Real Estate Division
BUSI 221: Real Estate
Finance in a Canadian
Context
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Webinar Seminar 1: Chapters 1-6
REAL ESTATE DIVISION
Introduction
• Webinar Presenter: Sharon Gulbranson
• B Comm 1986 and MBA 1990 from UBC
• Consultant for UBC since 1990
• Marker, lecturer, editor
• Focus on Real Estate Math
• Currently mark BUSI 100, 221, and 442
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REAL ESTATE DIVISION
Agenda
• Course Content
• Ch 1: Intro to Mtg Finance-Past and Present
• Ch 2: Mtg Finance Mkt Participants
• Ch 3: RE Finance and Gov’t Policy
• Ch 6: Mtg Math Review
• Next time: Thursday, February 3rd
• Questions?
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REAL ESTATE DIVISION
Course Content
• History (Ch. 1)
• Participants (Ch. 2)
• Government Policy (Ch. 3)
• Property and Contract Law (Ch. 4)
• Mortgage Law (Ch. 5)
• Mortgage Math Review (Ch. 6)
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REAL ESTATE DIVISION
Course Content
• Mortgage Underwriting and Res’l Borrower Qualification (Ch. 7)
• Comm’l Mortgage Underwriting (Ch. 8)
• Mortgage Loan Repmt Plans (Ch. 9)
• Loan Mgmt and Refinancing Options (Ch.10)
• Development Financing (Ch.11)
• Leasehold Finance (Ch.12)
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REAL ESTATE DIVISION
Ch. 1: Introduction to Mtg
Finance: Past and Present
• Why use debt?
• History of Canadian mortgages
• Financial, money, and capital markets
• Interest rates
• Mortgage market
• Characteristics of mortgage loans as investments
UNIVERSITY OF BRITISH COLUMBIA 7
REAL ESTATE DIVISION
Role Of Financing In Real Estate
Transactions
• Most purchasers borrow funds to purchase real estate (use of debt financing)
• Why?
• largely due to the high capital price relative to income
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REAL ESTATE DIVISION
Multiple Choice Question 1
Why might investors in income-producing properties use debt to finance a purchase?
• (1) Use equity for other activities
• (2) Financial leverage
• (3) Hedge against inflation
• (4) All of the above
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REAL ESTATE DIVISION
History of Mortgage Financing in
Canada (1900 – late 1920s)
• long-term interest only loans
• period of stable interest rates, low inflation and stable property values
• satisfactory for both parties until depression
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REAL ESTATE DIVISION
Depression Years (late 1930s –
early 1940s)
• individuals with little income (forced to live off savings), depreciated property values principal risk
• blended payment mortgage
• long-term fully amortized mortgage
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REAL ESTATE DIVISION
Post World War II Period
• mtg default insurance: introduced to get lender’s to supply mortgage $ by reducing lender’s loss
• Borrowers paid insurance fees into a fund to compensate lenders if default occurred at a later date
• Combo of insurance, expansion in economy, slow inflation, and slow growth in interest rates little change in mtgloans between 1950s to lates 1960s
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REAL ESTATE DIVISION
Late 1960s to Mid 1980s
• period of rapid inflation and rising consumer demands (and increasing interest rates)
• interest rate risk: risk for lenders being locked into LT loans at below market rates
• as a result, partially amortized mortgages were introduced
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REAL ESTATE DIVISION
1980s
• Peak in interest rate in 1981, from mid 1980s to mid 1990s, decline in interest rates
• Mtg Rate insurance program introduced in 1984 to protect borrowers against extraordinary increases in interest rates
• Introduction of MBS in 1986
• Changes to traditional sources of mtgs
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REAL ESTATE DIVISION
Mortgage-Backed Securities
(MBS)
• Mortgage Backed Securities (MBS): An undivided interest in a pool of insured residential mortgages (NHA insured)
• a very secure investment, guaranteed by CMHC, guaranteeing the investor a specified income flow even if the borrower defaults
• MBS are created by an issuer who brings together a pool of NHA insured mortgages
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$0
$50,000
$100,000
$150,000
$200,000
$250,000
$300,000
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
Mortgage-Backed Securities ($millions)
Mortgage-Backed Securities ($millions)
REAL ESTATE DIVISION
1990s to Present
• relatively low inflation, low interest rate environment
• Technological and market changes impacted structure of mtg finance
• increasingly competitive market—innovative options by lenders
• Increased role of mtg brokers
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The Financial Market
Households
Business
Government
Business
Government
Direct
Investments
Brokers
Financial Institutions
Secondary
Investments
$ INCOME SAVINGSSPENDING
$ BORROWING
REAL ESTATE DIVISION
Multiple Choice Question 2
Which of the following item is treated as a money market item?
• (1) long-term bonds
• (2) equity (common shares)
• (3) treasury bills
• (4) mortgages
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REAL ESTATE DIVISION
Mortgage Interest Rates
• while the overall level of interest rates are set by supply and demand, there is a structure of relative rates within the financial markets
• rates vary mainly due to risk (increased risk increased rate required to attract investors) and term structure
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0.00
2.00
4.00
6.00
8.00
10.00
12.00
14.00
16.00
18.00
20.001951
1953
1955
1957
1959
1961
1963
1965
1967
1969
1971
1973
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
Average 5 Year Mortgage Rate1951-2009
Average 5 Year Mortgage Rate
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REAL ESTATE DIVISION
Mortgage Market: Supply
• Key suppliers are the financial institutions
• Volume depends on the amount available in the form of savings and the competitive position of mortgages compared to other investments.
• Supply is also influenced by the monetary and fiscal policies of the Federal Government and the Bank of Canada.
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REAL ESTATE DIVISION
Mortgage Market: Demand
• a “derived” demand from the demand for housing
• influenced by interest rates, price of housing, other economic factors (employment, income and inflation), demographics (population growth, family formation and size), and specific policies and programs
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REAL ESTATE DIVISION
Multiple Choice Question 3
Which of the following best represents the characteristics of mortgage loans as investments?
(1) illiquidity, short repayment term, simple administration
(2) illiquidity, long repayment term, complex administration
(3) liquid investment, long repayment term, simple administration
(4) liquid investment, short repayment term, complex administration
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REAL ESTATE DIVISION
Ch. 2: Mortgage Finance and
Market Participants
• Identify and describe key players: chartered banks, credit unions, trusts and insurance companies
• Mortgage brokers and mortgage fraud
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REAL ESTATE DIVISION
Major Suppliers
• Chartered Banks
• Trusts and Mortgage Loan Companies
• Insurance Companies
• Credit Unions and Caisse Populaires
• Mtg Investors and Dealers
• NHA Mtg-Backed Securities
• Pension funds, private lenders, and mtgbrokers
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REAL ESTATE DIVISION
Major Suppliers of Mtg Loans
• Chartered Banks: single largest source, yet smaller % of their assets
• Trust Co/Mtg Loan Co: mtg specialists; used to be separate
• Life Co: used to be important, today much smaller role
• Credit Unions: steady contribution, high % of assets in mtgs
• Pension Funds: small % of market
• MBS: increasingly larger role
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REAL ESTATE DIVISION
Multiple Choice Question 4
Chartered banks:
• (1) have always been the most important source of mtg funds.
• (2) are governed by the Bank Act.
• (3) are not limited to the maximum 80% loan-to-value ratio for uninsured residential loans.
• (4) withdrew from the mtg mortgage in 1954 when interest rates exceeded 6%.
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REAL ESTATE DIVISION
Ch. 3: Real Estate Finance and
Government Policy
• History of Housing Policy in Canada
• Dominion Housing Act
• National Housing Act
• CMHC Act
• Mortgage Loan Insurance
• Mortgage Rate Insurance
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REAL ESTATE DIVISION
Government Role in Housing
Market
• As the federal government is precluded from direct intervention in housing markets (by the separation of powers under the Constitution),
• federal policies and programs affecting housing and residential mortgage financing have been extremely limited
• TRUE STATEMENT?
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REAL ESTATE DIVISION
History of Federal Government
Lending Programs
• Pre 1935: one mortgage lending program
• Dominion Housing Act (1935): joint lending, constant blended payments, property taxes in payment
• National Housing Act (1938/44): changes in joint mortgages, encourage lending in remote areas; prepay with penalty
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REAL ESTATE DIVISION
History of Federal Government
Lending Programs
• CMHC Act (1945): Crown corporation set up to administer federal participation in housing, make direct loans
• National Housing Act (1954): insured loans replaced joint lending, chartered banks able to lend on NHA mortgages, secondary mkt set up
• NHA Act and CMHC Act (1999): align CMHC’s legislation with other government legislation; also clarified CMHC’s right to enter public and private partnerships of a commercial nature
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REAL ESTATE DIVISION
Canada Mortgage and Housing
Corporation (CMHC)
• Federal government’s most direct tool for implementing housing policy
• Four divisions: affordable and sustainable housing, aboriginal housing, securitization, and mortgage insurance
• Programs: Home Adaptations for Seniors’ Independence (HASI), Residential Rehabilitation Assistance Program (RRAP), Shelter Enhancement Program (SEP)
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REAL ESTATE DIVISION
Multiple Choice Question 5
The Home Buyer’s Plan:
• (1) was introduced by the federal government in 1992
• (2) allows Canadians to withdraw up to $35,000 tax-free from the RRSP’s
• (3) amts withdrawn remain tax-exempt if repaid within 25 years
• (4) is no longer available
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REAL ESTATE DIVISION
Mortgage Loan Insurance
• provides for reimbursement to the lender in the event of borrower default
• Uninsured (conventional) mtgsmaximum loan-to-value of 80%
• with insured mtgs, maximum loan-to-value up to 95%
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REAL ESTATE DIVISION
History of Mortgage Loan Insurers
• 1954-1963: CMHC NHA approved mtgs
• 1963-1972: MICC entered the market
• 1993: MICC left market
• 1995: GE Capital Mortgage Insurance entered market (now Genworth Financial Canada)
• 2006: AIG United Guaranty entered the market
• April 2010: AIG United Guaranty sold to Canada Guaranty Financial Corp in April 2010
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REAL ESTATE DIVISION
Multiple Choice Question 6
What are the benefits of mortgage loan insurance (to borrower)?
(1) increased equity requirement
(2) investment protection should borrower default
(3) avoids legal and other costs of a second mortgage
(4) property less saleable
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REAL ESTATE DIVISION
Ch. 6: Mortgage Math Review
• Interest rates, payment, OSB
• Interest accrual loans
• Annuities: definitions and calculations
• P/I split: one payment and over time
• NPV, IRR, Profitability Index (PI)
• Mtg constant and final payments
UNIVERSITY OF BRITISH COLUMBIA 42
REAL ESTATE DIVISION
Important Financial Operations
and Formulation
• Use of calculator steps
• Use of formulation—for example
PV = PMT x a[[N, jm]] + FV(1 + i)-N
FV = PMT x s[[N, jm]]
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REAL ESTATE DIVISION
Interest Accrual Loans (Lump
Sum Problems)
PV (1 + i)n = FV and
FV(1 + i)-n = PV
PV = present value of the loan
i = periodic interest rate
n = number of compounding periods
FV = amount owed at end of loan, the future value
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REAL ESTATE DIVISION
Nominal and Periodic Rates
• Nominal interest rates: annual interest rate with a stated compounding frequency (jm)
• Periodic interest rates: interest rate per compounding period (i)
• Periodic interest rate = nominal interest rate divided by compounding frequency
• j/m = periodic rate
• i x m = nominal rate
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REAL ESTATE DIVISION
Multiple Choice Question 7
If Joanne deposited $5,000 in bank today and was able to earn j1=6%, how much will she save at the end of 5 years?
• (1) $7,068.58
• (2) $6,744.25
• (3) $7,220.64
• (4) $6,691.13
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REAL ESTATE DIVISION
Calculator Steps
6 I/YR
1 shift P/YR
5000 PV0 PMT5 N
FV -6,691.127888
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REAL ESTATE DIVISION
Interest Rate Conversions
• Based on the premise of equivalence
• (1 + ida)365 = (1 + imo)12 = (1 + iq)4 =
(1 + isa)2 = (1 + ia)1 = (1+iwk)52
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REAL ESTATE DIVISION
Interest Rate Conversions using
HP10BII
• Enter STATED nominal rate NOM%
• Enter STATED compounding frequency P/YR
• Calculate the effective annual rate EFF%
• Enter the DESIRED compding freq P/YR
• Calculate the equivalent nominal rate NOM%
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REAL ESTATE DIVISION
Multiple Choice Question 8
Calculate the annual rate, compounded monthly (j12) equivalent for a rate of 6% per annum, compounded semi-annually (j2 = 6%)?
(1) 0.49386220312%
(2) 6.07550187875%
(3) 0.506291823%
(4) 5.92634643744%
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REAL ESTATE DIVISION
Calculator Steps
6 shift NOM%
2 shift P/YR
shift EFF% 6.09
12 shift P/YR
shift NOM% 5.92634643744
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Annuities
Compounding
Periods and
Payment
Periods are:
PMTS occur at: Same (Simple) Different
(General)
Beginning of
period
SIMPLE
ANNUITY DUE
GENERAL
ANNUITY DUE
End of period ORDINARY
SIMPLE
ANNUITY
ORDINARY
GENERAL
ANNUITY
REAL ESTATE DIVISION
Formula for PV of Ordinary
Annuities
PV = PMT x [1 – (1 + i)-n]
i
where: [(1+i)-1 +(1+i)-2 + … + (1+i)-n]
= [1 – (1 + i)-n]
i
Formula is pre-programmed into calculator
PV = PMT x a [[n, jm]]
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REAL ESTATE DIVISION
Formula for FV of Ordinary
Annuities
FV = PMT x [(1 + i)n – 1]
i
where[(1+i)n-1 +(1+i)n-2 + … + (1+i)1 + (1+i)0] =
[(1 + i)n – 1]
i
Formula pre-programmed into calculator:
FV = PMT x s[[n, jm]]
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REAL ESTATE DIVISION
Multiple Choice Question 9
Given a purchase price of $350,000 and a $87,500 down payment, calculate the size of the monthly payment, assuming a rate of j12 = 5.25% amortized over 25 years.
• (1) $2,097.37
• (2) $2,097.36
• (3) $1,573.03
• (4) $1,573.02
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REAL ESTATE DIVISION
Calculator Steps
5.25 I/YR
12 shift P/YR
350000 – 87500 =
262500 PV
300 N
0 FV
PMT -1,573.02525232
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REAL ESTATE DIVISION
Outstanding Balances (OSB)
• Definition: how much is owing on a loan at a particular point in time
• Partially amortized loans will have OSBs
• Calculated at the end of term or at any point during the term
• 2 preprogrammed functions to solve
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REAL ESTATE DIVISION
Multiple Choice Question 10
Borrow $130,000 at j12 = 12% for a 20 year amortization period and a 2 year term. Payments are monthly. Calculate the amount of the monthly payment and the outstanding balance at the end of the term.
• (1) $1,431.42; $126,455.15
• (2) $1,369.20; $128,133.67
• (3) $1,427.66; $127,445.89
• (4) $1,399.65; $129,312.09
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REAL ESTATE DIVISION
Calculator Steps
12 I/YR
12 shift P/YR
130000 PV
240 N
0 FV
PMT -1,431.41197364
1431.42 +/- PMT
24 INPUT shift AMORT = = = 126,455.147249
24 N FV -126,455.147249
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REAL ESTATE DIVISION
Next time: 221 Webinar 2
• Review Mortgage Finance
• Chapters 7 and 8
• Project 1 preparation
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REAL ESTATE DIVISION
Questions?
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