RES/FIN 9776 Real Estate Finance Spring 2014 M/W 05:50-7:05pm Room: building 22, 137 East 22nd, Room 203

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1 RES/FIN 9776 Real Estate Finance Spring 2014 M/W 05:50-7:05pm Room: building 22, 137 East 22nd, Room 203 Instructor: Professor Ko Wang Office: C-412, building 22, 137 East 22nd Street Phone: (646) (Real Estate Department) (646) (Direct Line) Fax: (646) (Real Estate Department) (646) (Direct Line) Website: Office Hours: M/W 4:40 5:40 pm, or by appointment Course Description and Objectives This course examines selected techniques and issues in the area of real estate finance. Special emphasis will be placed on the design and valuation of mortgage instruments. Federal housing policies and institutional details of mortgage policies will not be emphasized. This class will be conducted using a lecture format. While my lectures will follow the table of contents of the textbook rather closely, there are times when supplemental readings will be required. The first 3 weeks of the course review the fundamentals of real estate finance. The next 12 weeks consider in detail three important issues in real estate finance: (1) residential real estate finance, which includes the valuation of alternative (creative) mortgage securities; (2) commercial real estate finance, which includes the ownership structure for financing real estate holding and valuation of mortgage-backed securities; and (3) special topics in real estate finance, which includes mortgage underwriting, portfolio and agency problems, and secondary markets. Course Prerequisites The prerequisite for this class is FIN9770 or equivalent. Students are assumed to have completed, as a background for the course, an introductory course in finance and in quantitative analysis. It is important for students to have a clear understanding of the time value of money concept and knowledge of how to use the spreadsheet before taking this class. Knowing how to use a calculator to solve present value problems (but without a clear understanding of the underlying concept) is not sufficient for tackling the course material of this class. In this class, I will not teach students how to use a (or any) calculator or spreadsheet. Course Materials:

2 (C): (O): (N): (F): "Real Estate Finance: Theory and Practice", 7th edition, by Terrence Clauretie and G. Stacy Sirmans, This book surveys the basic issues in real estate finance and investment, as such, it serves as a very good reference material for this class. My lectures will not follow the book very closely and I will rely heavily on my handouts (approximately 50% and 50%). Consequently, examination questions will not come directly from the textbook. However, I still suggest that students purchase the textbook because it provides very good back ground information for class discussions. "Real Estate Investment Trust: Structure, Performance, and Investment Opportunities", Oxford University Press (New York), 2003, by Su Han Chan, John Erickson, and Ko Wang. This book provides a systematic and comprehensive look at the REIT Industry, as such, it serves as a good reference book for students who are interested in pursuing more on this topic. This is a reference text and is not a required book for this class. A package of lecture notes that can be downloaded from my website. This package contains a rough draft of my lecture notes. I will follow the notes very closely in my lectures. It is necessary to obtain a password to obtain the files. The web site address is When you try to download the files, you will first see a login window. After you see the login window, type the following: Enter Password: ******** I will announce the password in the class. There are a total of 10 sets of lecture notes for this class. They are: N1: Introduction. PDF N1: Mortgage Concept. PDF N2: Development of Mortgage Market. PDF N3: Alternative Mortgages. PDF N4: Creative Financing. PDF N5: Secondary Mortgage Market. PDF N6: Underwriting and Foreclosure. PDF N7: Development and Construction Loans. PDF N8: Capital Decisions. PDF N9: Real Estate Return and Risk. PDF N10: REIT Performance. PDF A package of Excel files: This package contains the spreadsheet programs I used to derive some of the tables in my lecture note for this class. Those files are extremely helpful when a student wants to know the formula behind each calculation. I believe that a detailed study of the files will help students understand the course materials. Students can also download the Excel files from my website by following the same procedure described in section (N). F1: Time Value of Money. Excel Document F2: Sinking Fund & Mortgage Constant. Excel Document F3: Mortgage Concept. Excel Document F4: Monthly Amortization. Excel Document 2

3 F5: IRR & MIRR Calculation. Excel Document F6: Mortgage Amortization & Variations. Excel Document F7: Adjustable Rate Mortgages. Excel Document F8: Graduate Payment Mortgage. Excel Document F9: Price Level Adjustment Mortgage. Excel Document F10: Reverse Annuity Mortgage. Excel Document F11: Pledged Account Mortgage. Excel Document F12: Discount Points. Excel Document F13: Assumption Loan. Excel Document F14: Mortgage backed Bond. Excel Document F15: CMO & IOPO Calculations. Excel Document F16: Construction & Development Loans. Excel Document Course Structure and Classroom Procedures There will be two mid-term exams and one final exam. The mid-term exam will be held during regular class hours and the final exam will be comprehensive. The exam format will consist of two components: in-class and take-home. The in-class exam will be a combination of problems and conceptual questions. The take-home exam will be problems that require intensive calculations and students are expected to use spreadsheets to solve the problems (see appendix A for sample questions). The evaluation of class participation consists of two components: class discussion and quizzes. There are no specific rules on how to score points for the class discussions. A student's grade in this category is solely based on the instructor's objective judgement. However, a meaningful question to the instructor as well as the ability and willingness to answer the instructor's questions will definitely improve your performance. The quiz, if there is any, will be very simple. The grade of the quiz will be counted as a part of the Class Participation. Course Evaluation Your final grade will be weighted as follows: Two Mid-Term Exams: 50%, (25% each) Final Exam: 40% Class Participation: 10% The final class grade will be based on a relative frequency distribution (percentile ranking) of the total points accumulated over the entire semester. This approach implies that your final grade will be determined by the relative performance of the students in the class, as well as the overall performance of the entire class. Class participation will play an important role in your final grade if you are at the borderline between two grades. Course Policies and General Information 1. Unless otherwise told, you are NOT responsible for ALL the material in a chapter. Pay attention to my class lectures and use the textbook as a reference. The overhead 3

4 transparencies and class handouts contain the important points in this class. For the exams, use them as a guide to where your studying should be focused. 2. I will not take class attendance. However, if you miss classes, it will be EXTREMELY difficult for you to pass the exams. If you miss a lecture, it will take you a lot of time to catch up. 3. NO MAKE-UP EXAM will be given. Should you miss an exam without presenting to me a legitimate reason prior to the exam, you will be assigned a score of zero for the exam. 4. Please pay attention to the university's policy on academic dishonesty. 5. I will allow a student to drop this class as long as the procedure conforms to the university withdrawal policy. 4

5 Tentative Class Schedule ============================================================== Reading Date Topic Assignments ============================================================== Jan 27 Introductory Remarks Chp. 1. N1. Jan 29 Review of Financial Table Chp. 2. N1. Feb 3 Mortgage Concepts Appendix 1, Chp. 3. Feb 5 Mortgage Concepts N1. F1. F2. F3. F4. Feb 10 Mortgage Concepts N1. F1. F2. F3. F4. Feb 12 (Campus Closed) Feb 17 (Campus Closed) Feb 19 (Practice Exam) Feb 20 Property Market Chp. 3, 4. N2. F5. Feb 24 Fixed Interest Rate Mortgage Chp. 4. N2. F6. Feb 26 (Mid-Term Exam I) Mar 3 Post-War Finance Chp. 5. N2. Mar 5 Alternative Mortgage Instruments Chp. 6. N3. F7. F8. F9. Mar 10 Alternative Mortgage Instruments Chp. 6. N3. F10. F11. Mar 12 Alternative Mortgage Instruments Chp. 6. N3. F10. F11. Mar 17 Alternative Mortgage Instruments Chp. 6. N3. F10. F11. Mar 19 Alternative Mortgage Instruments Chp. 6. N3. F10. F11. Mar 24 Financing and Property Value Chp. 7. N4. F12. F13. Mar 26 Financing and Property Value Chp. 7. N4. F12. F13. Mar 31 Secondary Mortgage Market Chp. 10. N5. F14. Apr 2 (Mid-Term Exam II) Apr 7 Secondary Mortgage Market Chp. 10. N5. F14. Apr 9 Valuation of Mortgage Securities Chp. 11. N5. F15. Apr 14 (Campus Closed, Spring Recess) Apr 16 (Campus Closed, Spring Recess) Apr 21 (Campus Closed, Spring Recess) Apr 23 Valuation of Mortgage Securities Chp. 11. N5. F15. Apr 28 Valuation of Mortgage Securities Chp. 11. N5. F15. Apr 30 Defaults, Loan Origination & Insurance Chp N6. May 5 Development & Construction Loans Chp. 18. N7. F16 May 7 Capital Structure and Sources of Funds Chp. 15,17. N8. N9. May 12 International Portfolio and Ethics Chp. 21, 22. May 14 Real Estate Stock Market Chp. 20. N10. REIT Book Chp May (Final Exam) ============================================================== 5

6 Appendix A: Sample Questions In-class component: 1. A borrower can obtain a lower first year interest rate (as compared to the first year interest rate of a standard fixed-rate mortgage) when she/he selects an adjustable rate mortgage. Why (5 points)? Note: I will only read your first 30 words. 2. Given the following information: A. Original Loan Amount = $300,000. B. Loan Balance at the end of First Year = $296,800. C. First Year Debt Service = $45,950. What is the sinking fund factor of the loan? (5 points). Hint: To answer this question, you need to figure out the principal payment of the first year. Show your work for partial credit. 3. Given the following information, (1) Fixed-rate mortgage, (2) Annual interest rate = 12%, (3) Monthly payment, (or monthly interest rate = 1%), (4) Amortization period = 30 years (or 360 months), (5) Original loan amount = $100,000. Please calculate the annual debt service, annual interest payment, annual principal payment, and the ending loan balance at end of each year for the next three years. Specifically, please complete the following amortization table (10 points). =========================================================== Beginning Debt Interest Principal Ending Year Balance Service Payment Payment Balance =========================================================== 0 $100,000 NA NA NA NA 1????? 2????? 3????? ============================================================ Note: This mortgage assumes monthly payments. The amortization table is different from the one using annual payments. 4. Why would one expect that the cash-equivalent value of an assumable loan would not be fully capitalized into the house prices (10 points)? 5. Explain what interest only (IO) and principal only strips are (5 points). Which strip, the IO strip or the PO strip, is said to have negative duration (1 point)? Why (4 points)? 6

7 6. State and explain the two theories of default (2 points). Which theory makes more "intuitive" sense (3 points)? Take-home component: 1. Please re-construct the amortization tables of the five ARMs discussed in class. In addition, please extend the period from 37 months (as shown in my handouts) to 61 months. Please calculate the monthly IRR and MIRR (FMRR) for each of the 5 ARMs listed in problem 1 (20 points). 2. Please re-construct the amortization table of a graduated payment mortgage ($100,000 at 12 percent for 30 years, monthly payment, graduating in payments through the first 10 years) using 10% annual payment growth rate. Please report the amortization table of the first 181 months (10 points). 7