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Real Estate Debt

Learn about real estate debt, its definition, key mortgage terms, risk measures, loan sizing, interest rates, default mechanics, and the causes and effects of leverage. Understand the differences between debt and equity in real estate and explore various financial leverage scenarios.

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Real Estate Debt

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  1. Real Estate Debt

  2. Financial Leverage Road Map Real estate debt defined (vs. equity) Key mortgage terms First dollar vs. last dollar risk Key mortgage performance measures Loan sizing Mortgage interest rates Default mechanics and metrics Mortgage amortization Mortgage default history Causes and effects of leverage Subordinate debt

  3. Financial Leverage Road Map Real estate debt defined (vs. equity) Key mortgage terms First dollar vs. last dollar risk Key mortgage performance measures Loan sizing Mortgage interest rates Default mechanics and metrics Mortgage amortization Mortgage default history Causes and effects of leverage Subordinate debt

  4. Financial Leverage Road Map Real estate debt defined (vs. equity) Key mortgage terms First dollar vs. last dollar risk Key mortgage performance measures Loan sizing Mortgage interest rates Default mechanics and metrics Mortgage amortization Mortgage default history Causes and effects of leverage Subordinate debt

  5. Debt vs. Equity

  6. Financial Leverage Road Map Real estate debt defined (vs. equity) Key mortgage terms First dollar vs. last dollar risk Key mortgage performance measures Loan sizing Mortgage interest rates Default mechanics and metrics Mortgage amortization Mortgage default history Causes and effects of leverage Subordinate debt

  7. What terms differentiate mortgages? Cost of debt (interest) Key lender measures: LTV, DSCR, DY Recourse Fixed vs. floating payments Amortization Prepayment Transferability Extensions and extension tests Additional financing Leasing guidelines

  8. Financial Leverage Road Map Real estate debt defined (vs. equity) Key mortgage terms First dollar vs. last dollar risk Key mortgage performance measures Loan sizing Mortgage interest rates Default mechanics and metrics Mortgage amortization Mortgage default history Causes and effects of leverage Subordinate debt

  9. First dollar vs. last dollar risk

  10. Hypothetical transaction

  11. Scenario 1: 50% increase in value

  12. Scenario 2: 50% decrease in value

  13. Financial Leverage Road Map Real estate debt defined (vs. equity) Key mortgage terms First dollar vs. last dollar risk Key mortgage performance measures Loan sizing Mortgage interest rates Default mechanics and metrics Mortgage amortization Mortgage default history Causes and effects of leverage Subordinate debt

  14. Key lender measure: Loan-to-Value (LTV) LTV is the simplest indicator of leverage, or the amount of debt. A higher debt load leads to higher debt service payments, which is directly associated with higher default risk.

  15. Key lender measure: Debt Coverage (DSCR) DSCR is a measure of a property’s ability to cover its debt payment. Lower coverage, or margin of error, is directly associated with higher default risk.

  16. Key lender measure: Debt Yield (DY) Debt yield, like DSCR, is also a measure of a property’s ability to service debt payments, but it is in proportion to the overall loan amount, which makes it a purer indicator of income, because it isn’t skewed by interest rates or interest only payments. Debt yield is essentially the lender’s cap rate, or the amount of income relative to the lender’s basis in the property.

  17. Key lender measures in practice LTV drives DSCR and DY DSCR is a bigger driver of defaults Loan maturity often triggers default Lenders “size” mortgages based on LTV, DSCR and/or DY thresholds

  18. Financial Leverage Road Map Real estate debt defined (vs. equity) Key mortgage terms First dollar vs. last dollar risk Key mortgage performance measures Loan sizing Mortgage interest rates Default mechanics and metrics Mortgage amortization Mortgage default history Causes and effects of leverage Subordinate debt

  19. Loan sizing example What is the largest loan this lender can offer?

  20. Loan sizing example: Max LTV 1

  21. Loan sizing example: Max LTV

  22. Loan sizing example: Min DSCR 2

  23. Loan sizing example: Min DSCR

  24. Loan sizing example: Min DSCR

  25. Loan sizing example: Min DSCR

  26. Loan sizing example: Min DSCR

  27. Loan sizing example: Min DSCR

  28. Loan sizing example: Minimum DY 3

  29. Loan sizing example: Min Debt Yield

  30. Loan sizing example: Summary

  31. Loan sizing example: Summary What is the largest loan this lender can offer?

  32. Loan sizing example: Summary What is the largest loan this lender can offer?

  33. Loan sizing practice problem

  34. Financial Leverage Road Map Real estate debt defined (vs. equity) Key mortgage terms First dollar vs. last dollar risk Key mortgage performance measures Loan sizing Mortgage interest rates Default mechanics and metrics Mortgage amortization Mortgage default history Causes and effects of leverage Subordinate debt

  35. Debt pricing: Fixed Rate Example * Key base rates for institutional real estate debt: - Fixed rate loans = Treasury Yields - Floating rate loans = LIBOR

  36. Debt pricing: Deconstructing Interest Rates 4.31% Coupon Interest Rate Spread (150 bps) Base Rate (2.81%)

  37. Debt pricing: Deconstructing Interest Rates 4.31% Coupon Interest Rate Risk Free Rate: The yield on the safest investible alternative. i.e., comparable duration US Govt bond.

  38. Debt pricing: Deconstructing Interest Rates 4.31% Coupon Interest Rate Liquidity premium: Additional yield for investing in an instrument that can’t be quickly traded.

  39. Debt pricing: Deconstructing Interest Rates 4.31% Coupon Interest Rate Inflation premium: Additional yield for the expectation of repayment dollars being less valuable than current dollars.

  40. Debt pricing: Deconstructing Interest Rates 4.31% Coupon Interest Rate Maturity premium: Additional yield for investing in a longer-term fixed-rate instrument, since changes in interest rates more significantly affect instruments with longer durations.

  41. Debt pricing: Deconstructing Interest Rates 4.31% Coupon Interest Rate Default risk premium: Additional yield for investing in instruments with higher risk of loss from defaults.

  42. Financial Leverage Road Map Real estate debt defined (vs. equity) Key mortgage terms First dollar vs. last dollar risk Key mortgage performance measures Loan sizing Mortgage interest rates Default mechanics and metrics Mortgage amortization Mortgage default history Causes and effects of leverage Subordinate debt Exercises

  43. Debt pricing: Pricing Default Risk Default risk premium: In this scenario, the lender prices 32 bps of default risk into the spread charged to the borrower.

  44. Financial Leverage Road Map Real estate debt defined (vs. equity) Key mortgage terms First dollar vs. last dollar risk Key mortgage performance measures Loan sizing Mortgage interest rates Default mechanics and metrics Mortgage amortization Mortgage default history Causes and effects of leverage Subordinate debt

  45. Amortization Amortization refers to the periodic repayment of loan proceeds over time. Amortizing a loan over a shorter period will result in a lower loan balance at maturity, reducing default risk at maturity (all else equal).

  46. Sample Amortization Schedule

  47. Amortization Exercise ?

  48. Financial Leverage Road Map Real estate debt defined (vs. equity) Key mortgage terms First dollar vs. last dollar risk Key mortgage performance measures Loan sizing Mortgage interest rates Default mechanics and metrics Mortgage amortization Mortgage default history Causes and effects of leverage Subordinate debt

  49. Mortgage Default History

  50. Mortgage Default History

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