AN OVERVIEW OF REAL ESTATE FINANCE

Introduction
• Real Estate Finance is also called Real Estate Financial Management.
• Real estate is usually considered to be land, buildings, infrastructure on land and
buildable land.
• Common real estate assets include:
i. Office buildings,
ii. Industrial warehouses,
iii. Owner occupier buildings,
iv. Multifamily buildings,
v. Hotel Buildings,
vi. Hospital buildings,
vii. Commercial buildings,
viii. Retail space, etc

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• It is a form of tangible asset as opposed to a financial instrument. It is noteworthy
however that real estate assets can have derivative financial instruments e.g. mortgages,
REITs, Equities in real estate companies, Securitized mortgages, etc
• It can be taken as artificially delineated space with 4 dimensions referenced to a fixed
position on the face of earth. The four dimensions of a plot of land can be defined as:
i. Space above ground e.g. buildings, infrastructure, etc
ii. Space below ground e.g. minerals, underground parking spaces, underground roads,
underground railways, etc
iii. Areas within the building e.g. rooms in a building
iv. Periods of time- time sharing
v. Real Estate Finance Applies Financial management Principles to real estate
investments. Accordingly, the main decisions in Real Estate Finance are:
▪ Investing decisions
▪ Financing decisions
▪ Dividend decisions
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 ▪ Working capital decisions
▪ Risk management decisions
▪ Dealing with financial markets
▪ Capital structure decisions
▪ Financial planning
▪ Other areas of financial decision making
▪ Etc.
• Accordingly, real estate finance pursues the same objectives as regular financial
management (maximizing returns while minimizing risk). The common objectives
include:
i. Profit maximization
ii. Shareholder wealth maximization
iii. Corporate wealth maximization
iv. Revenue maximization
v. Stakeholder welfare maximization
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 vi. etc

Participants in the Real Estate Business

The main participants in the real estate markets and business include:
a) Owners: These are people who are pure investors. They do not consume the real estate
they purchase. They get investment returns including:
▪ Rent
▪ Leasing Income
▪ Property capital gains
▪ Etc.
b) Owner-occupiers: These are people who are both owners and tenants of real estate.
They purchase houses or commercial property as an investment and also occupy or
utilize as a business. They are both investors and consumers of real estate assets.
c) Renters: They are pure consumers of real estate.

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d) Developers: They are investors who prepare raw land for building which results in
product for the market e.g. Kings Property, VAAL property, Home Afrika Ltd,
Elderman Property, etc
e) Renovators: The suppliers of refurbished buildings to the market.
f) Facilitators: They enable investment and development of real estate. These include:
▪ banks,
▪ Real estate agents and brokers,
▪ Property managers,
▪ Tax professionals,
▪ Lawyers
▪ Contractors
▪ Accountants
▪ Industry suppliers
▪ Project managers
▪ Land economists, valuers and realtors
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 ▪ Interior designers
▪ Engineers
▪ etc
g) The government: They have both direct involvement in real estate development as
well as regulation of the real estate business and markets. The areas of involvement by
National and County Governments include:\
▪ Regulation
▪ Legal framework and dispute resolution e.g. rent tribunal
▪ Investor
▪ Consumers
▪ Facilitators
▪ Development e.g NHC
▪ etc

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Forms of Real Estate Investment
There are several forms of real estate investment which include:
i. Free and clear equity
ii. Leveraged equity
iii. Mortgages
iv. Aggregation vehicles
• Free and clear equity is also called fee simple. It refers to full ownership rights for an
indefinite period of time giving the owner the right, for example to lease the property to
tenants and resell the property at will. It is straight forward purchase of some real estate
property.
𝐴𝑠𝑠𝑒𝑡𝑠 = 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 + 𝐸𝑞𝑢𝑖𝑡𝑦
𝑅𝑒𝑎𝑙 𝐸𝑠𝑡𝑎𝑡𝑒 = 0 + 𝐸𝑞𝑢𝑖𝑡𝑦 − − − − − 100% 𝑜𝑤𝑛𝑒𝑟𝑠ℎ𝑖𝑝 𝑟𝑖𝑔ℎ𝑡𝑠
• Leveraged equity has the same ownership rights as free and clear equity but subject to
debt (a promissory note) and a pledge (mortgage) to hand over real estate ownership
rights if the loan terms are not met. Leveraged equity involves equity ownership plus a
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 requirement to transfer ownership of the equity in case of default on the debt. The debt
and the mortgage are usually packaged together into a mortgage.

𝐴𝑠𝑠𝑒𝑡𝑠 = 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 + 𝐸𝑞𝑢𝑖𝑡𝑦

𝑅𝑒𝑎𝑙 𝐸𝑠𝑡𝑎𝑡𝑒 = 𝑀𝑜𝑟𝑡𝑔𝑎𝑔𝑒 + 𝐸𝑞𝑢𝑖𝑡𝑦 − − − 𝑙𝑒𝑠𝑠 𝑡ℎ𝑎𝑛 100% 𝑜𝑤𝑛𝑒𝑟𝑠ℎ𝑖𝑝 𝑟𝑖𝑔ℎ𝑡𝑠
• As the loan in increasingly repaid, the mortgage portion reduces as the equity increases.
The mortgage is fully paid up, the investor acquires free and clear equity ownership
rights.
• A mortgage is a pledge of real estate ownership rights to another party as security for
debts owed to that party.
• Mortgages are real estate investment vehicles representing a type of debt investment.
Payments resulting from a mortgage include interest, mortgage servicing fees and
principal repayments.

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• Mortgage loans may include an early payment clause at the option of the debtor. These
are called mortgage prepayments.
• Mortgage risk diversification implies that an investor invests in securities issued against
a pool of securities. Here, an intermediary buys a pool of mortgages and then issues
securities backed by the mortgages (Mortgage securitization).
• Aggregation vehicles are instruments that help in pooling real estate resources. The
various types of aggregation vehicles are:
i. REITS
ii. Commingled funds
iii. RELPS
• Real estate limited partnerships (RELPS) pool together investors and aim at giving them
collective access to real estate investments. They operate like partnerships.

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• The arrangements allow the limited partners to participate in real estate projects while
preserving a liability limited to the initial investment and leaving management to the
general partners who are experts in real estate.
• Commingled funds are pools of capital created by like-minded institutional investors
organized together by an intermediary to invest chiefly in real estate investment projects.
The investors share in the investment rewards according to the amount of capital they
invest.
• There are two types of commingled funds:
– Open ended commingled funds
– Closed ended commingled funds
• Real estate investment trusts (REITS) are aggregation vehicles that operate like closed
ended investment companies. They issue shares that are traded on a stock market and
invest in various types of real estate.

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• They pool together individual investors and provide them an easy access to real estate
and diversification within the real estate sector. They can be:
– Mortgage REITS
– Equity REITS
– E.g.
o Acorn Student Accommodation Income REIT ( ASA I-REIT)
o Acorn Student Accommodation Development REIT ( ACORN D-REIT)
o ILAM Fahari I-REIT
• The risk characteristics depend on the type of real estate investment trust.

Characteristics of Real Estate Property

• Durability-land and buildings last for a long period of time
• Heterogeneity- every piece of real estate is unique. Such uniqueness make real estate
markets to suffer inefficiencies making pricing difficult. Uniqueness arises from:
o Size
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 o Workmanship
o Finishing
o Amenities
o Ownership rights
o Infrastructure
o Distance from facilities
• High transaction and management fees- e.g. costs of searching, real estate fees,
moving costs, legal fees, land transfer taxes, etc
• Immobility- real estate is locationally immobile
• Long term delays-the market adjustment process is slow
• Illiquidity- properties are generally illiquid due to their immobility and indivisibility.
• Duality: both investment and consumption goods
• Difficulties in valuation- because of lack of national or international auction markets
for properties.

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• Indivisibility: there is a limit beyond which it is difficult to further subdivide real estate
into even more smaller units.

Real Estate Ownership Interest

This defines the types of ownership stakes in real estate. It helps to identify the bundle of
rights in the real estate to the owner. The most common ownership interest include:
a) Freehold ownership interest- it is the most complete bundle of ownership interest. The
owner owns the property and the land on which it is built for an unlimited period of time.
• Hence a freehold title gives the purchaser complete ownership of the land and all the
buildings on it. It gives the buyer the right to do as they wish with their home subject
to the law and planning controls.
• Most regular houses are freehold property. Such properties are more valuable than
leasehold property.

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b)Leasehold ownership interest-a leasehold property is rented out from the freeholder for
a specified period of time. The lease usually includes a range of terms and conditions,
specifying the leaseholder’s responsibilities to the property and to the freeholder.
• The owner has ownership interest in the property for a fixed period of time although
they may not own the land on which it is built.
• Leases can be long term or short term. A long term lease for instance 999 years is
demanded by those wishing to buy a home. a short term lease for a few years implies
that the property is effectively being rented out to the lessee.
• Enfranchisement is the process of extending the length of a lease or buying a share of
the freehold.
• A lease is a legal document which sets out the rights and duties of both the leaseholder
and the landlord or freeholder. It specifies:
i. The length of time the lease is to run out
ii. The ground rent to be paid and other service fees

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iii. The obligations of each party towards maintenance of shared areas and
renovations.

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