net Real Estate Finance and Investments www.net Real Estate Finance and Investments Fifteenth Edition William B. Brueggeman, PhD Corrigan Chair in Real Estate Edwin L. Cox School of Business Southern Methodist University Jeffrey D. Fisher, PhD Professor Emeritus of Real Estate Kelley School of Business Indiana University President, Homer Hoyt Institute www.net REAL ESTATE FINANCE AND INVESTMENTS, FIFTEENTH EDITION Published by McGraw-Hill Education, 2 Penn Plaza, New York, NY 10121.
Copyright © 2016 by McGraw-Hill Education. All rights reserved. Printed in the United States of America. Previous editions © 2011, 2008, and 2005.
No part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written consent of McGraw-Hill Education, including, but not limited to, in any network or other electronic storage or transmission, or broadcast for distance learning. Some ancillaries, including electronic and print components, may not be available to customers outside the United States. This book is printed on acid-free paper. 1 2 3 4 5 6 7 8 9 0 QVS/QVS 1 0 9 8 7 6 5 ISBN 978-0-07-337735-3 MHID 0-07-337735-X Senior Vice President, Products & Markets: Kurt L.
Strand Vice President, General Manager, Products & Markets: Marty Lange Vice President, Content Production & Technology Services: Kimberly Meriwether David Managing Director: James Heine Executive Brand Manager: Charles Synovec Lead Product Developer: Michele Janicek Product Developer: Jennifer Upton Digital Product Developer: Tobi Philips Director, Digital Content: Douglas Ruby Digital Product Analyst: Kevin Shanahan Director, Content Design & Delivery: Linda Meehan-Avenarius Executive Program Manager: Faye M. Herrig Content Project Manager: Mary Jane Lampe Buyer: Sandy Ludovissy Content Licensing Specialist: Ann Marie Jannette Cover Designer: Studio Montage Cover Image: ©Erica Simone Leeds Compositor: SPi Global Typeface: 10/12 STIX MathJax Main–Regular Printer: Quad/Graphics All credits appearing on page or at the end of the book are considered to be an extension of the copyright page. Library of Congress Cataloging-in-Publication Data Brueggeman, William B. Real estate finance and investments / William B.
pages cm ISBN 978-0-07-337735-3 (alk. Mortgage loans—United States. Real property—United States—Finance.7'2—dc23 2015015605 The Internet addresses listed in the text were accurate at the time of publication. The inclusion of a website does not indicate an endorsement by the authors or McGraw-Hill Education, and McGraw-Hill Education does not guarantee the accuracy of the information presented at these sites.net Preface Introduction to Real Estate Finance and Investments This book prepares readers to understand the risks and rewards associated with investing in and financing both residential and commercial real estate.
Concepts and techniques included in the chapters and problem sets are used in many careers related to real estate. These include investing, development financing, appraising, consulting, managing real estate portfolios, leasing, managing property, analyzing site locations, managing corporate real estate, and managing real estate funds. This material is also relevant to individuals who want to better understand real estate when making their own personal investment and financing decisions. The turmoil in world financial markets during the late 2000s, which was closely tied to events in the real estate market, suggests that investors, lenders, and others who participate in the real estate market need to better understand how to evaluate the risk and return asso- ciated with the various ways of investing and lending.
This requires an understanding of the legal issues that can impact the rights of lenders and investors, the characteristics of the various vehicles for lending and investing in real estate, the economic benefits of loans and investments, and how local economies may affect the investment performance of properties as well as the goals of lenders and investors. This book is designed to help both students and other readers understand these many factors so that they can perform the necessary analysis and make informed real estate finance and investment decisions. As the book’s title suggests, we discuss both real estate finance and real estate investments. These topics are interrelated.
For example, an investor who pur- chases a property is making an “investment.” This investment is typically financed with a mortgage loan. Thus, the investor needs to understand both how to analyze the investment and how to assess the impact that financing the investment will have on its risk and return. Similarly, the lender, by providing capital for the investor to purchase the property, is also making an “investment” in the sense that he or she expects to earn a rate of return on funds that have been loaned. Therefore, the lender also needs to understand the risk and return of making that loan.
In fact, one of the risks associated with making loans secured by real estate is that, if a borrower defaults, the lender may take ownership of the property. This means that the lender also should evaluate the property using many of the same tech- niques as the investor purchasing the property. Organization of the Book From the above discussion it should be clear that many factors have an impact on the risk and return associated with property investments and the mortgages used to finance them. This is true whether the investment is in a personal residence or in a large income- producing investment such as an office building.
Part I begins with a discussion of the legal concepts that are important in the study of real estate finance and investments. Although a real estate investor or lender may rely heav- ily on an attorney in a real estate transaction, it is important to know enough to be able to ask the right questions. We focus only on those legal issues that relate to real estate invest- ment and financing decisions. Part II begins with a discussion of the time value of money concepts important for analyzing real estate investments and mortgages.
These concepts are important because real estate is a long-term investment and is financed with loans that are repaid over time. This leads to a discussion of the primary ways that mortgage loans are structured: fixed rate and adjustable rate mortgage loans.net vi Preface Part III considers residential housing as an investment and covers mortgage loan underwriting for residential properties. This is relevant for individuals making personal financial decisions, such as whether to own or rent a home, as well as for lenders who are evaluating both the loan and borrower. Part IV covers many topics related to analyzing income property investments.
We pro- vide in-depth examples that include apartments, office buildings, shopping centers, and warehouses. Many concepts also may be extended to other property types. These topics include understanding leases, demonstrating how properties are appraised, how to analyze the potential returns and risks of an investment, and how taxes impact investment returns. We also consider how to evaluate whether a property should be sold or renovated.
Finally, we look at how corporations, although not in the real estate business per se, must make real estate decisions as part of their business. This could include whether to own or lease the property that must be used in their operations, as well as other issues. While the first four parts of this book focus on investing or financing existing proper- ties, Part V discusses how to analyze projects proposed for development. Such develop- ment could include land acquisition and construction of income-producing property of all types to acquisition of land to be subdivided and improved for corporate office parks or for sale to builders of residential communities.
This section also includes how projects are financed during the development period. Construction and development financing is very different from the way existing, occupied properties are financed. Part VI discusses various alternative real estate financing and investment vehicles. We begin with joint ventures and show how different parties with specific areas of expertise may join together to make a real estate investment.
We use, as an example, someone with technical development expertise who needs equity capital for a project. A joint venture is created with an investor who has capital to invest but doesn’t have the expertise to do the development. We then provide a financial analysis for the investment including capital contributions from, and distributions to, partners during property acquisition, operation, and its eventual sale. In this section, we also discuss how both residential and commercial mortgage loan pools are created.
We then consider how mortgage-backed securities are (1) structured, (2) issued against such pools, and (3) traded in the secondary market for such securities. This also includes a discussion of the risks that these investments pose. Part VI also includes a discussion of real estate investment trusts (REITs). These public companies invest in real estate and allow investors to own a diversified portfolio of real estate by purchasing shares of stock in the company.
Finally, in Part VII, we discuss how to evaluate real estate in a portfolio that also includes other investments such as stocks and bonds. This includes understanding the diversification benefits of including real estate in a portfolio as well as ways to diversify within the real estate portfolio (including international investment). This is followed by a new chapter on real estate investment funds that are created for high net worth individuals and institutional investors. We discuss different fund strategies and structures and how to analyze the performance of the funds relative to various industry benchmarks.
Wide Audience From the above discussion, one can see that this book covers many topics. Depending on the purpose of a particular course, all or a selection of topics may be covered. If desired, the course also may emphasize either an investor’s or a lender’s perspective. Alternatively, some courses may emphasize various industry segments such as housing and residential real estate, commercial real estate, construction and development, mortgage-backed securities, corporate real estate, or investment funds.
In other words, this book is designed to allow flexibility for instructors and students to cover a comprehensive range of topics or to focus only on those topics that are most important to them.net Preface vii Changes to the Fifteenth Edition In addition to updating material throughout the text, we are particularly proud to introduce a new chapter in this edition. Chapter 23 provides extensive coverage of real estate invest- ment funds. These funds now play a major role in the ownership of both residential and commercial real estate. Typically, these funds are created by professional investment man- agers and private equity firms that offer opportunities to high net worth investors, pension plan sponsors, and other institutional investors to invest in professionally managed portfo- lios of real estate.
How these funds are structured, operated, and evaluated are among the important topics covered in this new chapter. Another important addition is a new concept box in Chapter 18 that summarizes the new SEC regulations resulting from the “JOBS Act” which allow for “crowd funding” to raise capital for real estate investments. The new regulations now allow the Internet to be used to reach investors which is expected to result in a significant increase in investment from individuals that was not previously available. This edition also introduces a new cloud-based, lease by lease, discounted cash flow pro- gram.
It is designed to do investment analysis and valuation of real estate income property investments, as discussed below. Excel Spreadsheets and REIWise Software This book is rigorous yet practical and blends theory with applications to real-world prob- lems. These problems are illustrated and solved by using a blend of financial calculators, Excel spreadsheets, and specialized software designed to analyze real estate income prop- erty. Excel spreadsheets, provided on the book’s Web site at www.com/bf15e, are an aid for students to understand many of the exhibits displayed in chapters throughout the text.
By modifying these exhibits, students also may solve many end-of-chapter problems without having to design new spreadsheets. Students can also register online to get free access to a cloud-based real estate valuation program called REIWise.