REAL 5100 Test Three
CMBS Volume 2015
100 B
Seller Motivations of Sale-Leaseback
100% financing possible, invest proceeds in core business, lease payments are tax deductible
CMBS Volume 2007
229 B
Breakeven Interest Rate
ATIRR/(1-tax), the maximum interest rate that could be paid on debt before the leverage become unfavorable, where leverage is neutral
Positive Financial Leverage
BTIRR > Interest rate on debt
Warnings for Commercial Property boom
Bond prices went down, overheated market, hedge funds were liquidating
Effective LTV
Bond value / total mortgage value
CMBS Competition
Bonds and fixed income securities
Collateralized Debt Obligation
Broader range of collateral, lower rated than CMBS, mezz loans, preferred equity, risk is substantial
Lenders
Care about whether the property generates enough income to service debt
Junior Tranches
Default risk most effects
Freddie Mac K Deals
Developers benefit, goal is to make multifamily housing more affordable, Freddie insures the K deals
Leverage
Enables creation of different investment products on same underlying property, magnifies both good and bad outcomes
Participation: Lender Motives
Exposed to greater risk, provides interest rate hedge for lenders, requires prepayment lock out or penalty
Bubble Theory
High house price expectations lead to credit expansion
Shopping
Issuer is bad guy, issuer goes to several ratings agencies and only buys the best rating
Convertible Mortgage
Lender has the option to convert debt to equity, gets repaid with remaining loan balance or equity share
Equity Participation Loans
Lenders receives % of NOI and property appreciation, lender offers lower interest rate
Participation: Borrower Motives
Lower base interest rate, allows increased leverage
Primary Lender with Mezz Debt
Minimal effect, mezz debt lender has the option to take over payments
Inside Job Theory
Misaligned incentives and financial innovation led to housing bubble
Less Subordination
More money for issuers
Why use debt?
Mortgage interest is tax deductible, buy more properties, diversify, financial constraints
Sale-Leaseback
Owner-user sells property to long-term RE investor, user leases back from investor and occupies under a long-term net lease
Credit Support
Par value of subordinate / total par value
Leverage risk for equity investor
Payments can increase default risk
Senior Tranches
Prepayment risk most effects and they have less interest rate risk
CDOs2
Pulls out pieces from two or more CDOs to create a new package
Mezz Debt Advantages
Quicker to foreclose on borrower's equity than property itself, lenders offer lower interest rates than 2nd mortgage loans due to the quicker process
Catering
Ratings agencies are the bad guys, compete for business by giving better ratings
CMBS
Reallocation of risk of underlying mortgages to different bond classes
Mezz Debt
Subordinate second loan secured by equity, below mortgages but above equity, structured as a loan
Preferred Equity
Subordinate to secured debt ont he property and any mezz debt to the operating entity, no formal lien on property
Negative Financial Leverage
The interest rate of debt is higher than the return to the property, the use of debt reduces the return on equity
Credit Default Swap
The owner does not have to own the underlying asset to buy the insurance on the bond
Why is leverage important?
There is tangible collateral backing the debt
CMBS Comeback
There's nothing wrong with them, improving property market, refinancing due to changes in interest rates and balloon loans
Borrower
Want higher LTV
Overcollateralization
value of the pool of loans exceeds the principle amount of the securities issued
