Property Finance & Investment
Explain the relationship between accrual rate, payment rate and loan amortization
-Accrual rate is the interest on the loan -Pay rate is the ratio of the mortgage payment to the loan amount
What are the economic fundamentals that determine the price of residential properties?
-Economic growth -Inflation -Interest rates
Explain some of the ways an investor can analyse risks to the returns before investing in property.
-IRR is the discount rate that makes the NPV of all cash flows from a project equal to zero • MIRR calculates the rate of return of a project assuming that positive cash flows are reinvested at the firm's cost of capital, and the initial outlays are financed at the firm's financing cost -NPV is the difference between the present value of cash inflows and the present value of cash outflows over a period of time
Explain how changes in the official cash rate may influence the property market.
-Influences the retail bank's interest rates which then influences the ability for consumers and businesses to get property loans
Briefly discuss different ways that returns in property investment are evaluated
-NPV -FV -IRR
What are different types of expenses that may be borne by a property investor?
-Rates -Insurance -Body corporate fees -Professional fees -Building maintenance and repair -Utilities
You are a fund manager considering whether or not to include property as an asset class in an investment portfolio. What information do you need to gather in order to make an informed decision?
-Risks and Returns of the property -IRR -Cash Flow -Mortgage Payments
Explain some of the ways an investor can analyse risks before investing in property.
-Using a scenario analysis -Using a sensitivity analysis
Discuss the pros and cons of the Price Level Adjusted Mortgage (PLAM) and the Floating Rate Mortgage within the category of ARMs?
A price level adjusted mortgage offers advantages to both the homebuyer and the lender. The homebuyer can benefit from keeping their interest rate at a consistently low level for the duration of the loan. This low-rate consistency helps to make the mortgage affordable at all stages. Since the lender doesn't incorporate expected inflation increases in the mortgage structure up front, the borrower starts out with lower interest rate and monthly mortgage payments than they would find on many conventional mortgages. Also, the borrower will not have to contend with a sudden substantial mortgage increases later on, because the lender will never hike the loan's interest rate. Lender benefits: -raising loan balance with inflation increases Disadvantages: -Borrowers have less predictable payments -Homeowners could see slight monthly increases to their payments for life of loan -Hard to plan and budget expenses -Less suited to borrowers on fixed incomes Floating Mortgage Rate: Advantage: -Flexibility -Can pay more on top of minimum monthly repayments -No cost penalty if you decide to sell your property and move Disadvantage: -Minimum repayments can rise or fall at any time -If on a tight budget, this could become a real problem
Explain how macro-prudential policy instruments attain stability in property markets.
Because the Reserve Bank have placed quantitative restrictions on the share of high loan-to-value ratio loans to the residential property sector, to keep the banks from making an economic loss or risking the bank's deposits for very risky home loans.
Why might an investor prefer a loan with a lower interest rate and a partnership with the lender?
Because then the investor will be able to benefit from a lower interest rate and lower principal payments, lower interest payments and a lower loan balance to pay overall. Also to lower the risk in the investment by going in a partnership with the lender and spread the risk
How is the break-even interest rate (BEIR) calculated and what does BEIR imply?
Break-even interest rate is calculated as when the after-tax IRR of debt equals the after-tax IRR of the project. BEIR implies that there is no risk premium for the equity investor as the interest rate at which the leverage is neutral.
Do adjustable rate mortgage loans carry more or less risk to the lender than fixed rate mortgage loans?
Less, because they are able to collect higher
Why do lenders charge origination fees and loan discount fees? Explain with examples
Loan origination fees: a lump sum amount levied to cover loan origination expenses Loan discount fees, or points: lender disburses less than the agreed loan amount by subtracting these fees Lenders charge origination fees to reduce the risk of borrower's refinancing once a better loan becomes available and increase the likelihood of borrowers paying their full loan back. Loan discount rates are used to help those that want to pay a portion of their interest and principal payments up front to decrease their loan amounts in the following periods.
What is meant by partitioning the internal rate of return? Why is this procedure meaningful?
Means splitting the internal rate of return into its cash flow and capital gain contributions Partitioning mechanism: • calculate the IRR of the investment • discount cash flows from the operations using the IRR • discount cash flow from property sale using the IRR • calculate the percentages This procedure is useful for comparing alternative investments, to evaluate the risk of the property eg. if 80% comes for sale, and a similar investment offers 60%, then this helps to take a less risky investment.
What are the reasons why users of commercial property space might find leasing more cost effective than owning?
Pros of leasing: -It's easier and quicker to move to new premises -Less risk involved -Don't need to invest a whole lot of capital upfront -Landlord handles day-to-day repairs and maintenance -Landlord is responsible for compliance and regulations related issues Cons of leasing: -Forced to move if owner wants to sell or your lease is not renewed -Rent rises -Issues with landlord communication
Briefly describe different types of properties sold in the market?
Residential -Property that people use to reside in, through rentals or permanent residency Commercial -Property that companies use as a shop surface to sell and exchange products/services with consumers Industrial -Property that companies use to store their products inside, while providing a surface area for workers to work under and ensure their safety
Discuss the demand and supply factors that influence the rental price of commercial properties.
The market interest rate is determined by the demand for and supply of mortgage funds - lenders are intermediaries, linking savers and borrowers - borrowers use other people's savings in the form of mortgage loans - demand for mortgage funds is derived from demand for properties - supply of mortgage funds depends on the availability of capital for lending, and the risks and returns of alternative investments
Discuss the important features of the NZ financial system that ensure that the Reserve Bank can influence short term interest rates.
Two important features of the NZ financial system ensures the Reserve Bank can influence short term interest rates: -RBNZ has been granted a legal monopoly on the issuance of currency notes and coins -RBNZ serves as the government's bank
What is positive and negative financial leverage? How does leverage on a before-tax basis differ from leverage on an after-tax basis?
When the before-tax or after-tax IRR are higher with debt than without debt, we say that the investment has positive or favorable financial leverage. When returns are lower with debt than without debt we say that the investment has negative or unfavorable financial leverage. Positive leverage occurs when the unlevered IRR is greater than the interest rate paid on the debt. Negative leverage occurs when the unlevered IRR is less than the interest rate paid on the debt. Returns and losses are magnified by the greater the amount of debt, the greater the return or loss to the equity investor. Leverage on a before-tax basis differs from leverage on an after-tax basis because interest is tax deductible. Therefore, we must consider the after-tax cost of debt which is different than the before-tax cost of debt.
