chapter 17: sources of commercial debt and equity capital Flashcards
estimated market value of all commercial real estate
6.5 trillion
there can be multiple forms of ownership
true
general partnership
multiple owners, unlimited liability for each equity holder, flow-through taxation of both taxable income and cash distributions
- treated as conduits for tax purposes
- do not face double taxation
limited partnership
created and tax the same as a general partnership
- have at least one general partner and one limited partner
- limited partners have limited liability
- limited partners dont have as much power and have a principal agent relationship
C corporation
a legal and taxable entity separate from the owners who are shareholders in the corporation
- earns income and incurs tax liabilities
- income from underlying properties may be taxed twice
- shareholders have limited liability
- operating decisions are made by managers
- not desirable for commercial real estate
subchapter S corporation
possesses the same limited liability benefits for its shareholders as C corporations
- a separate legal entity but not a separate taxable entity
- pay no income taxes
limited liability company (LLC)
a hybrid form of ownership that combines the corporate characteristics of limited liability with the characteristics of a partnership
- greater flexiblity than S corporations
- cheaper and easier to run than a limited partnership
- preferred ownership form for many real estate investors
tenancy in common
one of the oldest forms of co-ownership
- fee simple interest with multiple owners
- investors receive seperate deed but are direct owners
- investors can hold different ownership %s
- 35 investors or less
- became popular again in 2002 bc of income tax avoidance (but generally considered bad form for investing in RE) but dropped again after 2008
disadvantages of TIC
- sponsor fees may consume 15-25% of equity raised
- TICs overpaid for properties
- joint&several liability
- co-owners must unanimously approve all major things or agree to be bound by majority vote
optimal ownership form
- LLCs and LPs are dominant
- S corporations popular with some
- C- corps and GP are rarely chosen
intermediary
an entity that invests in real estate and sells claims on those investments to the ultimate investors
ultimate equity investors
investors can hold ownership positions directly or through intermediaries
-most cant invest directly
comparing direct vs. indirect investments
- control
- access to managerial expertise
- liquidity
- risk sharing
direct investment
-gives complete control
-but investor must supply the expertise
-liquidity of it reflects liquidity of entire market
-makes more sense the more the portfolio increases
-popular with large institutions but also smaller end of investor spectrum
(single family homes, etc)
pension funds
retirement savings accounts that now represent a major source of equity capital in commercial real estate markets
life insurance companies
are a major source of commercial real estate capital
- as of 2011, owned 27 billion of commercial real estate assets
- but more active as RE lenders than as investors
other investors in private RE equity markets
- foreign investors
- commercial banks
- savings associations
investment through intermediaries
seperate accounts
commingled real estate funds
real estate private equity funds
seperate accounts
- large investment management company will buy, hold, dispose of properties on behalf of investors
- allows investors to access expertise of manager in exchange for fees
- limited liqudity
- does little to help diversify portfolio
- conflicts of interest due to loss of full control
- closest alternative to direct ownership that still involves intermediation
securitized investments
pool money from multiple investors, purchased or resold in either public or private markets
-the norm in commercial real estate
syndication
the pooling of equity capital by investors to purchase real estate in private market
syndicate
a group of persons or legal entities who come together to carry out a particular activity
-a group organized to develop a parcel of land, buy an office building, purchase an entire portfolio of properties, make mortgage loans, or perform other RE activities
Commingled real estate funds (CREFs)
offered by many banks, life companies, investment banks, RE advisory firms
- organized as LPs
- targeted to pension funds that do not have in-house expertise
- fund managers pool contributions from multiple pension funds to purchase multiple properties
- allows for better diversification
- closed end or open end
- popular in the 80s and still common today
- front end and back end fees
real estate private equity funds
- didnt exist before 90s
- have a finite life (7-10 years)
- finite life forces fund manager to DISPOSE of assets and return investors capital
- include some degree of side-byside investment by fund manager
- fee structures are richer and more complex than CREFs
- fund manager is GP of fund, investors are LPs
- manager contributes 1% of funds equity
- once LP returns exceed an amount, GP earns an excess of 20% (the promote) as well as other compensation
full platform operating company
instead of being a passive investor in commercial real estate by means of placing money with an investment advisor, this strategy involves starting or acquiring and operating a real estate company itself
institutional vs. non institutional equity investors
12% held by institutional
88% held by investors from private equity funds and local syndications
real estate investment trusts
- mutual funds for investing in RE
- shareholders have same limited liability as in C corps
- a corporation or trust that uses the pooled capital of many investors to purchase and manage income property (equity REIT) and/ or mortgage loans (mortgage REIT)
- not taxed at corporate level if they:
- 100+ shareholders
- 75% of assests must be RE, cash or gov securities
- 75% of income must come from RE assests
- 90% of REIT taxable income must be paid out in dividends each year
equity REITs
invest and operate commercial properties
mortgage REITs
purchase mortgage obligations and thus become real estate lenders
sources of commercial real estate debt
74%, 2.4 trillion (out of 3.2) comes from
- commercial banks
- savings associations
- life insurance companies
- freddie & fannie
- state & local govs
- 26% is publically traded
umbrella partnership REIT (UPREIT)
the REIT is a managing partner and typically majority owner in a single large umbrella partnership, which in turns owns all or part of individual property partnerships
- section 1031 of IRC allows “like-kind” tax deferred exchanges which REITs use to acquire properties
- owners transferring LP into OP receive units in OP w/o triggering taxable sale (unlike REIT stock or cash)
- recipients of OP units receive dividends
- REIT is GP & majority owner of OP units
funds from operations (FFO)
- often used instead of accounting net income to measure current performance
- a supplemental measure of REITs operating performance
=net income (excluding gains and losses) \+ depreciation \+ amortization of leasing expenses \+ amortiztion of tenant improvements - gains/losses from infrequent & unusual events
-different from GAAP bc comm RE maintains value much better, tax depr is greater than econ depr
how are REIT stocks valued?
- management quality
- current dividend yield
- anticipated total return from stock
- capital sources
how are total returns estimated
attempt to forecast the dividends REIT will pay out over time
-this projected dividend stream is converted into a present value
net asset value (NAV)
the estimated total market value of a REITs underlying assets - all liabilities having a prior claim to cash flow including mortgages
- if total stock market capitalization is > than NAV, the REIT is selling for a premium
- a stock price in excess of per share NAV may mean a REIT is overpriced
- REITs selling at discounts to NAV may mean buying opportunities for investors
