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Real Estate


Real Estate: an Important Asset Class â—?

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Until recent stock market boom, single family homes value in US approximated value of entire stock market. Home mortgages 1999: $4.62 trillion Consumer credit is only 1.46 trillion. US National debt held by public is only $3 trillion (Source: FRB, Balance Sheets for US Economy)


Real Estate Partnerships ●

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Real estate limited partnerships represent the most important example of a Direct Participation Program (DPP), a class of investments that also includes oil and gas exploration programs and equipment leasing programs “Direct participation:” DPPs are “flow-throw vehicles” and investors can deduct program losses on personal taxes “Tax shelters” until the Tax Reform Act of 1986: losses used to offset “passive income.” Now, genuine businesses. DPPs escape the corporate profits tax IRS requirements, notably limitation of life


Limited Partnership Structure ●

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General partner runs the business, does not have limited liability General partner must own at least 1% Limited Partners are passive investors, with limited liability, rights to vote, can replace general partner General partner or associate usually runs the offering to sell units to investors Give additional performance-oriented compensation to the general partner


Accredited Investors â—?

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Regulation D: Accredited investors include individuals with net worth in excess of $1 million or with income in excess of $200,000 ($300,000 joint income) in each of the last two years National Association of Securities Dealers (NASD) requires suitability files and suitability tests for DPPs


Real estate investment trusts (REITS) ●

Real Estate Investment Trusts (REITs) were created by US Congress in 1960 to allow small investors access to real estate investments. Before 1960, public companies that owned real estate would be considered businesses, for which their earnings would be subject to corporate profits tax. So, until 1960, real estate was typically owned by partnerships, not suitable for small investors. Today, institutions invest in REITs too.


Restrictions on REITs ● ● ●

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75% of assets must be in real estate or cash 75% of income must be from real estate 90% of their income must be from real estate, dividend, interest & capital gains 95% of income must be paid out No more than 30% of income from sale of properties held less than four years –

These prevent regular businesses from being REITS


The 3 REIT Booms ●

First boom: Late 1960s: interest rates rose above deposit rate ceilings at banks, depositors fled to mortgage REITs. But, with recession of 1974, many REITs defaulted. Economic Recovery Tax Act of 1981 favored partnerships. Second boom: Tax Reform Act of 1986 eliminated advantages of partnerships, so investors switched to REITs. Third boom: Starting 1992, many private real estate companies found it advantageous to go public as REITs, specialized REITs developed.


History of Mortgages â—?

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In 1920s, 5-year term loans common, balloon payment due in five years, or refinance or sell house. In 1930s, decline in nominal home prices and rise in unemployment caused massive defaults Mortgage lending industry turned to long-term annuities


Kinds of Mortgages ● ● ●

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Conventional, fixed rate mortgage Adjustable rate mortgage (ARM) Price level adjusted mortgage (PLAM) payment adjusted to inflation so constant in real terms Dual rate mortgages (DRAMs) same as PLAM but interest rate floats Shared appreciation mortgages (SAMs) First mortgages: on purchase of home Home equity loans


Conventional Mortgages ●

Homeowners’ fixed rate mortgage: an annuity whose present value equals the initial loan. Traditionally, payments are monthly and compounding is monthly. With maturity m years and mortgage rate r we have:

Mortgage balance=monthly payment×

[

1 1 − r /12 ( r /12 ) (1+r /12 )12 M

]


Fannie Mae ●

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Federal National Mortgage Association, created by Congress in 1938 to create a secondary market for FHA approved mortgages. Borrows money, buys & holds mortgages. 1944 allowed to buy VA (Veteran Admin. Loans) 1954 Congress makes Fannie Mae a “mixed ownership corp., with private owners 1968 Pres. Johnson signs bill making Fannie a fully private corporation 1976 Conventional loans outnumber FHA & VA Still does not do jumbo loans (above $275000)


Behavior of Single Family Home Prices ● ● ●

Not a random walk, substantial inertia Occasional booms and busts Shared movements over wide regions of country, but not shared over entire country Boom of late 1980s infected many of largest cities of world


Characteristics of Real Estate Booms ● ●

Case Shiller Surveys of Homeowners 1988, 2003 Surveyed recent homebuyers in Anaheim CA (boom), Milwaukee WI (no boom) and Boston MA (post-boom) Nearly 1000 responses each survey


Figure 5 Los Angeles Real Home Price Index and Employment 120

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Column M Column D


Figure 8 Milwaukee Real Home Price Index and Employment 200.0

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Column J Column K


Long-Term Expectations “On average over the next ten years, how much do you expect the value of your home to change each year?” Los Angeles Milwaukee 1988 2003 1988 2003 14.3% 13.1% 7.3% 11.7%


Fears of Being Left Out “Housing prices are booming. Unless I buy now, I won’t be able to afford a house in the future.” Los AngelesMilwaukee 1988 20031988 2003 Agree79.5% 48.8% 27.8% 36.4% Disagree 20.5% 51.2% 72.2% 63.6%


Perceptions of Excitement “There has been a good deal of excitement surrounding recent housing price changes. I Sometimes I think I may have been influenced by it.� Los AngelesMilwaukee 1988 20031988 2003 Yes 54.3% 46.1% 21.5% 34.8% No 45.7% 53.9% 78.5% 65.2%


Word-of-Mouth Communication “In conversations with friends and associates over the last few months, conditions in the housing market were discussed.� Los AngelesMilwaukee 1988 20031988 2003 Frequently 52.9% 32.9% 20.0% 27.6%


“Real Estate is Best Investment” “Real estate is the best investment for long-term holders, who can just buy and hold through the ups and downs of the market.” Los Angeles Milwaukee 2003 2003 1. Strongly agree 53.7% 31.3% 2. Agree somewhat 33.1% 45.9% 3. Neutral 10.3% 11.3% 4. Disagree somewhat 2.7% 9.1% 5. Strongly disagree 0.0% 2.1%


Effects of Real Estate Booms &Crashes â—?

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Default rate on mortgages is function of loan to value ratio, which declines as prices rise, rises as prices fall. Mortgage insurance companies suffered massive losses in 1980s with decline of real estate prices in Texas. MGIC in great trouble then.


Real Estate Market Today ●

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Late 1990s have shown solid price increases in many cities San Francisco increased 28% 1999 III to 2000 III, fell 4.5% between 2001-I and 2001-IV . More low downpayment loans today Risk of stock market decline harming real estate market, thereby the PMIs, and mortgage lenders


Figure 5 Los Angeles Real Home Price Index and Employment 120

9000000

8000000 100 7000000

80

6000000

5000000 Real Price

60

employment 4000000

40

3000000

2000000 20 1000000

0 1970

1975

1980

1985

1990

1995

2000

0 2005


Figure 5 Los Angeles Real Home Price Index and Employment 120

9000000

8000000 100 7000000

80

6000000

5000000 Real Price

60

employment 4000000

40

3000000

2000000 20 1000000

0 1970

1975

1980

1985

1990

1995

2000

0 2005


Thankyou Michael S robinson 8880 Call center Dr Suite 1000 Sacramento www.ohana-homesolutions.com

Real estate investment  

Real Estate sector has thrown open multiple investment opportunities. The PPT provides a comprehensive overview of real estate sector.

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