Real Estate Finance- Chapter 5

Real Estate Investment Trust (REIT)

A Real Estate Investment Trust (REIT) is very similar to a mutual fund in the sense that it consists of a pool of real estate related investments. A mutual fund is a basket of stocks, bonds, and other investments owned by a group of investors and managed by a professional investment company. Similarly, a REIT is a company that owns, operates, or finances income-generating real estate. In a Real Estate Investment Trust, investors buy certificates in the trust, and the trust in turn invests in mortgages or real estate. Investors receive income according to the number of shares they own. A trust must receive at least 75% of its income from real estate to qualify as a REIT, and if certain other conditions are met, the trust does not have to pay any corporate income tax. Also, REITs are required by law to pay out at least 90% of annual taxable income (excluding capital gains) to their shareholders as dividends.

Real Estate Mortgage Trust Mortgage (REMT)

A Real Estate Mortgage Trust Mortgage (REMT) provides financing for income-producing real estate by purchasing or originating mortgages and mortgage-backed securities (MBS) and earning income from the interest on these investments. The majority of mortgage REIT profits are paid to investors as dividends.

Mortgage Banker

A mortgage banker is a company, individual, or institution that originates mortgages. Mortgage bankers use their own funds, or funds borrowed from a warehouse lender, to fund mortgages. A mortgage banker might work for a bank or financial institution, credit union, or mortgage company. Mortgage bankers usually will sell their loans in the secondary market and retain the servicing of the loans.

Mortgage Broker

A mortgage broker is a middleman who brings mortgage borrowers and mortgage lenders together but does not use its own funds to originate mortgages. Since a mortgage broker works with many different lenders, they have the opportunity to find the borrower the best mortgage product for the borrower's needs. Several different types of fees can be involved in taking on a new mortgage or working with a new lender, including origination fees, application fees, and appraisal fees. In some cases, mortgage brokers may be able to get lenders to waive some or all of these fees, which can save the borrower hundreds to thousands of dollars.

Pension and Retirement Programs

A pension plan is a retirement plan that requires an employer to make contributions to a pool of funds set aside for a worker's future benefit. The pool of funds is invested on the employee's behalf, and the earnings on the investments generate income to the worker upon retirement. Pension fund contributions should be carefully managed to ensure that retirees receive promised retirement benefits.

Individual (Private) Lenders

A private lender is someone who uses their capital to finance investments, such as real estate, and profits from interest paid on the loan. Private lenders are not affiliated with a bank or other financial institution and instead interact directly with the borrower.

Commercial Banks

Commercial banks make loans to its borrowers using the deposits from other customers. Since the customer deposits are insured by the Federal Deposit Insurance Corporation (FDIC), the deposits are not at risk to the customer in the event that the borrower defaults on the loan. Commercial banks typically will sell their loans in the secondary market to Fannie Mae or Freddie Mac. This allows the bank to maintain liquidity and continue to originate more loans to its customers.

Credit Unions

Credit unions are very similar to banks with one big difference...they are non-profit organizations. Credit unions typically require that its members be associated with either an employer or geographic community. Like banks, credit unions make loans from the funds deposited by their customers. Since credit unions are non-profit organizations, and since they are more likely to keep their loans in-house rather than selling them in the secondary market, they can afford to offer lower interest rates and more flexibility than banks. Because credit unions are less concerned with turning a profit, securing a mortgage with one will often result in fewer origination fees and other processing costs to its borrowers.

Ralph is a single guy who has invested in a real estate trust that will derive income using the net profits from the rent and sale of rental properties. He has invested in a

REIT

Primary lender

The primary lender initiates the loan and assumes the initial risk. The primary lender may service the loan or contract with a loan servicing company. The main role of loan servicing involves collecting the monthly payments, managing the escrow accounts by collecting payments and remitting to taxing authorities and insurance companies, and manage the borrower's accounts to keep current. A primary mortgage market lender may or may not sell its loans into the secondary market. If the primary lender keeps the loan, it is known as a portfolio loan and it requires less stringent underwriting criteria since it won't be sold in the secondary market.

The Primary mortgage market

The primary mortgage market consists of lenders who originate mortgage loans directly to borrowers. Primary mortgage market lenders include, but are not limited to: • commercial banks • life insurance companies • pension and retirement programs • credit unions • mortgage brokers and bankers • private lenders • foreign lenders

Private Lenders (Sellers, Individuals, Gifts)

The seller may provide some or all of the financing for the buyer's purchase. Some of the most common methods of seller financing are purchase money mortgages, including the wraparound, and the contract for deed.

Lease Option Agreement

This is a rental agreement that gives the tenant the option to buy the property either during the lease or when the lease expires. In most cases, the lease payments will be applied to the purchase price of the property.

Infrastructure

This is a small category among pension fund investments. It can consist of a diverse assortment of public or private developments involving power, water, roads, and energy.

Lease Purchase Agreement

This is also a rental agreement. In this agreement, the tenant is required to purchase the property before the end of the lease term.

Wrap-around Mortgage

This is similar to a purchase money mortgage and is an option for buyers who can't qualify for a mortgage loan from a traditional loan source. The seller finances the buyer's home purchase but keeps the existing mortgage on the home and "wraps" the buyer's loan into it. The seller will continue making monthly payments on their mortgage while collecting monthly payments from the buyer. It potentially enables the seller to profit from any difference between a lower interest rate on the senior loan and a higher rate on the wrap-around loan. A wrap-around is possible only if the senior mortgagee allows it.

Real Estate

Typically passive investments made through real estate investment trusts (REITs) or private equity pools. Long-term investments are in commercial real estate, such as office buildings, industrial parks, apartments, or retail complexes.

Contract for deed

Under a contract for deed arrangement, also known as a land contract, the seller retains title and the buyer receives possession and equitable title while making payments under the terms of the contract. The seller conveys title when the contract has been fully performed. This can be risky to the buyer since the seller may be able to foreclose on the property if the buyer misses a payment.

Purchase money mortgage

With a purchase money mortgage, also known as seller financing, the borrower gives a mortgage and note to the seller to finance some or all of the purchase price of the property. Typically, this occurs when a buyer has low credit, high debt, or low income and cannot get a loan from a bank or financial institution. The interest rate on a purchase money mortgage is generally higher than that of a bank loan.

Sally and her husband Mike have invested in a real estate trust deriving income from mortgage interest, loan fees, and profits from buying and selling mortgages. Sally and Mike have invested in

a REMT

Mr. and Mrs. Jackson have applied for a mortgage loan. Their loan officer Jeff will prequalify the couple, match them with an appropriate loan product, carry their case through to loan approval, and continue to service the loan. Jeff's company is

a mortgage banker

A ______________ is very similar to a bank with one big difference...it is a non-profit organization.

credit union

A mortgage broker may do all of these except

service the loan

Distinguishing between REIT and REMT

• The Bluebonnet Group buys a retail center using the funds contributed by its investors. Bluebonnet rents out space in the retail center and collects rent monthly from its tenants. Bluebonnet also manages the retail center. The Bluebonnet Group is a Real Estate Investment Trust (REIT). • The BlueBell Group lends money to Big Tex Investments who is a real estate developer. BlueBell generates income from the interest earned on the loan to Big Tex Investments. The BlueBell Group is a Real Estate Mortgage Trust (REMT).

Gifts

Individuals can give a gift to the purchaser of real estate. Sometimes the amount of the gift is limited by the lender guidelines. In many cases, there's no limit on the dollar amount of gift money that can go into a down payment, as long as the buyer is purchasing a primary residence. However, if someone uses a down payment gift to buy a second home or investment property, they have to pay at least 5% of the down payment. The rest can be a gift.

____________________________ invest primarily in commercial loans.

Life Insurance Companies

Life Insurance Companies

Life insurance companies invest primarily in commercial loans. Since they typically issue long-term life insurance policies to their customers, the companies prefer to invest in loans with a longer than average term. This is why lending to commercial customers is favorable to them. It also benefits the commercial property borrower since traditional financing can be difficult to obtain. It can be a win-win for both the life insurance company and the commercial borrower. Life insurance companies are more conservative in their lending policies. The down payment from a customer can be as much as 35%. If the borrower has a good credit history and the property is of high quality, a down payment of 25% might be acceptable. Loans are usually fixed-rate and generally start at $1,000,000. Most loans can be assumable if the borrower is selling the property and a qualified purchaser is interested in taking over the remaining term of the loan.

U.S. Blue Chip Common and Preferred Stocks

Managers are typically looking for options with a combination of growth and dividend potential.

Foreign Lenders

Foreign investment in United States property has been on the rise for quite some time. Foreign buyers have the ability to obtain mortgage loans from the traditional sources we have already discussed in this chapter. A mortgage loan to a non-resident person in the United States is called a Foreign National Mortgage loan. It's more difficult for borrowers outside of the U.S. to finance second homes here. However, private lenders do offer these mortgages to foreigners. They are riskier for lenders, so they carry higher interest rates. Borrowers also have to make much larger down payments that could reach 30 to 50 percent. For U.S. citizens looking to purchase real estate in foreign countries, there are banks in the United States that will make those loans but it is not the norm. Some global banking brands have specific international services designed for expats and people who invest overseas. These tend to be a better place to look when looking for an international mortgage direct from a bank.

Real Estate Bonds

Real estate bonds are fixed-income investments or loans, backed by real property. That means investors in housing bonds and other types of real estate bonds can expect cash flow from underlying mortgage repayments. These passive income opportunities come in many varieties with varying degrees of creditworthiness. The safest real estate bonds are agency residential mortgage-backed securities backed by Freddie Mac and Fannie Mae. Municipal bonds (or "munis" for short) are debt securities issued by states, cities, counties and other governmental entities to fund day-to-day obligations and to finance capital projects such as building schools, highways or sewer systems. By purchasing municipal bonds, the investor is in effect lending money to the bond issuer in exchange for a promise of regular interest payments, usually semi-annually, and the return of the original investment, or "principal." A municipal bond's maturity date (the date when the issuer of the bond repays the principal) may be years in the future. Short-term bonds mature in one to three years, while long-term bonds won't mature for more than a decade. Generally, the interest on municipal bonds is exempt from federal income tax.

Private Equity

Represents managed pools of money invested in the equity of privately-held companies with the intention of eventually selling the investments for substantial gains. Private-equity fund managers charge high fees based on promises of above-market returns.

Which of the following is falls into the category of a private lender?

Seller

Foreign Investment in Real Property Tax Act (FIRPTA)

The Foreign Investment in Real Property Tax Act ("FIRPTA") authorizes the IRS to tax foreign persons on the sale or disposition of U.S. real property. Although it is the foreign person (seller) who is being taxed, FIRPTA generally imposes a withholding obligation on the purchaser of the property. That is, the purchaser is required to withhold tax on the payment for the property, although withholding may be reduced under certain circumstances. The purpose of the act is to prevent tax evasion on taxable gains on the sale of the property if any. Foreign persons who are selling a property should seek advice from a CPA or attorney to determine the amount of tax that may be involved. Generally, the title company will ensure that the withholding is accounted for on the closing statement and remit any withholding to the IRS.