Reference no: EM131030773

Real Estate Finance

1. Consider a construction loan made to Middleton Development Co. The loan amount is $6 million, which will be drawn evenly (i.e., a $1,000,000 monthly draw) during the next six months to redevelop an existing apartment building. Note that each disbursement occurs at the end of the month. The annualized interest rate is expected to remain the same at 6% for the first three (3) months. For the next three (3) months, the annualized interest rate will be 8%. What is the total loan amount (including interest) required to finance this project and what is the total interest carry?

Month	Draws	Interest Carry	Cumulative Loan Bal.
1
2
3
4
5
6
Total

2. A multifamily property is expected to produce the following income stream over the next three years:

Year	NOI
1	$575,000
2	600,000
3	625,000

A lender is willing to make a $6,000,000 participation mortgage, at 6% interest rate, a 30 year amortization period, with a balloon payment at the end of year 3. For simplicity, annual compounding for this mortgage is assumed. In addition, the lender gets 10 % of each year's net operating income, and 20% of thenet sales proceeds (note: the net sales proceeds will be calculated as: the sales proceeds - the selling expenses - the mortgage balance). The purchase price of the property is $8 million. The investor of the property expects to sell the property for $9 million at the end of the third year with the selling expenses of 5.5%(based on the sales price).

a. Calculate the before-tax mortgage yield for the loan, assuming that the loan is held for 3 years.

b. What is lender's before-tax mortgage yield if the property ends up with selling for $8million at the end of the third year, instead of selling for $9 million?

c. Why do lenders issue participation loans? What are the benefits and risks associated with this type of loans for borrowers and lenders? Briefly discuss.

1. You are a mortgage banker at TD Bank in Miami. One borrower wants to borrow money from your bank to finance his new home.  He just finds a new job and plans to buy the house at a price of $300,000.  Hewants to borrow a 80% loan to purchase the home. You tell him that a constant payment, 30 year amortization period, fully amortizing loan (FRM) is available.  The interest rate for the loan is 4.5%, which is the same as the market interest rate.  Moreover, you will charge a loan origination fee of 3% for the loan.

(a) What is the monthly payment for the loan?

(b) What is the effective interest rate, assuming the mortgage is paid off after 30 years?

(c) If the borrower plans to repay the loan after three years, what is the effective interest rate?

(d) If the borrower wants to borrow a 90% loan, the loan rate will be 5.5%.  Everything else being equal (i.e., he prepays the loan after 3 years, with the 3% loan fee), would you recommend him to borrow the 90% loan?

(e) Suppose the borrower can get a loan with a below-market interest rate from the homebuilder. This fully amortizing FRM loan will have a 80% LTV, 4% interest rate, 30 years amortization period, and with no loan fees. At what price should the homebuilder sell the home to the borrower in order to earn the market rate of interest (4.5%) on the loan? Assume the borrower would hold the loan for the entire term of 30 years and the home would normally sell for $300,000 without any special financing.

3. Wells Fargo issues a CMBS security. The mortgages in the pool are interest only loans, with a total loan amount of $15 million. For simplicity, assume that the interest rate for the mortgages is 11%, and the loan maturity is 4 years. Further, assume that the mortgages are annually compounded.   

The bank issues three tranches of securities based on the mortgage pool: i) Senior Class or Tranche A, with an amount of $10 million at 8% coupon rate; ii) Subordinated Class or Trance B, with an amount of $3 million at 10% coupon rate; and iii) Residual tranche, with an amount of $2 million. These securities have a maturity of four years.

1. Suppose that there is no default in the mortgage pool over the four year period. Calculate the returns for the investors who purchase the three tranches of securities.

2. Now assume that the value of the properties associated with the mortgage pool at the end of the fourth year is only 80% of the outstanding loan balance. What are the returns for the investors for the three tranches of securities?

a.)

Year	CF from the pool	Senior Class	Subordinated Class	Residual Class
1
2
3
4
Return =

b.)

Year	CF from the pool	Senior Class	Subordinated Class	Residual Class
1
2
3
4
Return =

4. Bank of America issues a MBS security based on a mortgage pool with the following terms:

     Mortgage pool value                         $25,000,000

     Mortgage interest rate                            6.5%

     Loan Term                                           3 years

a) Suppose that the MBS has only one class of security, i.e., the basic MBS discussed during the class. What is the price of this MBS if the market interest rate is 6%? Assume annual compounding as well as a constant annual prepayment rate of 10% (based on the outstanding loan amount at the beginning of each year, the same as we discussed during the class).

b) Why is MBS considered a "callable" bond? How can this callable feature affect MBS pricing? Briefly discuss.

Now, another investment bank suggests that, instead of issuing the single-class MBS security as above, two classes of securities can be issued based on the same mortgage pool, i.e., an IO and a PO security.

c) Determine the price of the IO and PO security, assuming that there is no prepayment. Further assume that the IO investors require a market rate of return of 4.5% and the PO investors require a market return of 6%.

Now suppose future interest rate will fall, so there is a 15% prepayment for each year (again, prepayment calculation is based on the loan balance at the beginning of the year). The IO and PO investors require a market rate of return of 4% and 5.5%, respectively. Determine the prices of the IO and the PO security.

5. Luistook a mortgage loan 5 years ago for $120,000 at 7% interest for 15 years, to be paid in monthly payments.  Now, a lender is offering him a new mortgage loan at 5% for 10 years. The new loan amount is $92,895, the outstanding loan balance of the existing loan.  Suppose that a prepayment penalty of 3 % must be paid if Luis refinances the existing loan. Moreover, the lender who is making the new loan requires an origination fee of $3,000. Luis plans to hold the property for 10 years. Note: in this case, Luis has to pay the refinancing fees (i.e., the origination fee and the prepayment penalty) out of his pocket.

(a) What is the total financing cost (not include the loan amount itself)if Luis decides to refinance the oldloan?

(b) Given the information provided here, should Luis refinance? Please support your answer by calculating the effective interest rate of the new loan.

(c) Now suppose that Luis's current income is low. The new lender allows him to pay a monthly payment of $200 for the new loan (i.e., the actual monthly payment to the lender is only $200, while the loan interest rate is 5%). In this situation, negative amortization occurs. What will be the accrued interest or the amount of increased loan balance for the loan three years later from now?

(d) Assume that Luis has to borrow two loans in order to refinance. That is, he has to borrow a new mortgage ($70,000) at 5% for 10 years (i.e., the loan maturity and the amortization period are the same, 10 years) and another mortgage ($22,895) at 9% for 5 years (the loan maturity and the amortization period are the same, 5 years).  In this case, with the same origination fee of $3,000 and the prepayment penalty of 3%, should Luis go ahead with the refinancing plan? Please show the step to support your answer?