Real Estate Finance Lecture 1/9/06 Mortgage and Deed of Trust are interchangeable words for us. CA uses deeds of trust, but other states use mortgages. Construction loan is a loan given to the borrower in order to have funds to build something. Permanent loan is given after the project is completed. With a construction loan the risk is much higher. Things can go wrong. With construction loan they look at the person getting the loan. With perm loan they only care about the property. Common sources of funds: Where do people go to get there money. Commercial banks Life Insurance companies Pension Funds Seller Wall-Street There are mortgage brokers and then investment bankers and other people in between. Commercial Banks – They do construction loans. Life insurance companies – They generally do not do constructions loans, only permanent loans. The big ones are Signa, Prudential, Met Life, NY Life, John Hancock, Mass Mutual, Teachers, Guardian Life. The smaller ones get in through securitization. Pension funds – CALPERS is huge. Commercial Lenders – Heller, Westinghouse credit, General Electric Capital. These are more expensive, but do not do A+ projects. They take more risk. When a lender gets a $100 million promissory note they generally break it up in to traunches. These are called asset backed securities. If there is a default, they pool the mortgages. They take a bunch of mortgages and put them into trunches, then cut them up in to pieces and then sell them off. Generally banks don’t lend money on vacant land. Try to get the seller to give you a loan. In CA there is a one action rule – CCP 580(b) & (d), and CCP 726. This rule basically says there shall be one form of action. If you have a note secured by real estate, you have to foreclose. This is the law in about 8 states. In other states without that rule you can just forget the security and sue on the note. There also two anti deficiency statutes – 580(b), if you are a seller of property and you take back a mortgage, you can not get a deficiency judgment, you can only foreclose. But you can get other security and continue going to the other security. If that seller was really smart, instead of getting a mortgage on that land, they get a mortgage on something else. There are two ways to foreclose. 1. Judicial foreclosure. 2. Foreclosure by private power of sale. By far the second one is more common. You sign a deed of trust. When there is a default, you go to the trustee and start the foreclosure proceeding. They mail something to the borrower, and the 90 day period starts. Borrower has 90 days to cure. The statute says that if you come up to date on monthly payments then no foreclosure. If not cured, then they sent out a letter saying we are gong to sell the property in 30 days. If the lender wants to bid, they don’t have to come up with any money, they can do a credit bid, and give credit against the note. 580(d) says if you use the private power of sale, you can not get a deficiency judgment. So basically everything in CA is non-recourse financing. Time – there was a 90 day period and another 30 day period. Some time gets wasted in between, so really about 5 months. Judicial foreclosure is the way it is done in other states of the country. You file an action (lawsuit) in court and serve a complaint on all people with an interest in the property. The court conducts the auction. The lender gets a judgment for the difference between the appraisal and the amount of the loan. The borrower also has a full year to come up with the money and buy the property back. No lender wants to do this. If you foreclose using a private power of sale then any subordinate interests are extinguished. What kind of entity are you going to use? You must think about liability, tax treatment, think about investors. Possible ways to own it – (Liability you are worried about is not tort liability because that is taken care of with insurance, more contractual liability that you are worried about) • Own it yourself • Own it with others as tenants in common – same as a general partnership. The tax treatment is the same and the exposure to liability is the same, and it is the worst way because everyone is a general partner and sticks their nose in your business. • Corporation – Limits liability • Limited Partnership – General Partner is still exposed • Limited Liability Company – This is the most popular way. Similar to a corp. but no double taxation. 1/30/06 CAP rate: Rate of return you expect CAP rate is most useful in a stable environment, in a low inflation environment. Going in CAP rate is the cash on cash return.