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Copyright 2008 by The McGraw-Hill Companies, Inc. All Rights Reserved

Chapter 01:
Real Estate Investment: Basic
Legal Concepts
McGraw-Hill/I rwin Copyright 2011 by the McGraw-Hill Companies, I nc. All rights reserved.
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Real Estate Finance
Lecturer: Lee Rosner, CCIM SIOR
Coldwell Banker Commercial Island Corporate Services

Managing Principal
32 years of experience in commercial real estate
www.cbcli.com | lrosner@cbcli.com | 631-761-6886 Direct
LinkedIn: www.linkedin.com/in/leerosner
SBU Faculty Member in MBA Program
MBA 576 Real Estate Finance & Investment
Fall Semester
Adjunct Professor since 2010
Former Elected Official - Trustee
Incorporated Village of Port Jefferson 2010-2014
Commissioner of Building & Planning Dept. 2010-2014
Planning Board Liaison 2010-2014
Former Zoning Board of Appeals Chairman 2007-2010
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Real Estate generates
1. > 28 percent of U.S. gross domestic product (GDP)
2. Creates jobs for nearly 9 million Americans
3. Source of nearly 70 percent of local government revenues
4. The total contribution of the housing sector alone approaches 20 percent of GDP

Real Estate and U.S. Wealth
1. Total market value of real estate approximately $25.6 trillion excluding real estate
held by non-real estate corporations and real estate owned by various
governmental agencies.
2. Real estate constitutes the single largest asset class in the United States,

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The Role of Government
1. Government affects real estate markets, and therefore values
2. Local government has perhaps the largest influence on real estate.
a. Affects supply & cost of real estate through
i. Zoning codes and other land use regulations
ii. Fees on new land development
iii. Building codes that restrict methods of construction.
b. Property taxes
c. Supply and quality of real estate by its provision of roads, bridges, mass
transit, utilities, flood control, schools, social services, and other
infrastructure of the community.
3. State government has a lesser impact on real estate values, although it still is
important.
a. Licensing of professionals and agents
b. Statewide building codes
c. Disclosure laws and fair housing laws,
d. States set the basic framework of requirements for local government land
use controls
e. Intervene in the realm of land use controls for special purposes
f. Public services important to a community, including schools, transportation
systems, social services, law enforcement, and others.
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Continued

4. National government influences on real estate
a. Income tax policy
b. Housing subsidy programs
c. Federal flood insurance programs
d. Federal financial reporting and disclosure requirements
e. Consumer protection laws
f. Laws protecting the environment and endangered species.
g. National fair housing laws and other civil rights legislation


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Characteristics of Real Estate Markets
Real estate assets and markets are unique when compared to other goods.

1. Heterogeneous Products

2. Immobile Products

3. Localized Markets

4. Segmented Markets

5. Privately Negotiated Transactions with High Transaction Costs



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Real Estate Careers
www.business.uc.edu/realestate/careerpaths | www.realcareers.org

Real estate professionals must be able to research, analyze, negotiate, plan and
market.

Certain real estate specializations tend to require more of the analytical attribute, while
others require more of the people-oriented attribute.
Real estate people can never know too much.
Successful real estate professionals are entrepreneurial by nature and process-oriented.
Beyond general knowledge of business, economics and a global market perspective,
employers expect neophyte real estate professionals to be computer literate, using
spreadsheets, database analysis, word processing, graphical analysis and geographic
information systems.
Must communicate well and to make oral presentations.
Negotiation skills are important aspect of the real estate industry

Real Estate career paths:
Appraisal and Consulting
Brokerage and Leasing
Corporate Real Estate
Mortgage and Construction Lending
Property Management
Institutional Real Estate Investment
Development



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This is not a course about real estate law; however, a considerable amount of
legal terminology is used in the real estate business.

It is very important to understand both the physical nature and property rights
being acquired when making real estate investments..
Real Estate Law
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The term estate has evolved to mean "all that a person owns," including both
realty and personalty.
The portion of a person's estate that consists of realty has come to be known as
real estate.
The term real estate is used to refer to things that are not
movable such as land and improvements permanently
attached to the land
Real Estate Defined
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Property Rights and Estates
Real property vs. personal property
Estates
Based on Rights: Possession vs. Not in Possession
Based on Possession and Use: Freehold vs.
Leasehold
Possessory estates
Freehold
Fee Simple Estates
Life Estates
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Estates
Nonpossessory Estates: Future Estates
Reversion Estate
Remainder Estate
Leasehold Estates
Estate for Years (typical lease written). Generally
for one (1) yr or more
Estate from Year to Year (mo. to mo.)

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Additional Interests
An interest is a right or claim on real property, its
revenues, or production. In real estate, an interest is
usually thought to be less important than an estate.
A common example of an interest is when an owner
of real estate pledges or encumbers his property as a
condition for obtaining a mortgage. The lender is said
to have a secured interest.
An easement is a non-possessory interest in land. The
right is for the use of the land for a special purpose.
Examples include rights of way for road access and
utility lines.
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Title Assurance
The Meaning of Title
Abstract Term
Quantity of Rights Conveyed
Abstract of Title
Title Chain
Title Assurance
Title assurance refers to the means by which buyers
of real estate "(1) learn in advance whether their
sellers have and can convey the quality of title they
claim to possess, and (2) receive compensation if the
title, after transfer, turns out not to be as represented.

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Title Assurance
Deeds
Grantor & Grantee vs Seller & Buyer
General Warranty Deed
Covenant that the grantor has good title
Covenant that the grantor has the right to convey
the property
Covenant to compensate the grantee for loss of
property or eviction as a result of a superior claim
No encumbrances on title except those noted

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Title Assurance
Deeds
Special Warranty Deed
Limits the covenants to the ownership duration of
the current grantor.
No guarantees on the ownership of prior grantors.
Bargain and Sale Deed
Conveys property without seller warranties
Sometimes called an as-is deed
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Title Assurance
Deeds
Sheriffs Deed-Trustee Deed
Bargain and sale deed received by a buyer from a
foreclosure or other forced sale by sheriff or
trustee
No warranties are added
Quitclaim Deed
No Covenants
The least protection to the grantee
Grantor conveys whatever right may exist

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Title Assurance
Abstract & Opinion
Title search
Study of relevant records
Lawyers opinion on title
Is it good and marketable?
Are there any clouds on title?
Is there a break in the chain of title?
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Title Insurance
Why Title Insurance and not Abstract and Opinion?
1. Definite contract liability to the premium payer
2. Reserves sufficient to meet insured losses
3. Supervision by an agency of the state
4. Protection to the policyholder against financial
loss because of any kind of title defect,
disclosed or hidden
While an abstract and opinion method may still be
used because of cost considerations, in general
title insurance is used. As a general rule, lenders
will require that a buyer use title insurance.

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Title Assurance
Title Insurance
One time premium
Unseen Hazards in the Public Record
Risk is spread among many property owners
Owners Policy
Insures the interest of a new owner
Lenders Policy
Insures the interest of the lender
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Recording Acts
Recording protects the interest of the owner
Constructive Notice
A person is deemed to have whatever
information is in the public record
Mechanics Liens
May be recorded after the fact
Sellers affidavit
Lien waiver
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Limitations on Property Rights
Government Restrictions
Police Power
Zoning, building codes, etc.
Eminent Domain
Eminent domain is relatively expansive; depending
on the state, government has relatively broad
powers on what property they may take
possession of through eminent domain and for
what purpose.
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Limitations on Property Rights
Private Restrictions
Deed restrictions
Subdivision restrictions

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RE Investment Example
Consider a four-unit
apartment complex that is
offered for sale at $455,000.
The units are expected to
rent for $1,325 per month in
the first year (increasing at
3.5% per year) with an
annual vacancy rate of 5%.

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The property is expected to have
operating expenses of $25,420 in the first
year (increases at 3.5% per year).
A loan is available at 75% of the purchase
price for 7% interest with monthly
payments over 25 years.
The investor believes property value will
increase at the annual rate of 2% per year.
The investor faces a tax rate of 28%.


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Initial equity is $113,750
I = 10%
T = 5 years
NPV = $-2,044
IRR = 11.64%
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Income and Expense Pro Forma
# of Units Rent Year 1
Rental Income 4 1,325 $ 63,600 $
Vacancy & Credit Loss 3,180.0 $
Effective Gross income 60,420.0 $
Operating Expenses
Maintenance & Repairs: 4,550 $
Insurance: 3,975 $
Property Taxes: 11,375 $
Property Mgmt Fee: 5,520 $
Total Expenses 25,420 $
Net Operating Income: 35,000 $
Forecasted Annual Rent Increases 3.5%
Forecasted Annual OE Increases 3.5%
Vacancy Factor 5.0%
After-Tax Cash Flows from Operations Year 1 Year 2 Year 3 Year 4 Year 5
Gross Potential Income 63,600 $ 65,826 $ 68,130 $ 70,514 $ 72,982 $
Vacancy & Credit Loss 3,180 $ 3,291 $ 3,406 $ 3,526 $ 3,649 $
Effective Gross income 60,420 $ 62,535 $ 64,723 $ 66,989 $ 69,333 $
Operating Expenses 25,420 $ 26,310 $ 27,231 $ 28,184 $ 29,170 $
Net Operating Income: 35,000 $ 36,225 $ 37,493 $ 38,805 $ 40,163 $
Debt Service: 28,943 $ 28,943 $ 28,943 $ 28,943 $ 28,943 $
Before Tax Cash Flow: 6,057 $ 7,282 $ 8,550 $ 9,863 $ 11,221 $
- Income Tax 279 $ 603 $ 1,071 $ 1,560 $ 2,196 $
After Tax Cash Flow 5,778 $ 6,680 $ 7,479 $ 8,302 $ 9,025 $
NPV/IRR Cash Flow Analysis
EOY
Initial
Investment ATCF
Net Sales
Proceeds
Total
Annual CF
Present
Value
0 (113,750) $ (113,750) $ (113,750) $
1 5,778 $ 5,778 $ 5,253 $
2 6,680 $ 6,680 $ 5,520 $
3 7,479 $ 7,479 $ 5,619 $
4 8,302 $ 8,302 $ 5,671 $
5 9,025 $ 135,347 $ 144,371 $ 89,643 $
NPV ($2,043.79)
IRR 11.64%
Discount Rate: 10%
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Supporting Exhibits
Mortgage Data Initial Year 1 Year 2 Year 3 Year 4 Year 5
Purchase Price: 455,000 $
Loan to Value: 75%
Initial Mortgage Balance: 341,250 $ $336,030 $330,432 $324,429 $317,993 $311,091
Interest Rate 7%
Term (years): 25
Monthly Debt Service: (2,412) $
Annual Debt Service: (28,943) $
Interest: 23,722 $ 23,345 $ 22,940 $ 22,506 $ 22,041 $
Principal: 5,220 $ 5,598 $ 6,003 $ 6,436 $ 6,902 $
Tax Calculations Year 1 Year 2 Year 3 Year 4 Year 5
Net Operating Income: 35,000 $ 36,225 $ 37,493 $ 38,805 $ 40,163 $
- Interest Expense: 23,722 $ 23,345 $ 22,940 $ 22,506 $ 22,041 $
- Cost Recovery Allowance: 10,280 $ 10,727 $ 10,727 $ 10,727 $ 10,280 $
Taxable Income: 998 $ 2,153 $ 3,826 $ 5,572 $ 7,842 $
Ordinary Tax Rate 28% 28% 28% 28% 28%
Income Tax: 279 $ 603 $ 1,071 $ 1,560 $ 2,196 $
Depreciation
Purchase Price: 455,000 $
% of Value attributable to Improvements: 64.84%
$ Depreciable Value of Improvements: 295,000 $
$ of Value attributable to Land: 160,000 $
Depreciable period in years 27.5
Depreciation per annum: 10,727 $
*Cost Recovery Allowance Year One: 10,280 $
After Tax Equity Reversion
Gross Selling Price: 502,357 $
- Selling Expenses: 30,141 $
Net Selling Price: 472,215 $
Mortgage Payoff: 311,091 $
Before Tax Equity Reversion 161,125 $
Capital Gains Tax 12,592 $
Depreciation Recapture Tax: 13,186 $
After Tax Equity Reversion: 135,347 $
Appreciation Per Annum: 2%
Selling Expenses (% of Sale Price) 6%
Capital Gain Tax Calculations
Net Selling Price: 472,215 $
Book Value: 402,258 $
Capital Gain 69,958 $
Capital Gain Tax Rate: 18%
Capital Gain Tax: 12,592 $
Depreciation Recapture Tax
Accumulated Depreciation: 52,742 $
Depreciation Recapture Tax Rate: 25%
Depreciation Recapture Tax: 13,186 $
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NPV/IRR Cash Flow Analysis
EOY
Initial
Investment ATCF
Net Sales
Proceeds
Total
Annual CF
Present
Value
0 (113,750) $ (113,750) $ (113,750) $
1 5,778 $ 5,778 $ 5,253 $
2 6,680 $ 6,680 $ 5,520 $
3 7,479 $ 7,479 $ 5,619 $
4 8,302 $ 8,302 $ 5,671 $
5 9,025 $ 135,347 $ 144,371 $ 89,643 $
NPV ($2,043.79)
IRR 11.64%
Discount Rate: 10%