RE3043 Exam 3 Review 02 25 2016 Chapter 17 Sources of Commercial Debt and Equity Capital How Large is US Commercial Real Estate Market o Investible commercial real estate excludes property owned by non real estate companies government closest comparison to size of commercial RE market is market for US Treasuries The 4 Quadrants of RE Capital Markets Equity owners Debt lenders Private mkt Individuals partnerships llc private Public Mkt Publically traded RE investment trusts equity hedge funds REIT s real estate companies Banks thrifts insurance companies Commercial mortgage backed securities finance companies private lenders CMBs mortgage REITs Public Capital mkts small homogenous unites shares of ownership in assets traded on public exchanges Characterized by high degree of liquidity many buyers sellers price quotes available for all to see low transaction costs Private Capital mkts individually negotiated transactions Characterized by lower degree liquidity assets trade infrequently common for whole asset to be traded in a single transaction higher transaction costs Forms of Ownership for Pooled Private Equity Investments due to large size of commercial RE investments investors frequently pool equity capital i C corporation ii S corporation iii General partnership iv Limited partnership v Limited liability partnership 2 levels of organization common in commercial RE investment 1 Entity that owns property 2 Ultimate equity investors o ie an office bldg owned by a general partnership whose partners are a pension fund and publicly traded REIT What drives choice of ownership form income taxation liability limitation management control issues access to debt and addt l equity capital risk sharing liquidity Corporations an artificial person entity formed under the laws of a state to carry on business legal entity separate from owners shareholders 2 types under US federal income tax law C S Corporations o C Corp legal and taxable entity separate from owners shareholders Advantages shareholders have limited liability Disadvantages potential double taxation major issue separation of ownership and management agency problem o S Corp separate legal entity not separate taxable entity Advantage same limited liability as C corp taxable income passes through to shareholders Disadvantages not more than 75 shareholders Income must be allocated to each shareholder in proportion to his her ownership share major issue special allocations for syndicator or other investor classes not allowed o General partnership an unincorporated business entity owned by multiple ppl partners created by a formal partnership agreement Advantages pass through for tax purpose avoids double tax all partners make operating decisions how much leverage when to sell no agency issues w separation btwn ownership control share of cash flow taxable income determined by partnership agreement special allocations permitted Disadvantage all partners liable for all debts unlimited liability major issue contractual debts debts from legal actions wrongful acts committed by other partners personal assets are subject to claims of partnerships creditors result fairly uncommon and those that are created have few partners o Limited partnership special kind of partnership w 2 classes of partners 1 general partner same legal position manage control joint and several liability 2 limited partners share in profits but no say in business operations Advantages same pass through tax treatment as general partnership limited liability for LPs and unlimited for GP GP may be a corp GP organizes venture usually a knowledgeable builder broker or investor Disadvantages LPs give up control of management and policy making principal agent relationship is created w attendant problems o Limited liability companies combine pass through taxation of a partnership w limited liability of a corporation NOT a corporation partnership of sole proprietorship IS a separate legal entity like a corp but treated as a partnership for tax purposes Managing member creates operating agreement that explains operation and management of entity Optimal Ownership form aka most ideal o C corps and General partnerships seldom chosen o S corps popular among families o LPs and LLCs dominant ownership structures LPs typically provide RE funds marketed to very high net worth and institutional investors LLCs smaller local investments marketed to accredited but no institutional investors 1 Pension funds long term liabilities suite to LT RE investments direct purchases as well as Skip Tenancy in common Institutional Investors in Equity Mkts acquisitions through funds 2 Foreign investors 3 Life insurance companies long term liabilities also good match for long term illiquid private RE investments more active as RE lenders than as investors 4 Private institutions commercial banks savings associations Non institutional investors in Equity Mkts High net worth families and private equity hedge funds typically form limited partnerships The great investor masses that invest in private local RE syndications typically form LLCs Direct v indirect investment investors can hold ownership positions directly or through intermediaries for well capitalized investors choice of direct v indirect involves trade offs on four dimensions Control access to managerial expertise liquidity diversification Direct investment gives investors complete control who leases manages how much debt financing when is it sold but investor must supply expertise o Preferred by largest institutional market participants as size of investors portfolio increases direct ownership more economical retain in house experts or hire consultants diversify risk o Direct ownership also prevalent at smaller end of spectrum 1 4 unit rental homes owner occupied small office bldgs Best case trading lack of diversification for gains due to superior local market knowledge Investment through Intermediaries Separate accounts Large investment management company will buy hold and dispose of properties on behalf of investors mostly pension funds Each investor s properties are treated Independently Allows investors to access expertise of manager in exchange for fees Close to direct ownership but has Intermediation No improvements over direct investment it terms of liquidity and portfolio diversification Commingled Real estate funds CREFs Offered by banks life companies investment banks RE advisory firms Targeted to pension funds and other institutional