Real Estate Investment and Financing Basics

Real Estate Investment and Financing

• Corporations, owned by shareholders, with a BOD and management, pay corporate taxes and distribute income through dividends.
• Real Estate Operating Companies (REOC) are corporations primarily investing or operating real estate projects, paying regular corporate taxes.
• Real Estate Investment Trusts (REIT) are legal entities primarily investing in real estate, with specific asset and income requirements and public trading.
• Net Present Value (NPV) is the sum of cash flow PV minus initial investment, compared to the discount rate or hurdle rate.
• Internal Rate of Return (IRR) measures annual growth rate and is compared to the hurdle rate, calculated on unlevered or levered basis.
• Allocation of profit includes preferred returns, promote, and claw back for investors and partners.
• Exit strategies, such as Right of First Offer, Right of First Refusal, Shotgun Clause, and Sale by Appraisal, can ease investor exits.
• Capital structure includes secured debt, wrap-around, mezzanine debt, unsecured debt, and preferred equity.
• Additional sources of funds include Sale Leaseback, Ground Lease, Pad Sale, and Sale of rights.
• Development involves creating new properties, driven by specific user requirements or speculation, with development and construction costs.
• Development costs include professional services, environmental studies, land acquisition, permits, and zoning.
• Soft costs, part of development costs, start before construction and include professional services, studies, acquisition, permits, and zoning.

Real Estate Development and Financing Overview

• Real estate development involves several stages including site selection, predevelopment, entitlements, and construction with various costs associated with each stage.
• Construction costs include site preparation, building costs, and infrastructure development, and can be influenced by change orders and unforeseen risks.
• Types of construction contracts include fixed price, guaranteed maximum price, and cost plus contracts, each offering different levels of protection for the developer or the construction company.
• Unanticipated risks during the site work stage can include environmental, soil, and cultural issues, potentially leading to cost overruns.
• Interior finishing and tenant fit-out are critical in preparing the building for its ultimate purpose, with funding often provided by the developer through tenant allowances.
• Bringing a property to a stabilized income level can result in additional costs for the developer, including interest (carrying) costs and operational costs such as leasing and sales expenses.
• Delays in construction can negatively impact pre-leasing and pre-sales, leading to development risks including carrying costs of land and construction cost overruns.
• Development financing is required for different phases of development, with predevelopment typically funded by the developer's capital or corporate credit, and land acquisition and construction loans available with specific terms and conditions.
• Construction loans are based on the total expected cost and anticipated value at stabilization, with funding for carrying and operational costs during stabilization sometimes included.
• Bridge financing in the form of a mini perm can be arranged if the property has not reached its stabilized NOI, with take-out financing typically arranged once the property has reached its stabilized NOI or has been delivered to tenants.
• Real Estate Investment Trusts (REITs) are special purpose legal entities whose primary business is real estate investment, providing a vehicle for investment in real estate with specific tax advantages and requirements.
• REITs can invest in various types of real estate assets, including residential, commercial, and industrial properties, and are required to distribute a significant portion of their income to shareholders.

Real Estate Investment Trusts (REITs) and Real Estate Finance

• Equity REITs purchase, own, and manage income-producing properties, while Mortgage REITs focus on real estate debt, and Hybrid REITs combine both.
• REITs must meet specific qualifications, such as having at least 90% of their revenue come from rent or mortgage interest, and 75% of their property value in Canada.
• REITs must be publicly traded, with a high level of distributions, typically around 90% of income.
• Income within a REIT is not taxed if distributed to unitholders, providing an advantage to non-taxable institutional investors.
• The Canadian housing finance system involves mortgage originators, financial institutions, and non-regulated finance companies.
• Mortgage origination in Canada is dominated by banks, with 80% of mortgages originating from federally regulated lenders.
• Mortgage loan insurance is required for down payments less than 20% of the purchase price, with premiums ranging from 0.6% to 4.50% of the mortgage amount.
• Real estate investment offers diversification, low covariance with other assets, and availability of large size investments, attracting entities like Caisse de dépôt et placement du Québec and Canada Pension Plan.
• Debt securities are governed by terms and conditions, including interest rate, amortization, maturity date, security, seniority, and covenants.
• Debt can be issued privately through a lender or syndicate, or publicly through investment bankers, offering options like bonds, notes, commercial paper, and credit.
• Credit and risk assessment for real estate finance includes evaluating credit metrics, leverage, coverage, security, recourse, non-recourse, seniority, and covenants.
• Investors in real estate finance include commercial banks, investment banks, insurance companies, pension funds, private equity funds, sovereign funds, individuals/families, conduits, and various types of mortgage-backed securities.