INTRODUCTION TO REAL ESTATE FINANCE

REAL ESTATE INVESTMENTS- DEFINITION

 Real Estate investment refers to the investment of funds made by individuals or
institutions on real estate (land/building) that results in ownership. This investment could
be made either directly or indirectly and is known as equity investing.

 Moreover, real estate investment also includes lending against real estate property. This
is known as debt investing. For example, banks providing mortgage loans or investors
purchasing Mortgaged backed securities.

 To summarize, real estate investment refers to direct or indirect purchase of

land/building and/or providing loans to others to fund such purchase of land/building.
 CLASSIFICATION OF REAL ESTATE

Residential Real Estate Commercial Real Estate

 The primary purpose of is to occupy the  The primary purpose is to let, lease or use
property by the investor himself/herself. the property for any other commercial reason.
 Emphasis is on capturing personal  Emphasis is on generating income by
value/utility/satisfaction by accessing accessing the rights of ownership.
the rights of ownership.  Institutional investors are the major
 Individual investors are the major participant in this type of real estate.
participant in this type of real estate.  Investment/financing process is relatively
 Investment/financing process is more complex.
relatively less complex.
 RATIONALE FOR INVESTING IN REAL ESTATE

Ø From a financial perspective, investment in real estate is motivated by the following factors:
 Potential for competitive long term total returns driven by both income generation and capital
appreciation
 Real estate can be used by the investors to protect themselves from adverse cash flow effects of
economic shocks. This is achieved by leasing out real estates at fixed rates for multiple years.
 Likelihood that less-than-perfect correlation with other asset classes may provide diversification
benefits.
 Real estates can provide inflation hedge if rents can be adjusted quickly for inflation

Ø From a non-financial perspective, investment in real estate is due to the desire to get
access to the various property rights of ownership (i.e., right to possess, use, improve,
extract, dispose property)
 FORMS/TYPES OF REAL ESTATE
INVESTMENT

 Real estate investments can be categorized based on two dimensions;

ü debt or equity based (source of financing) and
ü private or public market (nature of transaction; direct or indirect).

Debt represented as follows:

 The categorization is visually Equity

Private § Mortgages § Direct ownership of real estate; can be

§ Construction Lending through sole ownership, joint ventures
etc.

Public § Mortgage backed securities (MBS) § Shares in real estate corporations

§ Collateralized Mortgage Obligations § Shares of Real Estate Investment Trusts
(CMO) (REIT’s)
 FORMS/TYPES OF REAL ESTATE INVESTMENTS (CONT’D)

The numerous forms of real estate investment are as follows:

 Fully equity financed (unlevered) investment in property that results in direct equity private ownership.
 Mortgage loans made by banks and Financial institutions to individuals for purchasing/ constructing property
are a form of direct debt private investment.
 Purchasing shares of real estate companies is a form of public equity real estate investment. This is because
the real estate company uses the money obtained by selling these shares to purchase real estate.
 Real estate investment trust (REIT) are similar to mutual funds. They sell publicly traded shares to the
people to raise money and use that money to invest in the real estate sector. As a result, an investor purchasing
a REIT’s share, is in effect, making a public-equity real estate investment.
 An investor can make a public-debt real estate investment by purchasing MBS and CMO.
PROPERTY RIGHT AND ESTATE

 Real estate is used to refer to things that are not movable such as land and improvements permanently
attached to the land.
 Ownership rights associated with real estate are referred to as real property.
 Real property has also been contrasted with personal property
FIXTURES

These are items that were once personal property but have become real property because they have either been
attached to the land or building in a somewhat permanent manner or are intended to be used with the land and
building on a permanent basis.
Examples include built-in dishwashers, furnaces, and garage door openers.
 REAL ESTATE AND ITS CHARACTERISTICS

 Real estate refers to all tangible and immovable property that an individual owns. It includes land and any
constructions made on it such as buildings, warehouse or other infrastructure.

 The characteristics of real estate are as follows:

 Tangibility
 Uniqueness- No two land are identically same
 Indestructibility
 Permanence
 Immobility
 Scarcity
TWO GENERAL CLASSIFICATIONS OF ESTATES

01 Estates in Possession: Entitles its owner to

Based on immediate enjoyment of the rights to that estate
Rights
Estate not in Possession: Represents a future
possessory interest in property
02
CLASSIFICATION BASED ON RIGHT

 Generally, estate not in possession does not convert to an estate in possession until the occurrence of a
particular event.
 Estates in possession are by far the more common.
 Lenders and investors are very interested in the nature of the estate possessed by the owner when considering
the purchase or financing of a particular estate in property.
TWO GENERAL CLASSIFICATIONS OF ESTATES

Freehold: A freehold estate lasts for an indefinite

01
period of time
Based on
Possession and
Use Leasehold: Expires on a definite date
02
CLASSIFICATION BASED ON POSSESSION AND USE

 A freehold estate connotes ownership of the property by the estate holder, whereas
a leasehold estate implies only the right to possess and use the property owned by
another for a period of time.
EXAMPLES OF FREEHOLD ESTATES

 Fee Simple Estate:

 Freehold estate represents the most complete form of ownership of the real estate.
 A holder of a fee simple estate is free to divide up the fee into lesser estates and sell,
lease, or borrow against them as he or she wishes, subject to the laws of the state in
which the property is located.
 Apart from government restrictions, no special conditions, limitations, or restrictions are
placed on the right of a holder of a fee simple estate to enjoy the property, lease it to
others, sell it, or even give it away. It is this estate in property that investors and lenders
encounter in most investment and lending transactions.
LIFE ESTATES

 life estate, which is a freehold estate that lasts only as long as the life of the owner of the
estate or the life of some other person.
 Upon the death of that person, the property reverts back to the original grantor (transferor
of property), his or her heirs, or any other designated person. Most life estates result from
the terms of the conveyance of the property. For example, a grantor may wish to make a gift
of his or her property prior to death, yet wish to retain the use and enjoyment of the
property until that time. This can be accomplished by making a conveyance of the property
subject to a reserved life estate.
 A life estate can be leased, mortgaged, or sold.
 However, parties concerned with this estate should be aware that the estate will end with
the death of the holder of the life estate (or that of the person whose life determines the
duration of the estate).
ESTATES NOT YET IN POSSESSION (FUTURE ESTATES)

 Reversion:
 A reversion exists when the holder of an estate in land (the grantor) conveys
to another person (a grantee) a present estate in the property that has fewer
ownership rights than the grantor’s own estate and retains for the grantor or
the grantor’s heirs the right to take back, at some time in the future, the full
estate that the grantor enjoyed before the conveyance.
 In this case, the grantor is said to have a reversionary fee interest in the
property held by the grantee. A reversionary interest can be sold or
mortgaged because it is an actual interest in the property.
ESTATES NOT YET IN POSSESSION (FUTURE ESTATES)

 Remainder:
 A remainder exists when the grantor of a present estate with fewer ownership rights
than the grantor’s own estate conveys to a third person the reversionary interest the
grantor or the grantor’s heirs would otherwise have in the property upon
termination of the grantee’s estate. A remainder is the future estate for the third
person. Like a reversion, a remainder is a mortgageable interest in property
LEASEHOLD ESTATES

 There are two major types of leasehold estates:

 estates for years vs estates from year to year.
 estates for years:
 An estate for years is the type of leasehold estate investors and lenders are most
likely to encounter. It is created by a lease that specifies an exact duration for the
tenancy. The period of tenancy may be less than one year and still be an estate for
years as long as the lease agreement specifies the termination date.
LEASEHOLD ESTATES

 An estate for years can be as long as 99 years (by custom, leases seldom exceed 99
years in duration), giving the lessee the right to use and control the property for that
time in exchange for rental payments.
 To the extent that the specified rental payments fall below the market rental rate of
the property during the life of the lease, the lease has value (leasehold value) to the
lessee.
 The value of this interest in the property can be borrowed against or even sold. For
example, if the lessee has the right to occupy the property for $1,000 per year when
its fair market value is $2,000 per year, the $1,000 excess represents value to the
lessee, which may be borrowed against or sold (assuming no lease covenants prevent
it).
LEASEHOLD ESTATES
 Estates from Year to Year:
 An estate from year to year (also known as an estate from period to period, or simply as a
periodic tenancy) continues for successive periods until either party gives proper notice of
its intent to terminate at the end of one or more subsequent periods.
 A “period” usually corresponds to the rent-paying period. Thus, such a tenancy commonly
runs from month to month, although it can run for any period up to one year.
 Such estates can be created by explicit agreement between the parties, although a definite
termination date is not specified. Since these estates are generally short-term (a year or less),
the agreement can be, and frequently is, oral. This type of estate can also be created without
the express consent of the landlord. A common example is seen when the tenant “holds over”
or continues to occupy an estate for years beyond the expiration date, and the landlord
accepts payment of rent or gives some other evidence of tacit consent.
INTERESTS, ENCUMBRANCES, AND EASEMENTS
 Interest:
 An interest in real estate can be thought of as a right or claim on real property, its revenues, or
production.
 Interests are created by the owner and conveyed to another party, usually in exchange for other
considerations. In real estate, interest is usually thought to be less important than an estate.
 For example, an owner of real estate in fee simple may choose to pledge or encumber his
property as a condition for obtaining a loan (mortgage loan). In this case, the lender receives only
a secured interest, but not possession, use, and so on, of the property. The nature of the secured
interest is usually documented in a mortgage which explains the actions that a lender may take in
the event that the loan terms are not met by the property owner. In the interim, the property
owner retains possession and use of the property. Another example of the creation of an interest
in real property occurs when an owner encumbers a property by granting an easement, or the
right to ingress or egress his property, to another party
INTERESTS, ENCUMBRANCES, AND EASEMENTS

 Easements:
 An easement is a nonpossessory interest in land. It is the right to use land that is owned or
leased by someone else for some special purpose (e.g., as a right of way to and from one’s
property). An easement entails only a limited user privilege and not privileges associated with
ownership.
 Examples of easements would be the following: property owner A allows property owner B
to use a driveway on A’s land to provide owner B with better access to his property. In some
retail developments, owners A and B may execute reciprocal easements to allow access
across both properties, thereby enhancing customer traffic flow and shopping opportunities
CASE 1

Mr. Rahman, a wealthy landowner in Bangladesh, owns multiple properties and has decided to distribute
them among his family and others. He has structured the ownership and leasing of these properties in
different ways:
1. Gulshan Villa – Mr. Rahman gives full ownership of this property to his eldest son, Arafat, with no
conditions or time limits.
2. Banani Heights – He leases this apartment complex to a real estate company for 20 years, after
which ownership will return to him.
3. Dhanmondi Residence – Mr. Rahman allows his sister, Salma Begum, to live in this house for the
rest of her life. Upon her death, the property will be transferred to his nephew, Imran.
4. Motijheel Tower – Mr. Rahman allows his niece, Rubi, to live in this house. After a certain time, his
son has the right to take back the property.
5. Uttara Apartment – A rental property leased out to tenants on a month-to-month basis.
v Requirement: You are required to type of estate for each scenario.
Questions for Discussion:
1. What type of estate does Arafat hold over Gulshan Villa?
2. What type of estate does the real estate company have over Banani Heights, and what happens
when the lease expires?
3. What estate does Salma Begum have in Dhanmondi Residence, and what is Imran’s interest in it?
4. What kind of estate is shared between Mr. Rahman and Mr. Karim for Motijheel Tower?
5. What type of leasehold estate applies to Uttara Apartment’s tenants?
ASSURANCE OF TITLE

 Buyers of property typically want assurance that they will become the legal owner of
the property and that the seller is lawfully possessed and has the right to convey title.
 Title assurance refers to the means by which buyers of real estate
 “(1) learn in advance whether their sellers have and can convey the quality of title
they claim to possess, and
 (2) receive compensation if the title, after the transfer, turns out not to be as
represented.”
 Lenders are also concerned about title assurance because the quality of title affects
the collateral value of the property in which they may have a secured interest.
THE MEANING OF TITLE

 Title is an abstract term frequently used to link an individual or entity who owns
property to the property itself.
 When a person has “title,” he is said to have all of the elements, including the
documents, records, and acts, that prove ownership.
 Ex: 1.2
149547

METHODS OF TITLE ASSURANCE

 General Warranty Deed:

It is important to understand that any deed, no matter how complete the warranties
contained therein, can only convey the quality of title that the grantor actually has to
the property.
This is why most buyers of real estate usually obtain independent assurance of the
validity and marketability of the title from a third party.
A general warranty deed is the most commonly used deed in real estate transactions
and the most desirable type of deed from the buyer’s perspective. It offers the most
comprehensive warranties about the quality of the title.
METHODS OF TITLE ASSURANCE

 Essentially, the grantor warrants that the title he or she conveys to the property is free and
clear of all encumbrances other than those specifically listed in the deed.
 As pointed out above, encumbrances listed in a deed could include easements and leases.
 Generally, the most significant covenants contained in such a deed are the following:
 (1) a covenant that the grantor has good (legally valid) title to the property,
 (2) a covenant that the grantor has the right to convey the property,
 (3) a covenant to compensate the grantee for loss of property or eviction suffered by the
grantee as a result of someone else having a superior claim to the property, and
 (4) a covenant against encumbrances on the property other than those specifically stated in
the deed.
METHODS OF TITLE ASSURANCE

 Special Warranty Deed

 A special warranty deed makes the same warranties as a general warranty deed
except that it limits their application to defects and encumbrances that occurred only
while the grantor held title to the property.
 Unlike the warranties in a general warranty deed, those in a special warranty deed do
not apply to title problems caused or created by previous owners.
METHODS OF TITLE ASSURANCE

 Bargain and Sale Deed

 A bargain and sale deed conveys property without seller warranties.
 This is sometimes referred to as an “as it is” deed.
 The buyer of property takes title with no assurances from the seller and must take
the initiative to determine whether any imperfections exist and, if desired, how to
cure such defects.
METHODS OF TITLE ASSURANCE

 Sheriff ’s Deed-Trustee’s Deed

 A sheriff’s deed-trustee’s deed is a type of bargain and sale deed received by a buyer
from a foreclosure or other forced sale because the sheriff or trustee is acting in a
representative capacity. No warranties are added
METHODS OF TITLE ASSURANCE

 Quitclaim Deed
 A quitclaim deed offers the grantee the least protection.
 Such a deed simply conveys to the grantee whatever rights, interests, and title that
the grantor may have in the property.
 No warranties are made about the nature of these rights and interests or of the
quality of the grantor’s title to the property.
 The quitclaim deed simply says that the grantor “quits” whatever “claim” he or she
has in the property (which may well be none) in favor of the grantee.