances, recover advances, postpone default decision
Sovereign Ceiling
determined by debt ratings
future flow attempts to break it
dependent on cash flow from the external source
What are Subprime Mortgages?
500- 660 FICO, poor credit history and documentation
designed to be short term, high interest, expected to refinance them
Types of non conforming mortgages?
Jumbo, Alt-A, Subprime
Subprime Mortgage Borrowers are...
2 + 30 day delinquencies las 24 months or 1 60 day, judgements forclosures repossession in last 24 months, bankruptcies in last 5 years, DStoIR 50% +
What happened for the housing bubble burst?
the subprime mortgages were pool to make investment grade bonds
volume focus not quality
people over-relied on ratings
Credit Default Swap
protection against corporate bond defaults
index ABS bonds
resell CDS over many times
Speculative investors bought and sold
Financial Crises Trends
are preceded by credit booms
Government Policy Theory
fluctuations in housing due to gov funding policies
discretionary credit policies steer construction sector
Residual Users Hypothesis Theory
RE construction sector is residual user of capital
booms - capital demand expansion, less cap for construction, reduction in activity
Bursts - excess capital allocated to construction sector leading to increase in activity
Securitization
integrate capital market with mortgage/lending market
freely flow of cash bw both sectors
Property Derivatives - RE investing in future
commercial is last major class w/o active derivatives
derivatives are attempt to allow investors to participate in the appreciation and performance of commercial RE w/o expenses and risks of physical ownership
circumvent the high transaction costs of owne
2 Accepted Index
NCREIF indext
Real Capital Analytics or FIMAT
neither contains hotels
NCREIF
lag the market
published quarterly and subject to revisions
appraisal smoothing?
Real Capital Analytics
national monthly indicies for officer, apt, industrial and retail
based on repeat sales approach
question transparency and sustainability when there arent enough repeat transactions
What is the only index that have traded?
NCREIF
Total Return Swap
swap b/w index payer(short) and index reciever (long)
Receiver pays a market determined fixed spread over LIBOR
payments determines by applying change in index on national exposure