Real Estate Financing

Real estate transactions involve large amounts of capital. Because of the need for these huge transactions, many ways to finance a property with debt have been created. Due to the time value of money, a dollar today is not worth the same as a dollar tomorrow.  When a lender provides a debt service for a borrower, the borrower pays the lender back the principal along with interest payments. As a result many firms have been created in order to take advantage of the profitable opportunities in real estate finance.  The formation of large real estate firms provides a sense of liquidity to the real estate market.

The Federal National Mortgage Association (FNMA) and the Federal Home Loan Mortgage Corporation (Freddie Mac) are examples of firms that developed because of the great demand for mortgage financing. 

With the increased creation of long-term mortgages, the Federal Housing Administration (FHA) was created.  The struggle of the U.S. economy during the Great Depression led to many debt obligations not being met.  New construction on properties came to a halt as the entire real estate market froze. 

The FHA was created to restore confidence in the mortgage market. The administration helped establish rigorous borrowing and lending standards.

Freddie Mac: 

• Designed to increase the flow of funds to the mortgage market
• Operated a secondary market for conventional loans
• Sold mortgage backed securities

Freddie Mac

Above is a link to the Federal Home Loan Mortgage Corporation website. This site includes vast amounts of information ranging from the firms inception to its current state.

Fannie Mae:

• Created to buy mortgages from lenders
• To serve as a clearinghouse for the secondary mortgage market for FHA-insured loans
• Provided FHA-insured loans to low-income borrowers

Fannie Mae

The link above serves as an excellent resource for further information about Fannie Mae.

Some of the actual instruments of real estate financing are discussed below. 

Real Estate Investment Trusts (REITSs): Sell shares of stock to investors through public and private markets, then use the proceeds to invest in commercial properties. They provide an excellent opportunity for small investors to participate in the commercial real estate market.

Commercial Mortgage-Backed Securities (CMBS): Commercial mortgages are divided into financial securities that represent claims on the cash flows to the mortgage holder. CMBS can be looked at as a pool of investors receiving their portion of the returns. 

Below is a link to an article that discussed the recent uptick in demand for CMBS. With the QE3 currently happening, investors are seeking higher returns. However, it is important to note that CMBS can be very risky assets to hold as part of a portfolio. They had a intricate part in the recent debt crisis.

CMBS Rally is Welcome News in Property Market