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Copyright © 2008 by the McGraw-Hill Companies, Inc. All ...

Copyright © 2008 by the McGraw-Hill Companies, Inc. All ...






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    Copyright © 2008 by the McGraw-Hill Companies, Inc. All ... Copyright © 2008 by the McGraw-Hill Companies, Inc. All ... Presentation Transcript

    • Chapter 18: Sources of Commercial Debt and Equity Capital
    • How Large is U.S. Commercial Real Estate Market? Core commercial real estate includes properties suitable for institutional ownership, excluding owner-occupied building and smaller properties
    • Value of U.S. Commercial RE? --Direct vs. securitized investments? --How leveraged is commercial real estate? --RE owned by non-RE corporations?
    • Privately Owned Commercial RE --88% ($1,700/$1,931) of private equity is owned by “non-institutional” investors --Who are these guys??!!!
    • Institutional Investors?
      • Public equity markets?
        • Real Estate Investment Trusts (REITs)
          • Can be described as mutual funds for investing in real estate
            • Diversification benefits
            • Liquidity
          • Types of REITs?
            • Equity REITs
            • Mortgage REITs
            • Hybrid REITs
    • More on REITs
      • REITs are not taxed at the corporate level if they satisfy a set of restrictive conditions on an ongoing basis:
        • At least 100 shareholders
        • 75% of assets must be real estate, cash, or government securities
        • At least 75% of gross income must come from real estate assets
        • 90% of REIT taxable income must be paid out in dividends each year
    • Institutional Investors in Core Private Equity Markets?
      • Pension funds
        • Important participant in commercial real estate equity markets
        • Commingled real estate funds
      • Life insurance companies
        • Long-term liabilities a good match for long-term, illiquid, real estate investments
        • More active as lenders than as investors
    • Institutional Investors in Core Private Equity Markets?
      • Others:
        • Foreign investors
        • Banks
        • Savings associations
    • Non-Institutional Core Investors in Private Equity Markets?
      • Individuals and families
      • RE syndications that form:
        • Limited partnerships (LPs)
        • Limited liability companies (LLCs)
        • S corporations
      • Syndication is a pooling of private equity capital
    • Advantages of Pooled Ownership Structures?
      • Allows investors to purchase an interest in larger properties
      • Diversification of portfolio
      • Economies of scale in acquisitions, management and disposition
      • Access to cheaper debt capital
      • Expertise of management team hired by organizer
    • Disadvantages of Pooled Ownership Structures?
      • Often must relinquish management control to active manager
      • Must compensate syndicator/manager with fees, salary and/or a disproportionate share of equity ownership
      • ➨ lower returns on equity, all else equal
    • Forms of Ownership for Pooled Equity Investments in Real Estate
      • C corporation
      • S corporation
      • General partnership
      • Limited partnership
      • Limited liability company
      • Tenancy-in-common
    • What Drives Choice of Ownership Form?
      • Federal income tax rules
      • Desire of investors for limited liability
      • Management control issues
      • Ability to access debt and additional equity capital
      • Ability of investors to dispose of their interests
    • Choosing Optimal Form of Ownership
    • Notes to Table
      • 1 Investors cannot utilize losses that are in excess of their individual tax basis in the entity. S corporation shareholders cannot include their share of any corporation mtg. debt in the calculation of their tax basis.
      • 2 The general partner(s) is subject to unlimited liability.
      • 3 The general partner manages the operations of a limited partnership.
      • 4 Corporate structures and LLCs allow ownership interests to be freely transferred; however, the actual liquidity of corporate or LLC investments depends on the size of the entity and, in the case of corporate shares, whether the shares are traded on a major exchange.
      • 5 Co-tenants are jointly and severaly liable for all debts of the TIC. This potential liability may be avoided if investors use bankruptcy remote, special purpose entities to invest in the TIC.
    • What Ownership Structure is Typically Chosen by Noninstitutional Investors?
      • C-corporation and GP structures are seldom chosen
      • S-corporations are popular with some sole proprietors
      • However, LLCs and LPs are the two dominant ownership structures
      • Recent emergence of TIC structures, designed primarily to help investors avoid capital gain taxes, is an important trend
    • More on Limited Liability Companies
      • IRS gave partnership tax status in 1998, then all 50 states had to enact LLC laws
      • NOT a corporation, partnership, or sole proprietorship
      • IS a blend of some of best characteristics of corporations, partnerships, and sole proprietorship.
      • ➨ a “super pass through entity”
      • IS a separate legal entity (like a corporation), but is treated as a partnership for tax purposes
    • More Limited Liability Companies
      • To create, “members” file articles of organization with state
      • Members should have an “operating agreement” that explains operation and management of business
      • Combines corporate characteristics of limited liability with flow-through tax characteristics of a partnership.
    • More Limited Liability Companies
      • Relative to LPs…
        • LLCs permit all owners to participate in management &
        • have limited liability.
    • New to the Scene: Tenancy-in-Common (TIC) Investments
      • Co-ownership by two or more investors
      • Investors possess undivided interests in property
      • Investors receive separate deed…considered direct owners
      • Investors share “pro rata” in CF, tax consequences, and appreciation
      • ≤ 35 investors
    • New to the Scene: Tenancy-in-Common (TIC) Investments
      • Co-owners must unanimously approve:
        • hiring of manager
        • sale of property
        • all leases
        • all mortgage liens
        • (voting implies a partnership)
      • For all other actions, co-owners may agree to be bound by a vote of more than 50% of co-owners
    • New to the Scene: Tenancy-in-Common (TIC) Investments
      • Approval requirements can be finessed (sort of) with a well-written TIC agreement
        • Allow other owners to buy out “problem” owners
        • Implied consent provision....if owners do not object to a suggested management “action” of which they are informed, the action is automatically approved
        • Master lease
    • Tenants in Common (TIC) Investments: So What’s all the Buzz?
      • In a tax-deferred exchange, real property can’t be exchanged for a partnership interest!
      • Also, in delayed exchange, seller must (1) identify replacement property within 45 days and (2) take title to replacement property within 180 days
      • However, under a revenue procedure released in March of 2002 by the IRS, taxpayers can exchange an interest in real property for a TIC investment
    • Tenants in Common (TIC) Investments: So What’s all the Buzz?
      • So……TIC properties:
        • Allow investor to complete a 1031 exchange
        • Often available as “turnkey” prepackaged investments with mgmt and financing in place
        • Allow investor to purchase any amount above a required minimum
        • -> thus allowing her to dollar match equity received from relinquished property
      Web Tip A tenant-in-common trade association www.ticassoc.org
    • Other Advantages: Tenant in Common (TIC) Investments
      • Provide many of the benefits associated with other forms of co-ownership :
        • Access to more expensive properties
        • Portfolio diversification
        • Benefit from services of professionals in acquisitions, mgmt, and dispositions
        • Access to cheaper debt capital
    • Disadvantage: Tenant in Common (TIC) Investments
      • Depending on structure, might be deemed a “security”
        • However, usually are Regulation D Private Placement Offerings; thus exempt from public registration if sold only to “accredited” investors
        • Sold only by licensed securities broker
      • Sponsor fees and expenses may consume up to 25% of equity
      • Illiquidity
      • Joint and several liability
    • Choosing an Optimal Form of Ownership In practice, choice is usually one of the following four
    • The Perspective in This Class ?
      • Single property investment and decision making
      • Property level valuation…..not investor level valuation
      • …… .although we will spend quite a bit of time with investor level taxation!!
    • Sources of Commercial Real Estate Debt  
    • Sources of Commercial Real Estate Debt
      • 73% of outstanding commercial debt ($2.2 trillion) is privately held by individual and institutional investors such as:
        • Commercial banks
        • Life insurance companies
        • Foreign investors
        • Savings associations
    • Sources of Commercial Real Estate Debt
      • 27% of outstanding commercial debt ($835 billion) is publicly traded
        • GSE backed commercial mortgage-backed securities (CMBSs)
        • Non-government backed CMBS
        • Investment grade unsecured debt of large REITs
    • Mortgage Originators vs. Long-Term Holders
      • Many long-term holders purchase mortgages in the secondary mortgage market
      • Who originates the mortgages purchased by life insurers, foreign investors, pension funds, and CMBS issuers?
        • Other long-term holders—primarily banks
        • Mortgage banking companies
    • A Closer Look at Syndications
      • A syndication is a group of people who pool funds to invest in real estate.
      • Not a separate form of ownership.
      • RE syndicates are usually organized as limited partnerships or limited liability companies
        • Syndicator is general partner (GP) in LP or managing member in LLC
        • How are LPs and LLCs taxed?
        • Why are LPs and LLCs the dominate form of ownership?
    • Advantages of Syndication (either through a LP or LLC)
      • Provides passive investors with benefits of real estate ownership
      • Professional management of properties
      • Freedom from personal liability
    • Roles of the Syndicator/Organizer
      • Organization Phase
        • Develop concept
        • Organize the legal entity
        • Draft offering memorandum
        • Market the ownership interests
        • Acquire the real estate (or purchase option)
    • Roles of the Syndicator/Organizer
      • Operation Phase
        • Manage the syndication
        • Send out tax information
        • Manage the property?
    • Roles of the Syndicator/Organizer
      • Disposition Phase
        • Prepare the property for sale
        • Market the property
        • Send out final tax information
        • Dissolve the syndication
    • Basics of Syndication Regulation
      • Under Federal Securities Acts of 1933 and 1934, all RE syndications are “securities”
      • All securities are subject to federal AND state securities laws
      • SEC has responsibility for administering federal securities laws
        • All offerings are registered with SEC
        • All offerings provide adequate disclosure
      • Every state also has securities laws
    • A Closer Look at REITs
    • Security Offerings by REITs Large surge in capital raising in 97-98 and 04-05; capital raised by REITs is primarily used to acquire properties Exhibit 18-8
    • In What Do REITs Invest?
    • Measuring REIT Income: Funds From Operations (FFO)
      • Cash flow, expressed as “Funds from Operations” (FFO), is often used instead of accounting net income to measure current performance
      • FFO is a supplemental measure of a REIT's operating performance .
    • Funds From Operations (FFO)
      • FFO =
        • Net (accounting) income (excluding gains/losses from sales of property )
        • + Depreciation (real property)
        • + Amortization of leasing expenses
        • + Amortization of tenant improvements
        • - Gaines/losses from infrequent and unusual events
    • Funds From Operations (FFO)
      • FFO is different from GAAP net income because commercial RE maintains value to a much greater extent than may other assets
        • Thus, economic depreciation < tax depreciation
      • Securities analysts judge REIT performance according to FFO growth
      • Price / FFO multiples reflect underlying RE value, management quality, and growth potential
    • How Are REIT Stocks Valued?
      • To determine share values, typical analyses involves one or more of the following criteria:
        • Management quality;
        • Current prevailing dividend yield
        • Anticipated total return from the stock
        • Capital Sources
          • Because REITs are obligated to distribute 90% of taxable income, they may require some external funding sources.
    • How Are Total Returns Estimated?
      • Investors attempt to forecast dividends REIT will pay out over time.
      • This projected dividend stream is converted into a present value
      • In practice, however, long-term dividend projections are difficult to develop
    • Net Asset Value
      • A commonly used valuation approach centers around concept of net asset value (NAV).
      • NAV is equal to estimated total market value of a REIT’s underlying assets, less all liabilities including mortgages.
    • How is NAV Used to Make Decisions?
      • If total stock market capitalization is greater than its NAV, REIT is said to be selling for a “premium” to NAV
      • A stock price in excess of per-share NAV may indicate a REIT is overpriced relative to value of assets currently in the portfolio
      • Conversely, REITs selling at “discounts” to NAV may signal buying opportunities for investors
    • REIT Investment Performance
    • End of Chapter 18