California Real Estate Finance
Bond, McKenzie, Fesler & Boone
Ninth Edition
Chapter 1
Introduction to Real Estate Finance
© 2011 Cengage Learning created by Dr. Richard S. Savich.
Objectives
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After completing this chapter, you should be able to:
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Describe current financing trends in the real estate market.
Trace the flow of money and credit into the mortgage
market.
Discuss the role of the Federal Reserve System.
List five characteristics of the California mortgage market.
Explain and illustrate two basic types of promissory notes.
Describe the differences among a deed of trust, mortgage,
and installment sales contract.
© 2011 Cengage Learning created by Dr. Richard S. Savich.
Outline
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Welcome to the Real World of Real Estate
Finance
Short Overview of the Mortgage Market
The Meaning of Money
The Flow of Money and Credit into the Mortgage
Market
Federal Control of the Money Supply
Cost Characteristics of the Mortgage Market
Instruments of Real Estate Finance
The Five-Step Financing Process
© 2011 Cengage Learning created by Dr. Richard S. Savich.
Welcome to the Real World of
Real Estate Finance
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Real Estate market in California
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Booms
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Busts (High interest rates,
government deficits, better
investment opportunities)
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Early 1960s
1971 – 1973
1975 – 1979
1982 – 1989
2000 – 2006
1966
1969
1974
1980 – 1981
1990 – 1996
2007 -- ????
Caused by disintermediation
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flow of money out of thrift
institutions into the general
money market
© 2011 Cengage Learning created by Dr. Richard S. Savich.
“Fog a Mirror” loans
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Interest only
Stated Income
100% Loans
Negatively Amortized Adjustable Rate
Mortgage (Option ARM)
© 2011 Cengage Learning created by Dr. Richard S. Savich.
Money is…
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Money
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Near money
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Coins
Paper currency
Checking accounts (demand deposits) (along with debit cards)
Negotiable orders of withdrawal (NOW accounts)
Money market accounts
Savings accounts (time deposits)
U.S. government bonds
Cash value of life insurance
Preferred and common stocks publicly traded
Money market mutual funds
Credit
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Credit cards
Overdrafts
Credit reserves
Home equity lines of credit
© 2011 Cengage Learning created by Dr. Richard S. Savich.
The Meaning of Money
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Created
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Accumulated
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Cash
Checking Accounts
Wages, fees & commissions
Interest
Dividends
Profits
Rents
Ultimate source of funds for borrowing is savings
© 2011 Cengage Learning created by Dr. Richard S. Savich.
The Flow of Money and Credit
into the Mortgage Market
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Income is
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Taxed
Spent
Saved
Savings go to financial institutions
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Known as intermediation
Withdrawals from savings are known as
disintermediation
Re-deposits are known as re-intermediation
© 2011 Cengage Learning created by Dr. Richard S. Savich.
© 2011 Cengage Learning created by Dr. Richard S. Savich.
Federal Control of the Money
Supply (Slide 1 of 2)
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Federal Reserve System
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Issues currency
Monetary policy
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Reserve requirements
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A 20% reserve
requirement means that
$200 in reserves is
needed for every
$1,000 of deposits
The higher the
requirement, the lower
the lending
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Fed buys and sells
government securities
The more government
securities sold, the
lower the lending
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Rate the Fed charges
banks
The higher the rate, the
lower the lending
Federal funds rate
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Open-Market operations
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Discount rates
Bank to bank borrowing
rate
The higher the rate, the
lower the lending
Prime rate
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Rate banks charge
preferred customers
© 2011 Cengage Learning created by Dr. Richard S. Savich.
© 2011 Cengage Learning created by Dr. Richard S. Savich.
Federal Control of the Money
Supply (Slide 2 of 2)
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U.S. Treasury
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Government Spending
Government Taxing
Together known as Fiscal Policy
When spending exceeds taxing, inflation results
Housing prices rise
Fewer people can afford housing
Established and promoted
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Federal National Mortgage Association (Fannie Mae)
Government National Mortgage Association (Ginnie Mae)
Federal Land Bank System
“Recovery Act” 2008
“Make Home Affordable” program 2009
© 2011 Cengage Learning created by Dr. Richard S. Savich.
Cost Characteristics of the
Mortgage Market (Slide 1 of 3)
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Deposit cost (Interest paid)
Borrowing costs (Underwriting and float)
Sales costs (Promotion costs)
Administration (Rent, utilities, etc.)
Reserves (?%)
Liquidity (Capital requirements)
Profit (for the shareholders)
© 2011 Cengage Learning created by Dr. Richard S. Savich.
Cost Characteristics of the
Mortgage Market (Slide 2 of 3)
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Interest rate changes due to
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Excessive government spending
Large government borrowings
Inflation
Supply
Demand
Federal reserve actions
© 2011 Cengage Learning created by Dr. Richard S. Savich.
Cost Characteristics of the
Mortgage Market (Slide 3 of 3)
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California Mortgage Market
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Large population and high demand
Financial institutions
Loan correspondents
Title companies
Security (Deed of trust)
Active secondary market
Diversification
© 2011 Cengage Learning created by Dr. Richard S. Savich.
Instruments of Real Estate
Finance (Slide 1 of 2)
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Promissory notes
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Straight
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Installment
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Both principal and interest
Balloon payments
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Interest only
Both principal and interest, but principal payments not
large enough, so more is due at end of note
Negatively amortized
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Payments not even enough to cover interest
© 2011 Cengage Learning created by Dr. Richard S. Savich.
Instruments of Real Estate
Finance (Slide 2 of 2)
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Deed of Trust (used in California instead of a
mortgage)
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Borrower – Trustor
Lender – Beneficiary
Third party – Trustee (Holds title until loan is paid in
full)
Installment Sales Contracts
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Title remains with seller
Seller is “lender”
© 2011 Cengage Learning created by Dr. Richard S. Savich.
© 2011 Cengage Learning created by Dr. Richard S. Savich.
The Five-Step Financing
Process
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Application (Chapter 10)
Analysis/Processing (Chapters 8 & 9)
Qualifying/Underwriting (Chapters 7 – 10)
Funding/Closing (Chapter 10)
Servicing (Chapters 10 & 11)
© 2011 Cengage Learning created by Dr. Richard S. Savich.
Questions and Comments?
© 2011 Cengage Learning created by Dr. Richard S. Savich.