REAL ESTATE FINANCE Ninth Edition. John P. Wiedemer and J. Keith Baker. Chapter 13 Other Financing Practices. LEARNING OBJECTIVES. At the conclusion of this chapter, students will be able to : • Explain varying types and uses of construction takeout commitments.
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John P. Wiedemer and J. Keith Baker
At the conclusion of this chapter, students will be able to:
• Explain varying types and uses of construction takeout commitments.
• Understand key differences in the various major mortgage types for
maximum loan amounts and how loan-to-value ratios tie into the residential real estate finance process.
• Describe the various types of leases involved in real estate and how they can serve to conserve cash, increase flexibility, and reduce liquidity risk.
• Differentiate between syndications and realty funds.
• Explain the differences between judicial and nonjudicial foreclosure as well as deficiency judgment.
• Describe the various title issues that face owners, lenders, and other
professionals dealing with real estate acquisition, funding, and management.
There is a growing use of land leases for several reasons:
Land Not for Sale:
In some areas land is simply not available for purchase. Land in these areas may be limited to large holders who see greater value in leasing than converting the land asset into cash that is subject to capital gains.
Leasing May Be Lower Cost:
It is quite possible to negotiate a multiyear lease on land at a lower cost than financing the purchase price. Lease payments are tax deductible (when used for business purposes), while land is nondepreciable.
To separate the ownership of improvements from the land ownership. The separation allows either one to be sold without capital gains tax being assessed on the other.
The landowner does not subordinate the ownership to the leasehold interest. If the ground rent is not paid, the landowner can foreclose and terminate the leasehold rights. In such a case, improvements could be claimed by the landowner, thus defeating any claim by a lender holding only a pledge of the leasehold interest. With this kind of lease the lender would normally require the borrower to pay the ground rent in escrow to the lender as a part of each mortgage payment.
The landowner subordinates the ownership of the land in favor of the mortgage holder. With this kind of lease, the developer, with only a leasehold interest, can pledge title to the land itself as part of the collateral to secure a development loan. The subordination agreement signed by the landowner grants a priority claim to the lender, which is similar to granting a first lien with a mortgage instrument.
Seller/tenant and buyer/landlord
Property acquisition by a group of participants. A syndicate is not a type of business organization; it is a name applied to any group set up to pursue a limited objective in business. Participants may be individuals, partnerships, or corporations. Real estate syndicates operate by two basic methods, either a sale of interests in existing properties or a sale of interests in property to be acquired.
Whenever a larger group (generally more than 35 persons or companies) is formed to participate in a real estate venture, registration with federal and state regulatory agencies is necessary. The participation can be in the form of “units” purchased in a realty fund, which is usually organized as a limited partnership. Realty funds are organized by persons or companies wishing to raise equity money for real estate projects, such as the purchase of raw land, a construction project, or the purchase of existing income properties.
There are several ways that real estate transactions can become involved with Securities and Exchange Commission requirements.
Sale of Mortgage Bonds
This consists of borrowing in the financial markets through the sale of bonds. Such an issue of bonds would be secured by a pledge of the real estate being developed. If such an issue is sold to the general public, it is subject to registration with the SEC.
Advance Payments on Real Estate
Real estate transactions that may be subject to SEC registration include the sale of predevelopment certificates for lots; the sale of condominium units in a building yet to be constructed for which a down payment is required; and the sale of limited partnership interests, if offered publicly.
A few companies utilize credit terms as an incentive to do business with these firms and, in so doing, provide additional financing for the customer. A major supplier may agree to extend payment terms for 60 or 90 days or, in some cases, until the project is finished and sold.
The ulterior motive in supplier financing is always to ensure the use of the lender’s products. This could be heating and air conditioning equipment or a full range of kitchen equipment, or it could be a utility company.
Where to Refinance: The best place to start is with the holder of the existing note. Most lenders accept a lesser rate than lose the customer.
Rate Reduction: Add the costs of refinancing, then compare those with the savings to see how many months it will take to recover the costs.
Refinancing Costs: No specific regulations apply. They may require a new application fee, title insurance, attorney’s fees, appraisal, discount points.
Effect of Tax Law: Adiscount for refinancing must be amortized over the life of the loan.
Restructuring the Loan: Refinancing is a negotiable transaction. It is possible that a lender wants a change from a fixed-rate to an ARM.
Appraisal Problems: When the market value of the house has declined and/or negative amortization has increased the loan amount.
Discuss methods a builder might use to assist with a home buyer’s permanent financing.
Discuss maximum and minimum dollar limits on loan amounts.
When is refinancing a mortgage loan practical? Why?
How is loan-to-value ratio used in lending practices?
What kind of real property transaction might fall under jurisdiction of the SEC?
Who benefits from a sale-and-leaseback deal, and how?
What is the risk involved in an unsubordinated leasehold mortgage, and how might protection from this risk be obtained?
Describe two of the three ways that title to property is protected against adverse claims.
What is syndication? What is a realty fund?
Describe a judicial foreclosure proceeding. How is it different from a nonjudicial foreclosure?