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Understanding Financing and Transaction Prices in Real Estate

Learn about the impact of financing terms on real estate transaction prices, including market financing and non-market (creative) financing options. Explore examples of non-market financing and the factors that affect their value. Discover the value of assumable loans, seller-paid discount points, buydown financing, wraparound financing, land contracts, and mortgage revenue bonds.

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Understanding Financing and Transaction Prices in Real Estate

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  1. Chapter 7 Financing and Property Values

  2. Chapter 7Learning Objectives • Understand how the terms of financing affect the transaction price of real estate • Understand the theoretical issues related to the interaction of financing and transaction prices • Understand the different types of financing alternatives that affect transaction prices

  3. MARKET VS. NON-MARKET FINANCING • Market Financing - Typical financing with current terms as offered by institutional mortgage lenders • Non-market (Creative) Financing - Financing with terms other than market financing. May be a different interest rate or other terms

  4. EXAMPLES OF NON-MARKET FINANCING • Assumable Loan - Buyer takes over payments on an existing mortgage. • Carryback Financing - Seller provides financing of some form • Buydown - Seller pays prepaid interest to “buy down” the buyer’s interest rate • Land Contract - Seller provides financing and retains title until some future time

  5. CREATIVE FINANCING ISSUES • Various factors may affect the value attached to creative financing, e.g. • the length of the intended holding period • the amount of tax-deductible interest • the required down payment

  6. FHA/VA DISCOUNT POINTS • FHA/VA loans had interest rate ceilings until the 1980s • Were time periods when the market rate was above the ceiling rate • FHA/VA properties should sell for more than those with conventional loans when rates are limited and points are charged

  7. SELLER-PAID DISCOUNT POINTS • Seller pays discount points on borrower’s loan • Would expect points to be capitalized into the price of the house • Some studies show the price increase to be greater than the benefit to the buyer

  8. ASSUMABLE LOANS • Have value if the contract rate is less than the market rate • Value of the assumable loan should be capitalized into the price of the house • Cash equivalent is value of the property if financed with cash or current market financing • Loan value is tied to payment savings

  9. BUYDOWN FINANCING • Seller pays money to lender to “buy down” the interest rate for the buyer for a specified time • Lender receives the funds up front and lowers the interest rate on the loan • Empirical research shows that the buydown was at least partially capitalized into the house price

  10. WRAPAROUND FINANCING • A new loan “wraps around” an existing loan • Simultaneous term, fully amortized wrap • Simultaneous term, partially amortized wrap • Extended term wrap • Shorter term wrap

  11. LAND CONTRACTS • Financing provided by the seller • Higher than market price may be paid if the contract terms are favorable to the buyer • Seller retains title but buyer obtains use of the property

  12. MORTGAGE REVENUE BONDS • Commonly referred to a municipals • Issued by state and local governments • Interest is free from federal income tax • Industrial bonds are used to construct industrial parks • Used to support affordable housing by using funds to subsidize interest rates

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