What are real estate bonds?

jaus tail said:

So I read this book The Vulture Fund but didn't understand some concepts. It would be nice if someone clarified them.

The plot is finance guy Lewis knows Manhattan real estate prices will go down soon. So he gets some money. Then when the real estate will collapse he plans to buy the real estate and sell them when prices go up.

Heh. That seems an unlikely plan.

But...

Where do Mace(employee of Webster) and Webster get the money from? (It says they got it from some super rich families, and some bank by Schuler and Chase. But why would the bank give them money? Loan?)(though in the end it's revealed what the families are? But why would a bank give them any money?)

Banks loan people and other institutions money - that's kind of what they do. I haven't read it, but I'd presume it's a loan, yes.

And then some real estate guy named Mr Hamilton has bought some bonds. What's a bond? And why would he buy?

Bonds are investments, generally more secure than stocks. A stock is a piece of a company that can gain or lose value. A bond is an investment you make in something that should pay a specific return. Like if a city wants to improve something but doesn't have the money up front it might sell bonds to basically borrow the money. This is super simplistic and missing lots of variables, but...

In the book Hamilton buys bonds from Lewis for some money. Some terrorist cause a nuclear threat over Manhattan so the real estate crashes, so Hamilton(real estate guy) sells bonds and now Lewis is offering very less money. Something like 30 cents for a dollar. Why can't Hamilton go to some guy?

Sorry if this is in the wrong forum. The book was pretty interesting by the way.

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I don't follow your last question I don't think.

jaus tail said:

So I read this book The Vulture Fund but didn't understand some concepts. It would be nice if someone clarified them.

The plot is finance guy Lewis knows Manhattan real estate prices will go down soon. So he gets some money. Then when the real estate will collapse he plans to buy the real estate and sell them when prices go up.

But...

Where do Mace(employee of Webster) and Webster get the money from? (It says they got it from some super rich families, and some bank by Schuler and Chase. But why would the bank give them money? Loan?)(though in the end it's revealed what the families are? But why would a bank give them any money?)

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Cornflake gave very good answers to the other questions.

And then some real estate guy named Mr Hamilton has bought some bonds. What's a bond? And why would he buy?

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A bond is a debt security, a commitment that the seller pay interest on the principal of the bond. For example, a 5% bond on a $1000 bond (bonds are usually denominated in thousand dollar units) would pay $50 per year. The right to receive the interest and the eventual repayment of the principal at the end of the term of the bond are all that bond holders get; they have no ownership interest, so they do not vote at annual meetings. The bonds could be either debts of a real estate company, like one of Trump's corporations, or they could be mortgage bonds, which are a little more complicated to explain, but they lose value when it becomes unlikely that the underlying mortgages will be paid.

In the book Hamilton buys bonds from Lewis for some money. Some terrorist cause a nuclear threat over Manhattan so the real estate crashes, so Hamilton(real estate guy) sells bonds and now Lewis is offering very less money. Something like 30 cents for a dollar. Why can't Hamilton go to some guy?

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Considering what happened to the real estate market after the terrorist attack, that may be the highest price anyone is offering, but Hamilton has the right to sell to anyone who will buy.


considering your questions, this looks like an interesting novel.

> Why can't Hamilton go to some guy?

Hamilton can try to find a private buyer for his bonds, but it's more efficient to put it up for sale on a stock exchange. Maybe in this case, Lewis is offering a bit more money than what the stock exchange is currently offering for his bonds.


-cb

ETA - cut off repetition.

A fund is a group of investors who are working together for investing purposes. Most common example is a mutual fund.

A vulture fund is a particular type of fund. A vulture fund specializes in going in an buying when a business is in trouble. The idea is to be able to pick the carcass clean and make some money. Lewis apparently has reason to believe that real estate prices in Manhattan will go down, so he has set up a vulture fund consisting of investors and either a loan agreement from a commercial bank or an investment from a investment bank.

Real estate in Manhattan is a bit unusual. Most buildings are own by syndicates such as partnerships, limited liability companies, and other forms of getting different people together to invest in one building. Cost of real estate is based upon both the cost of the building and land, and the rent from the building. Let's say the costs of a building is one million per year. Income from rent is $1.1 million. Real estate value goes down, the mortgage company rewrites the loan to reflect the loss in value of the collateral, and now the costs for the building are $1.2 million. Rent can't be increased because real estate are going down and it's easy for the tenants to move.

Result is the building is now $100,000 a year in the hole. So a vulture comes along and offers the owners a chance to cash out before it goes completely bad.

Is this making sense?

This is how a lot of rich people do investing. Think Bernie Madoff as a dishonest approach to this. It's a variation on your 401K.

Bonds here could be municipal bonds or junk bonds. Corporations and other businesses will sell bonds to raise money from sources other than banks. I'm inclined to doubt the writer means municipal bonds. To be able to repay a bond, you've got to have the money. This is what is happening with Puerto Rico and Argentina. Lots of bonds but not lots of money. And again, a vulture will circle around, waiting for the chance, and swoop in to pick the carcass clean.

If there is a threat like a nuclear attack on Manhattan, a lot of people will be looking to get out quick. They'll sell at any price. That's what going on to a lessor extent with the world markets at the moment. Everybody's panicking over China.

Is this making any sense?

Best of luck,

Jim Clark-Dawe

Real estate bonds are usually (always?) mortgage bonds. In other words, a bond secured by real estate holdings. The "scheme" with them is that if the real estate value drops, the bond can devalue. Otherwise, the bond can bet worth more than face value if real estate value goes up. It's similar to any other investment in that regard, and betting on whether the value rises or falls is the game with bonds and hedge funds.

Banks give people money because those people ask for it. In return, those people pay the bank interest. That's the sole reason a bank gives out money. Some people can take the loan out based on their signature (credit card style loans), others must pledge collateral. Such as real estate (that's a mortgage) or an item of value (car loan, furniture loan, boat loan, etc.) The amount of interest is based on the risk of the loan, which is based on the risk of not getting paid back.

Welcome to life in the US. In many countries/cultures, there are no loans.

Jeff

jaus tail said:

Thanks for all the answers. The overall concept is clear. Hamilton buys bonds in Manhattan Real Estate cause he thinks prices will rise, but they fall and Lewis buys the bonds back at less price.



I'm sorry but I'm really confused.

So basically a rich guy has a building. Cost to run it is 100 dollars(means the tax, electricity, plumbing, handymen). Families move in to live as tenants and pay total of 120 dollars. Profit is 20 dollars a year.

Building owner goes to bank, sells bonds of building, and gets money(loan). He uses the money to improve building and plans to increase rent. But some ghost rumors sprout and people move out. No one wants to move in this building. So owner is at loss. The bank has the building's bonds. The bank will search for someone to buy the bonds at highest price, like an auction or something. A vulture fund will come, buy bonds from bank*, take over the ghost building and turn it to haunted house amusement park.

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That profit ratio is remarkably good from real estate. A typical real estate investment pays 8 to 10 percent.

Some companies sell such bonds, but they are usually sold on the open market, rather than to a bank. Public utilities often sell such binds, which are called mortgage bonds or first mortgage bonds; that is, bonds secured by a mortgage interest in the building. I haven't seen such bonds being sold by real estate investment companies, but I haven't looked.

*The vulture fund will buy bonds from bank or from the owner? And how will the owner repay the loan? Seems he got away without repaying the loan since the vulture fund now repaid his loan by buying bonds from bank?

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The vulture fund could buy the bonds from the bank. At that point he would start paying the interest on the bonds to the vulture fund. The holder of the bonds would only gain control of the building, if the builder defaulted and bond holders foreclosed.

Remember that a bond is a debt obligation. The seller is borrowing money from the buyer of the bonds, but the ownership of the bonds does not grant ownership or control over the underlying asset. If the seller of the bonds defaults, fails to pay the interest stated in the bonds, then the owner of the bonds can foreclose and take control of the building.

The vulture fund will have to foreclose before it will be able to do anything with the building.

Sorry to be confusing. It's complicated and hard for me to reduce down. But let's see if I can clarify.

jaus tail said:

Thanks for all the answers. The overall concept is clear. Hamilton buys bonds in Manhattan Real Estate cause he thinks prices will rise, but they fall and Lewis buys the bonds back at less price.

Originally Posted by jclarkdawe
Cost of real estate is based upon both the cost of the building and land, and the rent from the building(why would rent come under cost? rent is profit the owner of building earns, and not spends to maintain the building). It depends upon how and when you're looking at the building. It's purchase cost is a combination of the real estate with no building, the building, and the rent being generated by the building that is presently on the lot. Another way of saying this is net worth. Rent is also an income producer, so it can be viewed on both sides of the equation.

Let's say you have a commercial building. The lot is worth $500k, the building is worth $3,000k, and it generates $2,000 worth of rent. To sell the building, I take the lot and building values ($3,500k) and start from there in establishing its price. These numbers are fairly easy to ascertain and are how you sell a house. If the real estate market is hot, I might figure 5 years of rent is a fair value, so I add $10,000k to the $3,500K and come up with a purchase price of $13,500,000. On the other hand, if the real estate market sucks, and I need money, I might set a selling price of one year rent $2,000k) for a total price of $2,000 and $3,500 equals $5,500,000.

Please note that the lot value will probably also drop if we're dropping the rent value. Further note that we're putting numbers on something that is in a lot of ways hard to come up with a value. Think how hard it is to come up with a value for a house.

Let's say the costs of a building is one million per year. Income from rent is $1.1 million. Real estate value goes down, the mortgage company(what's a mortgage company? the same people who owns the building, right?) No. A mortgage company is a company that writes (provides) mortgages. Common examples are banks and credit unions. But there are companies that all they do is provide mortgages.

rewrites the loan(what does rewrite a loan mean? does it mean they'll ask for another loan from some bank? why would they ask for another loan? the real estate goes down means that people don't want to spend so much money to move in the house as much as they paid earlier?) Rewriting a loan means going through the terms and conditions and changing them. Usually this is the interest rate for home owners. Let's say home mortgages drop from 5% to 3%. You can gain quite a bit of savings by writing your mortgage with the new rate. Commercial properties can do the same thing. Mortgage companies can force a rate increase on a mortgage (depending upon how the mortgage is written). At this point, the building owner might decide to go to a different mortgage company.

to reflect the loss in value of the collateral(what's a collateral? i've read collateral damage in some crime sitcom, but what's collateral in finance? thesaurus says security. does collateral means bonds?), Collateral is something you put up to get a loan. For example, in a car loan, your collateral is the car. In a home mortgage, it's the home.

Collateral damage is something else entirely.

and now the costs for the building are $1.2 million(why did it increase by 0.1 million?). Rent can't be increased because real estate are going down and it's easy for the tenants to move.

Because when the bank rewrote the mortgage, it increased the costs. For example, it might have increased the payments.

Result is the building is now $100,000 a year in the hole(i guess this means the building makes a loss of 100000 dollars a year). It means the income from rent is not covering the annual costs by $100k Solution is either to increase the rent or reduce your costs. If you can't do either, you slowly but surely go broke.

So a vulture comes along and offers the owners a chance to cash out before it goes completely bad(meaning a vulture offers to buy the 1 million building at say 900k dollars). A true vulture is more likely to offer $500k. A vulture fund is very close to the bird. It comes along to pick the dead.

Is this making sense? A little bit but I thought electrical engineering was confusing. Money is hard to understand. That's why most of us are broke.

Best of luck,

Jim Clark-Dawe



I'm sorry but I'm really confused.

So basically a rich guy has a building. Cost to run it is 100 dollars(means the tax, electricity, plumbing, handymen). Families move in to live as tenants and pay total of 120 dollars. Profit is 20 dollars a year. You forgot the purchase price of the building, which is often the mortgage.

Building owner goes to bank, sells bonds of building, and gets money(loan). He uses the money to improve building and plans to increase rent. But some ghost rumors sprout and people move out. No one wants to move in this building. So owner is at loss. The bank has the building's bonds. The bank will search for someone to buy the bonds at highest price, like an auction or something. A vulture fund will come, buy bonds from bank*, take over the ghost building and turn it to haunted house amusement park. No.

Let's do a house first, because most people are more used to that. You and your sweetie find a house for $300K. You've got $20k for a down payment. You go to your bank and the bank offers you a mortgage for $200k. You've got a shortfall of $80k. So you go to mom and dad and ask them to float you a loan of $80k.

Things go along well until you lose your job. The bank, with its mortgage, has a security interest and can collect its collateral (your house). The bank forecloses. So the bank gets first dibs on the sale of your house, your parents get second dibs, and after both of those are paid, you collect.

Remember that people want to diversify their risk and minimize it while maximizing profits.

Now let's go through that nice little building you want to buy in Manhattan for $20 million. You find a few friends with money and get $5 million. These people are the owners and have the maximum risk and minimum security. They also have a chance to make the most money. You approach a bank, which is willing to provide you with a $10 million dollar mortgage. This is probably going to actually be several banks coming in together.

This leaves you $5 million short. So you approach people to provide what some call a second mortgage. These are people who don't want ownership because they want some security. The financial instrument used is a "bond." Same idea as a junk bond. These bonds have a market, and their value goes up and down depending upon the likelihood of repayment.

These are the bonds I'm assuming the author is talking about. I don't think he's talking about mortgage bonds as Weasel is mentioning, but he could be.

*The vulture fund will buy bonds from bank or from the owner? The vulture fund will try to acquire whatever it can, whether it is the first mortgage or bonds. They'll be bought from anyone holding them. The owner will not have them.

And how will the owner repay the loan? The terms and conditions for repaying the loans will not change. It's just who the owner is sending the check through.

Seems he got away without repaying the loan since the vulture fund now repaid his loan by buying bonds from bank? The vulture fund has not repaid the loan. It has bought the loan. The owner still has to pay.

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Any clearer?

Jim

Think of a bond that says "Twick will pay Jaus Tail back the $100 she borrowed in one year, plus $20 interest".

So, the obvious value of the bond is $120 dollars. But if you're impatient, or need money soon, you could sell it to someone else for $110. That way, you get $110 now, and the other person makes a profit of $10. Everyone's happy.

But, to make things fuzzier, it's rarely 100% sure that I'll have the money to pay you back. Maybe, when the bond comes due, I only have $60 to my name. That's all I can pay. This means you have to factor in a potential loss of $40, as opposed to a profit of $120. If you think I'm not a particularly good risk, you could set the interest higher. This would increase your potential profit, to offset the risk of losing your money. So, you might demand that if there's 20% chance I'll not pay you back, I'll have to pay you $140 - that is, $40 interest - for the privilege of getting a loan.

Now, sometimes when the loan is made, the borrower looks good. So, they get the lower interest rate, since the risk is small. But then something happens (like, say, a terrorist attack disrupts the economy and I lose my job). You could only get a portion of your money back, or even none at all. So, you may want to sell the piece of paper that says "Twick will pay $120 in one year" for much less, since the other person isn't getting a guaranteed $120. The person buying, (the "vulture") may buy a lot of debt this way, hoping that the low price they pay for each debt will cancel out the risk of not being paid.

It's sort of like buying a lot of damaged cars really cheaply, hoping that some of them have only minor damage and you will be able to sell them for a nice profit once you fix them, even if some of them are write-offs.

Does this help?

A wrinkle to add: bonds are sold with different maturity dates (i.e. the date at which the bond must be repaid in full) -- some are very short-term (1 month, 2 month, 6 month, 1 year), some are much longer (5 year, 10 year, 15 year, 30 year).

Whoever has issued the bond owes the bondholder regular payments throughout the term of the bond.

Whoever has purchased the bond has the right to re-sell it at any time. But the value of the bond changes throughout its life, based on the amount of time till maturity, the level of certainty the market has that the issuer can pay as expected, and ultimately the value of the underlying collateral.

For real estate bonds ("mortgage backed securities") the collateral is the mortgage on the property. (Note: the collateral is the mortgage, not the property itself. The property is collateral for the mortgage.) These securities were traditionally considered a fairly safe investment, on the theory that mortgages were only issued to those who could and would pay them back on schedule. Residential mortgage backed securities were thought to be much safer than commercial, because commercial real estate was sometimes a plaything for speculators and other dodgy business types. When the assumption of sound lending practices falls apart, you get (1) a lot of foreclosures when people can't pay the mortgages they never should have gotten, and (2) a lot of investors losing stacks of money they had put into RMBS they thought were safe that have now lost all their value.

While mortgage backed securities are the variety of real estate bonds that became widely known in 2007, there also are Mortgage bonds, scroll down for a description http://www.investinginbonds.com/learnmore.asp?catid=10&subcatid=47&id=181

"A mortgage bond provides the bondholders with a 1[SUP]st[/SUP] lien on corporate property." another description
http://thismatter.com/money/bonds/types/corporate/corporate-bond-types.htm

Look for information on corporate bonds secured with real estate.

When someone doesn't pay, there are three things you look at. One is the loan agreement, one is the foreclosure laws in that state, and the last is bankruptcy.

Loan agreements are secured (car loan, home mortgage) or unsecured (credit cards). Loans and other indebtedness is ranked. For instance, with a home, the priority is the property taxes. If the house is sold for failure to pay on a loan, the first people paid are the town or city that has property taxes owed.

Loan agreement, signing date, and filing date determine the status of secured creditors. This is what people are talking about when they mention first mortgage, second mortgage, and third mortgage. First mortgage has priority. Liens also come into the equation. The loan agreement determines what a creditor can and can't do. For instance, it is possible to not have the right to foreclose in a secured loan.

Unsecured creditors' rights are more vague. It depends in part on what's in the laws for the state the property is in. But the usual remedy is bankruptcy court, where the court specifically determines the rights of each group of creditors.

Detail beyond this is going to be complicated. The minimum bankruptcy court filing is something like 10 to 15 pages. You've got to figure every asset and obligation and decide where it goes.

Best of luck,

Jim Clark-Dawe