REAL ESTATE FINANCE
Theory and Practice
7th Edition
Terrence M. Clauretie
G. Stacy Sirmans
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Chapter 1
Finance and Real Estate
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Chapter 1
Learning Objectives
 Understand the relationship between finance and real
estate
 Understand how financial markets work
 Learn, which major financial institutions direct the
flow of funds
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What is Finance?
 The study of the process, institutions, markets, and
instruments used to transfer money and credit
between individuals, businesses, and governments
 Applied economics
 Economics is the study of the allocation of resources for the
purpose of producing goods and services for various
members of society.
 The study of how the flow of money and credit
facilitates that production and allocation.
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What is Finance?
 Considers time value of money (TVM) and
implications of interest rates on TVM and financing
decisions:
 Focuses on cash flows, not profits
 Makes extensive use of the concept of risk
 Risk – the possibility that the actual result will differ from
the expected outcome
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What is Real Estate Finance?
 The study of the institutions, markets, and
instruments used to transfer money and
credit for the purpose of developing or
acquiring real property.
 Real property - the rights, powers, and privileges
associated with the use of real estate.
 Real estate - land and all fixed and immovable
improvements on it.
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What is Real Estate Finance?
 Includes the study of:
 Residential and commercial properties
 Terms of residential and property leases
 Appraisal of residential and commercial properties
 Financing of residential and commercial real estate
 Valuation of mortgages
 Real estate taxation issues
 Primary and secondary mortgage markets
 Securitization of mortgages
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The Environment of Real Estate Finance
 Financial instruments are used to transfer money and
credit for the purpose of developing and acquiring real
property.
 The institutions that create and purchase those
instruments and the markets within which they are
transferred constitute the environment of real estate
finance.
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Real Estate as Portion of the Financial
System
Table 1-1 Current-Cost Net Stock of Fixed Assets and Consumer Durable Goods
(billion USD)
Source: Bureau of Economic Analysis
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Savings-Investment Cycle
 An identity, whereby the amount of savings equals the
total amount invested
 Three groups of savings: by individuals, businesses, and the
government
 Investment considers amount invested in new plan
construction, equipment and real property
 The financial marketplace is the system whereby
savings are transferred from what are termed surplus
income units to what are termed deficit income units.
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The Environment of Real Estate Finance
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Financial Intermediaries
 Financial intermediaries are financial institutions that
channel funds from the surplus income units to the
deficit income units.
 Commercial Banks – accept demand and time deposits
 Thrift Institutions – S&L associations; mutual savings banks;
credit unions
 Investment Companies – pool the funds of savers and invest
the funds in a portfolio of assets
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Financial Intermediaries (Cont.)
 Insurance Companies - receive periodic or lump-sum
payments from individuals or organizations in return for a
promise to make future payments if certain events occur
 Pension Funds - pool the contributions of employees and
invest the funds similarly to insurance companies
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Direct Financing
 When the flow of funds takes place without the use of
intermediaries
 E.g. when a home seller grants a note to the home buyer
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Primary Mortgage Market
 The market where mortgages are originated
 Originators either hold mortgages in portfolio or sell
them into the secondary mortgage market
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Secondary Mortgage Market
 Major secondary market participants are the Federal National
Mortgage Association (FNMA, or Fannie Mae), the Federal Hole
Loan Mortgage Corporation (FHLMC or Freddie Mac), the
Government National Mortgage Association (GNMA, or Ginnie
Mae), the Federal Home Loan Bank Board
 The secondary mortgage market agencies and firms purchase
mortgages from other intermediaries or brokers that deal with
surplus income units, using funds raised though sales of
securities they create
 Issue mortgage-related securities (MRSs) using mortgage pools as
collateral
 A large and active secondary market makes securities more
liquid.
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Money and Capital Markets
 Financial markets can be divided into two categories:
money markets and capital markets.
 Money markets deal in short-term securities (maturities of 1
year or less)
 Capital markets deal in long-term securities (over 1 year in
maturity).
 Most real estate financing takes place in the capital
markets.
 Mortgages are long-term securities.
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