Flashcards in Principal forms of investment finance and their sources Deck (33)
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
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
What are some examples of private property finance vehicles?
Insurance companies (not so common)
Debt funds (i.e. junior / mezz)
Hedge funds (will use some sort of derivative)
Peer to peer
What are some examples of public property finance vehicles?
Commercial mortgage-backed security (CMBS)
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
What are the types of finance used in real property transactions?
Property development finance
Portfolio finance or revolving credit facility
Joint ventures (JV)
Securitisation and bonds
What is equity finance?
Raising of capital through sale of shares / equity in the company / asset
What is commercial mortgage 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
What is secured 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
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
What is property development 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
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
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%
What is portfolio finance / revolving credit facility 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
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
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
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
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
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
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
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
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
What are the FOUR quadrants of capital markets?
What is private equity?
Requires a broker
Buy / sell property direct investment / act as a developer / private equity fund
Core, value-added and opportunistic properties
What is private debt?
Commercial, mortgages, bridge and mezzanine loans.
What is public equity?
Publicly traded on stock exchange
REIT, prop cos, legislation for REITs = not taxed twice and have to distribute 90% profits
What is public debt?
Commercial mortgaged-backed securities
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
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