Real Estate Finance Exam 1 Chapter 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 process o 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 asset o 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 finance o Each of these deals with a different part of finance o 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 lending o 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 invested o Savings are identified by three groups Individual personal Business Government o Figure 1 1 Flow of funds illustrated in figure 1 1 o Left side are the surplus income units with the funds to lend o Right side are the deficit income units with a need to borrow credit o 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 intermediaries o 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 units o Intermediaries provide special services Commercial Banks accept and demand deposits and time deposits o May borrow funds from other sources o Deposits are insured by the FDIC o 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 unions o 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 do o 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 transaction o When a home seller grants a note to the home buyer o 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 year Chapter 2 Money Credit and the determination of Interest Rates The equation of exchange o V represents the velocity of circulation o P general price level o T the volume of trade o 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 mechanism o 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 recent experience Real estate of interest earning interest over time o I r p The gibbon Paradox R is the real rate of return P is the expected inflation over the maturity of the bond o The liquidity effect an upward pressure on the bond price forcing interest rate to