Property Economics and Finance for Securitisation - myassignmenthelp

Question: Discuss about theProperty Economics and Finance for Securitisation. Answer: Sources and Types of Finance The developer within the property industry has to identify and evaluate the various alternatives of financing before selecting the best one. Most of the developers first go for personal savings as source of funds. In addition, they also rely on different banks and life insurance companies for funding as its primary source. However, globalization has led other sources like private funders and joint ventures to emerge as an alternative for many developers. Moreover, they can also get advances from third parties as lease and securitisation (SPVs). Further, they get the funds from mortgage brokers and mortgage bankers for re-mortgaging as they have proficiency and understanding in property industry. Other main sources include pension funds, auction finance and bridging finance, real estate investment trusts, corporate finance and state finance programs (Berry et al., 2013). The capital structure in property industry helps to know the quantum of equity and debt in financing property and further expansion. Further, this also helps in to compute the firms leverage (Migl, 2016). In this industry developer majorly uses debt for financing so the company has a high leverage. However, it plays a crucial role in period of bankruptcy also. It is important for a developer to focus on capital structure as helps to maximize the market value of the firm which in turn increase the share price and dividends, minimizes the cost of financing, recognize better investment opportunities for growth of the company and the industry (Trisha, 2018). The main capital structuring issue that are relevant to investor returns is considering cost of capital which should be lower than expected returns. In addition to this, a tax deduction in debt financing decreases the cost of debt and increases the possibility of returns and dividends. Further, a high tax rate increases the proportion of debt in financing, but increase the risk of bankruptcy. The concept of window of opportunity is also a major issue as it states the time when the funds are available at a lower cost considering the economy conditions. Further, the restrictions on management and its style adopted as aggressive or conservative is also a major issue affecting the investors return. The growth rate of the company can finance its capital from debt easily increasing the business risk of the company (Lumen, 2018). Financing Techniques The various risk faced by the financiers in the project finance are identified as controllable or uncontrollable risks. Construction and completion risk is crucial to lenders as they need to mitigate it by commodity derivatives if the completion costs increases. Operating risk is faced when the cost of operations goes up and these can be mitigated through future contracts, lump sum payments, turnkey contracts and warranty agreements. Force majeure and change in law is a major risk for lenders so they need to regularly review it. Further, political and regulatory risks are uncontrollable risk so lenders should be ready to face this risk. This risk can be reduced through insurance. Repayment risk is the most important risk to lenders and it is managed through Project Company itself by maintaining reserve accounts and evaluating potential ratios. Currency exchange risk and interest rate risk are some other risks that lenders have to deal with. To reduce it to the lowest level they use t he method of swapping with a different market financier (World Bank Group, 2018). Further, the risk between parties is shared considering that which party can control the risk efficiently and effectively. The party which can control the risk should tolerate it. However, if none of the parties can control it than the party which can tolerate it easily should take efforts to do so. Evaluation Techniques Computation of Net Present Values- Period Cash Flows ($) PVF @ 8.90% PV of Cash Flows 0 -450551 1 -450551 1 45000 0.918273646 41322.31405 2 45000 0.843226488 37945.19196 3 45000 0.774312661 34844.06976 4 45000 0.71103091 31996.39096 5 45000 0.652920946 29381.44257 NPV 626040.4093 Period Cash Flows ($) PVF @ 7.50% PV of Cash Flows 0 -600000 1 -600000 1 45000 0.930232558 41860.46512 2 45000 0.865332612 38939.96755 3 45000 0.80496057 36223.22563 4 45000 0.74880053 33696.02384 5 45000 0.696558632 31345.13846 NPV 782064.8206 Period Cash Flows ($) PVF @ 8.00% PV of Cash Flows 0 -562500 1 -562500 1 45000 0.925925926 41666.66667 2 45000 0.85733882 38580.24691 3 45000 0.793832241 35722.45085 4 45000 0.735029853 33076.34338 5 45000 0.680583197 30626.24387 NPV 742171.9517 Period Cash Flows ($) PVF @ 8.5% PV of Cash Flows 0 -529412 1 -529412 1 45000 0.921658986 41474.65438 2 45000 0.849455287 38225.48791 3 45000 0.782908098 35230.86443 4 45000 0.721574284 32470.84279 5 45000 0.665045423 29927.04405 NPV 706740.8936 Period Cash Flows ($) PVF @ 9% PV of Cash Flows 0 -500000 1 -500000 1 45000 0.917431193 41284.40367 2 45000 0.841679993 37875.5997 3 45000 0.77218348 34748.2566 4 45000 0.708425211 31879.1345 5 45000 0.649931386 29246.91238 NPV 675034.3069 Period Cash Flows ($) PVF @ 9.5% PV of Cash Flows 0 -473684 1 -473684 1 45000 0.913242009 41095.89041 2 45000 0.834010967 37530.49353 3 45000 0.761653851 34274.42331 4 45000 0.695574293 31300.84321 5 45000 0.635227665 28585.24494 NPV 646470.8954 Period Cash Flows ($) PVF @ 10.00% PV of Cash Flows 0 -450000 1 -450000 1 45000 0.909090909 40909.09091 2 45000 0.826446281 37190.08264 3 45000 0.751314801 33809.16604 4 45000 0.683013455 30735.60549 5 45000 0.620921323 27941.45954 NPV 620585.4046 Period Cash Flows ($) PVF @ 10.50% PV of Cash Flows 0 -428571 1 -428571 1 45000 0.904977376 40723.9819 2 45000 0.81898405 36854.28226 3 45000 0.741162036 33352.29164 4 45000 0.670734875 30183.06936 5 45000 0.606999887 27314.99489 NPV 596999.6201 Period Cash Flows ($) PVF @ 11.00% PV of Cash Flows 0 -409091 1 -409091 1 45000 0.900900901 40540.54054 2 45000 0.811622433 36523.0095 3 45000 0.731191381 32903.61216 4 45000 0.658730974 29642.89384 5 45000 0.593451328 26705.30976 NPV 575406.3658 The WACC taken as the discount rate for future cash flows assess the present value of the property for overall year instead of a single year. The company will have a net present value of around USD$626040 by discounting the cash flows with WACC at 8.90%. On the other hand, the company under property industry also uses capitalization rate for discounting its cash flows to assess the value and profitability the property will attain. Further, the capitalization rate is the rate which is driven by market forcesThe capitalisation rate will give ambiguous results when the cash flows of the property tend to change. Therefore, the investor selects that investment which will generate him more profits. So, after analysis from the above calculation the investor will tend to be more biased were the NPV is higher and that is at the PV Factor of 7.50% generating the value of USD$ 782064.8206. The use of capitalisation rates has helped the above analyses in decision making. It has helped to compare the property with discounted cash flow method and take out its valuation. This approach of rule of thumb is easy and quick to measure the financial position of the assets (Kobzeff, 2016). The value of the property is influenced by many factors which should be considered by the investors. These include location of the property, valuation of the property, purpose of the investments and profit expectations. Risk and Risk Management From the investors side, the key risk connected with the property investment is market risks which include equity, interest and currency risks. Liquidity risk is challenge to sell the investment at a reasonable price. There is concentration risk also i.e. not diversifying in different portfolios. Investors who do not get their principal amount and interest on maturity from Companies facing financial difficulties faces credit risk. Some other major risks faced by the investors are foreign investment risks, horizon risk, inflation risk, capital risk, on-going return risk, degradation in the value of the property. These risks when identified can be majorly managed through guidance from experts and diversification of the property portfolio. Investors should avoid leverage margin trading. Risk can also be reduced by investing in companies which have a stable and consistent record of stock in the past. Further, in the recession period, investors should avoid investing in levered companies. However, a positive cash flow should be managed by the investors for high returns (Duggan Benzinga, 2014). Correlation indicates the degree of relationship between the two variables or sectors. It helps the investors to diversify their risk in investments by decreasing the correlation between them. Commercial and residential sectors as two variables have a strong correlation between them. This means that the value for both will fluctuate in same directions. According to some economist, there are same factors that affect the demand for both the sectors. However, demand plays an important factor for measuring the relationship between these two markets. For example, increase in the household market cause the commercial market to also increase indicating a strong positive correlation. Similarly, a negative correlation is seen when there is unemployment caused in the commercial market affecting the household market (Konigsberg, 2018). However, this indicates that these sectors are more risky as they have a positive correlation. This portfolio risk can be diluted by using the assets that have a lesser amount of correlation, thus contributing to an efficient portfolio (Reisman, 2014). Property economics overall view Changes to interest rates When any change is seen in the interest rates, it has a significant impact on mixed development. A high interest rate will make it difficult for the developer to gather funds for financing from different sources. Further, this leads to increase in costs of loans and other fundings. The new mixed development proposal will have to face a challenge by this factor as for commercial and residential development, huge amount of funds are required. Federal government changes (increase) to withholding tax applicable to offshore REIT investors Retail Estate Investment Trust (REIT) investors are tax efficient investors in the property industry. They will tend to invest less in the property due to increased changes in the federal government to withhold tax applicable to them. This will reduce their profits as they have to pay more tax. From the profits they earn, they are required to benefit their investors and shareholders by paying out 90% out of it. So, they will be left with lesser profits after tax disappointing the shareholders. Rising unemployment Rising unemployment will have a major impact on the new mixed development proposal. This will make the proposal less attractive. The problem of unemployment leads to less capital in the hands of developer and as well as investors. There will be fewer saving from the household sectors leading to decrease channelizing and mobilizing of funds. Therefore, it will have a direct impact on the developer as they will be less investor in the market. Rapid growth in supply of residential property - to be delivered / settled within 3 years This rapid growth will affect the commercial property proposal by the developer to the investors. The corporate investors will not find this proposal attractive as they want the commercial development also fast along with residential property supply. On the contrary, this will benefit the household investors in many ways like working from home in case of emergencies. Continued strength / investment in the resources sector Investment in the resources sector will affect the investments in the new mixed development proposal; thereby, putting the developer in great loss. Resources sector needs a great development for the uplift of the economy and the country thereby, letting the property industry to struggle in the market for its development. The government and the legislation will majorly emphasize on this sector instead of property development. Rising interest rates A rise in the interest rate will make the investors more prone to invest in property. This will generate huge loss to the developers. Therefore, it will have a direct impact on the mixed used development proposal. The investors will not find this situation attractive to buy or purchase the property and will wait for the market conditions to improve and fall in the interest rates. References Berry, J.N., Deddis, N.G., McGreal, W.S. (2013). Urban Regeneration: Property Investment and Development: Taylor Francis. Yardney, B. (2018, April 6). Property Development Guide Part 5 Financing your Project. Retrieved from https://propertyupdate.com.au/property-development-finance/. Migl, A. (2016). Capital Structure in the Modern World: Springer. Trisha, (2018, February 28). Capital Structure: Concept, Definition and Importance. Retrieved from https://www.yourarticlelibrary.com/financial-management/capital-structure/capital-structure-concept-definition-and-importance/44063. Lumen, (2018, February 28). Capital Structure Considerations. Retrieved from https://courses.lumenlearning.com/boundless-finance/chapter/capital-structure-considerations/. Fletcher, P. Pendleton, A. (2018, February 28). Identifying and Managing Project Finance Risks: Overview (UK). Retrieved from https://www.milbank.com/images/content/1/6/16376/5-564-5045-pl-milbank-updated.pdf. World Bank Group (2018, February 28). Risk Allocation, Bankability and Mitigation in Project Financed Transactions. Retrieved from https://ppp.worldbank.org/public-private-partnership/financing/risk-allocation-mitigation. Duggan, W. Benzinga (2014, November 18). 4 Ways to Manage Risk in your Portfolio. Retrieved from https://www.benzinga.com/general/education/14/11/5012949/4-ways-to-manage-risk-in-your-portfolio. Koenigsberg, R. (2018, February 28). A Link between Commercial and Residential Real Estate. Retrieved from https://aiprops.com/newsletter/april/Koenigsberg-Bulletin_commercial-and-residential.pdf. Reisman, E. (2014, May 19). What is Correlation and Why Does it Matter for your Portfolio? [Blog post]. Retrieved from: https://www.stockrover.com/blog/what-is-correlation-and-why-does-it-matter-for-your-portfolio/. Kobzeff, J. (2016, July 19). Capitalization Rate: How to Compute and Use. Retrieved from: https://www.proapod.com/Articles/capitalization_rate.htm.