310 REAL ESTATE INVESTMENT: HOLDING FINANCIAL ASSETS

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1 310 REAL ESTATE INVESTMENT: HOLDING FINANCIAL ASSETS 3. Merton [1977) has developed a model of deposit insurance as an option. The exercise price cannot be gauged accurately, because the amount of covered deposits, below the threshold, and its ratio to total liabilities, is not parametric, but fluctuates. Estimates of the variation in premium levies from risk-based deposit insurance have been presented by Ronn and Verma [1986). 4. The 40% permitted tax shield for the bad-debt provision is modified by certain adjustments. To be permitted any deduction for a bad-debt provision, an institution must have at least 60% of its assets in housing-related investments or in federal government or agency securities. To obtain the full 40"10 exclusion from income, a savings and loan institution must have 82% of its assets in these investments, losing 0.75% of the bad-debt deduction for each 1% below the threshold. The analogous parameters for savings banks are 72% and 1.5%. Thrifts are not permitted the 85% exclusion of income for dividends received from other corporations, which increases the incentive to hold mortgages and mortgage backed securities. 5. The specific characteristics of these securities are described in chapter 11. Bibliography Allen, R. C. [1981). Nothing Down. New York: Simon and Shuster. Black, F., and Scholes, M. (1973). "The Pricing of Options and Corporate Liabilities." Journal of Political Economy 81, Bradford, D. E, et al. (1984). Blueprintsfor Basic Tax Reform. 2nd edition. Arlington, VA: Tax Analysts. Brueggeman, W. 8., and Stone, L. D. (1981). Real Estate Finance. Homewood, IL: Richard D. Irwin. Downs, A. [1986). The Revolution in Real Estate Finance. Washington, DC: The Brookings Institution. Federal Deposit Insurance Corporation (FDIC) [1983). Deposit Insurance in a Changing Environment. Washington, D.C.: Federal Deposit Insurance Corporation. Federal National Mortgage Association. FNMA Yield Book. Washington, DC: Federal National Mortgage Association, various issues. Fisher, I. (1930). The Theory of Interest Rates. London: Macmillan. Government National Mortgage Association. GNMA Price and Equivalent Yield Tables. Washington, DC: Government National Mortgage Association, various issues. Hulten, c., and Wykoff, R. (1981). ''The Measurement of Economic Depreciation." In C. Hulten (ed.), Depreciation, Inflation and the Taxation of Income from Capital. Washington, DC: Urban Institute Press. Kane, E. 1. (1983). "A Six-Point Program for Deposit Insurance-Reform." Housing Finance Review 6, Kane, E. 1. (1985). The Gathering Crisis in Federal Deposit Insurance. Cambridge, MA: MIT Press.. McKean, H. P., Jr. (1965). "Appendix: A Free Boundary Problem for the Heat Exchange Equation Arising from A Problem in Mathematical Economics." Industrial Management Review 6,

2 MORTGAGE BANKING: DIRECT LENDERS 311 McKean, H. P., Jr. [1%9]. Stochastic Integrals. New York: Academic Press. Merton, R. C. [1973]. "Theory of Rational Option Pricing." Bell Journal of Economics and Management Science 4, Merton, R. C. [1977]. "An Analytic Derivation of the Cost of Deposit Insurance and Loan Guarantees." Journal of Banking and Finance I, Ronn, E. I., and Verma, A. K [1986]. "Pricing Risk-Adjusted Deposit Insurance: An Option-based Model." Journal of Finance 41, Rosen, K [1981]. 'The Effect of Proposition 13 on House Prices in Northern California: A Test of the Intetjurisdictional Capitalization Hypothesis." Journal of Political Economy 89, Smith, C. W.,Jr. [1976]. "Option Pricing: A Review." Journal of Financial Economics 3, Tobin, J. [1969]. "A General Equilibrium Approach to Monetary Theory." Journal of Money, Credit and Banking I, United States Department of the Treasury, Internal Revenue Service [1986]. Publication 436, Washington, DC: Government Printing Office. Wilcox, R. [1983]. "Why Interest Rates Were So Low in the 1970s." American Economic Review 73,

3 INDEX Accelerated cost recovery system (ACRS) 170 Adjustable rate mortgage (ARM) Comparison with FRPM 89 Going in or teaser rate 96 Indexes 98 Payment calculations 100 Periodic or total cap 96 Spread or margin 96 Appraisal Cost Hedonic Market Income capitalization Assumable financing 141 Annual percentage rate (APR) 123 Annuity Present value of 57,65 Future value of 60, 65 CAMEL (Capital, asset quality, management, earnings and liquidity) 304 Capitalization (cap) rate 26 CATS (Certificates of accrual of Treasury securities) 243 Closing costs 73 Coldwell Banker 42 Collateralized mortgage obligations 229 Comparable properties (comps) 30 Community property 16 Consumer Price Index Fisher theory of interest rates 51 Deed Grant deed 24 Quitclaim deed 24 Deed of trust 20 Trustee's sale 32 Deposit insurance 302 Depreciation 174 Equity participation loan (joint venturing) 162 Equity loan (Home)

4 314 Federal Bankruptcy Act 206 Federal Deposit Insurance Corporation (FDIC) 293 Federal Savings and Loan Insurance Corporation (FSLIC) 293 Federal Emergency Management Association 123 Farmers' Home Administration '(FmHA) 213 Federal Home Administration (FHA) 213 Federal Home Loan Bank Board (FHLBB) 213 Federal Home Loan Mortgage Corporation (FHLMC-Freddie Mac) 213 Federal National Mortgage Association (FNMA-Fannie Mae) 213 Appraisal 27 Purpose 214 UndeIWriting standards 120 Flexible payment mortgage (FPM) (seller financing) 107 Fixed rate and payment mortgage (FRPM) Cash on cash calculation 79 Effective interest rate 77 Loan amortization 72 Mortgage multiplier 58 Payment calculation 70 Generally accepted accounting practice (GAAP) 182 Government National Mortgage Association (GNMA-Ginnie Mae) 216 Graduated payment mortgage (GPM) 103 Hedging 260 Income capitalization (appraisal) 26, Income properties Appraisal-Russell index 45 Appraisal-Liquidity index 45 Inflation Risk 91 INDEX Installment payment 64 Interest rate risk 88 Investment real estate Cash on cash returns 151 Risk 157 Single period 148 Threshold marginal tax rate (MTR) 155 Joint tenancy 12 Leverage Residential real estate 127 Investment real estate 160 Nothing down strategies 155, 176 Limited partnership Bankruptcy 206 Cash on cash returns 193 Definition 189 Tax oriented 201 Loan balance Balance outstanding 62 Master limited partnership 207 Mortgage banking 292 Mortgage, definition 21 Mortgage equity 238 Mortgage exchange 253 Mortgage (backed) securities Adjustable rate mortgages 254 Cash on cash returns 217 Purchase warrants 280 Risk 221 Secondary market 212 Mortgage multiplier Actuarial v. United States rule 67 Derivation 58 Formula 66 Municipal bonds 243 Negative amortization 97 Options Call 271

5 INDEX Pricing 266 Security prices 270 Straddle 276 Partnership 17 Points Defined 69 Rationale 74 Portfolio loans 297 Prepayment penalties 76 Price level adjusted mortgage (PLAM) 108 Property taxes 179 Proposition Proposition Real estate investment trusts (REITs) 189,208 Real estate owned (REO) 296 Real Estate Settlement Procedures Act (RESPA) 123,293 Refinancing Option to 88 Relocation 181 Renegotiable rate (rollover) mortgage 106 Residential real estate Cash on cash returns 127 Owner-occupied 124 Refinancing 138 Reverse annuity mortgage III Royal Lepage 42 Self-insured mortgage security (SIMS) Sell v. hold decisions 166 Shared appreciation mortgage 109 Shared equity mortgage 113 Shell space 181 Short-term (interim financing) Add-on interest loan 82 Prepaid interest loan 81 Straight line (SL) depreciation 170 STRIPS (Separate Trading of Registered Interest and Principal of Securities) 243 Sinking fund 63, 65 Syndication 189 Tax Reform Act (TRA) 123 Tenancy in common 16 Tenancy by the entirety 16 Tenant improvements (TIs) 181 Thrifts 294 Tilting 92 Trust 18 Underwriting standards (borrower) 120 Veterans' Administration (VA) 213 Wellenkamp v. Bank of America 22 Wraparound loans 142 Zoning 23