Real Estate Financing Flashcards
Sources of Real Estate Financing
public (REITs, CMBS) <> private (Mezzanine, Opportunity Funds)
equity (REITs, Opportunity Funds) <> debt (CMBS, Mezzanine)
Real Estate Equity Investment
- direct real estate investments
- indirect real estate investments (listed [REITs, REOCs] and unlisted [open-, closed-ended structures])
Direct Real Estate Investment
hard to be diversified properly because of high capital intensity high number of different markets
Comparison of Real Estate Equity Investments (Direct Real Estate)
Direct Real Estate
- high control
- high transparency
- low volatilty
- high diversifaction to other asset classes
- low diversifaction of property rist
- low liquidty
- high instant exposure/ draw down
Comparison of Real Estate Equity Investments (Listed Funds)
- limited control
- high transparency
- high volatilty
- low-medium diversification to other asset classes
- high diversifaction of property risk
- high liquidity
- high instant exposure/ draw down
Comparison of Real Estate Equity Investments (Open-ended - usually core)
- low control
- medium transparency
- low volatility
- high diversification to other asset classes
- high diversification of property risk
- medium-high liquidity
- medium-high instant exposure/ draw down
Comparison of Real Estate Equity Investments (Closed-ended - usually value added/ opportunistic)
- low-medium control
- medium transparency
- medium volatility
- medium diversification to other asset classes
- medium diversification of property risk
- limited liquidity
- low instant exposure/ draw down
Determining characteristics of real estate private equity funds
- investors
- fund structures
- investment managers
- strategies/ risk structure
How do investors look at (real estate) investment options?
- absolute value (total return, income, appreciation)
- relative value (return vs. alternatives, return vs. risk, alpha, beta)
- diversification (geography, sector, currency, demographic)
Real assets options
- equity vs debt
- public vs private
- income vs growth
- …
Sources of Real Estate Private Equity
Institutional investors: -public pension funds -private pension funds -insurance companies -corporates -sovereign wealth funds -banks Private investors (feeder vehicle): -high net worth individuals -retail clients
Investor execution options (level of delegation, expertised management)
High level of expertised management -in house -joint venture -programmatic venture -seperate account -commingled fund -fund of fund High level of delegation
Real Estate Private Equity investment cycle (J-Curve)
- capital commitment with fund closing
- capital calls during investment period
- capital repayment at exit
- repayment might start before final capital call
Investment Characteristics (determining factors)
- location
- sector
- deal access
- holding period
- risk taking
Range of Investment Styles
Cash dividend oriented:
- core (fully leased multi-tenant property)
- core-plus (stable lease roll, moderate NOI upside)
Total return oriented:
- value added (repositioning, moderate development)
- opportunistic (distressed sellers, significant redevelopment)
Trends in Real Estate Private Equity (post GFC)
- direct investing, joint ventures & clubs
- income and preservation of capital
- less leverage, cautious on secondary locations
- stronger home bias
- longer-term holds to maximize equity multiples and reduce re-investment risk
Leverage (why using leverage?)
- insufficient funding
- diversifying equity
- tax shield of interest payments
- leverage effect (higher returns on equity)
Real Estate Financing (Equity and Debt)
Equity Financing:
- open/ closed ended funds
- institutional investors
- private equity funds
- stock based real estate companies
Debt Financing:
- mortgage backed loan
- asset securitisation
- joint venture financing
- real estate leasing
Hybrid Financing:
- mezzanine financing
- participating mortgage
- convertible mortgage
Financing Process (Phase I-V)
- Investment Decision (project valuation, budget, feasability, DD) [Developer]
- Credit Analysis (Documentation, Communication) [Developer/ Bank]
- Mandate (Offer, Term Sheet, Mezzanine Capital) [Bank/ Developer]
- Term Sheet (Adjustment of hard facts, term sheet II, underwriting risks, loan contract) [Bank/ Developers]
- Capital Market (info-memo, refinancing, securitization) [Bank/ Capital Market]
100% Leverage
Bank A: 60% loan backed by property
Bank B: 40% loan (asset backed financing, subscription financing [undrawn equity commitments])
Profit distribution (in general)
- Return of Debt
- Return of Equity
- Prefered return (preference tranche)
- catch-up tranche
- promote tranche
Leveraged/ unleveraged returns
-operating with or without the use of borrowed money
Relevance:
- lower cost of capital
- if cost of debt is less than the unlevered project return, then leverage will increase equity returns (positive leverage effect)
Initial yield
= annual NOI / project cost
yield on cost
= net cash flow / project cost
yield on equity
= cash flow after debt service / equity investment
Internal Rate of Return (IRR)
- discount rate at which NPV equals 0
- represents the annual compounded average total return on investment
- technical problem when cashflow has more than two changes between + and -
profit on cost
= profit after tax / total project cost
- indication on how much risk is involved in a project
- static ratio, no indication about timing and performance
equity multiple
= (equity invested + profit) / equity invested
-static ratio, no indication about timing or leverage
DCF Valuation Procedure
- forecast the expected future payments
- define the required total return
- discount the future payments to present value at required rate of return
The present value reflects the maximum you can pay for the investment to still achieve your required return
-NPV never below zero, but NPV = 0 is ok
Inverted DCF Procedure
instead of calculating the value associated with a given expected return, calculate the expected return (IRR) associated with a given price for the property
- maximise difference between IRR and required return
- never do deal with IRR
Hedging (Natural Hedging & Hedging Instruments)
Natural Hedging:
- Loans in local currency
- higher LTV
- inflation/ currency exchange rate
Hedging instruments:
- swaps
- caps
- forwards
- collars
Crucial Real Estate Risks
- Interest rate
- currency
- commodity prices
Gründe für indirekte Investements
- Specialist asset management
- tax efficient cross border structures
- alignement of interest
- access to off balance sheet gearing
