Sources of Financing

Like the various mortgages and loans available, not all lenders are the same. Debt financing on real estate can be obtained through a number of sources, both private and public (government). Private sector sources range from traditional commercial banks and life insurance companies, to the increasingly popular Real Estate Investment Trusts (REITs), pension funds, and investment bankers.

Commercial Banks
Commercial banks remain the largest financial intermediaries in the United States. They directly provide both short-term financing for development and construction and long-term mortgage financing for acquisition. They also provide home improvement loans, equipment loans, and lines of credit to other concerns that invest in real estate.

Other sources of financing include mortgage brokers, individual investors, insurance companies, pension funds, and investment trusts. Mortgage brokers help originate loans by bringing borrowers and lenders together.

Insurance Companies
Life insurance companies are the oldest and most diversified commercial real estate lending source. Improved commercial and industrial properties and apartment buildings constitute the major portion of life insurance company mortgage portfolios. Life insurance companies are the major lenders in many commercial and industrial properties. They specialize in placing long-term debt in large amounts.

Federal Government
The federal government finances real estate both through direct loans and as guarantor and/or insurer of mortgages held by private insurers. The U.S. Department of Housing and Urban Development (HUD) makes direct loans to public agencies through the Urban Renewal Program and to private developers through the New Communities Program.

In addition, the federal government provides mortgage insurance through the U.S. Federal Housing Administration (FHA). This agency’s only function is to insure loans. It was created in 1934 to encourage improvement in housing standards and conditions, facilitate sound home financing on reasonable terms, and exert a stabilizing influence in the mortgage market.

In order to obtain FHA insurance, lenders, borrowers, and the property must meet specified requirements. Mortgage insurance through the FHA is available for single-family, multiple-family, cooperative, elderly, and other housing projects. Mortgages for qualified veterans are similarly insured through the U.S. Department of Veterans Affairs.

Real Estate Investment Trusts (REITs)
REITs, or real estate investment trusts, have been a major source of diverse funding. A Real Estate Investment Trust (REIT) is a company that owns and, in many cases, operates income-producing real estate. REITs sell publicly traded shares similar to the stock market. To be a REIT, a company must annually distribute at least 90% of its taxable income to shareholders in the form of dividends. The United States is home to almost 200 publicly traded REITs that have assets totaling nearly $400 billion. REITs invest in all property types, but the majority of investment is in retail, office, and multifamily property.

For more information on REITs, visit the National Association of Real Estate Investment Trusts (NAREIT) website at http://www.nareit.com.

Pension Funds
Pension funds accumulate cash on a tax-exempt basis for future payment to retiring employees. Corporate, labor union, and government employee benefit accounts for future pensions or profit sharing are large sources of pension fund investment capital. The overriding investment objectives of most pension fund managers have been protecting the accumulated capital and maintaining sufficient liquidity to meet future payment requirements.

For more information on pension funds and real estate, visit the Pension Real Estate Association (PREA) website at http://www.prea.org.

Investment Banks
Investment banks, such as Goldman Sachs, Morgan Stanley, and Merrill Lynch, have traditionally been involved in underwriting and distributing initial public offerings and acting as dealmakers for the private placement of debt and for corporate mergers and acquisitions. Their business activities in real estate began in the 1970s with brokerage and investment. They created the secondary market for residential mortgage loans where original mortgages (bundled and securitized) are sold.

Today, investment banks offer direct commercial mortgage loans. These offerings are typically for hard-to-finance deals, such as properties with past problems, repositioned properties, or properties that have complex financing needs. Investment banks have come to compete directly with REITs, as they do with commercial banks.

Private Sources
Individual investors, acting alone or in limited partnerships, make money available directly for real estate projects in any phase of a property’s development: raw land, construction, or improvements. Private lenders are often the only source of financing for raw land. Typically, the loan amount is small and for a short term. The lending interests of parties in this group are unique, and they can include any type of funding. Such investors are nota primary source of real estate lending.

Syndicators are a special type of limited partnership that packages real estate investments as tax shelters. Their goal is to make ownership of large properties available to numerous small investors who desire an investment with favorable tax treatment. These firms were a significant financing source in the early 1980s, but they have since lost much of their presence because of tax law reform, overbuilding, poor investment decisions, and in some cases, the collection of excessive fees.

Private Mortgage Insurance
Modern private mortgage insurance was established in 1957, when the Mortgage Guarantee Insurance Corporation (MGIC) was formed. Lending institutions can make high-ratio loans because the mortgage is insured. Originally formulated to assist in the financing of single-family homes, the concept has broadened to include multifamily, commercial, and industrial properties and leaseholds.