Chapter 7Chapter 7Financing and Financing and Property ValuesProperty Values

Chapter 7Chapter 7Learning ObjectivesLearning Objectives

Understand how the terms of financing Understand how the terms of financing affect the transaction price of real affect the transaction price of real estateestate

Understand the theoretical issues Understand the theoretical issues related to the interaction of financing related to the interaction of financing and transaction pricesand transaction prices

Understand the different types of Understand the different types of financing alternatives that affect financing alternatives that affect transaction pricestransaction prices

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MARKET FINANCING VS MARKET FINANCING VS NON-MARKET FINANCINGNON-MARKET FINANCING

Market Financing - Typical financing Market Financing - Typical financing with current terms as offered by with current terms as offered by institutional mortgage lendersinstitutional mortgage lenders

Non-market (Creative) Financing - Non-market (Creative) Financing - Financing with terms other than Financing with terms other than market financing. May be a different market financing. May be a different interest rate or other termsinterest rate or other terms

EXAMPLES OF NON-EXAMPLES OF NON-MARKET FINANCINGMARKET FINANCING

Assumable Loan - buyer takes over Assumable Loan - buyer takes over payments on an existing mortgage.payments on an existing mortgage.

Carryback Financing - seller provides Carryback Financing - seller provides financing of some formfinancing of some form

Buydown - seller pays prepaid interest Buydown - seller pays prepaid interest to “buy down” the buyer’s interest rateto “buy down” the buyer’s interest rate

Land Contract - seller provides Land Contract - seller provides financing and retains title until some financing and retains title until some future timefuture time

CREATIVE FINANCING CREATIVE FINANCING ISSUESISSUES

Various factors may affect the Various factors may affect the value attached to creative value attached to creative financing, e.g.financing, e.g. the length of the intended holding the length of the intended holding

periodperiod the amount of tax-deductible interestthe amount of tax-deductible interest the required down paymentthe required down payment

FHA/VA DISCOUNT POINTSFHA/VA DISCOUNT POINTS

FHA/VA loans had interest rate FHA/VA loans had interest rate ceilings until the 1980sceilings until the 1980s

Were time periods when the Were time periods when the market rate was above the ceiling market rate was above the ceiling raterate

FHA/VA properties should sell for FHA/VA properties should sell for more than those with conventional more than those with conventional loans when rates are limited and loans when rates are limited and points are chargedpoints are charged

SELLER-PAID DISCOUNT SELLER-PAID DISCOUNT POINTSPOINTS

Seller pays discount points on Seller pays discount points on borrower’s loanborrower’s loan

Would expect points to be Would expect points to be capitalized into the price of the capitalized into the price of the househouse

Some studies show the price Some studies show the price increase to be greater than the increase to be greater than the benefit to the buyerbenefit to the buyer

ASSUMABLE LOANSASSUMABLE LOANS

Have value if the contract rate is less Have value if the contract rate is less than the market ratethan the market rate

Value of the assumable loan should Value of the assumable loan should be capitalized into the price of the be capitalized into the price of the househouse

Cash equivalent is value of the Cash equivalent is value of the property if financed with cash or property if financed with cash or current market financingcurrent market financing

Loan value is tied to payment savingsLoan value is tied to payment savings

BUYDOWN FINANCINGBUYDOWN FINANCING

Seller pays money to lender to Seller pays money to lender to “buy down” the interest rate for “buy down” the interest rate for the buyer for a specified timethe buyer for a specified time

Lender receives the funds up front Lender receives the funds up front and lowers the interest rate on the and lowers the interest rate on the loanloan

Empirical research shows that the Empirical research shows that the buydown was at least partially buydown was at least partially capitalized into the house pricecapitalized into the house price

WRAPAROUND FINANCINGWRAPAROUND FINANCING

A new loan “wraps around” an A new loan “wraps around” an existing loanexisting loan

Simultaneous term, fully amortized Simultaneous term, fully amortized wrapwrap

Simultaneous term, partially Simultaneous term, partially amortized wrapamortized wrap

Extended term wrapExtended term wrap Shorter term wrapShorter term wrap

LAND CONTRACTSLAND CONTRACTS

Financing provided by the sellerFinancing provided by the seller Higher than market price may be Higher than market price may be

paid if the contract terms are paid if the contract terms are favorable to the buyerfavorable to the buyer

Seller retains title but buyer Seller retains title but buyer obtains use of the propertyobtains use of the property

MORTGAGE REVENUE MORTGAGE REVENUE BONDSBONDS

Commonly referred to a municipalsCommonly referred to a municipals Issued by state and local governmentsIssued by state and local governments Interest is free from federal income taxInterest is free from federal income tax Industrial bonds are used to construct Industrial bonds are used to construct

industrial parksindustrial parks Used to support affordable housing by Used to support affordable housing by

using funds to subsidize interest ratesusing funds to subsidize interest rates