Assignment for next Mon. • Read pgs. 39-50 in materials. • Find an article on Explanation of the Mortgage Crisis on the web or in a magazine or newspaper. Read it and be ready to share! Basic Real Estate Principles – cont. You want to buy an apartment complex…. Talked about the first thing you do • F • Important factors to consider? Once you find the bldg. you want…. • • • • • • • What’s next? Inspections Financing Title Report Rent Rolls Occupancy rate Estoppel certificates What gives buyer right to do these things? • PURCHASE CONTRACT: • Offer – Includes price – Financing terms – Inspection rights – Condition of title – Other terms? • Seller – accepts, rejects or most likely, ? • Counters Terms • Equity – Examples: • Own my home - no mortgages. How much equity if the house has a Fair Market Value of $1 million? • Apartment building - FMV = $5 million. Seller has a loan on it = $3 million. How much equity? • Apt. bldg. FMV = $5 million. Loans against it for $6 million. Equity? Sellable? • Definition? • Advantages to having equity? Terms • Leverage $100,000 cash in pocket. – Could buy 1 property with $100,000. Appreciates 10% in one year. Now worth $110,000. – Could buy 2 properties, each FMV = $100,000. $50,000 down, loan on each for $50,000. Each appreciates 10% in one year. How much have you made? [Remember though you make mortgage payments too.] • Definition of “Leverage” (modified from Investopedia) – Use of borrowed capital to increase the potential return of an investment. Down payment • Define • Where does it come from? • Why does lender (generally) require buyer to put in $? • “Cushion” • Assume FMV = $500,000 • Assume Down Pymt. = $100,000 • Assume loan = $400,000 • How much would property have to depreciate before lender at risk? Once “in contract”…. • • • • • • Financing – What kind of loan? List various possibilities: Interest only: advantages? Disadvantages? Fully amortized loan ARM 100+ variations Found the loan you want…. • Bank – lender • What steps will (should) bank take (due diligence)? • Appraisal • Credit check • Verify employment/income • Verify other assets such as down pymt. At closing (Close of Escrow) • • • • • First – How does buyer get title? Lender will require buyer/borrower to sign ? What does the note include? What does the mortgage do? Property encumbered by a mortgage Buyer gets title [Seller gets $ from buyer and lender – pays off loans.] Buyer signs promissory note in favor of lender secured by a mortgage on the bldg. Before getting into greater depth.. • Articles you found on real estate financing…. Promissory Note - pg. 33 • • • • • • • “jointly and severally” What type of loan is this? How can you tell? Prepayment Acceleration Due-On-Sale Attorneys’ Fees Security And where did the process get offtrack? Then we’ll examine why • • • • • • Financing process – pg. 27 Loan application Loan analysis Approval and processing Closing Servicing Subprime Loans – pg. 34 • Application process: No documentation • Loan analysis – low credit scores; no verification • Higher interest rates • Negative amortization • Where does equity come into play? – “High debt-to-equity” ratio Loan Analysis • Appraisal – what was happening in the mid2000s? http://www.youtube.com/watch?v=MS5X8bo UACI Mortgages (called Deeds of Trust in some places) • • • • Your understanding? Why does lender require this? Bought car on credit? Can a property have more than one mortgage? • Why? More than one mortgage… • Assume Buyer buying apt. house for $3 million. • Has $500,000 down. • Qualifies for $2 million loan from Bank – what security? • $500,000 short. • Solution? $500,000 down Second mortgage [junior] • • • • Goes to another lender – or even same lender Why would someone lend additional $500k? What would first mortgage holder allow this? What is the cushion (margin of security) for 1st? FMV = $3,000,000 (purchase price) Down = 500,000 1st = $2,000,000 2nd = 500,000 Any cushion for 2nd [junior]? • FMV = $3,000,000 (purchase price) Down = 500,000 1st = $2,000,000 2nd = 500,000 Would 2nd be “safe”? What happens if property values decline? Seller Carry-Backs • Assume same facts: • FMV = $3,000,000 • Down payment = $ 500,000 • 1st = $2,000,000 And buyer can’t find a lender to loan the rest but seller wants/needs to sell. Solution? How structured? Term: “Under Water” • Assume FMV declines from $3,000,000 to $2,000,000. • First mortgage – balance of $2,000,000 • Second - balance of $ 500,000 How much would you pay for the property? In order to sell what has to happen? Will discuss why borrowers defaulting – but let’s first look at the process • Foreclosure – What does this mean? – What gives lender the right? – And – what’s the process? • Same facts: • Value at time of default = $2,000,000 • 1st loan = $2,000,000 First forecloses; what is the highest bid? Another Term: Deficiency Judgment Assume same facts Value = $2,000,000 at time of default 1st has balance due of $2,000,000 High bid = $1,500,000. Now what? And what about 2nd? (balance due = $500,000)