Real Estate FinanceExam 1Chapter 1• Can be framed by three questions:o What is finance? The study of the process, institutions, markets, and instruments used to transfer money and credit between individuals, business, and governments Is an applied economics• Economics, the study of the allocation of resources for the purpose of producing goods and services to members of society Finance consists of the time value of money concept Considers time value of money and the implications for interest rates on the time value of money and financing decisions• Deals with the valuation of assets and the valuation processo Also focuses on cash flows, not profits Risk- the possibility (and associated probabilities) that the actual result (return on investment, i.e.) will differ from the expected outcome• Considers the effect of risk on the valuation of an asseto What is real estate finance? There are plenty of subdiciplinaries within finance including • Managerial or corporate finance• Investment and securities (inclusing real estate) analysis and portfolio theory• Financial instituation and financial services• Personal finance• Insurance and risk management• Real estate financeo Each of these deals with a different part of financeo Real estate finance studies the institutions, markets and instructions 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• Includes not only real estate, but all of the rights and privileges of the uses that can be transferred Real estate- land and all fixed and immovable improvements on it. Includes the following:• Owner-occupied residential property • Rental residential property• Terms of residential property leases• Appraisal of residential properties• Loans and mortgages on residential properties• Sales and exchange of residential properties• Economics of brokerage of residential properties• Markets for exchange of residential mortgages• Valuation of residential mortgages• Commercial properties, including urban office buildings, suburban office buildings, hotel/motels, retirement communities, recreation facilities, mini-warehouses, warehouses, apartments complexes, industrial facilities, and retail trade facilities• Loans on commercial properties• Markets for the exchange of commercial property loans• Valuation of loans on commercial properties• Appraisal of commercial properties• Investment in commercial properties• Portfolios of real estate investment• Real estate taxation issues• Law and real estate lendingo What is 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 or purchase those instruments and the markets within they are transferred constitute the environment of real estate finance• Savings-investment cycle- the amount of savings equals the total amount investedo Savings are identified by three groups: Individual(personal) Business Governmento Figure 1.1• Flow of funds- illustrated in figure 1.1 o Left side- are the surplus income units with the funds to lendo Right side- are the deficit income units with a need to borrow credito Each are broken into three categories: individuals, business, and governments Both surplus and deficit exists in each category, but some categories will dominate (i.e. government/ surplus)• Excess funds flow from the surplus income to the deficit income units either directly or through intermediarieso Direct financing takes place when the surplus income unit advances funds directly to the deficit income unit• Financial intermediaries- financial institutions that channel funds from the supplies income units to the deficit income unitso Intermediaries provide special services• Commercial Banks –accept and demand deposits and time depositso May borrow funds from other sourceso Deposits are insured by the FDICo Are an important source of commercial real estate loans (ADC loans) Also source residential loans• Thrift Institutions- include savings and loan associations, mutual savings banks, and credit unionso Are a major depository of individuals’ savings• National credit Union administration (NCUA)- supervise thrift institutions• Investment Companies- pool the funds of many savers and invest the funds in a portfolio of assets• Insurance Companies- especially life 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.o Invest in many commercial real estate companies• Pension Funds- pool the contributions of employees and invest the funds just as insurance companies doo Project to increase use of commercial property in the future• Direct Financing- surplus income units advance funds directly to deficit income units with the aid of brokers that facilitate the transactiono When a home seller grants a note to the home buyero Second mortgage markets- these agencies and firms include the federal national mortgage association (FNMA, government national mortgage association, federal home loan mortgage corporation, federal home loan bank and other private firms Issue securities called mortgage –related securities (MRSs)o Primary and secondary markets-  Primary- security is created and sold for the first time Secondary-subsequent sale • Investors like securities that are easily sold (are liquid)o Money and Capital Markets- Money markets- deal with short term securities Capital markets-long term securities… more than one yearChapter 2: Money, Credit, and the determination of Interest Rates• The equation of exchangeo V represents the velocity of circulationo P general price levelo T the volume of tradeo Monetary theory of inflation- for a fully employeed economy, the limit on growth in the real volume of trade is determined by growth in real resources, velocity is stable Money supply and prices are linked• The fisher equation-completes the final portion of the money-inflation-interest rare mechanismo Inflation creates the expectation of future inflation• Adaptations model of inflationary expectation- assumes that credit market participants adapt their expectations of near term future inflation on the basis of the most