Principal forms of investment finance and their sources Flashcards Preview

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1

Why is commercial property financed?

Not having the required level of capital to pay for an investment

Borrowing can provide exposure to leverage = can increase potential return from investment

Access to several finance types: traditional bank lending / insurance funds / ‘platforms’ that can offer various types of products

2

What is Debt Finance?

Where an investor / company (the borrower) takes out a loan OR issues a bond to raise capital for an asset/portfolio/project/business

Lender receives a regular interest rate payment for providing the loan

Like residential mortgage for fixed amount from a bank (the lender) to buy a house but usually for a shorter fixed period (circa 5 years) at agreed interest rate

3

What are some examples of private property finance vehicles?

Banks

Insurance companies (not so common)

Debt funds (i.e. junior / mezz)

Hedge funds (will use some sort of derivative)

Crowdfunding

Peer to peer

4

What are some examples of public property finance vehicles?

Commercial mortgage-backed security (CMBS)

Government Bonds

5

What is Equity Financing?

Involves an investor /asset owner / company giving shares in the ownership in exchange for capital

No promise to repay the investment like in a loan arrangement, nor is there an interest component

Both parties share in the upside and downside risk of the investment

6

What are the types of finance used in real property transactions?

Equity

Commercial mortgage

Unsecured loans

Secured debt

Floating charges

Property development finance

Bridging finance

Mezzanine finance

Portfolio finance or revolving credit facility

Sharia finance

Joint ventures (JV)

Securitisation and bonds

7

What is equity finance?

Raising of capital through sale of shares / equity in the company / asset

8

What is commercial mortgage finance?

Debt finance

Most common type of lending used

Secured against underlying property whereby the lender lends a certain % of property value for fixed period of time

Rate will be quoted as x% over base rate / LIBOR (London Inter-bank Offered Rate) = interest-rate avg calculated from estimates submitted by London leading banks

When rate = not fixed = variable rate mortgage

Borrower pays lender back with a predetermined set of payments over a specified period

9

What is secured debt finance?

Debt finance

Secured debt uses collateral from another asset such as a house / business / car as security

This is usually for a lower amount than required for a commercial mortgage

10

What is floating charges finance?

Is a security interest / lien over a group of non-constant assets that change in quantity and value

A floating charge is used as a means to secure a loan for a company

The assets used in a floating charge = usually short-term current assets that the company consumes within 1 year

11

What is property development finance?

Debt finance

Usually in the form of a short-term loan that's used for development of a new building project/refurbishment of existing property

Interest rates tend to be higher than commercial mortgages to reflect uncertainty / risk

12

What is bridging finance?

Short-term finance solution favoured by property developers and investors

Provides quick way to finance purchase of a property

Lender will take a first charge on your property, and will seek an exit once the loan has come to term

13

What is mezzanine finance?

More complex and hybrid type of finance

Combines elements of debt AND equity - secured against the property

Gives lender right to convert to equity interest in company in case of default, after venture capital companies and other senior lenders are paid

Helps property developers reduce their cash flow requirement, enabling them to finance projects that would normally require a larger capital share

One of highest-risk forms of debt.

Subordinate to pure equity but senior to pure debt

Some of highest returns compared to other debt types, with rates between 12-20% per year, sometimes as high as 30%

14

What is portfolio finance / revolving credit facility finance?

Debt finance

Whereby a variable amount = available as a loan that can be drawn as required

Long-term business loan

Usually offered to large corporate property owners such as REITS

Lender offers ability to consolidate borrowing into 1 loan

15

What is sharia finance?

Islamic finance / Sharia finance = how corporations in the Muslim world, including banks and other lending institutions, raise capital in accordance with Sharia / Islamic law

Also refers to types of investments that are permissible under this form of law

16

What is joint venture (JV) finance?

A business entity created by 2 or more parties, generally characterised by shared ownership, shared returns and risks, and shared governance

17

What is securitisation and bond finance?

Securitisation = process where issuer creates a financial instrument by combining other financial assets and then marketing different tiers of the repackaged instruments to investors

This process can encompass any type of financial asset and promotes liquidity in the marketplace

18

What are the risks in debt finance?

For the borrower and lender:
- Non-payment of the interest payment
- Potential of capital depreciation of the asset
- When borrowing, the higher LTV /debt the more expensive it is
- This LTV along with the interest rate = 2 key factors when modelling the performance of a property / portfolio
- Higher level of debt = higher interest that needs to be paid back and as part of the lender’s underwriting they need to be comfortable that the rent being paid is sufficient to cover the interest payments

19

What are some recent innovations and events in property finance?

Significant transaction in the UK by British Land in 1999

The purchase of 20 St Marys Axe (Gherkin) in 2006

20

What happened during the significant transaction in the UK by British Land in 1999?

£1.5bn securitisation (issuer creates a financial instrument by combining other financial assets and then marketing different tiers of the repackaged instruments to investors) of their Broadgate Estate Asset

BL issued asset-backed bonds for period of time = an income coupon was paid to purchasers of the bond

As a result, BL raised / received £1.5bn to grow and develop their existing portfolio

The sheer size and scale of this make it a stand out transaction

21

What happened during the purchase of 20 St Marys Axe (Gherkin) in 2006?

Gherkin was purchased by German fund manager IVG Private Funds + London-based private equity firm Evans Randall from Swiss Re for £600m

Financing was provided by several banks / via a syndication

As part of borrowing, IVG took out its share in Swiss Francs as cheaper to borrow than in sterling

To protect themselves from currency risk, agreement was made with occupier Swiss Re to pay part of rent in Swiss Francs = creating a hedge

Not all rent was covered by the hedge and appreciation in the Swiss Franc against sterling caused IVG’s borrowing cost to rise by circa 60% or £100m

Borrowers also took out interest rate swaps to protect them from interest rate rises but during this time interest rates fell

Created a double whammy of a £100m rise in borrowings + circa £140m in swaps debt, which wiped out the equity put in by borrowers

Property values in London also fell

By 2009, Gherkin’s value had dropped to £480m and the building’s owners breached their LTV covenants and defaulted on their loans

22

What is a syndication?

A partnership between several investors - they combine their skills, resources, and capital to purchase and manage a property they otherwise couldn't afford

23

What are the FOUR quadrants of capital markets?

Private equity
Private debt
Public equity
Public debt

24

What is private equity?

Requires a broker

Buy / sell property direct investment / act as a developer / private equity fund

Unlisted fund

Core, value-added and opportunistic properties

25

What is private debt?

Commercial, mortgages, bridge and mezzanine loans.

26

What is public equity?

Publicly traded on stock exchange

REIT, prop cos, legislation for REITs = not taxed twice and have to distribute 90% profits

27

What is public debt?

Commercial mortgaged-backed securities

Corporate bond

28

What are the TWO types of income on property?

Capital appreciation = generally higher standard deviation therefore more volatile

Rental income = generally secure and stable = lower standard deviation

29

What are property derivatives?

Financial instruments which allow the investor to take a position in property / hedge a position without actually buying or selling properties

They receive / pay a return based on the performance of the MSCI IPD (in the UK) or NCREIF (in the US) or any other established property index

30

What is a common share (equity)?

Common share = RIGHT to vote in a company and a % of profit = a dividend

This equity normally has fewer rights associated with it than preferred equity and can be offered to employees at the company

Paid dividends after preferred share holders