A property or building can be owner-occupied or rented i.e. an investment property. Property finance is money raised for the purpose of expenditure on properties. Whether the property is owner-occupied or an investment property may alter the criteria for the raising and application of the funds, but the fundamental concepts may well be the same.' For instance, funds could be raised internally or externally by an organisation but the criteria for the internal loan or transfer of funds may well need to match those in the market.
The investment market for property cannot be seen in isolation from other investment markets. The application of funds to property has to face competition from other forms of investment. The decision to invest in a particular area will be a comparison of return and security. The nature of the lender and the property to which finance is applied is also important.
At its simplest it is an individual purchasing a single property with a single loan. However much finance is also raised by corporate entities, such as property companies, lending on the back of existing property and other assets for the purchase of a portfolio of assets, which may also include property assets.
At its simplest it is an individual purchasing a single property with a single loan. However much finance is also raised by corporate entities, such as property companies, lending on the back of existing property and other assets for the purchase of a portfolio of assets, which may also include property assets.
Property and finance are also significant to the economy. The importance can be shown in three different ways: as a factor of production, as a corporate asset and as an investment. As a factor of production, property is the space in which economic activity will take place, the efficiency and costs of such space will affect the cost of goods and services produced. As a corporate asset, it forms the major asset value in the balance sheet and the majority of corporate debt is secured against it. As an investment it is one of the major types of investments held by the financial institutions on which pensions and assure benefits depend.'
The Structure of the Investment Market
There are three major areas of traditional investment opportunity: these are fixed interest securities, company stocks and shares and real property. The stock exchange provides a market for listed shares and certain fixed interest securities such as those issued by the Government, local authorities and public bodies.
The market in real property contrasts with that of company shares and other securities. The property market is fragmented and dispersed while that of shares and other securities is highly centralised. The centralisation of markets assists the transferability of investments, as does the fact that stock and shares can be funded in small units, thereby assisting transferability.
Compared to other traditional investment opportunities real property investment has the distinguishing features of being heterogeneous and indivisible and having inherent problems of
rnar~agement.~T hese problems of management may include collecting rents and dealing with repairs and lease renewal and thus may lead to real property being an unattractive proposition for the small investor. A decentralised market will tend to have high costs of transfer of investments and also there will be an imperfect knowledge of transactions. Thus the nature of the real property market makes property difficult to value. There is no centralised market price to rely on, as the price may be too difficult to ascertain unless a transaction has recently taken place. Many of the problems of valuation relate to difficulties of trying to relate comparable transactions to properties being valued or even trying to assess what transactions could be considered comparable. Because of the nature of real estate market, individual investors have tended to withdraw from the market. This is also due to the channeling of savings into collective organisations, such as pension funds and insurance companies rather than individuals using their savings for direct investment.~
Financial Structures
Property finance is important in the property investment market. The costs and availability of finance will affect the cost of the provision of new investment property and therefore its supply. It is through finance that the structure of the investment interest in property may be created, so finance has effect on the form of the interest. While costs and availability of funding are obvious in the case of the funding of development property, it is critical to the investment market also. There are basic principles of the financial structure, which have been identified among others.'
A company must maintain a balance between equity and debt capital. Traditionally property companies are highly geared; thls means that these companies carry a high level of debt capital relative to equity or total capital. The security of property and the growth in rental values and capital value have provided an appropriate environment for increasing debt capital. Apart from the balance of equity and debt, the nature and composition of equity and debt in themselves are also important. There should be a balance of maturity dates of the debt with the majority being long-term.
Redemptions should be spread evenly to avoid the risk of a major refinancing operation occurring at a time of adverse financial conditions. The proportion of the money should be flexible so that it can be repaid without cost or penalty at any time during the duration of the term.
A company should match short-term assets with short-term liabilities and long-term assets with long-term liabilities. If long-term property investment is funded through short-term borrowing e.g. overdraft or short-term debt, then there could be major problems for refinancing, as an appropriate stock of new capital may not be available at the crucial time of refinancing. This may mean that the property asset would have to be disposed of at an inappropriate time, leading to a collapse in its value.
Companies should maintain a balance between fixed interest money and variable interest money. Fixed interest rates protect the company in a period of rising interest rates but obviously are expensive if rates fall. Variable rates need to be available if interest rates fall so that the benefits of the reduced cost of money can be obtained. Fixed interest money w~the xorbitant interest rate could have a disastrous effect on a property company in a period of low inflation.
Debt should be structured so that interest repayments are spread over the year so as to even out the cash flow for the company. To avoid foreign currency risk, companies with operations overseas should reduce their exposure to this risk by matching overseas assets and debts in the same currency. . The financ~asl tructure should aim to maximize the tax shield i.e., the avoidance of tax payment to maximise the after-tax cash flow. The arranging costs should also be minimised. The price of capital includes not just the interest rates, but commitment and arrangement fees, penalties for early repayment and is based on the frequency and how interest is calculated on the outstanding amount.
Blanket Mortgage
An investor in the process of developing and selling a large tract of homes may find it economical to obtain a blanket mortgage on the entire group of homes. As each unit or lot is sold, the borrower will settle with the lender to release the unit from the blanket mortgage.
Package Mortgage
A mortgage in its pure form is an instrument secured by real property. When a developer is building and selling homes, it may be desirable to include personal property under the mortgage. Stoves, dishwashers or even furniture may be sold in the home and covered by a package mortgage loan.
Transactions Involving Mortgaged Property
When a property is sold with a mortgage lien against it, there are at least three ways of handling the situation.I0 The buyer may allow the seller to discharge the loan by refinancing the property with a new mortgage. The proceeds of the new loan will be used to pay off the old one. The old lien will thus be removed and a new one put on.
The second solution is for the buyer to assume the seller's existing loan. In this situation, the buyer will make the payments on the loan. This process often allows that buyer to lower the cost of the transaction by avoiding the cost of refinancing. However the seller remains secondarily liable for the loan if the buyer fails to pay the payments properly.
Lending Criteria
The cost and availability of lending is a function of the value of any particular project and the amount of cost to be financed. The nature of the development is also important: the design, mix, location and likely demand. The letting conditions are important, as are whether or not the investment is pre-let or speculative. The qualities of the tenant, who will be providing the cash flow to the investment, are also important. Other important criteria are the track record of the developer and the strength of security. Finally the duration of the loan will be important as well as the details of repayment, for example, the anticipated regularity of repayments and the size and amount of repayments prior to redemption. Most lenders look for the same aspects of a lending proposal,
