real estate finance in a canadian context · pi = (gdsr x gross income) – prop taxes pi= (35% x...

Real Estate Division

Real Estate Finance in a Canadian Context

Webinar 2: Chapter 7, 8 and Project 1 Preparation

Sharon Gulbranson

IntroductionREAL ESTATE DIVISION

d• Introduction • Overview of session

UNIVERSITY OF BRITISH COLUMBIA 3

TopicsREAL ESTATE DIVISION

Topics

• Review of Mortgage Finance• Chapter 7: Mortgage Underwriting and Residential Borrower Qualification

• Chapter 8: Commercial Mortgage Underwriting

• Project 1 Preparation• Questions


Multiple Choice Question 1REAL ESTATE DIVISION

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B $150 000 t j 4% f 25Borrow $150,000 at j2 = 4% for a 25‐year amortization period and a 2‐year term. Payments are monthly and rounded up toPayments are monthly and rounded up to the next higher dollar. What is the amount of the monthly payment?

(1) $789(2) $790( ) $(3) $791(4) $792(4) $792


Calculator StepsREAL ESTATE DIVISION

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4 shift NOM%4 shift NOM%2 shift P/YRshift EFF% 4 04shift EFF% 4.0412 shift P/YRshift NOM% 3 967068389656shift NOM% 3.967068389656150000 PV300 N300 N0 FVPMT ‐789.030307937



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S f t f ti 1Same facts from question 1• Calculate the principal paid during the 12thpayment and the total interest paid during year 1payment and the total interest paid during year 1.

(1) $485.05; $6,211.08(2) $309.85; $3,556.74(2) $309.85; $3,556.74(3) $412.88; $4,765.01(4) $304.99; $5,885.72( ) $ ; $ ,

7UNIVERSITY OF BRITISH COLUMBIA

Calculator Steps (continued)REAL ESTATE DIVISION

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790 / PMT790 +/‐ PMT12 INPUT shift AMORT = ‐304.990490825

h f1 INPUT 12 shift AMORT = = ‐5,885.71723019



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B d h f ll i h fl l l h• Based on the following cash flows, calculate the NPV at a rate of j1 = 6%.

• Cost: $150 000• Cost: $150,000• Yr 1 CF = ‐$50,000; Yr 2 CF = $20,000; Yr 3 CF = $45,500, Yr 4 CF = $30,000 and Yr 5 CF = $175,000$ , , $ , $ ,

(1) $13,365.79(2) $65,366.80(3) $107,705.41(4) $27,667.98


Calculator StepsREAL ESTATE DIVISION

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shift C ALLshift C ALL6 I/YR1 shift P/YR150000 +/‐ CFj50000 +/‐ CFj20000 CFj45500 CFj30000 CFj30000 CFj175000 CFjshift NPV 13 365 7850062shift NPV 13,365.7850062


Ch 7: Mtg Underwriting and R id ti l Q lifi ti

REAL ESTATE DIVISION

Residential Qualification

• Introduction• Information Collection• Lending Policy• Examplep


Chapter 7: IntroductionREAL ESTATE DIVISION

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• the process used by lenders in determining whether or not to lend mortgage money and how much if anyhow much, if any

• focus on residential properties (owner occupied)occupied)

• 2 types of risk: Default risk: will borrower honour contract?Default risk: will borrower honour contract?Capital risk: will property retain its value?


Information CollectionREAL ESTATE DIVISION

• How?• Loan application• Credit analysis• Appraisal of propertypp p p y


Loan ApplicationREAL ESTATE DIVISION

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• Personal InformationPersonal Information• Employment Information• Income InformationIncome Information• Assets and Liabilities• Mtg Financing Needs• Mtg Financing Needs• Loan requested• Characteristics of Property• Characteristics of Property• Subsequent Costs Clause

P i i Cl d Si• Permission Clause and SignatureUNIVERSITY OF BRITISH COLUMBIA 14

Credit AnalysisREAL ESTATE DIVISION

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• Purpose: to provide info on applicant’s past pmt behaviour and the likelihood this will

ti i t th f tcontinue into the future• attempt to get a handle on ability to pay and intention to comply with the mortgage termsintention to comply with the mortgage terms

• attempt to minimize future default, based on past recordpast record


Appraisal of PropertyREAL ESTATE DIVISION

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• nature of real property pledged as security is very important to the lenderA i l T h i Di C i• Appraisal Techniques: Direct Comparison Approach and Cost Approach

• Market Val e e pe ted sale pri e• Market Value: expected sale price• Lending Value: LT conservative estimate of value; the value used for lending purposesvalue; the value used for lending purposes


Lending PolicyREAL ESTATE DIVISION

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• Rules of lending that determine the maximum loan that can be supported by:

• the lending value of the property h l ’AND the applicant’s income


Lending ConstraintsREAL ESTATE DIVISION

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• Loan‐to‐value ratio

• Debt service ratios (GDSR and TDSR)

• NB: Find the maximum loan underall constraints. The lowest loan amt will set the overall loan size


Loan-to-Value (LTV) Ratio REAL ESTATE DIVISION

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• Maximum Loan = LTV Ratio x Lending Value• less than 100%• % set by: statutory maximums for institutional lenders, lender’s general policy, current

il bilit f t f d i k lavailability of mortgage funds, risk on loan, and availability of mortgage insurance


Debt Service RatiosREAL ESTATE DIVISION

• maximum loan which can be supported by borrower’s income

• based on annual estimate of gross• based on annual estimate of gross income

• GDSR = PITGross Income

TDSR PIT Oth P t• TDSR = PIT + Other PaymentsGross Income


Residential Qualification Example REAL ESTATE DIVISION

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Based on the following information, calculate the maximum loan allowable?

$Purchase price = $485,000; lending value = $480,000; annual gross income = $90,000; annual net property taxes = $2 750; otherannual net property taxes = $2,750; other debts = $5,000 per year

Constraints: loan‐to‐value= 80%; GDSR= 35%;Constraints: loan‐to‐value= 80%; GDSR= 35%; TDSR= 40%

Loan: j12=5 5%; 25‐yr amortization; mo pmtsLoan: j12 5.5%; 25 yr amortization; mo pmts



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B d LTV i f 80% h i h• Based on a LTV ratio of 80%, what is the maximum loan under the loan‐to‐value ratio?ratio?

• Purchase price: $485,000• Lending value = $480 000• Lending value = $480,000(1) $388,000(2) $363 750(2) $363,750(3) $375,000( ) $38 000(4) $384,000


SolutionREAL ESTATE DIVISION

Maximum loan = 80% x Lending ValueMaximum loan = 80% x $480,000Maximum loan = $384,000



PI = (GDSR x Gross Income) – Prop TaxesPI= (35% x $90,000 ) ‐ $2,750PI = $28,750 per yr; $2,395.83 per moAND (with TDSR)PI = (TDSR x Gross Income) – Taxes – Other PMTs

PI = (40% x $90,000) ‐ $2,750 ‐ $5,000PI = $28,250 per yr; $2,354.16 per month


Solution ContinuedREAL ESTATE DIVISION

Max loan = $2,354.16 x a[[300, j12 = 5.5%]] Max loan = $383,359.055.5 I/YR12 shift P/YR2354.16 +/‐ PMT300 N0 FVPV 383,359.053814


Chapter 8: Commercial Mortgage U d iti


Underwriting

• Residential vs commercial• Application process• Cash flow analysis• Lending constraintsg• Example


The ProcessREAL ESTATE DIVISION

• income producing properties non owner• income producing properties ‐ non‐owner occupied residential property and all non‐residential property (apts, office, medical, p p y ( pwarehouse etc.)

• underwriting process is similar to residential, but f i PROPERTY i t b ’focus is on PROPERTY income, not borrower’s income

• lending practice under residential is relatively• lending practice under residential is relatively uniform among lenders, not so with commercial mtg lending. Why?



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Commercial lending activities are less uniform than residentialCommercial lending activities are less uniform than residential because:

(1) Commercial borrowers are generally less sophisticated ( ) g y pwith respect to financing than typical residential borrowers

(2) Commercial properties are homogeneous(3) The large size of commercial loans requires less detailed

analysis than with residential applications(4) The nature of the covenant to pay on commercial loans is(4) The nature of the covenant to pay on commercial loans is

much more diverse than income used in residential underwriting


Cash Flow AnalysisREAL ESTATE DIVISION

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Gross Potential Rental Income+ Other Income‐ Vacancy and Bad Debt Allowances= Effective Gross Income (EGI)‐ Operating Expenses= NET OPERATING INCOME (NOI)



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Example of NOI CalculationREAL ESTATE DIVISION

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Based on the following information, calculate the annual NOI.

20 i 8 b d i @ $1 20020 suite apartment: 8 two bedroom units @ $1,200 per month and 12 one bedroom units @ $900 per monthmonth

Other Income ‐ $5,000 per year (collected)Vacancy and Bad Debts are 3% of Gross RentalVacancy and Bad Debts are 3% of Gross Rental Income and operating expenses are $95,000 per yearyear



8 x $1200 x 12 = $115 2008 x $1200 x 12 = $115,20012 x $900 x 12 = $129,600

$244 800$244,8003% Vacancy ‐$7,344

$$237,456Other Income $5,000Effective Gross Income $242,456Operating Expenses $95,000NOI $147,456


Items Omitted in NOIREAL ESTATE DIVISION

• Depreciation• Income Tax• Capital Cost Allowance (CCA)• Debt Service (Mortgage Payments)( g g y )


Lending PolicyREAL ESTATE DIVISION

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l l f i i (l l )• two levels of constraints: security (loan‐to‐value) and income (safety margin and debt coverage ratio)ratio)

• choose the lowest constraint in order to qualify for the maximum loanfor the maximum loan


Income Constraints REAL ESTATE DIVISION

f f d h• Safety Margin: % of NOI set aside as a cushion to ensure that there is adequate income to cover the mtg pmtscover the mtg pmts

• Debt Coverage Ratio (DCR) = NOI/Debt Service; must be greater than 1; related to the safetymust be greater than 1; related to the safety margin: [1/(1‐Safety Margin)]


Loan-to-Value RatioREAL ESTATE DIVISION

M i l % L di V l• Maximum loan = % x Lending Value• Maximum/minimum % set by lender

l di l k l• assume lending value = market value• How do we calculate market value?• Use Direct Capitalization Approach or Discounted Cash Flow Approach


Direct Capitalization TechniqueREAL ESTATE DIVISION

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M k V l NOI S bj P /M kMarket Value = NOI Subject Property/Market Cap Rate

M k t t i th t f t t dMarket cap rate is the rate of return expected (yield) on recently sold similar properties

Yield = NOI/Sale Price (market value)Yield = NOI/Sale Price (market value)


Commercial Qualification E l


Example

• Based on the following, calculate the maximum loanallowable under the LTV ratio and the debt coverage ratio.Which is the binding constraint?Which is the binding constraint? • Interest rate: j12=10%. Monthly payments will be

amortized over 20 years with a 3‐year term. y y• Loan to value: 70%; DCR: 1.2• Market Cap Rate: 8%• NOI = $107,400 per annum



LTVLTVMax loan = Lending Value x 70%Max loan = $107 400/0 08 x 70%Max loan = $107,400/0.08 x 70% Max loan = $1,342,500 x 70%Max loan $939 750Max loan = $939,750DCRM i l (PMT) NOI/DCRMaximum annual payment (PMT)= NOI/DCRPMT = $107,400/1.2 = $89,500 per year

$PMT = $7,458.33 per monthUNIVERSITY OF BRITISH COLUMBIA 39

Solution continuedREAL ESTATE DIVISION

Solution continued

PV = $7,458.33 x a[[240, j12 = 10%]]10 I/YR12 shift P/YR7458.33 +/‐ PMT240 N0 FVPV 772,866.602327DCR is binding, max loan = $772,866DCR is binding, max loan $772,866


Project 1REAL ESTATE DIVISION

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• Covers lessons 1‐6 (chapters 1‐8)• 20% of course grade


Question 1: Residential Q lifi ti


Qualification

• Show work• Interest rate• Rounding of payment• GDSR payment rounding• For the overall max loan, compare LTV and GDSR


Question 2: Commercial Q lifi ti


Qualification

• Calculate NOI • Interest rates‐‐brief explanation required

• Max loan: calculate and compare all i LTV f i d DCRoptions: LTV, safety margin, and DCR


Question 3: History of RatesREAL ESTATE DIVISION

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• Provide ample and detailed discussion• Show graph and supporting table • Show extended time frame• Provide source explicitly and on tablep y• Look at general trends and specific blips in time


Question 4: Residential Mortgage P d t


Products

• Include a table• Compare products and provide some details

• Give reasons for similarities/differences• Identify and compare basic and uniqueproducts


Question 5: Mortgage Loan I


Insurers

• Discuss all three mortgage loan insurers • Include table• Add some detail to list


Question 6: Internet Research P j t


Project

• Follow framework: overview, description, and analysis

• On topic: legal issue related to mtg finance• Use headings/sub‐headings• Sample text required• 5 marks for presentation


Next Webinar SessionREAL ESTATE DIVISION

• Project 2 preparation• Covers Lessons 7‐10 and course overview

• 20% of course grade


QuestionsREAL ESTATE DIVISION

49UNIVERSITY OF BRITISH COLUMBIA

real estate finance in a canadian context · pi = (gdsr x gross income) – prop taxes pi= (35% x...

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