COMM 405 REAL ESTATE

FINANCE

„ LESSON 1

Instructor: Larry Wosk

WHAT IS FINANCE?
„ FINANCE IS THE STUDY OF THE
PROCESS, INSTITUTIONS, MARKETS,
AND INSTRUMENTS USED TO TRANSFER
MONEY AND CREDIT BETWEEN
INDIVIDUALS, BUSINESSES AND
GOVERNMENTS.

SUB-DISCIPLINES OF FINANCE

„ There are several disciplines such as:

„
„

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REAL ESTATE FINANCE
„ A VERY BROAD CATEGORY INCLUDING:
„ THE STUDY OF INSTITUTIONS, MARKETS,
AND INSTRUMENTS USED TO TRANSFER
MONEY AND CREDIT FOR THE PURPOSE
OF DEVELOPING OR ACQUIRING REAL
PROPERTY

REAL ESTATE TRANSACTIONS

„ THE TRADING OF OWNERSHIP OF

INTERESTS IN LAND

REAL ESTATE FINANCE

INCLUDES
„ THE STUDY OF:
„
„
„

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RELATIONSHIP BETWEEN
CREDIT vs. FUTURE SAVINGS
„ CREDIT IS AN ADVANCE OF FUTURE
SAVINGS OR PURCHASING POWER AS IT
SUBSTITUTES FOR CAPITAL YET TO BE
ACCUMULATED

BORROWING ON INCOME
PRODUCING PROPERTIES
„ EVEN IF YOU HAVE THE FINANCIAL
LIQUIDITY TO PURCHASE AN INCOME
PRODUCING PROPERTY OUTRIGHT IT
MAY BE PREFERRABLE TO BORROW
PART OF THE PURCHASE PRICE ANYWAY
„ WHY?

FINANCIAL MARKETS
„ MONEY MARKET

„ CAPITAL MARKET

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FINANCIAL INTERMEDIARIES
„ FINANCIAL INSTITUTIONS THAT
CHANNEL FUNDS FROM THE SURPLUS
INCOME UNITS TO THE DEFICIT INCOME
UNITS.

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LARGEST POOLS OF CAPITAL IN CANADA –

FINANCIAL INTERMEDIARIES

„ CHARTERED BANKS

„ LIFE INSURANCE COMPANIES

„ TRUST COMPANIES

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PRIMARY & SECONDARY

MARKETS

„ PRIMARY MARKETS

„ SECONDARY MARKETS

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INTEREST

„ “RENTAL” PAYMENT FOR THE USE OF

CAPITAL THE LENDER HAS INVESTED

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INTEREST ON MORTGAGES

„ FROM A LENDER’S VIEWPOINT

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DETERMINING THE LOAN RATE

THERE A SEVERAL KEY ELEMENTS TO BE

CONSIDERED WHEN SETTING THE RATE

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MORTGAGE MARKET
„ SUPPLY SIDE

„ DEMAND SIDE

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MOVEMENT OF INTEREST RATES

„ TEND TO MOVE WITH FLUCTUATIONS IN

THE NATIONAL ECONOMY

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GENERAL LEVEL OF INTEREST

RATES
START OFF WITH A “RISKLESS” BOND
„ ISSUER WILL MEET ALL INTEREST AND
PRINCIPAL PAYMENTS WITH CERTAINTY
„ INSTRUMENT CAN BE SOLD INSTANTLY
FOR CASH AT A STATED PRICE
„ NO EXPECTATION OF INFLATION
(DEFLATION) AT ANY TIME IN THE
FUTURE

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RISK CHARACTERISTICS
„ DEFAULT

„ CALLABILITY

„ MATURITY

„ MARKETABILITY (LIQUIDITY)

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YIELD CURVE
„ A GRAPHICAL REPRESENTATION
THAT RELATES MATURITY AND
YIELD ON BONDS OF THE SAME
GRADE AT A POINT IN TIME

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NORMAL YIELD CURVE

7
6
5
4
Yield (%)
3
2
1
0
1 5 10 20

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INVERTED YIELD CURVE

7
6
5
4
YIELD (%)
3
2
1
0
1 5 10 15 20 25

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HUMPED YIELD CURVE

7
6
5
4
Yield (%)
3
2
1
0
1 5 10 20 30

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3 PRINCIPAL THEORIES RESPONSIBLE FOR

THE SHAPE OF THE YIELD CURVE

„ LIQUIDITY PREMIUM THEORY

„ MARKET SEGMENTATION THEORY

„ EXPECTATIONS THEORY

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LIQUIDITY THEORY
„ LONG-TERM RATES TEND TO BE HIGHER
THAN SHORT-TERM RATES BECAUSE A
PREMUIM MUST BE PAID TO INVESTORS
WHO ARE RELUCTANT TO TIE UP THEIR
FUNDS FOR LONG PERIODS OF TIME

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MARKET SEGMENTATON
THEORY
„ THIS GROUP BELIEVES THAT THERE IS
NOT ONE CONTINUOUS BOND MARKET,
BUT SEVERAL DISCRETE SEGMENTS,
WITH DIFFERENT PLAYERS IN EACH
SEGMENT.

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EXPECTATIONS THEORY

„ THIS APPROACH SUGGESTS THAT THE

YIELD CURVE IS A PICTURE OF WHAT
PEOPLE EXPECT RATES TO BE IN THE
FUTURE.

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SOURCES:
„ Baxter, D., Hamilton,S.W., & Ulinder, D.D. Real Estate Finance
in a Canadian Context (1998) UBC Real Estate Division
„ Clauretie, T.M. & Sirmans,G.S. Real Estate Finance, Theory &
Practice (2003) Mason, Ohio: Thomson Southwestern
„ Croft, R. Yield Curves and what they mean Retrieved Sept 9,
2004 http://www.canada.etrade.com/yieldcurves.shtml

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