Concord Eastridge, Inc.

Finance Presentation Lesson #2

Copyright 2013 Robert Paul Ellentuck

Sources of Real Estate Returns

Sources of returns from investment in real estate Cash flow from property operations Proceeds of sale of property Sources of returns from investment in mortgages Periodic (monthly) payments of interest Repayment of principal (monthly and/or at maturity)

What is Real Estate Equity?

Equity-money that is invested in a property Represents ownership of the property Participates in the operating and financial risks of property ownership Shares in the profits and losses of property operations and proceeds of property sale

What is Real Estate Debt?

Debt (Mortgage) Capital Money loaned to owner, developer or investor in exchange for promise to repay money loaned (principal) together with a specified current return for the use of the funds (interest) for a specific period of time (term) Lenders function as intermediaries, linking savers and borrowers Lenders view a mortgage loan as a fixed income investment that is repaid over a long period of time

Characteristics of Real Estate Mortgage Market

Source of real estate loan determined by term of the loan
Lenders seek to match assets and liabilities, thereby creating a matched book

Short-term loans generally used for planning through construction stages (until permanent long-term financing funded)

Long-term loans used for operation/ownership stage

Loan sourced from lenders who raise funds in the Capital Markets

Loan sourced from lenders who raise funds in the Money Markets

Structural Characteristics of Mortgage Loans

Non-recourse Secured Specified term-when it must be repaid Interest-calculated based upon fixed or variable rates Amortization-how principal will be repaid (self-amortizing/balloon) Prepayment
When and if available Cost to prepay (penalties)

Balloon and Fully Amortizing Mortgage Loans

Non-Amortizing ("Balloon") Loan
$1,000 $900 $800 $700 $600 $500 $400 $300 $200 $100 $0
2 4 6 8 0 2 4 6 8 0 2 4 5 200 200 200 200 201 201 201 201 201 202 202 202 202

Self-Amortizing Loan
$1,000 $900 $800 $700 $600 $500 $400 $300 $200 $100 $0
2 4 6 8 0 2 4 6 8 0 2 4 202 200 200 200 200 201 201 201 201 201 202 202 202 5

Loan Balance Monthly Payment

Loan Balance Monthly Payment

Mortgage Constant
The mortgage constant represents the annualized debt service payment (principal amortization, if any, plus mortgage interest) on a loan It is usually calculated via computer, financial calculator, or by reference to a pre-calculated table It is calculated on the basis of $1.00 of mortgage principal amount and the resulting factor is then applied to the amount of the mortgage The mortgage constant is dependent upon the period required to amortize the loan, the interest rates, and the frequency with which debt service payments are made
9

Components of the Private Real Estate Capital Markets

Commodity debt:
Low volatility, many lenders, and efficient pricing Income (interest) return drives total expected return on investment Higher volatility, first loss position Appreciation component drives total expected return High yield return, high volatility Income/appreciation return drives total expected return

Equity:

Mezzanine Investors:

10

Lenders Underwriting Decision, Method I

Adequacy of value of property as collateral for loan Test # 1- Loan-to-Value (LTV) Ratio LTV is an absolute standard; no loans in excess of 75% of market value Example: Market value = $1,250,000 x 75% LTV ratio = $937,500 loan At 75% LTV ratio, maximum loan is $937,500

11

Lenders Underwriting Decision, Method II

Adequacy of value of property as collateral for loan Test # 2 debt service coverage (DSC) ratio Ratio of dollar of NOI per dollar of debt service DSC is an absolute standard; no loans without minimum debt service coverage of 1.2 x 1 Example: NOI = $125,000 / 1.2 = $104,167 amount of NOI available to pay debt service To calculate amount of loan, divide amount available for debt service by loan constant $104,167 / 10.5% = $992,063 At 1.2 x 1 DSC, maximum loan is $992,063
12

What Would You Loan the Borrower? Why?

Loan-to-Value Ratio Debt Service Coverage Ratio $937,500 $992,063

13

Review of Debt Service Formulas

Annual Debt Service = Loan Amount x Mortgage Constant Debt Service Coverage Ratio = Net Operating Income/ Debt Service Maximum Loan Amount = Maximum $ Available for Debt Service*/ Required Mortgage Constant * Maximum $ Available for Debt Service = Net Operating Income/ Debt Service Coverage Ratio
14

Sources of Debt Financing

Commercial banks Insurance companies Savings and loan association Non-bank financial institutions (credit companies) Securitized lenders (CMBS or Conduits) Mortgage REITs Pension funds Government sponsored entities (i.e. FNMA)

15

16

Income and Expense Statement: Projected 2005

17

Debt Underwriting Back of the Envelope

Borrower Acquisition, development or refinance Acquisition: In contract Are equity and/or mezzanine in-place Development: Is developer ready to start construction September 2008 Retail Center LLC Development

Refinance: Does borrower need to refinance immediately Property Characteristics: Property Type Shopping Center

Major Tenants, (sq. ft., lease exp., rent, % GLA, credit ratings, etc.) Supermarket Subway Dry Cleaners 51,674 sf 2,500 sf 1,808 sf 25Y 5Y 10Y $9.68/sf. $20.00/sf $15.00/sf 93.98% 2.73% 3.29% BBB BB NR

Square Feet/Rooms/Units % Occupied/Pre leased/Pre sold

54,982 sf 100%

18

Debt Underwriting Back of the Envelope

Story/Loan Structure Excellent location, great sponsor, good anchor, appropriate inline space, excellent demographics, and good contractor GMP. Proposed Capitalization: Acquisition/Development Cost Closing Costs Other Capital Expenditures TOTAL Debt Mezzanine Equity $7,146,524 $0 $0 $0 $7,146,524 $ 5,717,200 $ $ 1,429,324 20 80 % % %

19

Debt Underwriting Back of the Envelope

Underwriting: Cash Flow: NOI (before TILC) Percentage Rent [50% if prepay history] $581,599 $39,520

Vacancy allowance % of Gross Revenue $5,720 (10 % of inline space) Management Fee % of Gross Revenue FF&E Reserve % of Gross Revenue Franchise Fee % of Gross Revenue Structural Reserve $ PSF/$Unit TILC Reserve $ PSF Underwritten NOI (after TILC) Return on Cost 3% of EGI NA NA $.25 psf GLA $3.00 psf GLA of inline space $554,930 7.77 %

20

Debt Underwriting Back of the Envelope

Loan Sizing: Fixed Rate or Floating Rate DSCR Spread/Base Rate Floor Rate/Actual Rate Amortization/Mortgage Constant Minimum Constant & DSCR LTV & Est. Cap Rate LTC DSCR Loan Amount Minimum Constant Loan Amount LTV Loan Amount LTC Loan Amount 75 % 80.0 % $6,160,960 $ $5,945,679 $5,717,200 7.0 % Fixed 1.20 X 1.50 % over 10Y USTN 6.40% 30Y 7.506 % 4.90 %

21