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Exam 3 Chapter 17 Sources of Commercial Debt and Equity Capital 1 Intro size of commercial real estate market 2 Five forms of property ownership 3 Sources of ultimate private equity investment 4 Types of investment i institutional investors ii Non institutional investors i Direct investment ii Three types of indirect investment o o o o 5 Sources of private and public mortgage debt Section 1 classes o Describes size of U S commercial real estate market relative to other asset o How large is U S investible Commercial Real Estate Market o What share of capital is privately owned o Which sector accounts for the largest proportion of market value o How leveraged is commercial real estate o Characteristics of Public Capital Markets Investible commercial RE excludes property owned by non real estate companies 10 trillion and government Closest comparison to size of commercial RE market is market for U S treasuries 81 Private 50 from each Debt Lenders and Equity Owners Small homogenous units shares of ownership in assets traded on public exchanges Characterized by o Many buyers and sellers o Price quotes available for all to see 1 High degree of liquidity o Characteristics of Private Capital Markets 2 Low transaction costs Individually negotiated transactions Characterized by 1 Lower degree liquidity o Assets trade infrequently o Common for whole asset to be traded in a single transaction indivisibility 2 Higher transaction costs o o Identifies five ownership structures for pooling private equity capital and explains advantages and disadvantages of each Forms of Ownership for Pooled Private Equity Investments Due to large size of commercial RE investments investors frequently pool equity capital Two levels of organization common in commercial RE investment 1 Entity that owns the property Section 2 2 Ultimate equity investors Section 3 Example an office building owned by a general partnership whose partners are a pension fund and a publicly traded REIT C Corporation S Corporation General partnership Limited partnership What Drives Choice of Ownership Form Limited Liability Company Section 2 o Corporations 1 Income taxation 2 Liability limitation 3 Management control issues 4 Access to debt and additional equity capital 5 Risk sharing 6 Liquidity An artificial person entity formed under the laws of a state to carry on business Key characteristic legal entity separate from owners shareholders Two types under U S federal income tax law 1 C Corporations o o Advantages o Disadvantages Legal and taxable entity separate from owners shareholders Shareholders have limited liability Potential double taxation major issue Separation of ownership and management Agency Problem 2 S Corporations o Separate legal entity not separate taxable entity o Advantages o Disadvantages Same limited liability for shareholders as C corps Taxable income passes through to shareholders 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 partners An unincorporated business entity owned by multiple people known as Created by a formal partnership agreement Advantages Pass through for tax purposes o Avoids double taxation All partners make operating decisions o How much leverage when to sell etc o No agency issues with separation between ownership and control Share of cash flow and taxable income determined by partnership agreement o Special allocations permitted All partners liable for all debts major issue o Contractual debts debts arising from legal actions wrongful acts committed by other partners o So Personal assets are subject to claims of partnership s creditors Fairly uncommon and those that are created have few partners Result Disadvantages Special kind of partnership that creates two classes of partners o Limited Partnership o Advantages 1 General partners same legal position as in general partnerships i e o Management control o Joint and several liability 2 Limited partners share in profits but no say in business operation Same pass through tax treatment as general partnership Limited liability for LP s and unlimited for GP GP organizes venture usually a knowledgeable builder broker o But GP may be a corporation or investor LPs give up control of management and policy making Principal agent relationship is created with attendant problems Disadvantages Combines pass through taxation of a partnership with limited liability NOT a corporation partnership or sole proprietorship Managing member creates operating agreement that explains of a corporation IS a separate legal entity like a corporation but treated as a partnership for tax purposes operation and management of entity o Limited Liability Companies o Optimal Ownership Form C corporations and GPs seldom chosen S corporations popular with families LPs and LLCs dominant ownership structures LPs typically private RE funds marketed to very high net worth and institutional investors LLCs typically smaller local investments marketed to accredited but not institutional investors Section 3 Identifies the ultimate sources of private equity investment in commercial real estate o o 3 1 Institutional Investors in Equity Markets 1 Pension funds Long term liabilities suited to LT RE investments Direct purchases as well as 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 and savings associations High net worth families and private equity hedge funds o 3 1 Non institutional Investors in Equity Markets Typically form limited partnerships The great investor masses that invest in private local RE syndications Typically form Limited Liability Companies LLCs Identifies advantages and disadvantages of investing in commercial RE directly and through intermediaries o o Direct vs Indirect Investment Section 4 Investors can hold ownership equity positions directly or through intermediaries For well capitalized investors choice of direct vs indirect involves trade offs on four dimensions 1 Control 2 Access to managerial expertise 3 Liquidity 4 Diversification o Direct Investment Gives investors complete control Who leases it who manages it how much debt financing is used when it is sold But investor must supply the expertise As


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FSU REE 3043 - Chapter 17: Sources of Commercial Debt and Equity Capital

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