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Real estate finance and investments 14th Edition by William Brueggeman Jeffrey Fisher
Real estate finance and investments 14th Edition by William Brueggeman Jeffrey Fisher
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William B. Brueggeman JeFFrey D. FisherReal estate Finance
and investments
fourteenth edition
@GUSTpdf
,Real Estate
Finance and
Investments
,The McGraw-Hill/Irwin Series in Finance, Insurance, and Real Estate
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,Real Estate
Finance and
Investments
Fourteenth Edition
William B. Brueggeman,
Ph.D.
Corrigan Chair in Real Estate
Edwin L. Cox School of Business
Southern Methodist University
Jeffrey D. Fisher, Ph.D.
Charles H. and Barbara F. Dunn Professor
of Real Estate
Kelley School of Business
Indiana University
,REAL ESTATE FINANCE AND INVESTMENTS
Published by McGraw-Hill/Irwin, a business unit of The McGraw-Hill Companies, Inc., 1221 Avenue of the
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ISBN 978-0-07-337733-9
MHID 0-07-337733-3
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Library of Congress Cataloging-in-Publication Data
Brueggeman, William B.
Real estate finance and investments / William B. Brueggeman, Jeffrey D. Fisher.—14th ed.
p. cm.—(The McGraw-Hill/Irwin series in finance, insurance, and real estate)
Includes index.
ISBN-13: 978-0-07-337733-9 (alk. paper)
ISBN-10: 0-07-337733-3 (alk. paper)
1. Mortgage loans—United States. 2. Real property—United States—Finance. I. Fisher,
Jeffrey D. II. Title.
HG2040.5.U5B78 2011
332.7'2—dc22
2009053484
www.mhhe.com
,Preface
Introduction to Real Estate Finance and Investments
This book prepares readers to understand the risks and rewards associated with investing in
and financing both residential and commercial real estate. Concepts and techniques in-
cluded in the chapters and problem sets are used in many careers related to real estate.
These include investing, development financing, appraising, consulting, managing real es-
tate portfolios, leasing, managing property, analyzing site locations, and managing corpo-
rate real estate. This material is also relevant to individuals who want to better understand
real estate for their own personal investment and financing decisions.
The recent turmoil in world financial markets, which has been closely tied to events in
the real estate market, suggests that investors, lenders, and others who participate in the real
estate market need to better understand how to evaluate the risk and return associated with
the various ways of investing and lending. This requires an understanding of the legal issues
that can impact the rights of lenders and investors, the characteristics of the various vehi-
cles for lending and investing in real estate, the economic benefits of the loan or invest-
ment, the importance of the local economy where properties are located, and the goals of
the particular lender or investor.
This book is designed to help students and other readers learn how to understand these
factors, so that they can perform the right kind of analysis and make informed real estate
finance and investment decisions. As the book’s title suggests, we discuss both real estate
finance and real estate investments. These topics are inter-related. For example, an investor
who purchases a property is making an “investment.” This investment is typically financed
with a mortgage loan. Thus, the investor needs to understand both how to analyze the in-
vestment and how financing the investment will impact its risk and return.
Similarly, the lender, by providing capital for the investor to purchase the property, is
also making an “investment” in the sense that he or she expects to get some rate of return
on the money that has been loaned. Therefore, the lender also needs to understand the risk
and return of making that loan. In fact, one of the risks associated with loaning money is
that the lender may end up owning the property. So the lender needs to evaluate the prop-
erty in many of the same ways as the investor purchasing the property.
Organization of the Book
From the above discussion it should be clear that many factors have an impact on the risk
and return associated with property investments and the mortgages used to finance them.
This is true whether the investment is in your personal residence or in a large income-
producing investment such as an office building.
Part I of the book begins with a discussion of the legal concepts that are important in
the study of real estate finance and investments. Although a real estate investor or lender
may rely heavily on an attorney in a real estate transaction, it is important to know enough
to be able to ask the right questions. We focus on those legal issues that relate to real estate
investment and financing decisions.
Part II begins with a discussion of the time value of money concepts important for an-
alyzing real estate investments and mortgages. These concepts are important because real
estate is a long-term investment and is financed with loans that are repaid over time. This
leads to a discussion of the primary ways that mortgage loans are structured: fixed rate and
adjustable rate mortgage loans.
v
,vi Preface
Part III focuses on residential housing as an investment as well as loan underwriting for
residential properties. This is relevant for individuals making personal financial decisions,
such as whether to own or rent a home, as well as for lenders who are evaluating a loan and
a borrower.
Part IV covers many topics related to analyzing income property investments such as
apartments, office buildings, shopping centers, and so on. These topics include under-
standing leases, knowing how properties are appraised, and being able to analyze the po-
tential returns and risks of an investment and how taxes impact the return. We also consider
how to evaluate whether a property should be sold or renovated. Finally, we look at how
corporations that are not in the real estate business per se, but that use real estate as part of
their business, can decide whether to own or lease the property they use.
While the first four parts focus on investing or financing existing properties, Part V dis-
cusses how to analyze proposed projects, such as the development of an apartment or of-
fice building or the development of land for sale to builders. It also discusses how projects
are financed during the development period, which is different from the way properties are
financed once construction is complete and they are occupied.
Part VI discusses various alternative real estate financing and investment vehicles. We
start with joint ventures, which allow different parties with different areas of expertise and
different amounts of capital to join forces for the purpose of making a real estate invest-
ment. For example, someone with development expertise who needs equity capital may en-
ter into a joint venture with an investor who has capital to invest but doesn’t have the
expertise to do the development. Next, we discuss the secondary market for both residen-
tial and commercial mortgages and examine how mortgage-backed securities are struc-
tured. This includes a discussion of the risks these investments pose, which is important to
making sound investments. Part VI also includes a discussion of real estate investment
trusts (REITs). These public companies invest in real estate and allow investors to own a
diversified portfolio of real estate by purchasing shares of stock in the company. Finally, we
discuss how to evaluate real estate in a portfolio that also includes other investments such
as stocks and bonds. This includes understanding the diversification benefits of including
real estate in a portfolio as well as ways to diversify within the real estate portfolio (in-
cluding international investment).
Wide Audience
From the above discussion, one can see that this book covers many topics. Depending on
the purpose of the particular course, not all of the topics will be covered. The focus of the
course may lean toward an investor’s perspective (real estate investment) or a lender’s per-
spective (real estate finance). Some courses will emphasize housing and residential real es-
tate more than others, and some will have a different emphasis on development. This book
is designed to allow flexibility for instructors and students to focus on those topics that are
most important to them, so that it can meet the purpose of each unique course.
Changes to the Fourteenth Edition
Several new topics have been added to the fourteenth edition. Some of these were in response
to the recent turmoil in the financial markets, caused in part by the problems associated with
subprime mortgages. While the previous edition of the book discussed subprime mortgages,
this edition adds further emphasis to the importance of proper underwriting of mortgage
loans, whether they are subprime or not and whether they are for residential or commercial
properties. Many new concept boxes have been added to provide information about recent
trends in mortgage-backed securities and how the government has worked to add liquidity to
mortgage markets, in addition to taking over the Federal Home Loan Mortgage Corporation.
, Preface vii
The chapters that discuss the different ways mortgages can be structured have also
been expanded, so that readers can understand all the ways in which a mortgage can be
structured and the associated risks with each structuring.
A new section on market analysis has been added to provide readers with a better un-
derstanding of how data on the supply and demand for real estate can be used to project oc-
cupancy and rental growth. For more advanced readers, a new concept box describes
statistical techniques that can be used in market analysis.
Also new to this edition, a discussion has been added that outlines the various owner-
ship structures that can be used for ownership of investment property, along with the ad-
vantages and disadvantages of each.
Because investors often look for ways to defer capital gains taxes when selling invest-
ment properties, a new section has been added on installment sales and tax-free ex-
changes. This includes a discussion on how to evaluate whether these tax-deferral
strategies are better than a regular sale.
The chapter on real estate investment trusts (REITs) has been expanded to reflect the
current economic landscape and also to include discussion on how to value a REIT. Since
REITs are companies that invest in real estate, the value of the properties they hold is im-
portant, but techniques commonly used to value corporations such as earnings multipliers
and dividend discount models are also important.
Finally, we have expanded the integration of financial calculators and Excel into the
solutions of problems, since this is what is done in practice. The way that solutions are pre-
sented has been simplified by using new notation introduced in this edition.
Excel Spreadsheets and ARGUS Software
The book is rigorous yet practical and blends theory with applications to real-world problems.
These problems are illustrated and solved by using a blend of financial calculators, Excel
spreadsheets, and specialized software designed to analyze real estate income property. Excel
spreadsheets, provided on the book’s Web site at www.mhhe.com/bf14e, are an aid for stu-
dents to understand many of the exhibits displayed in chapters throughout the text. By modi-
fying these exhibits, students also may solve many end-of-chapter problems without having
to design new spreadsheets.
ARGUS Valuation DCF is used in several chapters to supplement the use of Excel
spreadsheets to solve investment analysis and valuation problems. ARGUS data files, avail-
able on the book’s Web site at www.mhhe.com/bf14e, replicate the examples in the book.
An educational version of the ARGUS Valuation DCF software can be obtained for students
using this book in their course. First the professor must send a list of students to ARGUS
Software, and then individual students can request a license that allows them to use ARGUS
Valuation DCF while they are enrolled in the course. Professors and students can contact
ARGUS Software by sending an email to StudentLicense@argussoftware.com.
Internet Tools and Assets
Making informed real estate investment and financing decisions depends on being able to
obtain useful information. Such information may include national and local market trends,
interest rates, properties available for acquisition, financing alternatives, and the opinions
of experts concerning the outlook for various real estate sectors.
The Internet now provides a rich source of information to real estate investors and lenders.
Knowing how to find information on the Web is an important part of the “due diligence” that
should be done before making any real estate investments. This edition includes a number
of Web App boxes that provide exercises that require finding relevant information on the
,viii Preface
Internet. These Web App boxes provide practical examples of the types of data and other re-
sources that are available on the Internet. The fourteenth edition also contains Web site ref-
erences that students can use to research various real estate topics. In addition to research,
these resources provide readers with an opportunity to remain current on many of the top-
ics discussed in the book.
The book’s Web site, located at www.mhhe.com/bf14e, contains additional helpful
materials for students such as Web links, multiple-choice quizzes, Excel spreadsheets,
ARGUS data files, and appendixes to the text. Using a password-protected instructor
log-in, instructors can find a solutions manual, test bank, and PowerPoint presentations.
Supplements
Several ancillary materials are available for instructor use. These include:
• Solutions Manual—developed by Jeffrey Fisher and William Brueggeman.
• Test Bank—developed by Eric Fruits, Portland State University.
• PowerPoint slides—developed by Joshua Kahr, Columbia University.
Acknowledgments
We would like to thank several people who contributed to recent editions by either being a
reviewer or providing feedback to us in other ways that helped improve the current edition:
Edward Baryla Deborah W. Gregory
East Tennessee State University University of Arizona
Robert Berlinger, Jr. Arie Halachmi
University Institute of Technology Tennessee State University (USA)
Roy T. Black Sun Yat-Sen University (China)
Georgia State University Barry Hersh
Thomas P. Boehm NYU-SCPS Real Estate Institute
University of Tennessee-Knoxville Samuel Kahn
Thomas Bothem Touro College
University of Illinois at Chicago Joshua Kahr
Wally Boudry Columbia University
University of North Carolina-Chapel Hill W. Keith Munsell
Grace Wong Bucchianeri Boston University
Wharton School, University of Pennsylvania Michael Schonberger
Ping Cheng Rutgers University-New Brunswick
Florida Atlantic University Tracey Seslen
John Fay University of Southern California
Santa Clara University Carlos Slawson
Michael Fratantoni Louisiana State University
Georgetown University Jan Strockis
Eric Fruits Santa Clara University
Portland State University
, Preface ix
In addition, we are grateful to Robert Martin, MAI, who helped prepare the ARGUS
examples used in the book. Ron Donohue with the Homer Hoyt Institute helped revise the
chapter on real estate investment trusts. Youguo Liang at Prudential Real Estate Investors
provided significant input on the structure of joint ventures. Charles Johnson and Aaron
Temple helped with Web references. Jacey Leonard helped prepare the Excel templates
for the previous edition that were used in this edition. Anand Kumar helped with Web
references and spreadsheets. Candi Duke helped in the preparation and submission of the
manuscript. Ji’ Reh Kore helped with research on recent trends impacting the real estate
finance industry, as well as with the preparation of the Solutions Manual. Deverick Jordan
and Diem Chau also helped with the Solutions Manual and with chapter exhibits. Nathan
Hastings helped update the legal chapters and provided input on the ownership structures
used for real estate.
We will miss the late Theron Nelson, who contributed to prior editions of the book,
including creating the original version of several of the spreadsheet templates. We appreci-
ate his contributions to this book and to the real estate profession.
Our thanks to the book team at McGraw-Hill/Irwin for their help in developing the new
edition: Michele Janicek, executive editor; Christina Kouvelis, senior developmental
editor; Alyssa Otterness, editorial coordinator; Dean Karampelas, marketing manager;
Suresh Babu, media project manager; Dana Pauley, project manager; Michael McCormick,
lead production supervisor; and Matt Diamond, designer.
We also continue to be indebted to people who have contributed to previous editions,
especially the late Henry E. Hoagland, who wrote the first edition of this book, and Leo D.
Stone, who participated in several editions. Finally, we thank all of the adopters of previous
editions of the book, who, because of their feedback, have made us feel that we have helped
them prepare students for a career in real estate.
William B. Brueggeman
Jeffrey D. Fisher
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