THE 39TH CREDIT:

A STUDENT'S NOTEBOOK AND

GUIDE TO THE
MASTERS OF SCIENCE IN
REAL ESTATE DEVELOPMENT
AND INVESTMENT
PROGRAM AT
NEW YORK UNIVERSITY
BY JEREMY LITT

MANAGERIAL ACCOUNTING FOR REAL ESTATE

PROFESSOR MICHAEL F.X. WATERS
AUTUMN 1989

ACCOUNTING NOTES
PROFESSOR MICHAEL F.X.WATERS
SEPTEMBER 7, 1989
FINANCIAL ACCOUNTING (WITH FINANCIAL STATEMENTS)
HOW TO PROVE TO INTERESTED OTHERS WHAT IS GOING ON IN A BUSINESS
A.K.A. COMPLIANCE ACCOUNTING
TO I.R.S., S.E.C., BOARD OF DIRECTORS OF BANKS, LENDERS, CREDITORS
PRODUCED FOR EXTERNAL USE
MANAGERIAL ACCOUNTING
A.K.A. CONTROL ACCOUNTING
MANAGING THE RESOURCES RESULTANT OF BUSINESS POLICY
IN WATERS' VIEW, THE MAIN FOCUS OF ACCOUNTANTS IS THE FINANCIAL
ACCOUNTING AS OPPOSED TO MANAGERIAL ACCOUNTING.
THIS IS PROBLEMATIC
BECAUSE THE FIRST IS DONE, IN SUBSTANCE, TO ACCOMMODATE THE PROPER
UTILIZATION OF THE SECOND.
GAAP GENERALLY ACCEPTED ACCOUNTING PRINCIPLES
FASB FINANCIAL ACCOUNTING STANDARDS BOARD (IN EXISTENCE SINCE 1973)
GAAP AND FASB DETERMINE THE APPROPRIATE STANDARDS FOR THE INDUSTRY
FASB IS LIKE THE SUPREME COURT OF ACCOUNTING
WHY DO ACCOUNTANTS DEAL MOSTLY WITH "EXTERNAL" ACCOUNTING?
FOR TWO REASONS:
ACCOUNTANTS MAKE MORE MONEY DOING IT
CERTIFIED AUDITS ARE NECESSARY TO GET LENDING, MANAGEMENT IS NOT
CPA - CERTIFIED PUBLIC ACCOUNTANT
CMA - CERTIFIED MANAGEMENT ACCOUNTANT
THEY ARE DIFFERENT, AND ARE SPECIALISTS, AND CAN NOT DO EACH OTHERS
WORK.
"WHAT IS NOT COUNTED CAN NOT BE MEASURED, WHAT CAN NOT BE MEASURED CAN
NOT BE CONTROLLED"
- OR YOU HAVE TO KNOW WHAT YOUR COSTS ARE IN ORDER TO CONTROL AND MANAGE THEM
TYPES OF ACCOUNTING FOR JOINT VENTURES
EQUITY METHOD OF ACCOUNTING
RE: THE EQUITY METHOD OF ACCOUNTING FOR INVESTMENTS IN COMMON STOCK
THE STATEMENT INDICATES THAT A VENTURER SHOULD ACCOUNT FOR THE ONGOING
OPERATIONS OF THE JOINT VENTURE ON THE EQUITY METHOD. THAT PRESUMPTION
MAY BE OVERCOME, HOWEVER, WHEN A VENTURER HAS LESS THAN A 10 PERCENT
INTEREST IN THE TOTAL VENTURE AND CAN CLEARLY BE CONSIDERED A PASSIVE
PARTNER IN THE JOINT VENTURE. IN THESE CASES IT MAY BE APPROPRIATE TO

USE THE COST METHOD.

AS A GENERAL RULE, UNDER THE EQUITY METHOD THE INVESTOR INITIALLY RECORDS
ITS INVESTMENT IN THE VENTURE AT COST AND ADJUSTS THE CARRYING AMOUNT OF
THE INVESTMENT TO RECOGNIZE THE INVESTOR'S SHARE OF EARNINGS OR LOSSES OF
THE VENTURE SUBSEQUENT TO THE DATE OF ACQUISITION.
DISTRIBUTIONS
RECEIVED FROM THE VENTURE REDUCE THE CARRYING AMOUNT OF THE INVESTMENT
(SEE EXAMPLE 9 BONGIORNO 2.53.1).
COST METHOD OF ACCOUNTING
IN SOME INSTANCES A PARTNER'S INTEREST IN THE JOINT VENTURE MAY BE SO
MINOR THAT THE VENTURER MAY HAVE VIRTUALLY NO INFLUENCE OVER THE
OPERATING AND FINANCIAL POLICIES OF THE REAL ESTATE VENTURE.
IN SUCH
CASES THE COST METHOD OF ACCOUNTING FOR THE VENTURER'S INVESTMENT MAY BE
APPROPRIATE. UNDER THE COST METHOD, INCOME RECOGNIZED BY THE VENTURER IS
LIMITED TO DISTRIBUTIONS RECEIVED, EXCEPT THAT DISTRIBUTIONS IN EXCESS OF
THE VENTURER'S SHARE OF EARNINGS AFTER THE DATE OF THE INVESTMENT ARE
APPLIED TO REDUCE THE CARRYING VALUE OF THE INVESTMENT. (SEE BONGIORNO
2.53.3)
FULL CONSOLIDATION METHOD OF ACCOUNTING
WHERE THE VENTURER HAS AN INTEREST OF MORE THAN 50 PERCENT, IT MAY
CONSOLIDATE FOLLOWING NORMAL CONSOLIDATING RULES.
IF THESE JOINT
VENTURERS ARE NOT CONSOLIDATED, IT MAY BE APPROPRIATE TO INCLUDE SEPARATE
COMBINED JOINT VENTURE FINANCIAL STATEMENTS AND FOOTNOTES, ALONG WITH THE
CONSOLIDATED FINANCIAL STATEMENTS.
PROPORTIONATE CONSOLIDATION METHOD OF ACCOUNTING
IN SITUATIONS WHERE AN OWNER HAS AN UNDIVIDED INTEREST IN EACH ASSET AND
IS PROPORTIONATELY LIABLE FOR ITS SHARE OF EACH LIABILITY, AND WHERE THE
JOINT VENTURE AND THE VENTURER ARE IN A RELATED BUSINESS, SOME COMPANIES
HAVE PROPORTIONATELY CONSOLIDATED THE JOINT VENTURE - RECOGNIZING THE
VENTURER'S
PROPORTIONATE
SHARE
OF
THE
JOINT
VENTURE'S
ASSETS,
LIABILITIES, REVENUES, AND EXPENSES.
PROPORTIONATE CONSOLIDATION IS RARE BECAUSE IT CAN NOT PRESIDE OVER
PROPERTIES THAT REQUIRE JOINT CONTROL (REQUIRING TWO OR MORE OWNERS TO
SIGN OFF ON DECISIONS).
ALLOCATION OF INCOME TO PARTNERS
IN ORDER TO DETERMINE THE INVESTOR'S SHARE OF VENTURE NET INCOME AND
LOSS, SUCH AGREEMENTS OR ARRANGEMENTS SHOULD BE ANALYZED TO DETERMINE HOW
AN INCREASE OR DECREASE IN NET ASSETS OF THE VENTURE, DETERMINED IN
ACCORDANCE WITH GAAP, WOULD AFFECT CASH PAYMENTS TO THE INVESTOR OVER THE
LIFE OF THE VENTURE AND ON ITS DISSOLUTION.
PROJECTED CASH
DISTRIBUTIONS, OR THEIR EQUIVALENT, ARE USED AS THE DETERMINING FACTOR

BECAUSE THIS IS THE ONLY WAY THAT THE INVESTOR CAN REALIZE HIS
INVESTMENT.
AS A GENERAL RULE, SPECIFIED PROFIT AND LOSS ALLOCATION RATIOS SHOULD NOT
BE USED TO DETERMINE AN INVESTOR'S EQUITY IN VENTURE EARNINGS IF THE
ALLOCATION OF CASH DISTRIBUTIONS AND LIQUIDATION DISTRIBUTIONS ARE
DETERMINED ON SOME OTHER BASIS. FOR EXAMPLE AN AGREEMENT ALLOCATING ALL
DEPRECIATION TO ONE INVESTOR AND ALL REVENUE AND EXPENSES EQUALLY, BUT
PROVIDING THAT IRRESPECTIVE OF SUCH ALLOCATIONS CASH DISTRIBUTIONS TO THE
INVESTORS WILL BE MADE SIMULTANEOUSLY AND DIVIDED EQUALLY BETWEEN THEM,
THERE IS NO SUBSTANCE TO THE PURPORTED ALLOCATION OF DEPRECIATION
EXPENSE.
HOW TO OWN PROPERTY
PROPRIETORSHIP - TITLE DEED IS RECORDED IN INDIVIDUAL'S NAME
PARTNERSHIP - TWO OR MORE PERSONS (GENERAL AND LIMITED PARTNERSHIPS)
CORPORATION - AN ENTITY FOR OWNING LAND (S CORPORATION AND C CORPORATION)
JOINT VENTURE - A MIX OF THE ABOVE
INITIAL CAPITAL CONTRIBUTIONS
INVESTMENT IN THE FORM OF PROPERTY IS RECOGNIZED AT THE COST BASIS OF THE
PROPERTY.
AN EQUITY INTEREST IN A JOINT VENTURE, OBTAINED IN EXCHANGE FOR SERVICES
RENDERED OR TO BE RENDERED, SHOULD BE RECOGNIZED AT THE COST OF THOSE
SERVICES.
AS A GENERAL RULE, AN INVESTMENT IN A JOINT VENTURE SHOULD BE RECOGNIZED
AT THE VENTURER'S COST OF THE ASSETS CONTRIBUTED.
SOME TRANSACTIONS, STRUCTURED IN THE FORM OF CAPITAL CONTRIBUTIONS, MAY
IN ECONOMIC SUBSTANCE, BE SALES AND SHOULD BE ACCOUNTED FOR UNDER THE
GUIDELINES OF FASB 66.
AN
INVESTOR
CONTRIBUTING
PROPERTY
TO
A
VENTURE
MAY
OBTAIN
DISPROPORTIONATELY SMALL INTEREST IN THE VENTURE BASED ON A COMPARISON OF
THE CARRYING AMOUNT OF THE PROPERTY WITH THE CASH CONTRIBUTED BY THE
OTHER INVESTORS.
SUCH A SITUATION MAY INDICATE THAT THE INVESTOR
CONTRIBUTING THE PROPERTY HAS SUFFERED A LOSS THAT SHOULD BE RECOGNIZED.
SEE BONGIORNO 2.52.3 FOR EXCEPTIONS TO THESE RULES.
THE JOINT VENTURE
CORPORATE JOINT VENTURES ARE OWNED AND OPERATED BY A SMALL GROUP OF
VENTURERS TO ACCOMPLISH A MUTUALLY BENEFICIAL VENTURE OR PROJECT.
UNDIVIDED INTERESTS ARE AN OWNERSHIP ARRANGEMENT IN WHICH TWO OR MORE
PARTIES JOINTLY OWN PROPERTY, AND TITLE IS HELD INDIVIDUALLY AND
OPERATIONS ARE SHARED TO THE EXTENT OF EACH PARTY'S INTEREST.
THE PROPRIETORSHIP (W-2)

PROPRIETORSHIP POSITIVES - PAY EXPENSES, GET PROFITS, NO REPORTS

NECESSARY TO BE PREPARED FOR ANYBODY, FREE FROM OUTSIDE CONTROL, PASSIVE
INCOME (IE. DEPRECIATION) LOSSES MAY BE USEFUL.
PROPRIETORSHIP NEGATIVES - PAY EXPENSES, GET LOSSES, MAY HAVE LOSSES
WHICH ARE PASSIVE AND NOT OFFSET AGAINST NON-PASSIVE LOSSES.
BONGIORNO - THE SOLE PROPRIETORSHIP HAS THE DISADVANTAGE OF UNLIMITED
LIABILITY, ALTHOUGH IT HAS THE ADVANTAGE OF UNLIMITED CONTROL.
THE GENERAL PARTNERSHIP

(K-1)

GENERAL PARTNERSHIP POSITIVES - GENERALLY, EASY TO CREATE. NO PERMISSION

NEEDED EXCEPT FOR AGREEMENT OF THE OTHER PARTIES IN THE PARTNERSHIP (FOR
EXAMPLE, A PARTNERSHIP CAN NOT BE LEGALLY WILLED TO ANOTHER SINCE ALL
PARTIES MAY NOT BE IN AGREEMENT), OWNERSHIP INTEREST IN PARTNERSHIP
ASSETS (I.E. IF YOU HAVE A 10% INTEREST, YOU OWN 10% OF ALL THE
PARTNERSHIP'S ASSETS. COSTS ONLY 1500 TO 2000 DOLLARS TO FORM.
GENERAL PARTNERSHIP NEGATIVES - PERSONAL LIABILITY FOR ALL CLAIMS AGAINST
ASSETS.
YOU ARE 100 PERCENT LIABLE FOR ALL DEBTS EVEN THOUGH YOUR
OWNINGS MAY NOT REPRESENT MORE THAN 10 PERCENT OF THE PARTNERSHIP.
BONGIORNO- DOES NOT PAY TAXES AS SUCH.
ALL INCOME OR LOSS OF THE
PARTNERSHIP IS PASSED THROUGH TO THE INDIVIDUAL PARTNER AND BECOMES PART
OF THE INDIVIDUAL PARTNER'S PERSONAL TAXABLE INCOME OR LOSS FOR ANY GIVEN
YEAR.
THE LIMITED PARTNERSHIP
LIMITED PARTNERSHIP POSITIVES - SEE OTHER POSITIVES OF GENERAL
PARTNERSHIP, THEY ALSO APPLY HERE. COMBINES THE BENEFITS OF PARTNERSHIPS
AND CORPORATIONS. A LIMITED PARTNER CAN NOT BE INVOLVED IN THE MANAGEMENT
OF A COMPANY, OTHERWISE HIS STATUS CHANGES TO "GENERAL PARTNER".
LIMITED PARTNERSHIP NEGATIVES - NEED APPROVAL TO FORM (FROM THE STATE OR
COUNTRY), NOT EASY TO FORM, EXPENSIVE TO FORM, FORMATION MUST BE
ANNOUNCED IN PAPER SEVEN CONSECUTIVE WEEKS IN A ROW, AND THE
ADVERTISEMENT MUST SAY "WHO" AND "HOW MUCH" IS INVOLVED, TAKES 10,000 TO
15,000 DOLLARS TO FORM.
BONGIORNO- ALL INCOME OR LOSS OF THE LIMITED PARTNERSHIP IS PASSED
THROUGH TO THE INDIVIDUAL PARTNER AND BECOMES PART OF THE INDIVIDUAL
PARTNER'S PERSONAL TAXABLE INCOME OR LOSS FOR ANY GIVEN YEAR. IT IS AN
ASSOCIATION IN WHICH ONE OR MORE GENERAL PARTNERS HAVE UNLIMITED
LIABILITY AND ONE OR MORE PARTNERS HAVE ONLY SUCH PERSONAL LIABILITY AS
THEY SPECIFICALLY UNDERTAKE IN THE PARTNERSHIP AGREEMENT. THIS TYPE OF
ENTITY IS ONE OF THE MORE POPULAR FORMS OF OWNERSHIP AS IT COMBINES
LIMITED LIABILITY WITH INDIVIDUAL TAX TREATMENT.
-------------DISCUSSION CONTINUED
AT LEAST ONE GENERAL PARTNER, ANY NUMBER OF LIMITED PARTNERS.

THE GENERAL PARTNER HAS UNLIMITED LIABILITY

THE LIMITED PARTNER HAS LIMITED LIABILITY, CORRESPONDING
CONTRIBUTION TO THE PARTNERSHIP AS MADE, OR AS PROMISED.

TO

HIS

FOR EXAMPLE:
BUY A BUILDING FOR TEN MILLION DOLLARS.
I NEED ONE MILLION TO TAKE OVER THE BUILDING.
I GET TEN FRIENDS WITH
100,000 DOLLARS EACH (50,000 CASH, 50,000 NOTE PAID OVER TWO YEARS). EVEN
THOUGH A CLAIM MAY BE MADE AGAINST THE COMPANY BEFORE THE FULL TWO YEARS
PASSED AND WITH THE 50,000 NOTE NOT FULLY PAID, THE LIABILITY OF THE
LIMITED PARTNER IS STILL THE FULL 100,000 DOLLARS.
THE GENERAL PARTNER IS USUALLY A CORPORATION WITH NO ASSETS, OFF SHORE.
THE GENERAL PARTNER NEED NOT CONTRIBUTE ANY MONEY.
THE LIMITED PARTNER CAN NOT BE INVOLVED IN MANAGEMENT ACTIVITIES,
THEREFORE THE COMPANY NEEDS A MANAGER. IF THE LIMITED PARTNER DOES GET
INVOLVED, HE BECOMES A GENERAL PARTNER.
THE K-1 IS THE FORM DETAILING INCOME AND LOSS ON INTEREST IN A LIMITED
PARTNERSHIP.
THE INFORMATION RETURN WHICH IS THE W-2 EQUIVALENT FOR
INDIVIDUAL RETURNS OF A LIMITED PARTNERSHIP. THE VEHICLE IS THE BUSINESS
WHICH IS THE LIMITED PARTNERSHIP.

THE CORPORATION
CORPORATION POSITIVES - OWNERS SHIELDED FROM SUITS, LIMITED LIABILITY,
CREDITORS HAVE NO CLAIM AGAINST THE OWNERS' PERSONAL ASSETS, ONLY AGAINST
THE CORPORATIONS' ASSETS.
CORPORATION NEGATIVES - CORPORATE TAX FOR THE "C" CORPORATION (SEE ALSO,
PROBLEM WITH "S"CORP., UNDER "PROBLEM"
-------------DISCUSSION CONTINUED
THE "C" CORPORATION - ORGANIZED IN ACCORDANCE WITH STATE LAW. IT IS A
LEGAL ENTITY ("A PERSON"). CORPORATION OWNS 100% OF STOCK.
TAXES ARE PAID BY THE CORPORATION AS IF IT WERE A PERSONAL ENTITY (I.E. A
PERSON) BASED ON A GRADUATED SCALE .
TOPS OUT AT 34% OVER 75,000
DOLLARS.
THE "S" CORPORATION - SINCE 1959.
THE SAME AS A C CORPORATION EXCEPT
TAXED UNDER SUBCHAPTER S OF THE INTERNAL REVENUE CODE, TO BE TAXED AS IF
IT WERE A PARTNERSHIP.
IT IS A CONDUIT WHICH TAKES PROFIT AND DISTRIBUTES IT TO STOCKHOLDERS WHO
THEN PAY TAXES ON IT ON THEIR 1040.
THEREFORE, SINCE PROFITS ARE
DISTRIBUTED, IT PAYS NO TAXES. K-1 IS GIVEN TO EACH STOCKHOLDER.
PROBLEM:
YOU ARE TAXED ON SHARE PROFIT WHETHER OR NOT YOU WITHDRAW AND
TAKE POSSESSION OF THE MONEY.

MAXIMUM TAX AT 28 PERCENT, THE PERSONAL RATE.

MUST HAVE A BASIS IN CORPORATION TO TAKE A LOSS, CANNOT TAKE A LOSS
GREATER THAN YOUR INVESTMENT UNLESS YOU ARE A GENERAL PARTNER.
END OF CLASS ONE

9/14/89
CHAPTER ONE REVIEW AND PARTNERSHIP ACCOUNTING
THE "ENTITY", WHAT IS IT?
I.E. AN INDIVIDUAL MAY OWN LAND AS A PROPRIETOR, CORPORATION, OR PARTNER.
THE ACCOUNTING
RULES ARE DIFFERENT AND ALL MUST BE CONSIDERED
SEPARATELY.
THE BASIS OR METHOD OF ACCOUNTING............ ACCRUAL OR CASH BASIS
ASSETS = LIABILITY + CAPITAL
DEFINITION: ASSETS ARE ANYTHING THAT THE BUSINESS OWNS, OR POSSESSES
UNDER A CAPITAL LEASE WHICH CAN, BUT NOT NECESSARILY WILL, BRING A FUTURE
CASH FLOW.
THERE MUST BE A CLAIM WHICH LINKS OWNER WITH ASSET.
LIABILITY = DEBT OR CLAIM AGAINST AN ASSET
CAPITAL: HAS DIFFERENT TITLES DEPENDING ON TYPE OF OWNERSHIP. BASICALLY,
IT IS THE INVESTMENT IN THE BUSINESS ENTERPRISE FOR ITS DURATION.
CAPITAL IS CONSTANTLY CHANGING OR SUBJECT TO CHANGE.
EQUITY CAPITAL IS AN ASSET OR INVESTMENT WITH NO CLAIM AGAINST IT.
DEBT CAPITAL IS AN ASSET WITH A CLAIM AGAINST IT.
REVENUE IS THE RECEIPT OF FUNDS.
IT IS ALL KINDS OF INCOME, SUCH AS,
COMMISSIONS, RENTALS, MISCELLANEOUS.
IT IS THE INFLOW OF RESOURCES,
GENERALLY IN THE FORM OF CASH, NOTES, OR ACCOUNTS RECEIVABLE.
INCOME IS THE EXCESS OF REVENUE OVER THE ASSOCIATED EXPENSES AND LOSSES
FOR A PERIOD.

EXPENSES IS THE COST OF GOODS, SERVICES, AND FACILITIES USED IN THE

PRODUCTION OF CURRENT REVENUE (THAT REVENUE TO BE RECEIVED WITHIN ONE
YEAR).
REVENUE - EXPENSES = NET INCOME
FOR EXAMPLE:
INCOME
EXPENSES
10,000
2,000 RENT
2,500 SUPPLIES
1,000 SALARY
500 OTHER
--------------------------10,000
6,000
=
4,000
THEREFORE, 4,000 IS THE NET INCOME.

THE MATCHING PRINCIPLE - MATCHING "APPROPRIATE" REVENUE AGAINST

"APPROPRIATE" EXPENSES.
"APPROPRIATE" REFERS TO THOSE EXPENSES AND
REVENUES WITHIN THE SAME PERIOD.
RULE:

CAPITAL INCREASES WITH INCOME AND DECREASES WITH LOSS.

THE CASH AND ACCRUAL METHODS OF ACCOUNTING

THE ACCRUAL METHOD:

1. THE INSTALLMENT METHOD

2. THE COMPLETED CONTRACT METHOD
3. THE PERCENTAGE OF COMPLETION METHOD

THE METHOD YOU CHOOSE DEPENDS ON YOUR BUSINESS. THE ACCRUAL METHOD IS
PREFERABLE, BECAUSE THE MATCHING PRINCIPLE IS BETTER APPLIED.
THE CASH METHOD: USED IN THE REPORTING OF INCOME RECEIVED DURING A
PERIOD, AND DOES NOT CONSIDER INCOME EARNED BUT NOT RECEIVED.
AN EXAMPLE OF ACCRUAL METHOD:
A LOAN, TAKEN OUT ON OCTOBER 30, 1989, HAS A PAYMENT DUE ON FEBRUARY 1,
1989. INTEREST FOR 1989 COMPUTED IN RELEVANT PERIOD (1989) BY COMPUTING
INTEREST FROM OCTOBER 30, 1989 TO DECEMBER 31, 1989.
QUESTION: WHEN MUST THE ACCRUAL METHOD BE USED?
ANSWER: WHEN REQUIRED.
WHEN YOU ARE USING INVENTORY IN YOUR BUSINESS,
FOR INSTANCE. (I.E. BUSINESS OF BUYING AND SELLING PROPERTY; BUILDINGS
AND LAND ARE YOUR INVENTORY)
INVENTORY IS SOMETHING THAT YOU ACQUIRE WITH THE INTENT TO SELL TO A
CUSTOMER IN THE NORMAL COURSE OF BUSINESS, FROM THE POINT OF ACQUISITION.
BUSINESSES WITH INVENTORY MUST USE THE ACCRUAL METHOD. BUSINESSES WITH

INVENTORY CAN NOT HAVE A CAPITAL GAIN ON THAT INVENTORY.

FINANCIAL STATEMENTS:
WHEN YOU GET A FINANCIAL STATEMENT, YOU ASSUME THAT IT WAS PREPARED BY
THE ACCRUAL METHOD UNLESS OTHERWISE STATED.
THE OPPOSITE IS TRUE WITH
INDIVIDUAL RETURNS.
CERTIFIED PUBLIC ACCOUNTANTS THE "COMPANY" PREPARES THE FINANCIAL
STATEMENT, NOT THE C.P.A., BECAUSE IT IS USED FOR EXTERNAL USE. SO, WHAT
KIND OF CERTIFICATION OR SERVICE DOES THE CPA PROVIDE?
THE CPA USES GAAP TO LEND CREDIBILITY TO THE FINANCIAL STATEMENT, SO THAT
THE EXTERNAL PARTY CAN GAIN COMFORT FROM KNOWING THE REPORT WAS
PROFESSIONALLY REVIEWED.
THE INVOLVEMENT BY THE CPA MAY BE GREAT, OR
ALMOST NO INVOLVEMENT AT ALL.

THE CERTIFIED FINANCIAL STATEMENT: A.K.A. THE CLEAN STATEMENT (AAA)

CANNOT BE CERTIFIED IF ANY ENTRY BY THE CPA FIRM IS MADE BY THE STAFF OF
THE CPA FIRM RATHER THAN THE COMPANY, SINCE THE COMPANY PREPARES THE
REPORT.
STATEMENT: PREPARED ACCORDING TO GAAP.
NO OMISSIONS OR BASIS FOR DETERMINING FRAUD IN THE
PREPARATION
OF STATEMENTS.
ACCOUNTING PRACTICES CONSISTENTLY APPLIED. "CONSISTENT" MEANS
"WE LOOKED AT LAST YEAR ALSO".
YOU DON'T ALWAYS NEED THIS DEGREE OF REVIEW.
IT IS VERY
EXPENSIVE BECAUSE EVERYTHING IS REVIEWED IN GREAT DETAIL.
"CLEAN" MEANS, NO EXCEPTIONS, NO RESERVATIONS EXPRESSED.
A CERTIFIED FINANCIAL STATEMENT WITH EXCEPTIONS MEANS THAT
THE
REVIEW HAS DISCLAIMERS, THAT CERTAIN AREAS MAY NOT HAVE BEEN
EXAMINED, AND THAT THEREFORE NO OPINION IS EXPRESSED.
THE REVIEW REPORT
"WE REVIEWED THE FINANCIAL STATEMENT AND HAVE REASON TO BELIEVE THAT
THERE NEED BE NO MODIFICATION FOR THE DOCUMENT TO BE IN ACCORDANCE WITH
GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP)".
A REVIEW REPORT IS A LIMITED STATEMENT.
THE COMPILATION REPORT
"WE REVIEWED THE FINANCIAL STATEMENTS, LISTED THEM, AND EXPRESS NO
OPINION ON THE ACCURACY, CONFORMANCE, OR FAIRNESS ACCORDING TO GAAP.
NOBODY STANDS BEHIND IT.

DEPRECIATION
DEPRECIATION =

COST / ESTIMATED LIFE SPAN

TO BE A DEPRECIABLE ASSET, IT MUST HAVE A USEFUL LIFE THAT EXCEEDS THE

ACCOUNTING PERIOD (I.E. ONE YEAR). FOR EXAMPLE A BUILDING EXISTS FOR 40
YEARS. WE CAN NOT, FOR EXAMPLE, MATCH THE INCOME TO THE FULL COST IN A
PARTICULAR YEAR. A VIOLATION OF THE MATCHING PRINCIPLE WOULD RESULT.
ESTIMATED USEFUL LIFE - HOW LONG WILL THE ASSET SERVE ITS INTENDED USE?
ENGINEERING INPUT AND APPRAISAL BASED ON SOUND TECHNICAL ADVICE. LAND IS
NEVER DEPRECIABLE, SO YOU CAN ONLY DEPRECIATE THE BUILDING ASPECT OF A
PROPERTY.
THE STRAIGHT LINE METHOD OF DEPRECIATION
COST - RESIDUAL VALUE + SALVAGE VALUE
PERIOD

AMOUNT OF DEPRECIATION IN

I.E.

450,000 = DEPRECIABLE COST

40 YEARS = ECONOMIC LIFE
450,000 / 40 = 8,750
DECLINING BALANCE
200% - DOUBLE DECLINING BALANCE - GENERALLY UNACCEPTABLE TO I.R.S.
BUT THERE ARE EXCEPTIONS.
150% - DECLINING BALANCE - GENERALLY ACCEPTABLE TO I.R.S.
SEE PAGE 159 OF EISEN
TAKE THE DEPRECIABLE COST, DIVIDE BY ECONOMIC LIFE, DO NOT PROVIDE FOR A
SALVAGE OR RESIDUAL VALUE.
COST / ECONOMIC LIFE x 200% = 17,500
DEPRECIATION IS AN EXPENSE WHICH REDUCES INCOME FOR A PERIOD, AND WOULD
THEREFORE REDUCE YOUR TAXES PAID IN A PERIOD, BECAUSE OF LOWER INCOME.
SUM OF THE YEARS DIGITS (SYD)
SEE PAGE 161 OF EISEN
FOR THE PURPOSES OF ACCOUNTING, YOU HAVE TWO ASSET ACCOUNTS; LAND AND
BUILDINGS. THIS IS BECAUSE LAND IS NOT DEPRECIABLE.
THE INCOME STATEMENT:
PROPERTY TAX IS INCLUDED IN OPERATING EXPENSES.
ALSO INCLUDED ARE
MAINTENANCE, UTILITIES, ETCETERA.
THESE ARE EXPENSES NECESSARY TO
GENERATE INCOME.

CAPITALIZED STATEMENT:
WHAT MAY BE CAPITALIZED? IF AND ONLY IF EXPENDITURE EXTENDS THE ECONOMIC
LIFE BEYOND THAT WHICH WOULD OTHERWISE BE EXPECTED.
MAY IT BE CAPITALIZED?

SOME EXAMPLES...

YES
NEW BOILER
ALL NEW ROOF

NO
PAINT
PATCH ROOF

END OF SECOND CLASS

9/21/89
BONGIORNO - 2.22.4 TABLE
RENT
1ST 24
NEXT 18
NEXT 18
NEXT 12

MONTHS................................120,000
MONTHS................................150,000 "AN
MONTHS................................180,000 ESCALATING
MONTHS................................160,000 LEASE"
---------72 MONTHS TOTAL
610,000
FOR FINANCIAL STATEMENT PURPOSES, THE ABOVE MUST BE "EVENED OUT" (NOT
APPLICABLE TO TAX ACCOUNTING).
(610,000 / 72) x 12 = 101,667 (RENTAL EXPENSES IN EACH YEAR)
DEFINITION OF "MATERIAL" INFORMATION:
THAT INFORMATION
IMPORTANT, WHICH IS DEFINED AS 5 PERCENT OR GREATER OF INCOME.
ESCALATION CLAUSES.............EXAMPLES
BASE LABOR PRICE
HEATING COSTS
REAL ESTATE TAXES

10

WHICH

IS

TO THE EXTENT THAT YOU KNOW THE ABOVE, YOU ADJUST THE FIGURES PERTAINING
TO THEM.
ESTIMATED USEFUL LIFE IS NOT RELEVANT TO TAX ACCOUNTING BECAUSE THE
FIGURE FOR DEPRECIATION IS GIVEN BY REGULATION, AND IS NOT ESTIMATED.
THESE FIGURES ARE AS FOLLOWS:
COMMERCIAL REAL ESTATE = 31.5 YEARS
RESIDENTIAL REAL ESTATE = 27.5 YEARS
REGULATORY ACCOUNTING:
WHEN LOOKING AT FINANCIAL STATEMENTS, BE SURE YOU ARE LOOKING AT THE
FINANCIAL REPORT RATHER THAN THE TAX REPORT.
SALARY - A DIVISION OF PROFITS, NOT A SALARY TO EMPLOYEES, UNDER THE
PARTNERSHIP ENTITY.
NO WITHHOLDING OF FICA AND SOCIAL SECURITY PAYMENTS
NOT A "SALARY EXPENSE" (SEE PAGE 25, WILEY)
PARTNER CAN NOT BE AN EMPLOYEE AND RECEIVE A SALARY...HIS SALARY
IS IN A DIFFERENT "CLASS".
-UNLESSA GUARANTEED PARTNER GETS THE PARTNER "NAME", GETS A GUARANTEED
SALARY, VOTING RIGHTS, BUT NO SHARE IN THE BUSINESS. WHEN YOU
ARE A TRUE PARTNER, YOU LOSE GUARANTEED SALARY.
REVENUE RECOGNITION - WHEN DO WE RECOGNIZE REVENUE? SEE PG. 29, WILEY AND
PG. 36,37 WILEY.
FASB 66- ANSWERS THE FOLLOWING QUESTIONS:
AT WHAT POINT ARE REVENUES RECOGNIZED?
IF PROFIT OR LOSS IS TO BE RECOGNIZED, WHICH RECOGNITION METHOD
SHOULD BE USED?
REVENUE IS RECOGNIZED WHEN BOTH OF THE FOLLOWING CONDITIONS ARE MET:
THE EARNING PROCESS IS COMPLETE
AN EXCHANGE HAS TAKEN PLACE
FOR FINANCIAL REPORTING PURPOSES, AMOUNTS FOR RENT RECEIVED IN ADVANCE
ARE NOT TREATED AS REVENUE OF THE PERIOD IN WHICH THEY ARE RECEIVED, BUT
AS REVENUE OF THE PERIOD IN WHICH THEY ARE EARNED.
AS A RULE, THERE ARE TWO BASIC CRITERIA WHICH MUST BE MET FOR PROFIT TO
BE RECOGNIZED:
THE COLLECTIBILITY OF THE SALES PRICE SHOULD BE REASONABLY ASSURED,
AND THE AMOUNT THAT WILL NOT BE COLLECTIBLE SHOULD BE ABLE TO BE
ESTIMATED SO THAT THE AMOUNT OF PROFIT CAN BE DETERMINED; AND
THE SELLER SHOULD NOT BE OBLIGATED TO PERFORM SIGNIFICANT
ACTIVITIES AFTER THE SALE TO EARN THE PROFIT; THAT IS, THE EARNINGS
PROCESS SHOULD BE COMPLETE.
RECOGNITION OF ALL OF THE PROFIT AT THE TIME OF SALE OR AT SOME LATER
TIME WHEN BOTH CONDITIONS EXIST IS REFERRED TO AS THE FULL ACCRUAL

11

METHOD.
SEE BONGIORNO 2.61.2 FOR DECISION TREE OF PROFIT RECOGNITION
DETERMINING PROPER METHOD OF PROFIT RECOGNITION
PROFIT ON REAL ESTATE SALES TRANSACTIONS INCLUDING PARTIAL SALES IS NOT
TO BE RECOGNIZED BY THE FULL ACCRUAL METHOD UNTIL ALL OF THE FOLLOWING
CRITERIA ARE MET:
*
A SALE IS CONSUMMATED
*
THE BUYER'S INITIAL INVESTMENT IS ADEQUATE TO DEMONSTRATE A
COMMITMENT TO PAY FOR THE PROPERTY.
*
THE BUYER'S CONTINUING INVESTMENT IS ADEQUATE TO DEMONSTRATE A
COMMITMENT TO PAY FOR THE PROPERTY.
*
THE SELLER HAS TRANSFERRED TO THE BUYER THE USUAL RISKS AND REWARDS
OF OWNERSHIP IN A TRANSACTION THAT IS IN SUBSTANCE A SALE. THE
SELLER DOES NOT HAVE A SUBSTANTIAL CONTINUING INVOLVEMENT WITH THE
PROPERTY.
CONSUMMATION OF SALE TAKES PLACE WHEN:
THE PARTIES ARE BOUND BY THE TERMS OF A CONTRACT;
ALL CONSIDERATION HAS BEEN EXCHANGED;
ANY PERMANENT FINANCING FOR WHICH THE SELLER IS RESPONSIBLE HAS
BEEN ARRANGED;
ALL CONDITIONS PRECEDENT TO CLOSING HAVE BEEN MET.
IN MOST CASES, THESE FOUR CRITERIA ARE MET AT THE TIME OF CLOSING, AND
NOT MET AT THE TIME AN AGREEMENT TO SELL IS SIGNED OR AT PRECLOSING.
FASB 66 HAS ONE EXCEPTION TO THE FOURTH ITEM: DUE TO THE AMOUNT OF TIME
THAT ELAPSES DURING THE CONSTRUCTION PERIOD, A CERTIFICATE OF OCCUPANCY,
WHICH IS A CONDITION PRECEDENT TO CLOSING, MAY NOT YET HAVE BEEN OBTAINED
AT THE TIME OF CLOSING. IN THIS CASE, INCOME MAY BE RECOGNIZED DURING
THE PERIOD OF CONSTRUCTION SUBJECT TO THE FOLLOWING CONDITIONS:
PROFIT SHOULD BE RECOGNIZED ON A PERCENTAGE OF COMPLETION BASIS,
PROVIDED THAT THE COSTS MAY BE REASONABLY ESTIMATED. IF THE SELLER
DOES NOT HAVE A SUCCESSFUL CONSTRUCTION HISTORY FROM WHICH TO MAKE
ESTIMATES, COMPLETED CONTRACT METHOD IS USED.
CONSUMMATION OF SALE HAS NOT TAKEN PLACE: WHAT DO YOU DO?
THE DEPOSIT METHOD OF ACCOUNTING IS TO BE USED UNTIL
CONSUMMATED.

THE

SALE

IS

CONSUMMATION OF SALE HAS TAKEN PLACE: WHAT DO YOU DO?

CHECK TO SEE IF SALE MEETS THE FOLLOWING CRITERIA:
ADEQUACY OF INITIAL INVESTMENT
ADEQUACY OF CONTINUING INVESTMENT
TRANSFER OF RISKS AND REWARDS OF OWNERSHIP
INITIAL INVESTMENT CRITERIA
THE ADEQUACY OF A BUYER'S INITIAL INVESTMENT IS MEASURED BY ITS
COMPOSITION AND ITS SIZE COMPARED WITH THE SALE VALUE OF THE PROPERTY.

12

BUYER'S INITIAL INVESTMENT IS CASH PAID BY THE BUYER AS A DOWN PAYMENT.

IT IS ALSO A BUYER'S NOTE BACKED BY IRREVOCABLE LETTERS OF CREDIT
FROM AN INDEPENDENT LENDING INSTITUTION.
IT IS ALSO PAYMENT MADE BY THE BUYER TO THIRD PARTIES TO REDUCE
EXISTING INDEBTEDNESS ON THE PROPERTY.
IT IS ALSO OTHER AMOUNTS PAID BY THE BUYER THAT ARE PART OF THE
SALES VALUE.
OTHER CONSIDERATION RECEIVED BY THE SELLER, INCLUDING OTHER NOTES OF THE
BUYER NOT BACKED BY IRREVOCABLE LETTERS OF CREDIT, ARE INCLUDED AS PART
OF THE BUYER'S INITIAL INVESTMENT ONLY WHEN THEY ARE CONVERTED TO CASH
WITHOUT RECOURSE TO THE SELLER.
FOR EXAMPLE, A SALE MIGHT BE FINANCED
WITH A 60 PERCENT DOWN PAYMENT AND A 40 PERCENT UNSECURED NOTE FROM THE
BUYER TO THE SELLER.
THE BUYER OBTAINED THE CASH REQUIRED FOR THE 60
PERCENT DOWNPAYMENT WITH A LOAN FROM A THIRD PARTY, USING THE PROPERTY AS
COLLATERAL.
THE DOWNPAYMENT WOULD NOT QUALIFY FOR INCLUSION IN THE
BUYER'S INITIAL INVESTMENT BECAUSE THE LOAN OBTAINED FROM THE THIRD
PARTY, HAVING A SUPERIOR LIEN TO THE SELLER'S RECEIVABLE, WOULD IN EFFECT
SUBORDINATE THE SELLER'S RECEIVABLE TO THE NEW LOAN, AND, IN SUBSTANCE,
THE BUYER HAS NO REAL INVESTMENT IN THE PROPERTY.
THE FOLLOWING ADDITIONAL ITEMS SHOULD BE EXCLUDED FROM THE CALCULATION OF
THE BUYER'S INITIAL INVESTMENT.
AMOUNTS PAID BY THE BUYER TO OUTSIDE PARTIES FOR IMPROVEMENTS TO
THE PROPERTY. (THESE PAYMENTS BENEFIT THE BUYER, NOT THE SELLER).
ANY FUNDS THAT WILL BE PROVIDED EITHER DIRECTLY OR INDIRECTLY BY
THE SELLER. FUNDS INDIRECTLY PROVIDED BY THE SELLER WOULD INCLUDE LOANS
MADE BY AFFILIATED FINANCING INSTITUTIONS OF THE SELLER.
LOAN GUARANTEES OR COLLATERAL SUPPORT TO INDUCE THIRD PARTIES TO
MAKE LOANS TO THE BUYER.
DETERMINING SALES VALUE
SALES VALUE IS DEFINED AS FOLLOWS:
THE STATED SELLING PRICE DECREASED BY THE AMOUNT OF ANY DISCOUNT REQUIRED
TO REDUCE A RECEIVABLE TO ITS PRESENT VALUE (RECEIVABLES WITH BELOWMARKET INTEREST RATES) AND BY THE NET PRESENT VALUE OF ANY SERVICES
PROVIDED BY THE SELLER WITHOUT COMPENSATION;
THE STATED SELLING PRICE INCREASED BY ALL AMOUNTS THAT ARE ADDITIONAL
SALES PROCEEDS (IE. FUNDS PAID TO SELLER FOR THE EXERCISE OF AN OPTION).
INITIAL INVESTMENT (ADEQUACY OF )

13

SEE TABLE IN BONGIORNO 2.63.3 FROM FASB 66

TABLE OF MINIMUM INVESTMENTS
A BUYER'S INITIAL INVESTMENT IS GENERALLY CONSIDERED ADEQUATE IF THE
INVESTMENT IN THE PROPERTY IS LARGE ENOUGH TO GIVE THE BUYER A SUFFICIENT
STAKE IN THE PROPERTY SO THAT THE RISK OF LOSS THROUGH DEFAULT MOTIVATES
THE BUYER TO HONOR HIS OBLIGATIONS TO THE SELLER.
THE TABLE OF MINIMUM INITIAL INVESTMENTS IS BASED ON USUAL LOAN LIMITS
FOR VARIOUS TYPES OF PROPERTIES.
HOWEVER, LENDERS' APPRAISALS OF
SPECIFIC PROPERTIES MAY DIFFER.
THEREFORE, IF A RECENTLY PLACED
PERMANENT LOAN OR FIRM PERMANENT LOAN COMMITMENT FOR MAXIMUM FINANCING OF
THE PROPERTY EXISTS WITH AN INDEPENDENT ESTABLISHED LENDING INSTITUTION,
THE MINIMUM INITIAL INVESTMENT SHOULD BE WHICHEVER OF THE FOLLOWING IS
GREATER:
THE MINIMUM PERCENTAGE OF THE SALES VALUE OF THE PROPERTY IN THE
BONGIORNO TABLE 2.63.3; OR
THE LESSER OF :
THE AMOUNT OF THE SALES VALUE OF THE PROPERTY IN EXCESS OF
115
PERCENT OF THE AMOUNT OF A NEWLY PLACED PERMANENT LOAN OR
FIRM
PERMANENT LOAN COMMITMENT FROM A PRIMARY LENDER THAT IS AN
INDEPENDENT ESTABLISHED LENDING INSTITUTION; OR
TWENTY FIVE PERCENT OF THE SALES VALUE.
SEE EXAMPLES OF THESE PRINCIPLES, BONGIORNO 2.63.3
CONTINUING INVESTMENT CRITERIA FOR ACCRUAL METHOD
ACCORDING TO FASB 66, CONTINUING INVESTMENT IS NOT DEMONSTRATED UNLESS
BUYER IS CONTRACTUALLY OBLIGATED TO MAKE ANNUAL DEBT SERVICE PAYMENTS ON
THE DEBT ASSOCIATED WITH THE PURCHASE. THE PAYMENTS SHOULD BE IN AMOUNTS
AT LEAST EQUAL TO THE LEVEL ANNUAL PAYMENT THAT WOULD BE NEEDED TO PAY
THE DEBT AND INTEREST ON THE UNPAID BALANCE OVER NO MORE THAN :
20 YEARS FOR LAND;
THE CUSTOMARY MORTGAGE TERM OF A FIRST MORTGAGE LOAN BY AN
INDEPENDENT ESTABLISHED LENDING INSTITUTION FOR OTHER SIMILAR REAL
ESTATE.
THE SELLER'S RECEIVABLES SHOULD NOT BE SUBJECT TO FUTURE SUBORDINATION.
THIS CONDITION DOES NOT APPLY IF THE SUBORDINATION IS TO A FIRST MORTGAGE
ON THE PROPERTY EXISTING AT THE TIME OF SALE OR IF IT IS A FUTURE LOAN,
INCLUDING AN EXISTING PERMANENT LOAN COMMITMENT IF THE TERMS OF THE SALE
AND THE PROCEEDS OF THE LOAN WILL BE APPLIED FIRST TO THE PAYMENT OF THE
SELLER'S RECEIVABLE.
CONTINUING INVESTMENT CRITERIA MET
EXAMINE THE TRANSACTION TO ASSURE THAT IT
NECESSARY FOR FULL PROFIT RECOGNITION.

14

MEETS THE

OTHER CRITERIA

CONTINUING INVESTMENT CRITERIA NOT MET

USE THE INSTALLMENT METHOD IF OTHER FULL ACCRUAL CONDITIONS ARE MET, AND
IF THE RECOVERY OF THE PROPERTY IS REASONABLY ASSURED IN CASE OF DEFAULT.
USE THE COST RECOVERY METHOD IF THE ABOVE IS TRUE, BUT RECOVERY OF THE
PROPERTY IN DEFAULT IS NOT REASONABLY ASSURED.
USE THE REDUCED PROFIT METHOD IF PAYMENTS BY THE BUYER EACH YEAR ARE
GREATER THAN OR EQUAL TO THE SUM OF THE FOLLOWING:
THE INTEREST AND PRINCIPAL AMORTIZATION ON THE MAXIMUM FIRST
MORTGAGE LOAN THAT COULD BE OBTAINED ON THE PROPERTY, AND INTEREST,
AT AN APPROPRIATE RATE, ON THE EXCESS OF THE AGGREGATE ACTUAL DEBT
ON THE PROPERTY OVER SUCH A MAXIMUM FIRST MORTGAGE LOAN (EFFECTIVE
SECOND MORTGAGE).
IF REQUIRED AGGREGATE ANNUAL PAYMENTS ON TOTAL INDEBTEDNESS (AS IN AN ALL
INCLUSIVE OR WRAPAROUND MORTGAGE) ARE NOT AT LEAST EQUAL TO ANNUAL
PAYMENTS OF PRINCIPAL AND INTEREST ON MAXIMUM FIRST LIEN INDEBTEDNESS,
PLUS INTEREST AT THE STATED RATE ON THE EFFECTIVE SECOND MORTGAGE, PROFIT
MUST BE RECOGNIZED ON THE INSTALLMENT OR COST RECOVERY METHODS.
SEE 2.64.4 BONGIORNO, EXAMPLE 20
SEE TEST FOR REDUCED PROFIT RECOGNITION, BONGIORNO, PAGE 2-71
CONTINUING INVOLVEMENT CRITERION FOR THE ACCRUAL METHOD.
IF A SELLER CONTINUES TO BE INVOLVED IN THE PROPERTY IN ANY WAY THAT
RESULTS IN RETENTION OF SUBSTANTIAL RISKS AND REWARDS OF OWNERSHIP, THEN
THE ABSENCE OF THE CONTINUING INVOLVEMENT CRITERION HAS NOT BEEN MET AND
FULL PROFIT RECOGNITION IS NOT APPROPRIATE. IN THESE INSTANCES, PROFIT
IS RECOGNIZED BY A METHOD DETERMINED BY THE NATURE AND EXTENT OF THE
SELLER'S CONTINUING INVOLVEMENT.
AS A GENERAL RULE, PROFIT CAN BE
RECOGNIZED AT THE TIME OF SALE IF THE AMOUNT OF THE POTENTIAL LOSS OF
PROFIT RESULTING FROM THE CONTINUING INVOLVEMENT BY THE SELLER CAN BE
DETERMINED.
THE PROFIT THEN RECOGNIZED IS REDUCED BY THE MAXIMUM
EXPOSURE TO LOSS.
A SELLER'S CONTINUED INVOLVEMENT MAY CONSIST OF A SELLER'S AGREEMENT TO
PROVIDE FINANCING; MANAGEMENT, DEVELOPMENT OR CONSTRUCTION OF THE
PROPERTY; GUARANTEE OF A RETURN TO THE BUYER; OR A CONTRACTUAL OR IMPLIED
OBLIGATION TO INITIATE AND SUPPORT OPERATIONS.
A COMMON FORM OF
CONTINUING INVOLVEMENT IS THROUGH REAL ESTATE SYNDICATION WHEREBY THE
SELLER BECOMES A GENERAL PARTNER IN A LIMITED PARTNERSHIP HOLDING THE
PROPERTY. AS A GENERAL PARTNER THE SELLER IS RESPONSIBLE FOR PROFITABLE
OPERATIONS OF THE PROJECT AND IS ALSO LIABLE FOR LOSSES OF THE
PARTNERSHIP. IN ADDITION, IF THE SALES PRICE IS FINANCED THROUGH A NOTE
FROM THE PARTNERSHIP TO THE SELLER, REALIZATION OF THE NOTE IS IN MOST
CASES DEPENDENT ON PROFITABLE OPERATIONS OF THE PARTNERSHIP.
NO PROFIT SHOULD BE RECOGNIZED UNTIL PERMANENT FINANCING IS AVAILABLE TO
THE BUYER.
AN EXCEPTION IS WHERE THE SELLER IS PRIMARILY A FINANCING
INSTITUTION. PROFIT MAY SOMETIMES THEN BE RECOGNIZED ON THE PERCENTAGE

15

OF COMPLETION
COMPLETED.

METHOD

AS

THE

REMAINDER

OF

THE

EARNINGS

PROCESS

IS

GIVEN THE FOLLOWING SITUATION:

OXY REALTY SELLS TO CLOUT REALTY THE JENKINS RANCH FOR 7,600,000.
OXY'S COST BASIS FOR FASB PURPOSES IS 4,600,000.
7,600,000 - 4,600,000 = 3,000,000 INCOME.
THE TERMS: CLOUT PAYS OXY 760,000
AND, 7,000,000 OVER THE NEXT 30 YEARS AT 8 PERCENT INTEREST.
CLOUT SELLS LAND TO OXY FOR 2,600,000
OXY PAYS THEM 760,000 WITH BALANCE IN MORTGAGE.
THE REAL ESTATE
TRANSACTIONS.

BROKER

HAS

COMMISSION

OF

114,000

ON

THE

TWO

IN FASB TERMS, OXY RECORDS SALE OF PROPERTY WITH 3,000,000 PROFIT WITH
114,000 EXPENSE (THE BROKER'S FEE)
EARNINGS PER SHARE IS THE MOST COMMONLY USED FINANCIAL FIGURE.
IT IS
USED TO GAUGE THE MARKET VALUE OF A SECURITY. IT EFFECTS PRICE/EARNINGS
RATIO. EPS BRINGS UP P.E.R., WHICH INCREASES STOCK PRICE. THIS WAS THE
PURPOSE OF THE ABOVE OXY/CLOUT DEAL.
FASB GUARDS ACCESS TO FULL ACCRUAL ACCOUNTING OF REAL ESTATE SALES.
VALUATION ISSUES
NET REALIZABLE VALUE
LAND AND BUILDINGS HELD FOR SALE OR BEING DEVELOPED FOR SALE, REPRESENT
THE INVENTORY OF THE COMMERCIAL DEVELOPER. INVENTORIES SHOULD BE CARRIED
AT 'COST', WHICH IS NOT IN EXCESS OF MARKET OR AT 'LOWER OF COST OR
MARKET'. BECAUSE THERE IS NO QUOTED MARKET AND BECAUSE OF THE UNIQUENESS
OF LAND AND BUILDING LOCATIONS, WHICH OFTEN DISCREDITS THE VALIDITY OF
REPLACEMENT COST, MARKET IS USUALLY CONSIDERED TO BE NET REALIZABLE
VALUE. THUS, THE NET REALIZABLE VALUE IS GENERALLY THE FAIR MARKET VALUE
REDUCED BY THE COSTS OF DISPOSITION.
NRV IS BASED ON A PROJECT BY PROJECT ANALYSIS. INDIVIDUAL PROJECTS ARE,
FOR THIS PURPOSE, COMPONENTS OR WHOLES OF A PROJECT THAT ARE HOMOGENOUS
IN NATURE.
FOR EXAMPLE, A MULTIPHASE DEVELOPMENT CONSISTING OF A TRACT OF SINGLEFAMILY HOUSES, A CONDOMINIUM COMPLEX, AND A LOT SUBDIVISION WOULD BE
EVALUATED AS THREE SEPARATE PROJECTS.
IN DETERMINING THE COST OF

A PARTICULAR PROJECT IN ORDER TO APPLY THE

16

LOWER OF COST OR MARKET CRITERIA, ALL PROJECT COSTS MUST BE CONSIDERED.

THESE COSTS INCURRED INCLUDE COSTS OF ACQUISITION, CARRYING,DEVELOPMENT,
CONSTRUCTION, AND INTEREST WHICH IS CAPITALIZED DURING THE DEVELOPMENT
PERIOD AND ANY INTANGIBLE COSTS.
AS COSTS FOR DEVELOPMENT OR CONSTRUCTION ARE INCURRED, CAPITALIZATION
SHOULD NOT CEASE WHEN IT BECOMES NECESSARY TO RECOGNIZE A LOWER VALUE FOR
AN ASSET THAN THE HISTORICAL COSTS INCURRED FOR THAT ASSET.
WHEN THE CAPITALIZED COSTS OF REAL ESTATE HELD FOR SALE OR FOR
DEVELOPMENT AND SALE EXCEED ITS ESTIMATED NET REALIZABLE VALUE, AN
ALLOWANCE SHOULD BE PROVIDED TO REDUCE THE CARRYING AMOUNT OF THE ASSET
TO NET REALIZABLE VALUE.
THE USE OF AN ALLOWANCE ACCOUNT ALLOWS THE
ACCUMULATION OF THE TOTAL PROJECT COST WHILE STILL VALUING THE ASSET AT
THE LOWER OF COST OR MARKET FOR FINANCIAL STATEMENT PURPOSES. FUTURE
INTEREST COSTS SUBSEQUENT TO THE COMPLETION OF THE DEVELOPMENT NEED NOT
BE CONSIDERED.
ABANDONMENT AND CHANGES IN USE
CAPITALIZED ASSETS, INCLUDING ALLOCATED COMMON COSTS OF REAL ESTATE
ABANDONED, SHOULD BE WRITTEN OFF AS CURRENT EXPENSES OR, IF APPROPRIATE,
TO ALLOWANCES ESTABLISHED FOR THAT PURPOSE.
THE COSTS OF THESE
ABANDONED PROJECTS SHOULD NOT BE ALLOCATED TO OTHER COMPONENTS OF THE
PROJECT OR TO OTHER PROJECTS, EVEN IF THESE OTHER PROJECTS ARE CAPABLE OF
ABSORBING THE LOSSES. PROPERTY DONATED TO GOVERNMENTAL AGENCIES FOR USES
THAT WILL BENEFIT A PROJECT ARE NOT ABANDONMENTS.
THE COSTS OF THE
PROPERTY DONATED ARE ALLOCATED AS A COMMON COST OF THE PROJECT.
CHANGES IN USE
CHANGES IN THE USE OF A REAL ESTATE PROJECT OR A PORTION OF THE PROJECT
MAY OCCUR AFTER SIGNIFICANT DEVELOPMENT OR CONSTRUCTING COSTS HAVE BEEN
INCURRED.
IN SUCH CIRCUMSTANCES, DEVELOPMENT AND CONSTRUCTION COSTS
INCURRED BEFORE THE CHANGE SHOULD BE WRITTEN OFF, EXCEPT AS FOLLOWS:
IF THE CHANGE IS MADE PURSUANT TO A FORMAL PLAN FOR A PROJECT THAT
IS EXPECTED TO PRODUCE A HIGHER ECONOMIC YIELD, THE WRITE-OFF MAY BE
LIMITED TO THE AMOUNT BY WHICH THE CAPITALIZED COSTS INCURRED AND TO BE
INCURRED EXCEED THE ESTIMATED VALUE OF THE REVISED PROJECT AT THE DATE IT
IS SUBSTANTIALLY COMPLETE AND READY FOR ITS INTENDED USE;
IN THE ABSENCE OF A FORMAL PLAN FOR A PROJECT THAT IS EXPECTED TO
PRODUCE A HIGHER ECONOMIC YIELD, THE WRITE-OFF MAY BE LIMITED TO THE
AMOUNT BY WHICH TOTAL CAPITALIZED COSTS EXCEED THE ESTIMATED NET
REALIZABLE VALUE OF THE PROPERTY, DETERMINED ON THE ASSUMPTION THAT IT
WILL BE SOLD AT A LATER DATE.
COST BASIS = HISTORICAL COST PURSUANT TO FASB, IMPLYING GAAP.
I.E.

I HAVE A CHAIR, WHICH I BOUGHT FOR 50 DOLLARS.

17

IT HAS A FIVE YEAR DEPRECIATION PERIOD, OR 10 DOLLARS PER YEAR (SLN)

AFTER TWO YEARS, I SELL IT.
50 DOLLARS, MINUS 20 DOLLARS DEPRECIATION, EQUALS THIRTY DOLLARS.
LETS SAY THAT I SOLD IT FOR 40 DOLLARS. 30 FROM 40 EQUALS A TEN DOLLAR
GAIN.
ANYTIME YOU HAVE A DEPRECIABLE
DEPRECIATION ACCOUNT.

ASSET, YOU

WILL HAVE

AN ACCUMULATED

BUILDING.....................................3,000,000
LESS
ACCUMULATED DEPRECIATION..................... 200,000
EQUALS
-------------BOOK VALUE.................................. 2,800,000
LAND........................................
100,000
EQUALS
-------------TOTAL VALUE................................. 2,900,000
SOLD FOR.................................... 3,000,000
FINANCIAL GAIN..............................
100,000
SEE SECTION 179 - DEPRECIATION
AS PERTAINING TO TAX ACCOUNTING, 10,000 PER YEAR MAY BE DEDUCTED AS
DEPRECIABLE ASSETS (EXCLUDING REAL PROPERTY).
THIS HAS NOTHING TO DO
WITH FASB, HOWEVER, AS IT DOES NOT PERTAIN TO FINANCIAL ACCOUNTING.
DEPRECIATION IS PRO-RATED OR DISBURSED ON MID YEAR CONVENTION FOR
PROPERTY PURCHASED AT TIMES OTHER THAN THE FIRST OF THE YEAR OR SOLD
BEFORE THE LAST OF THE YEAR.
READ BONGIORNO CHAPTER TWO
CHAPTER THREE, STARTING 3.01 TO 3.43
WILEY, CHAPTER 3 AND 4
END OF THIRD CLASS

9/28/89
REAL ESTATE ESCALATIONS
LABOR COSTS
CONTINGENT uncertainty in facts

18

C.P.I.

UNDERSTAND WHY FASB

RECOGNITION
WILEY PG 30 TO 35

GOT

may or may not happen

COMPLETED see Bongiorno 2.33.4 supplement
straight line method
INVOLVED

IN

SETTING

THE

LAW

ON

REVENUE

KNOW THAT YOU CAN NOT RECORD EXPENSES UNLESS IT CAN BE MATCHED WITH
REVENUES WHICH CAUSED THEM TO OCCUR.
EXAMPLE: ON NOVEMBER 30, 1989, A COMPANY SIGNS A LEASE
ON DECEMBER 1, 1990, THEY OCCUPY THEIR OFFICE SPACE.
RENT: 5,000 MONTHLY FOR FIVE YEARS
AT THE SIGNING OF THE LEASE, THEY PUT UP 2 MONTHS RENT AS SECURITY
(10,000).
ADDITIONALLY, THEY PUT UP THE FIRST MONTH'S RENT (5,000).
FURTHERMORE, THEY TURN OVER A CHECK FOR 60,000 FOR LEASEHOLD ALTERATIONS
THAT HAVE BEEN COMPLETED. THE TOTAL AMOUNT, THEN, IS 75,000.
UNDER ACCRUAL ACCOUNTING, WHAT IS THE EXPENSE FOR THIS OFFICE SPACE?
UNDER THE RULES OF FINANCIAL ACCOUNTING, THIS EXAMPLE IS AN OPERATING
LEASE. WE MUST DETERMINE THE RENT EXPENSES, AND EVALUATE THE TIMING OF
THE RECOGNITION OF THOSE EXPENSES.
FIRST MONTHS RENT

5,000

ASSETS
LIABILITIES
10,000 SECURITY (NEVER AN EXPENSE)
5,000 RENT
60,000 LEASEHOLD IMPROVEMENTS
1,000 FOR IMPROVEMENTS
MINUS
(60,000 / 60 MONTHS)
1,000 DEPRECIATION ON THE 60 MONTH LEASE
------59,000
10,000
-----69,000
FOR TAX ACCOUNTING PURPOSES, THE IMPROVEMENTS ARE DEPRECIATED OVER THE
LIFESPAN OF THE IMPROVEMENT, NOT THE LEASE PERIOD FOR THE TENANT. FOR
THE OWNER, THE OFFICE SPACE WOULD BE DEPRECIATED OVER 31.5 YEARS.
FOR FINANCIAL ACCOUNTING PURPOSES, YOU AMORTIZE THE IMPROVEMENTS OVER THE
LIFE OF THE LEASE OR THE ECONOMIC LIFE OF THE IMPROVEMENTS, WHICHEVER IS
LESS.
THEREFORE, EQUIPMENT IN THE BUILDING WITH AN ECONOMIC LIFE OF,
SAY, 7.5 YEARS WILL STILL DEPRECIATE AT 5.0 YEARS BECAUSE THE LEASE IS
OVER 60 MONTHS.
IS IT AN OPERATING LEASE OR A CAPITAL LEASE?
3.30 AND 3.31 IN BONGIORNO (CAPITAL LEASE).

19

FOR AN ANSWER, SEE SECTION

BONGIORNO - ACCOUNTING FOR LEASING TRANSACTIONS

THE CONCEPTUAL BASIS FOR LEASING ACCOUNTING:
A LEASE THAT TRANSFERS SUBSTANTIALLY ALL OF THE BENEFITS AND RISKS OF
OWNERSHIP SHOULD BE ACCOUNTED FOR AS AN ACQUISITION OF AN ASSET AND THE
INCURRENCE OF AN OBLIGATION BY THE LESSEE (A CAPITAL LEASE) AND SHOULD BE
ACCOUNTED FOR AS A SALE OR FINANCING BY THE LESSOR ( A SALES-TYPE, DIRECT
FINANCING, OR LEVERAGED LEASE). OTHER LEASES SHOULD BE ACCOUNTED FOR AS
OPERATING LEASES, THAT IS, THE RENTAL OF THE PROPERTY.
THE DUCK TEST
IF THE LESSEE APPEARS TO HAVE ASSUMED AN OWNERSHIP POSITION, IN EFFECT HE
HAS PURCHASED THE PROPERTY. IF HE DOES NOT BEAR THE RISK AND REWARDS OF
OWNERSHIP, HE HAS NOT PURCHASED THE PROPERTY.
THE CAPITAL LEASE
CAPITALIZATION CRITERIA
IF THE LEASE MEETS ANY ONE OF THE FOLLOWING FOUR CAPITALIZATION CRITERIA,
IT IS A CAPITAL LEASE.
THE LEASE TRANSFERS OWNERSHIP OF THE LEASED PROPERTY TO THE LESSEE
DURING THE TERM OF THE LEASE OR AT ITS END;
THE LEASE HAS A BARGAIN PURCHASE OPTION;
THE LEASE TERM INCLUDING RENEWAL PERIODS EQUALS AT LEAST 75 PERCENT
OF THE ESTIMATED ECONOMIC USEFUL LIFE OF THE LEASED PROPERTY; OR,
THE PRESENT VALUE OF THE MINIMUM LEASE PAYMENTS EQUALS AT LEAST 90
PERCENT OF THE FAIR VALUE OF THE LEASED PROPERTY.
THE LAST TWO CRITERIA ARE NOT APPLICABLE WHEN THE BEGINNING OF THE
LEASE TERM FALLS WITHIN THE LAST 25 PERCENT OF THE TOTAL ESTIMATED
ECONOMIC LIFE OF THE LEASED PROPERTY.
THE RECORDING OF ASSETS AND LIABILITIES WITH A CAPITAL LEASE
THE LESSEE RECORDS AN ASSET AND RELATED LIABILITY EQUAL TO THE LOWER OF
THE FAIR VALUE OF THE LEASED PROPERTY, OR THE PRESENT VALUE (AT THE
INCEPTION OF THE LEASE TERM) OF MINIMUM LEASE PAYMENTS DURING THE LEASE
TERM, EXCLUDING EXECUTORY COSTS. THE RECORDED ASSET, EXCEPT FOR LAND, IS
THEN DEPRECIATED IN A MANNER CONSISTENT WITH OTHER SIMILAR ASSETS BEING
DEPRECIATED BY THE LESSEE. IF THE LEASE DOES NOT TRANSFER TITLE AT THE
END OF THE LEASE OR CONTAIN A BARGAIN PURCHASE OPTION, THEN THE
AMORTIZATION PERIOD SHOULD BE THE LEASE TERM AND THE ASSET SHOULD BE
AMORTIZED TO ITS EXPECTED VALUE AT THE END OF THE LEASE TERM.
LAND
ASSETS RECORDED UNDER A CAPITAL LEASE ARE NOT DEPRECIATED.
IF THE LEASE COVERS LAND ONLY, THEN ONLY THE FIRST CRITERIA APPLY. IF
NONE OF THE CRITERIA APPLY, IT IS AN OPERATING LEASE.

20

OPERATING LEASES
NEITHER AN ASSET NOR A LIABILITY IS RECORDED FOR AN OPERATING LEASE.
RENTAL PAYMENTS ARE CHARGED TO OPERATIONS AS THEY BECOME DUE.
IF RENTAL PAYMENT IS NOT MADE ON A STRAIGHT LINE BASIS, RENTAL EXPENSE
SHOULD, HOWEVER, BE RECOGNIZED ON A STRAIGHT LINE BASIS UNLESS ANOTHER
SYSTEMATIC BASIS IS MORE APPROPRIATE UNDER THE CIRCUMSTANCES.
LESSOR ACCOUNTING
THE SALES TYPE, DIRECT FINANCING, AND LEVERAGED LEASES
TO QUALIFY AS A SALES TYPE, DIRECT FINANCING OR LEVERAGED LEASE, THE
FOLLOWING CRITERION MUST BE MET:
COLLECTIBILITY OF THE MINIMUM LEASE PAYMENTS IS REASONABLY
PREDICTABLE AND ASSURED;
THE LESSOR CAN REASONABLY ESTIMATE ANY UNREIMBURSABLE COSTS YET TO
BE INCURRED.
MUST MEET ONE OF THE FOUR CRITERION UNDER THE HEADING FOR CAPITAL
LEASE DEFINITION ABOVE.
THE SALES TYPE LEASE
IF THE LEASE MEETS THE ABOVE CRITERIA AND GIVES RISE TO A PROFIT OR LOSS
TO THE LESSOR (THAT IS, IF THE FAIR MARKET VALUE OF THE LEASED PROPERTY
AT THE INCEPTION OF THE LEASE IS GREATER OR LESS THAN ITS COST OR
CARRYING AMOUNT), THEN THE LEASE QUALIFIES AS A SALES TYPE LEASE.
FOR A SALES-TYPE LEASE, THE PRESENT VALUE OF THE MINIMUM LEASE PAYMENTS
IS REPORTED AS SALES. THE CARRYING AMOUNT OF THE LEASED PROPERTY PLUS
ANY INITIAL DIRECT COSTS, LESS THE PRESENT VALUE OF ANY UNGUARANTEED
RESIDUAL, IS CHARGED AS COST OF SALES. THE LESSOR REPORTS AS AN ASSET ON
THE BALANCE SHEET THE NET INVESTMENT IN THE LEASE.
THIS IS DONE BY
RECORDING THE SUM OF THE LEASE PAYMENTS AND THE UNGUARANTEED RESIDUAL
(THE GROSS INVESTMENT) AT THEIR PRESENT VALUE, USING THE INTEREST RATE
IMPLICIT IN THE LEASE AS THE DISCOUNT FACTOR.
THE DIFFERENCE BETWEEN THE GROSS INVESTMENT AND THE NET INVESTMENT IS
UNEARNED INCOME THAT IS AMORTIZED INTO INCOME OVER THE LEASE TERM TO
PRODUCE A CONSTANT PERIODIC RATE OF RETURN ON THE NET INVESTMENT.
THE SALES-TYPE LEASE WILL BE REGARDED AS AN OPERATING LEASE IF IT DOES
NOT, IN ADDITION TO THE OTHER CRITERIA, MEET WITH THE FASB 66 CONDITIONS
OF FULL AND IMMEDIATE PROFIT RECOGNITION.
DIRECT FINANCING LEASES
IF NO PROFIT IS TO BE RECOGNIZED (I.E. FAIR MARKET VALUE OF THE LEASED
PROPERTY EQUALS ITS COST), AND UNLESS THE LEASE MEETS ALL OF THE CRITERIA
SPECIFIED BELOW FOR LEVERAGED LEASES, THE LEASE IS CLASSIFIED AS A DIRECT

21

FINANCING LEASE. UNDER A DIRECT FINANCING LEASE, THE LESSOR RECORDS AS

AN ASSET ON THE BALANCE SHEET THE NET INVESTMENT IN THE LEASE CONSISTING
OF THE GROSS INVESTMENT LESS UNEARNED INCOME (SEE BONGIORNO 2.33.1).
UNEARNED INCOME IS CALCULATED BY SUBTRACTING THE COST OR CARRYING AMOUNT
OF THE LEASED PROPERTY FROM THE GROSS INVESTMENT.
UNEARNED INCOME IS
AMORTIZED OVER THE LEASE TERM TO PRODUCE A CONSTANT PERIODIC RATE OF
RETURN ON THE NET INVESTMENT.
IF ON PERIODIC REVIEW, THE ESTIMATED
RESIDUAL VALUE OF THE LEASED ASSET HAS DECREASED, AN IMMEDIATE WRITE-DOWN
IS REQUIRED FOR OTHER THAN TEMPORARY DECLINES. NO WRITE-UP IS ALLOWED.
LEVERAGED LEASES
A LEVERAGED LEASE IS ONE IN WHICH THE LESSOR HAS, IN ESSENCE, PURCHASED
THE LEASED PROPERTY SUBJECT TO FINANCING PROVIDED BY A LONG-TERM
CREDITOR. A LEVERAGED LEASE IS A DIRECT FINANCING LEASE THAT ADDITIONALLY
HAS ALL OF THE FOLLOWING CHARACTERISTICS.
IT INVOLVES AT LEAST THREE PARTIES: A LESSEE, A LONG-TERM CREDITOR,
AND A LESSOR.
THE FINANCING PROVIDED BY THE LONG TERM CREDITOR IS SUBSTANTIAL TO
THE TRANSACTION (I.E. GREATER THAN 50 PERCENT) AND IS NONRECOURSE TO THE
LESSOR.
THE LESSOR'S NET INVESTMENT DECLINES IN THE
INCREASES DURING THE LATER YEARS OF THE LEASE TERM.

EARLY

YEARS

AND

ANY INVESTMENT TAX CREDIT RETAINED BY THE LESSOR IS ACCOUNTED FOR

AS ONE OF THE CASH FLOW COMPONENTS OF THE LEASE.
THE LESSOR RECORDS HIS INVESTMENT IN A LEVERAGED LEASE NET OF THE
NONRECOURSE DEBT.
THE INVESTMENT IN THE LEASE IS THE EXCESS OF THE
PRESENT VALUE OF THE RENTAL PAYMENTS, PLUS ESTIMATED RESIDUAL VALUE, LESS
DEBT SERVICE REQUIREMENTS.
INCOME (TOTAL CASH RECEIVED LESS ORIGINAL
INVESTMENT) IS RECOGNIZED ONLY IN PERIODS IN WHICH THE INVESTMENT NET OF
RELATED DEFERRED TAXES IS POSITIVE.
TO DETERMINE THE PERIODIC INCOME,
THE RATE OF RETURN ON THE NET INVESTMENT IN YEARS IN WHICH IT IS POSITIVE
IS DETERMINED (BY USING PROJECTED CASH FLOW) AND IS APPLIED TO THE NET
INVESTMENT.
OPERATING LEASES
IF NONE OF THE FIRST CAPITALIZATION CRITERIA ARE MET, OR IF ONE OR MORE
OF THE CAPITALIZATION CRITERIA ARE MET AND BOTH OF THE ADDITIONAL
CRITERIA ARE NOT MET, THEN THE LEASE IS TO BE TREATED AS AN OPERATING
LEASE
UNDER THE OPERATING LEASE, THE LESSOR CONTINUES TO DEPRECIATE THE LEASED
PROPERTY OVER ITS ESTIMATED USEFUL LIFE AND RECORDS RENTAL INCOME WHEN
THE RENT PAYMENTS BECOME DUE FROM THE LESSEE. IF RENTAL PAYMENTS ARE NOT

22

MADE ON A STRAIGHT LINE BASIS, THEN RENTAL INCOME SHOULD BE RECOGNIZED ON

A STRAIGHT LINE BASIS, UNLESS SOME OTHER SYSTEMATIC BASIS IS MORE REPRESENTATIVE OF THE TIME PERIODS IN WHICH BENEFITS ARE DERIVED FROM THE
LEASED PROPERTY. INITIAL DIRECT AND INDIRECT COSTS ASSOCIATED WITH THE
LEASE SHOULD BE DEFERRED AND AMORTIZED INTO EXPENSE OVER THE RELATED
LEASE TERMS.
LEASE PROVISIONS INVOLVING REAL ESTATE
LAND AND BUILDINGS
IF A LEASE INVOLVING BOTH THE LAND AND BUILDINGS MEETS EITHER OF THE
FIRST TWO CAPITALIZATION CRITERIA ABOVE (TRANSFER OF OWNERSHIP OR BARGAIN
PURCHASE OPTION), THEN THE LAND AND BUILDING ARE SEPARATELY CAPITALIZED
BY THE LESSEE.
THE PRESENT VALUE OF THE MINIMUM LEASE PAYMENTS LESS
EXECUTORY COSTS, INCLUDING ANY PROFIT THEREIN, IS ALLOCATED BETWEEN LAND
AND BUILDINGS IN PROPORTION TO THEIR FAIR MARKET VALUES AT THE INCEPTION
OF THE LEASE. THE BUILDING IS THEN DEPRECIATED IN ACCORDANCE WITH THE
LESSEE'S NORMAL PRACTICE.
IN SITUATIONS WHERE THE LEASE DOES NOT TRANSFER OWNERSHIP AND THERE IS
NOT A BARGAIN PURCHASE OPTION, CRITERIA 3 AND 4 MUST BE APPLIED (FROM THE
CRITERIA FOR CAPITALIZATION OF LEASES ABOVE). IF THE FAIR VALUE OF THE
LAND IS LESS THAN 25 PERCENT OF THE TOTAL FAIR VALUE OF THE LEASED
PROPERTY AT THE INCEPTION OF THE LEASE, THEN BOTH THE LESSEE AND LESSOR
WILL CONSIDER THE LAND AND THE BUILDING AS A SINGLE UNIT FOR APPLYING
CRITERIA 3 AND 4. THE ECONOMIC LIFE OF THE BUILDING IS CONSIDERED THE
ECONOMIC LIFE OF THE SINGLE UNIT.
IF EITHER CRITERIA IS MET AND THE
LEASE IS A CAPITAL LEASE, LESSEE AND LESSOR ACCOUNTING IS SIMILAR TO THAT
PREVIOUSLY DESCRIBED. THE LESSEE WILL CAPITALIZE AND DEPRECIATE THE LAND
AND THE BUILDING AS A SINGLE UNIT.
IF THE FAIR VALUE OF THE LAND EXCEEDS 25 PERCENT, THE LAND AND THE
BUILDING MUST BE TREATED AS TWO SEPARATE LEASES. IF THE BUILDING ELEMENT
MEETS CRITERIA 3 OR 4 MENTIONED ABOVE, THE BUILDING ELEMENT WILL BE
TREATED AS A CAPITAL LEASE AND ACCOUNTED FOR BY THE LESSEE AND LESSOR AS
PREVIOUSLY DESCRIBED. THE LAND ELEMENT IS THEN ACCOUNTED FOR SEPARATELY
AS AN OPERATING LEASE.
IF NEITHER CRITERIA (3 OR 4) IS MET BY THE BUILDING ELEMENT, BOTH THE
BUILDING ELEMENT AND THE LAND ELEMENT WILL BE TREATED AS A SINGLE
OPERATING LEASE.
SEE SECTION 2.34.3 AND 2.34.4 FOR ACCOUNTING FOR LEASES OF BUILDING OR
LAND ONLY, FOR LESSOR AND LESSEE.
SUBLEASES AND TERMINATIONS
ORIGINAL LESSOR
AN ORIGINAL LESSOR WILL NOT CHANGE HIS ACCOUNTING FOR A LEASE IF THE
ORIGINAL LESSEE SUBLEASES THE PROPERTY OR SELLS OR TRANSFERS THE ORIGINAL

23

LEASE TO A THIRD PARTY. IF THE LEASE IS TERMINATED AND A NEW LEASE IS

ENTERED INTO WITH A NEW LESSEE, THE NET INVESTMENT ON THE BOOKS OF THE
LESSOR IS REMOVED, THE LEASED ASSET IS RECORDED AT THE LOWER OF ITS
ORIGINAL COST, PRESENT FAIR VALUE, OR PRESENT CARRYING AMOUNT, AND THE
NET ADJUSTMENT IS CHARGED TO INCOME IN THE CURRENT PERIOD. THE NEW LEASE
IS CLASSIFIED AND ACCOUNTED FOR AS A SEPARATE AND DISTINCT TRANSACTION.

ORIGINAL LESSEE
THE ORIGINAL LEASE IS A:
CAPITAL LEASE
AN ORIGINAL LESSEE MAY SUBSTITUTE A NEW LESSEE UNDER THE ORIGINAL
LEASE AGREEMENT (WHO BECOMES THE PRIMARY OBLIGOR) OR CANCEL THE ORIGINAL
LEASE AGREEMENT OUTRIGHT. IF THE ORIGINAL LEASE WAS A CAPITAL LEASE THE
ASSET AND OBLIGATION REPRESENTING THE ORIGINAL LEASE IS REMOVED FROM THE
ACCOUNTS AND A GAIN OR LOSS IS RECOGNIZED FOR THE DIFFERENCE.
ANY
CONSIDERATION PAID OR RECEIVED TO EFFECT THE TERMINATION IS INCLUDED IN
THE DETERMINATION OF GAIN OR LOSS.
IF THE ORIGINAL LEASE MET EITHER THE FIRST OR THE SECOND OF THE
CAPITALIZATION CRITERIA AND WAS CAPITALIZED BY THE ORIGINAL LESSEE, AS
SUBLESSOR HE MUST CLASSIFY THE NEW LEASE AS A SALES TYPE LEASE OR DIRECT
FINANCE LEASE IF THE NEW LEASE MEETS THE CRITERIA FOR A CAPITAL LEASE.
THE UNAMORTIZED BALANCE OF THE ASSET UNDER THE ORIGINAL LEASE BECOMES THE
COST OF THE LEASED PROPERTY UNDER THE NEW LEASE.
IF THE NEW LEASE
DOESN'T QUALIFY, IT IS TREATED AS AN OPERATING LEASE.
IN EITHER CASE,
THE ORIGINAL LESSEE CONTINUES TO ACCOUNT FOR THE OBLIGATION RELATED TO
THE ORIGINAL LEASE AS BEFORE.
IF THE ORIGINAL LEASE MET THE THIRD OR FOURTH CRITERION OF
CAPITALIZATION, BUT NOT THE FIRST OR THE SECOND, THE ORIGINAL LESSEE MUST
(WITH ONE EXCEPTION) CLASSIFY THE NEW LEASE IN ACCORDANCE WITH CRITERION
THREE AND THE TWO ADDITIONAL CRITERIA (UNDER LESSOR ACCOUNTING) ONLY. IF
THE TRANSACTION MEETS THESE CRITERIA, THE LESSEE SHOULD ACCOUNT FOR IT AS
A DIRECT FINANCING LEASE WITH THE UNAMORTIZED BALANCE OF THE ASSET UNDER
THE ORIGINAL LEASE BECOMING THE COST OF THE LEASED PROPERTY UNDER THE NEW
LEASE. IF NOT, IT IS AN OPERATING LEASE. HOWEVER, IF THE NATURE OF THE
SUBLEASING ACTIVITY SUGGESTS THAT THE SUBLEASE WAS INTENDED TO BE AN
INTEGRAL PART OF THE OVERALL TRANSACTION, AND THE ORIGINAL LEASE ONLY
SERVES AS A CONDUIT, THE SUBLEASE SHALL BE CLASSIFIED ACCORDING TO THE
THIRD AND FOURTH CRITERION AND THE TWO ADDITIONAL CRITERION UNDER LESSOR
ACCOUNTING.
THE ORIGINAL LEASE IS
AN OPERATING LEASE:
IF

THE

ORIGINAL

LEASE

IS

AN

OPERATING

24

LEASE,

THE

ORIGINAL

LESSEE

CONTINUES TO ACCOUNT FOR IT AND THE NEW LEASE AS OPERATING LEASES. THE
NEW LESSEE IS OBLIGED TO CLASSIFY THE NEW LEASE IN ACCORDANCE WITH THE
FOUR CAPITALIZATION CRITERIA AND TO ACCOUNT FOR IT AS APPROPRIATE IN THE
CIRCUMSTANCES.
A MORTGAGE VS. A LEASE
A MORTGAGE PAYMENT CONTAINS
PRINCIPLE + INTEREST.
A LEASE PAYMENT CONTAINS PAYMENT FOR THE LEASE OBLIGATION AND IMPUTED
INTEREST.
KNOW HOW TO TELL THE DIFFERENCE BETWEEN AN OPERATIONAL LEASE AND A
CAPITAL LEASE, AND HOW IT IS RECORDED (3.31 BONGIORNO)
THE STATEMENT OF CASH FLOWS
A NECESSARY STATEMENT IN FINANCIAL ACCOUNTING WHEN PREPARING A COMPLETE
STATEMENT (SEE BONGIORNO SUPPLEMENT, 3.04).
FINANCIAL STATEMENT
INCOME STATEMENT :
FOR A PERIOD (I.E., FOR THE YEAR 1989)
BALANCE SHEET:
AS OF A CERTAIN DATE (I.E. 12/31/89)
STATEMENT OF CAPITAL:
ON A CERTAIN DATE (I.E. 12/31/89)
STATEMENT OF CASH FLOW:
FOR THE YEAR ENDING (I.E. 12/31/89)
THE STATEMENT OF CASH FLOWS IS NEEDED TO EXPLAIN WHERE THE CASH CAME
FROM, AND WHERE IT WENT. IT MAKES ACCRUAL METHOD EXPLAINABLE.
OPERATING REVENUE IS MATCHED AGAINST OPERATING EXPENDITURES.
INVESTING REVENUE IS MATCHED AGAINST INVESTING EXPENDITURES.
FINANCING REVENUE IS MATCHED AGAINST FINANCING EXPENDITURES.
A CORPORATION PURCHASES LAND FOR 500,000
AN EXISTING HOUSE ON THE PROPERTY WAS DEMOLISHED, AND NEW CONSTRUCTION
BEGINS IN APRIL OF 1989. BY DECEMBER 31, 1989, YOU HAVE THE FOLLOWING:
DEMOLITION
TITLE INSURANCE AND LEGAL FEES
ARCHITECT'S FEES
NEW BUILDING CONSTRUCTION
(BONGIORNO, 6.41 TO 6.45)

70,000
50,000
75,000
1,000,000

WHAT WOULD THE FINANCIAL STATEMENT FOR THE BUILDING AS OF 12/31/89 LOOK
LIKE?
ASSETS

LIABILITIES

25

LAND
BUILDING

500,000
1,000,000

DEMOLITION
FEES

70,000*
50,000#
75,000*

*CAPITALIZED LIABILITY
#EXPENSED LIABILITY
THE BATTLE BETWEEN CAPITALIZING AND EXPENSING
CAPITALIZING - AN IMPROVEMENT
USEABLE, EXTENDING ITS LIFE.

WHICH

MAKES

THE

PROPERTY

MORE

EXPENSING - DOES NOT IMPROVE THE PROPERTY. IT IS AN ORDINARY AND

NECESSARY EXPENSE NEEDED TO EARN INCOME THIS YEAR.
LAND, CONSTRUCTION OF THE BUILDING, INTEREST EXPENSES, AND REAL ESTATE
TAXES ARE ALL CAPITALIZED DURING CONSTRUCTION.
REVIEW READING MATERIAL FOR NEXT WEEK: WILEY (CHAPTERS 3 AND 4)
BONGIORNO "THE CAPITAL LEASE" (3.3,3.7,3.9,3.11,3.16,3.17,3.19,3.24,3.25)
END OF FOURTH CLASS
10/05/89
SALES TYPE LEASE
UNDER ORIGINAL OPERATING LEASE BONGIORNO 2.37.2
UNDER SUBLET CAPITAL LEASE
NET REALIZABLE VALUE ALLOWANCE

(BONGIORNO 2.42)

FOR THE PURPOSES OF THE APPLICATION OF THE FULL ACCRUAL METHOD, CAN
PROFIT BE RECOGNIZED IF THE SELLER TRANSFERS THE PROPERTY BY WAY OF A
SALE LEASEBACK TRANSACTION?
APPORTIONMENT - PORTIONS OF MONTHS OR PERIODS MUST BE TAKEN INTO ACCOUNT
WHEN PREPARING STATEMENTS UNDER THE ACCRUAL METHOD OF ACCOUNTING, IN
ORDER TO MATCH EXPENSES WITH REVENUES. EXAMPLES OF THIS ARE : INTEREST,
REAL ESTATE TAXES, AND DEPRECIATION.
EXCEPTION:
AN EXCEPTION TO MATCHING EXPENSES IS WITH CONSTRUCTION AND
DEVELOPMENT.
WE CAPITALIZE REAL ESTATE TAX AND INTEREST DURING THIS
PERIOD, AND YOU MAY NOT DEDUCT THESE ITEMS DURING THIS PERIOD. THEY ARE
CALLED PERIOD COSTS.
THE COSTS ARE TRANSFERRED OUT OF THE PERIOD AND
INTO THE ASSET ACCOUNT.
YOU ADD TO THE COST OF THE PROJECT BY ADDING
THESE COSTS TO THEM.
THEN, WHEN CONSTRUCTION IS COMPLETED, THE NEW
COMPLETED VALUE, INCLUDING THE TAXES AND INTEREST, ARE DEPRECIATED WITH
THE BUILDING.

26

THE CONCEPT OF CAPITALIZATION

CAPITALIZATION HAS THE EFFECT OF CHANGING AN EXPENSE TO AN ASSET, BY
CHANGING THE EXPENSE FROM A PERIOD COST TO AN INVENTORY OR FIXED ASSET
COST.
THE UNIFORM CAPITALIZATION RULES - DERIVE FROM AN ECONOMIC CONCEPT WHICH
FOCUSES ON COST ACCOUNTING, AND WHETHER OR NOT WE WILL HAVE FULL
ABSORPTION ACCOUNTING. THIS MEANS THAT THE PRODUCT IS BURDENED WITH ALL
OF THE COSTS OF MANUFACTURING THE PRODUCT.
A CORPORATION MANAGES HOTELS, LEISURE INTERESTS, AND LAND DEVELOPMENT.
IT IS MANAGED BY EXECUTIVES WHO DO ALL KINDS OF WORK OF EACH OF THESE
MATTERS. SAY, AN EXECUTIVE MAKING 500,000 PER YEAR SPENDS 20 PERCENT OF
HIS TIME ON THE CORPORATIONS HOTEL HOLDINGS. THOSE HOLDINGS WOULD THEN
BE CHARGED WITH 500,000 x 20% = 100,000 DOLLARS, WHICH WOULD BECOME AN
EXPENSE OF THE HOTELS.
INTEREST COSTS CAPITALIZATION
IF A PERIOD OF TIME IS REQUIRED IN ORDER TO CONSTRUCT OR CARRY OUT OTHER
ACTIVITIES NECESSARY TO BRING AN ASSET TO USABLE CONDITION, THE INTEREST
COST INCURRED DURING THAT PERIOD SHOULD BE CAPITALIZED AS PART OF THE
HISTORICAL COSTS OF THAT ASSET.
CAPITALIZATION OF INTEREST AS A COST OF THE PROPERTY IS APPROPRIATE ONLY
WHEN THE PROPERTY IS A QUALIFYING ASSET. A QUALIFYING ASSET IS AN ASSET
THAT IS CONSTRUCTED FOR AN ENTERPRISE'S OWN USE OR CONSTRUCTED FOR SALE
OR LEASE. PROPERTY THAN IS NOT UNDERGOING SUCH ACTIVITIES NECESSARY TO
BRING IT TO THE STAGE OF ITS INTENDED USE IS NOT A QUALIFYING ASSET, AND
THEREFORE INTEREST CAPITALIZATION WOULD NOT BE APPROPRIATE. FOR EXAMPLE,
IF LAND WERE BEING PREPARED FOR SALE AS DEVELOPED LOTS, INTEREST
CAPITALIZATION WOULD BE APPROPRIATE; WHEREAS, IF LAND WERE ACQUIRED AS
INVENTORY FOR FUTURE DEVELOPMENT BUT THAT DEVELOPMENT ACTIVITY HAD NOT
YET COMMENCED, INTEREST CAPITALIZATION WOULD NOT BE APPROPRIATE.
THE AMOUNT OF INTEREST CAPITALIZED DURING AN ACCOUNTING PERIOD CANNOT
EXCEED THE TOTAL COST INCURRED BY THE ENTITY DURING THAT PERIOD.
IT
SHOULD BE DETERMINED BY APPLYING AN APPROPRIATE INTEREST RATE TO THE
AVERAGE AMOUNT OF ACCUMULATED EXPENDITURES FOR EACH PROPERTY BEING
DEVELOPED. THE INTEREST RATE, OR CAPITALIZATION RATE, IS DETERMINED UPON
THE RATE OF THE NEW BORROWING TO ACQUIRE THE LAND.
IF THE AVERAGE
ACCUMULATED DEVELOPMENT COSTS EXCEED THE SPECIFIC NEW BORROWINGS, THEN
THE CAPITALIZATION RATE USED FOR THE EXCESS COSTS SHOULD BE BASED ON THE
WEIGHTED AVERAGE INTEREST RATE OF THE OTHER BORROWINGS.
THE PERIOD OF INTEREST CAPITALIZATION IS COINCIDENT WITH THE FOLLOWING
CONDITIONS:
EXPENDITURES FOR THE PROPERTY HAVE BEEN MADE
DEVELOPMENT ACTIVITIES HAVE COMMENCED AND ARE STILL IN PROGRESS
INTEREST COSTS HAVE BEEN INCURRED BY THE ENTITY
WHENEVER DEVELOPMENT ACTIVITIES HAVE BEEN SUSPENDED FOR SOME TIME, THE

27

INTEREST CAPITALIZATION SHOULD CEASE UNTIL ACTIVITIES ARE RESUMED. LABOR

STRIKES, WEATHER, ETC. ARE INHERENT TO THE DEVELOPMENT PROCESS, AND WOULD
NOT BE CAUSE TO STOP INTEREST CAPITALIZATION.
THE INTEREST CAPITALIZATION PERIOD CEASES WHEN, ACCORDING TO FASB 67, THE
PROJECT IS SUBSTANTIALLY COMPLETE AND READY FOR ITS INTENDED USE.
SEE 2.13.5, BONGIORNO, FOR EXAMPLE OF CAPITALIZATION OF INTEREST
INTEREST INCURRED DURING THE DEVELOPMENT PERIOD RELATED TO LAND FINANCING
IS CONSIDERED PART OF THE ACQUISITION COST OF THE STRUCTURE.
INTEREST
INCOME GENERATED FROM THE INVESTMENT OF UNUSED FUNDS ON SPECIFIC
BORROWINGS SHOULD BE RECOGNIZED AS INCOME WHEN EARNED AND SHOULDN'T BE
OFFSET AGAINST CAPITALIZED INTEREST COSTS.
FULL ABSORPTION ACCOUNTING HAS BEEN REQUIRED UNDER TAX LAW SINCE 1987.
ALL EXPENSES NEEDED TO ACQUIRE A PROPERTY ARE TO BE CAPITALIZED.
ALL EXPENSES REQUIRED TO BRING A BUILDING TO RENT ARE TO BE CAPITALIZED.
THE DEMOLITION OF A BUILDING ON LAND TO MAKE WAY FOR A NEW BUILDING IS
EXPENSED, BECAUSE IT DOES NOT BRING THE BUILDING TO RENT; IT ONLY
PREPARES THE LAND.
WATCH OUT FOR ASSETS HAVING CONDITIONS.
UNLESS IT IS OF A CERTAIN
NATURE, IT MIGHT IMPACT THE VALUE OF THE STOCK.
SEE WILEY CHAPTER SEVEN, PG 133
HANDOUT PASSED TO CLASS
GOING CONCERN - ACCORDING TO GAAP, ONE OF THE ASSUMPTIONS YOU MAY HAVE
THAT A BUSINESS WILL BE WHAT IT IS TOMORROW WHAT IT IS TODAY, AND IS NOT
IN DANGER OF NOR POISED FOR LIQUIDATION. A NOTE TO THIS EFFECT MUST BE
ENTERED IF STATEMENT IS PREPARED.
PROJECT PASSED OUT
J. MICHAELS REALTY
NOTICE THE "STATEMENT OF LOSS". A DEVELOPMENT STAGE COMPANY IS AN
ENTERPRISE WHICH COMMITS TO FINISHING A PROJECT WHICH IS NOT YET
FINISHED. IT IS AN ENTITY IN THE "DEVELOPMENT STAGE".
E.P.S. IS THE EARNINGS PER SHARE.
DIVIDING INCOME OR LOSS.

IT IS THE MOST COMMON METHOD OF

TERMS
CURRENT ASSETS - HAS THE ABILITY TO BE TURNED INTO CASH, IT MUST BE
LIQUID, AND MUST BE INTENDED TO BE TURNED INTO CASH WITHIN ONE YEAR OF
ITS ACQUISITION.
INVENTORY, RENT RECEIVABLES NOT YET PAID BUT PAYABLE
ARE EXAMPLES OF CURRENT ASSETS.

28

ADVANCES TO OFFICERS - THE OFFICER OWES US MONEY.

RECEIVABLE.

A.K.A. ACCOUNTS

NOTES RECEIVABLE - WHEN ACCOUNTS RECEIVABLE CAN NOT BE PAID ON TIME (I.E.
BETWEEN 30 TO 45 DAYS HENCE), A NOTE IS TAKEN WHICH FORMALLY BINDS THE
DEBTOR TO THE CREDITOR WITH INTEREST.
WE NEED TO KNOW THE ABILITY OF THE COMPANY TO COLLECT MONEY AND TO PAY
ACCOUNTS.
OTHER ASSETS ASSETS.

NOT INTENDED FOR CASH WITHIN ONE YEAR - SEE CURRENT

DEFERRED DEVELOPMENT AND MORTGAGE COST - ADDED TO THE ASSETS WHEN THEY
COME INTO EXISTENCE, AND DEPRECIATED.
THIS IS THE CAPITALIZED
DEVELOPMENT COST OF THE PROJECT.
CURRENT LIABILITIES - MIRROR IMAGE OF CURRENT ASSETS.
IT IS THE
INTENTION THAT THE OBLIGATION TO PAY IS WITHIN ONE YEAR OF THE INCURRED
LIABILITY.
ACCOUNTS PAYABLE - OBLIGATIONS TO PAY CREDITOR WITHIN 30 TO 45 DAYS.
ACCRUED EXPENSES -

INCLUDES PROPERTY TAX, PAYROLL TAX, ETC.

MORTGAGES PAYABLE, CURRENT - SELF-EXPLANATORY

LONG TERM LIABILITY
SHAREHOLDERS' EQUITY - (EQUITY MEANS CAPITAL)
CAPITAL STOCK- COMMON STOCK
PREFERRED STOCK
PAID IN SURPLUS IS THE OPPOSITE OF CAPITAL IN EXCESS OF PAR
RETAINED EARNINGS
DEVELOPMENT STAGE.

IS

THE

OPPOSITE

OF

DEFICIT

ACCUMULATED

DURING

WHEN FORMED, A CORPORATION CAN CHOOSE TO HAVE STOCK. IF A CORPORATION

HAS PAR VALUE, ITS VALUE WOULD BE RESERVED ON THE BALANCE SHEET AS
CAPITAL AND AS A BUFFER AGAINST DISTRIBUTIONS.
NO-PAR VALUE STOCK - CHEAPER, IT SERVES NO PURPOSE IF WE DO NOT NEED
SURPLUS CASH.
THE DECISION EITHER WAY, BE IT PAR VALUE OR NO-PAR VALUE, IS BASED ON
COST, INTENTION, NEED FOR SURPLUS CASH, AND WHETHER OR NOT YOU ARE
DEALING WITH THE PUBLIC.
CONTINUED DISCUSSION OF PAR VALUE...

29

CAPITAL IN EXCESS OF PAR

THE STATE SAYS "IF YOU CHOOSE PAR VALUE METHOD, YOU MUST SELL STOCK AT NO
LESS THAN THE PAR VALUE". IF STOCK IS SOLD FOR LOWER, CREDITORS MAY COME
AFTER THE DIRECTORS OF THE CORPORATION.
FOR EXAMPLE:
PAR IS 10, WHILE 50 IS COST.
BALANCE SHEET
CAPITAL IN EXCESS OF PAR = 40
PAR VALUE (CAPITAL STOCK, LEGAL CAPITAL) = 10
DIVIDENDS MAY BE PAID OUT OF PRESENT EARNINGS OR SURPLUS. THE SURPLUS IS
THE CAPITAL IN EXCESS OF PAR, OR STATED OTHERWISE, PROFIT.
THE LOWER THE PAR VALUE, THE SHAKIER WE FEEL BECAUSE THE CAPITAL BUFFER
IS SMALLER WITH LOW PAR VALUES.
USUALLY, THE VALUE IS ONE TO SEVEN
DOLLARS.
NOTICE THAT STATEMENTS (J. MICHAELS REALTY) ARE "UNAUDITED", WITH NO
ACCOUNTANT'S NAME.
STATEMENTS ARE PROVIDED TO THE SEC EVERY THREE
MONTHS, SO THERE IS NO NEED FOR AN ACCOUNTANT FOR THIS PURPOSE.
END OF CLASS FIVE
10/19/89
FINISH FINANCIAL ACCOUNTING, START MANAGERIAL ACCOUNTING
WHAT ARE THE POINTS OF
MANAGERIAL ACCOUNTING?

FINANCIAL

ACCOUNTING

THAT

ARE

RELEVANT

FOR

CHAPTER FOUR - WE ARE TAKING THE PRINCIPLES OF FINANCIAL ACCOUNTING AND

APPLYING THEM TO REAL ESTATE, WHILE USING TERMS PECULIAR TO REAL ESTATE.
PG 60 EXHIBIT 4-1
OPERATING EXPENSES - BONGIORNO SIGNIFICANT DIRECT RENTAL OPERATING
EXPENSES INCLUDE DEPRECIATION, INSURANCE, REPAIRS AND MAINTENANCE,
PROPERTY TAXES, CUSTODIAL AND SECURITY EXPENSES, UTILITIES, INTEREST AND
PROPERTY MANAGEMENT.
SUCH COSTS CAN GENERALLY BE CLASSIFIED AS PERIOD
EXPENSES (COSTS ASSOCIATED WITH THE REVENUE OF THE CURRENT PERIOD) OR
PREPAID COSTS (COSTS ASSOCIATED WITH FUTURE REVENUE) WHICH ARE ALLOCATED
TO FUTURE PERIODS AS EXPENSE IN A SYSTEMATIC AND RATIONAL MANNER.
COSTS TO RENT REAL ESTATE PROJECTS THAT DO NOT MEET THE CRITERIA FOR
DEFERRAL SHOULD BE ACCOUNTED FOR AS PERIOD COSTS AND CHARGED TO EXPENSE
AS INCURRED (I.E. MEDIA ADVERTISING COSTS, RENTAL SALARIES, AND
OVERHEAD).
NET OPERATING INCOME / NET OPERATING EXPENSES

30

EXPENSES
DO
DO
DO
DO

IN ACCOUNTING WITH THE FOLLOWING MODIFICATIONS:

NOT INCLUDE DEBT SERVICE (PAYMENT OF INTEREST AND PRINCIPLE)
NOT INCLUDE DEPRECIATION
NOT INCLUDE INCOME TAX ON THE ENTITY THAT OWNS THE PROPERTY
NOT INCLUDE CAPITAL EXPENDITURES SUCH AS AMORTIZATION OF
LEASEHOLD IMPROVEMENTS.

FINANCIAL ACCOUNTING FOR MANAGERIAL ACCOUNTING

PAST AND CURRENT INCOME, COSTS, AND EXPENSES ARE PROJECTED IN THE FORM OF
AN INCOME ANALYSIS - CASH FLOW. WHAT WILL BE THE FUTURE BASED UPON THE
PAST PATTERNS? USED TO PROJECT VALUE.
VALUE - THE STREAM OF INCOME OF A PROPERTY, AND WHAT THAT STREAM IS
WORTH.
BREAK EVEN ANALYSIS - WHEN DOING THE BREAK EVEN ANALYSIS, WE ARE
INTERESTED IN TODAY AND TOMORROW. FINANCIAL STATEMENTS ARE PUT TO BED.
FIXED AND VARIABLE EXPENSES FIXED; DOES NOT INCREASE AS PER VOLUME OR ACTIVITY.
VARIABLE; COST WHICH VARIES AS PER VOLUME OR ACTIVITY
AT SOME POINT, A FIXED COST MAY BECOME A VARIABLE DUE TO VOLUME.
YOU
REALLY CAN NOT COUNT ON FIXED COST BECAUSE IT IS A MISNOMER, AN IMPRECISE
TOOL TO PREDICT THE FUTURE AND BUDGET THE CASH FLOW.
FIXED EXPENSES (I.E. REAL ESTATE TAX, INTEREST, INSURANCE, SALARIES,
DEPRECIATION)
VARIABLE EXPENSES (I.E. SALARIES, UTILITIES)
INTEREST FACTOR (CAP RATE)
AN INTEREST FACTOR HELPS US TO DECIDE THE VALUE OF A CASH FLOW BY USING
THE CAPITALIZATION METHOD.
NET OPERATING INCOME (NOI) IS THE FLOW OF INCOME TO THE OWNER
FLOW OF INCOME TO THE OWNER
PROPERTY WORTH =
CAPITALIZATION RATE
SEE CHAPTER 5 AND 6, HOTELS AND MOTELS
A PROPERTY IS WORTH ITS CASH RETURN TO THE INVESTORS
END OF CLASS SIX
10/26/89

31

STOCKHOLDERS' EQUITY = COMMON STOCK

HOW MUCH OF LEGAL CAPITAL HAS BEEN DEDICATED TO THE CORPORATION?
AUTHORIZED STOCK - THE STATE HAS GIVEN PERMISSION TO ISSUE STOCK, NOT
THAT IT WAS ACTUALLY ISSUED.
ISSUED AND OUTSTANDING - STOCK THAT WAS AUTHORIZED AND ISSUED
PAR VALUE - MERELY AN ARBITRARY AMOUNT THAT YOU PICK WHEN YOU FORM THE
CORPORATION.
IT IS A BOOKKEEPING DEVICE TO SPLIT STOCKHOLDERS EQUITY
INTO TWO TYPES OF CAPITAL:
1. COMMON STOCK
2. PAID IN CAPITAL IN EXCESS OF PAR ( OR PAID IN SURPLUS )
THESE WILL APPEAR ON FINANCIAL STATEMENTS ONLY IF YOU CHOOSE THE PAR
VALUE VEHICLE FOR STATING CAPITAL.
PAR VALUE, OPTIONS ARE NO PAR VALUE AND STATED VALUE.
THE PAR VALUE IS MEANINGLESS.
IT AT ALL WHEN STOCK IS SOLD.

THE STOCKHOLDER IS NOT EVEN ENTITLED TO

RETAINED EARNINGS - A VERY IMPORTANT ACCOUNT; CONTAINS EARNINGS AND

PROFITS OF THE CORPORATION FROM "DAY ONE".
+ EARNINGS AND PROFITS (CUMULATIVE ACCOUNT)
- LOSSES
- DIVIDENDS (REDUCES PROFITS)
LEGAL CAPITAL IS CAPITAL IN EXCESS OF PAR VALUE.
BONGIORNO - SALE/LEASEBACK, BOOK AND SUPPLEMENT
2.36, 4.24 SEE HANDOUT FASB JUNE 1989
CHAPTER 13 AND 14 WILEY
NOI HAS A DIFFERENT CONCEPT THAN FOUND IN GENERAL FINANCIAL ACCOUNTING
THAN FOR MANAGERIAL ACCOUNTING.
THE MAJOR DISTINCTION IS THE DEBT
SERVICE AND DEPRECIATION AND INCOME TAX ARE NOT INCLUDED IN OPERATING
EXPENSES.
THE MATCHING OF REVENUE AND EXPENSES WILL NOT INCLUDE THE
ELEMENTS INCOME TAX, DEBT SERVICE AND DEPRECIATION.

THE PROBLEM WITH NOI:

NOI DOES NOT TAKE INTO ACCOUNT THE TIME VALUE OF MONEY OR INFLATION.
THIS IS A MAJOR LIMITATION FOR THIS TYPE OF EVALUATION METHOD.
TIME VALUE OF MONEY - ASSUMES VALUE OF MONEY TODAY IS DIFFERENT FROM ITS
VALUE TOMORROW.
END OF CLASS SEVEN

32

11/2/89
INTEREST FREE TRANSACTIONS AND BELOW MARKET LOANS
GIVEN A PROPERTY
150,000 IS PRICE
30,000 DOWN PAYMENT
-------------------120,000 PAYABLE OVER THREE YEARS WITHOUT INTEREST
IRS MOVED IN 1982 AND 1984 WITH ACTS ON IMPUTED INTEREST TO NEGATE THE
BENEFITS OF CAPITAL GAINS VS. HIGHEST TAX ISSUE AND THE EFFECT IT HAD ON
INCREASING SALES PRICE TO REFLECT THE 0% INTEREST RATE.
IF YOU HAVE A BELOW MARKET LOAN, IRS CAN CHARGE IMPUTED INTEREST
SEE EXAMPLES OF IMPUTED INTEREST IN EXAMPLE 15, BONGIORNO, 2.63.3
NOVEMBER INTEREST RATES HANDED OUT, SEE PACKET
THERE ARE EXCEPTIONS:
DOES NOT
DOES NOT
DOES NOT
BUSINESS
PERSONAL

APPLY TO LOANS OF 2,000,000 OR LESS

APPLY TO PRIMARY RESIDENCE
APPLY TO PROPERTY THAT IS FOR PERSONAL USE AS OPPOSED TO
USE.
LOAN OF 10,000 OR LESS

THE SALE/LEASEBACK
A MEANS OF GAINING CASH FROM A TRANSACTION WHICH WOULD OTHERWISE BE LOST.
A FINANCING TECHNIQUE FOR GETTING MONEY OUT OF A PROPERTY.

NON-PROFIT ORGANIZATIONS ARE THE "MAIN PLAYERS" IN THE PAST FOR THIS KIND
OF TRANSACTION
I.E. CHURCHES
UNIVERSITIES
PENSION TRUST
FOUNDATIONS
NONE PAY TAXES ON INCOME DERIVED FROM ACTIVITIES
A SALE/LEASEBACK IS A SALE - YOU NO LONGER OWN IT AND YOU PAY RENT WHICH
IS AN OPERATING EXPENSE.
FROM 1946 TO 1969, THE PERIOD OF LITTLE IRS CONTROL OVER "NON-PROFITS"
PURCHASE OF PROPERTIES FOR SALE/LEASEBACK - 1969 TAX CODE INSTITUTED A
TAX ON INCOME FROM OTHER INCOME THAN THAT GAINED IN TYPICAL BUSINESS

33

(I.E. THE TYPICAL BUSINESS FOR EDUCATION IS BOOK SALES.

BE MACARONI SALES). STILL, TAX IS ONLY 3 1/2 PERCENT.

ATYPICAL WOULD

DISADVANTAGE: IF SELLER HAD TAKEN A MORTGAGE, HE WOULD HAVE DEPRECIATION

AND INTEREST EXPENSES TO DEDUCT AGAINST INCOME WHICH MAY BE SIGNIFICANT
ENOUGH TO OFFSET BENEFITS FROM RENTING IN A SALES/LEASEBACK AGREEMENT.
SALE/LEASEBACK IS SUBJECT TO FASB 66 TO SEE IF IT WAS EITHER A SALE
AND/OR A LEASE.
SO, WHO CARES?
THE IRS
FASB
CAP RATE METHOD - HELPS TO GAIN A HYPOTHETICAL VALUE OF A PROPERTY "AT
MARKET".
CAP RATE AND OTHER RATIOS ARE REAL ESTATE'S RULES OF THUMB.
DISCOUNTED CASH FLOW AND PRESENT VALUE ARE NOT OFTEN USED BECAUSE THEY
ARE TOO COMPLICATED TO MOST PEOPLE.
CAP RATE USED BY MOST SMALL INVESTORS (THOSE WITH LESS THAN 5 MILLION)
END OF CLASS EIGHT
11/9/89
CHAPTER 7, WILEY
CHAPTER 10, BONGIORNO
10.1 TO 10.35
+ HANDOUTS
BONGIORNO - PREACQUISITION - PREACQUISITION COSTS CONSTITUTE COSTS
INCURRED PRIOR TO THE LEGAL ACQUISITION OR FORMAL COMMITMENT TO ACQUIRE
THE PROPERTY.
ANY COSTS INCURRED THAT ARE RELATED TO THE PROPERTY
ACQUISITION AND ARE PREREQUISITES TO DETERMINING WHETHER OR NOT TO
ACQUIRE THE PROPERTY ARE CONSIDERED PREACQUISITION COSTS. THESE INCLUDE
APPRAISALS, RESEARCH, AND CONSULTING FEES, MARKET AND ENVIRONMENTAL
STUDIES, ARCHITECTURAL AND ENGINEERING SERVICES, LEGAL AND OTHER
PROFESSIONAL FEES, ZONING APPROVALS, FINDER'S FEES, GOOD FAITH DEPOSITS,
AND STANDBY FEES.
PREACQUISITION COSTS, INCLUDING PAYMENTS TO OBTAIN A PURCHASE OPTION,
SHOULD BE CAPITALIZED AS INCURRED PROVIDED THAT ALL THE FOLLOWING
CONDITIONS ARE MET.
*
COSTS ARE DIRECTLY IDENTIFIABLE WITH THE SPECIFIC PROPERTY
*
COSTS WOULD BE PROPERLY CAPITALIZABLE IF THE PROPERTY WERE ALREADY
ACQUIRED.
*
ACQUISITION OF THE PROPERTY OR ACQUISITION OF AN OPTION TO ACQUIRE
THE PROPERTY IS PROBABLE (LIKELY TO OCCUR).
*
TOTAL CAPITALIZED COSTS DO NOT EXCEED NET REALIZABLE VALUE.

34

IF THE PROSPECTIVE BUYER CANNOT DEMONSTRATE THAT THESE CONDITIONS ARE

MET, COSTS INCURRED PRIOR TO THE ACQUISITION OF THE PROPERTY SHOULD BE
EXPENSED AS INCURRED.
WHENEVER PROBABLE THAT THE PROPERTY WILL NOT BE ACQUIRED, THESE COSTS
SHOULD BE CHARGED TO EXPENSE TO THE EXTENT THEY ARE NOT RECOVERABLE.
DIRECT ACQUISITION COSTS ARE COSTS DIRECTLY ASSOCIATED WITH THE
ACQUISITION OF THE PROPERTY. THEY GENERALLY INCLUDE:
PURCHASE PRICE OF THE PROPERTY.
ESCROW, TITLE GUARANTEE, TITLE SEARCH, AND RECORDING FEES
BROKER'S FEES AND COMMISSIONS.
DIRECT ACQUISITION COSTS SHOULD BE CAPITALIZED. PROPERTY HELD FOR FUTURE
DEVELOPMENT REQUIRES CONTINUAL EVALUATION AS TO RECOVERABILITY OF THE
ACCUMULATED CAPITALIZED COSTS.
IN SITUATIONS WHERE THE LAND HAS AN EXISTING STRUCTURE, THE DEVELOPER'S
INTENT IS CRITICAL IN DETERMINING THE PROPER ACCOUNTING OF ITS COST. IF
THE STRUCTURE IS TO BE RAZED, THE COST OF THE ENTIRE PROPERTY SHOULD BE
ALLOCATED TO THE LAND AND REDUCED BY ANY REVENUE RECEIVED FOR TEMPORARY
RENTAL OR SALVAGE.
IF THE STRUCTURE IS TO BE UTILIZED OR RESOLD, A
PORTION OF THE TOTAL PROPERTY COST SHOULD BE ALLOCATED TO THE STRUCTURE.
IF THE STRUCTURE IS USED IN OPERATIONS, IT SHOULD BE DEPRECIATED AS ANY
OTHER STRUCTURE WOULD BE.
INDIRECT ACQUISITION COSTS
ARE COSTS
THAT ARE INDIRECTLY ASSOCIATED
WITH THE ACQUISITION OF A PARTICULAR PROPERTY, SUCH AS ADMINISTRATIVE AND
OVERHEAD EXPENSES. OVERHEAD COSTS SUCH AS THOSE INCURRED BY PLANNING AND
DEVELOPMENT DEPARTMENTS, MAY BE CAPITALIZED AS PART OF THE COST OF LAND
IMPROVEMENTS. SUCH COSTS MAY BE PROVIDED BY OUTSIDE CONTRACTORS OR MAY
BE IDENTIFIABLE INTERNAL COSTS.
IF INTERNAL OVERHEAD COSTS ARE
CAPITALIZED, SUFFICIENT EVIDENCE SHOULD EXIST SUPPORTING THE METHOD IN
WHICH SUCH INTERNAL COSTS ARE ALLOCATED TO SPECIFIC PROPERTIES (I.E. TIME
SHEETS DISPLAYING HOW MUCH TIME IS SPENT ON EACH PROPERTY BY AN
EMPLOYEE).
GENERALLY, GENERAL AND ADMINISTRATIVE EXPENSES SHOULD BE CHARGED TO
EXPENSE AS PERIOD COSTS.
HOWEVER, THERE MAY BE SITUATIONS WHERE
CAPITALIZATION OF THESE COSTS IS PROPER BECAUSE THEY CAN BE CLOSELY
IDENTIFIED WITH A PARTICULAR PROPERTY.
IN EFFECT, THESE COSTS ARE THE
COST OF PROPERTY CLASSIFIED WITH GENERAL AND ADMINISTRATIVE EXPENSES.
EXAMPLES OF SUCH COSTS INCLUDE ATTORNEY AND ACCOUNTANTS' FEES, INTERNAL
FEASIBILITY STUDIES, TRAVEL COSTS, AND SO FORTH.
ALL GENERAL AND
ADMINISTRATIVE EXPENSES, INCLUDING OFFICERS' SALARIES, SHOULD BE EXPENSES
AS INCURRED.
THE KEY IS WHETHER OR NOT A PARTICULAR COST CAN BE IDENTIFIED WITH A
SPECIFIC PROPERTY.
ACCOUNTING FOR HOLDING COSTS - AS A GENERAL RULE, HOLDING COSTS, SUCH AS

35

PROPERTY TAXES AND INSURANCE, SHOULD BE CAPITALIZED AS PART OF THE COST

OF THE PROPERTY DURING THE PERIODS IN WHICH THE PROPERTY IS BEING
DEVELOPED.
COSTS INCURRED FOR SUCH ITEMS AFTER THE PROPERTY IS
SUBSTANTIALLY COMPLETE AND READY FOR ITS INTENDED USE SHOULD BE CHARGED
TO EXPENSE AS INCURRED. IF CAPITALIZATION OF COSTS RESULTS IN CARRYING
AMOUNTS IN EXCESS OF NET REALIZABLE VALUE, AN APPROPRIATE ALLOWANCE
SHOULD BE PROVIDED.
ACCRUAL METHOD OF ACCOUNTING FOR RECORD OF SALE
NEED A DOWNPAYMENT ON THE LAND THAT CONFORMS TO FASB STATEMENT, OR
TEN PERCENT DOWNPAYMENT
DURING CONSTRUCTION, YOU CANNOT EXPENSE ITEMS.
YOU CAPITALIZE
THEM, SUCH AS INTEREST AND TAXES, ACCORDING TO GAAP
BUILDINGS CAPITALIZED AT 31.5 YEARS FOR COMMERCIAL
AND
27.5 YEARS FOR RESIDENTIAL
CHAPTER 7 WILEY
HOW DO YOU ALLOCATE OVERHEAD WHEN YOU HAVE SEVERAL PROJECTS UNDER
CONSTRUCTION ?
BONGIORNO - REFER TO FASB 67.
BONGIORNO - INDIRECT PROJECT COSTS GENERALLY CONSIST OF THE FOLLOWING:
CONSTRUCTION ADMINISTRATION
LEGAL AND ACCOUNTING FEES
VARIOUS OFFICE COSTS OF PROVIDING SERVICES TO THE PROJECT
INDIRECT COSTS MAY RELATE TO SEVERAL PROJECTS AND SHOULD BE ALLOCATED TO
EACH PROJECT IN A RATIONAL MANNER BASED ON THE NATURE OF THE ACTIVITY.
THIS ALLOCATION PROCESS MAY BE BASED ON DETERMINING THE PERCENTAGES OF
TIME SPENT ON THE DEVELOPMENT EFFORT AS COMPARED TO OTHER ACTIVITIES.
FOR EXAMPLE, ASSUME THAT THE ACCOUNTING DEPARTMENT SPENDS APPROXIMATELY
30 PERCENT OF ITS TIME MAINTAINING CONSTRUCTION COST RECORDS AND
DEVELOPING ESTIMATES FOR COMPLETION, AND THE REMAINING 70 PERCENT OF ITS
TIME MAINTAINING GENERAL ACCOUNTING RECORDS.
THE 30 PERCENT SHOULD BE
CAPITALIZED AS A DEVELOPMENT COST AND SHOULD BE ALLOCATED TO THE SPECIFIC
PROJECTS BASED UPON THE AMOUNT OF CURRENT ACTIVITY.
IF THE RECORDS
NEEDED TO DO THIS ARE NOT SUFFICIENT TO MAKE AN ESTIMATE, THEN THE RESULT
WOULD BE THAT ALL OF THE POTENTIALLY ALLOCABLE ACCOUNTING COSTS WOULD BE
EXPENSED.
IF MANAGEMENT INVOLVEMENT IN THE DEVELOPMENT PROCESS IS ACTIVELY TAKING
PLACE, IT MAY BE APPROPRIATE TO ALLOCATE A PORTION OF THE PAYROLL EXPENSE
TO THE PROJECT AS A CAPITALIZABLE COST.
THE ALLOCATION OF THE COST OF AMENITIES - WHEN AN AMENITY OF A
DEVELOPMENT PROJECT IS SOLD, THEN ITS COST IS ALLOCATED PROPORTIONALLY TO
THE UNITS USING THE AMENITY ACCORDING TO THE SALES VALUE OF THOSE UNITS
AS A PERCENTAGE OF THE AGGREGATE SALES VALUE OF THE PROPERTY. THE WHOLE

36

AMENITY MAY NOT BE EXPENSED, IN OTHER WORDS, WITH THE SALE OF THE FIRST
UNIT IN A 1,000 UNIT DEVELOPMENT.
WHEN THE DEVELOPER INTENDS TO RETAIN THE AMENITY AND CHARGE FEES TO USE
IT, THE ACTUAL DEVELOPMENT COST OF THE AMENITY IN EXCESS OF THE ESTIMATED
FAIR VALUE CAN BE CAPITALIZED AND ALLOCATED AS A COMMON COST. HOWEVER,
ONCE THE AMENITY IS SUBSTANTIALLY COMPLETE AND AVAILABLE FOR USE, ANY
REVENUE AND OPERATING COSTS SHOULD BE INCLUDED IN CURRENT OPERATING
RESULTS SINCE THE FACILITIES ARE NO LONGER PART OF THE DEVELOPMENT
PROCESS.
THE ALLOCATION OF CAPITALIZED COSTS TO COMPONENTS OF A PROJECT
IN ORDER TO PROPERLY MATCH COSTS WITH REVENUES, THE COSTS OF ACQUISITION,
DEVELOPMENT, AND CONSTRUCTION MUST BE ASSIGNED TO THE INDIVIDUAL
COMPONENTS OF THE PROJECT BEING SOLD. AN AMENITY, FOR EXAMPLE, MAY BE
OPERATED BY THE DEVELOPER AT A LOSS DURING THE SALE OR RENT-UP PERIOD TO
PROMOTE DISPOSITION OF THE PROPERTY. THESE LOSSES SHOULD BE CONSIDERED
IN THE DETERMINATION OF TOTAL COSTS OF THESE AMENITIES.
IF SPECIFIC IDENTIFICATION IS NOT PRACTICABLE, THE CAPITALIZED COSTS ARE
ALLOCATED AS FOLLOWS:
COSTS INCURRED PRIOR TO CONSTRUCTION; (I.E. LAND COST) ALLOCATED TO
EACH LAND PARCEL BENEFITTED, BASED ON THE RELATIVE FAIR MARKET
VALUE OF THE LAND VALUES BEFORE CONSTRUCTION AS DETERMINED AT THE DATE OF
ALLOCATION.
CONSTRUCTION COSTS; ALLOCATED TO INDIVIDUAL UNITS (LOTS) IN THE
PHASE OR PROJECT ON THE BASIS OF RELATIVE SALES VALUE OF EACH UNIT
IF THE METHODS OF RELATIVE VALUE ARE ALSO IMPRACTICABLE, THEN CAPITALIZED
COSTS SHOULD BE ALLOCATED BASED ON AREA METHODS SUCH AS THE SQUARE
FOOTAGE METHOD.
OTHER METHODS OF ALLOCATION ARE:
SPECIFIC IDENTIFICATION WHICH ASSIGNS COSTS BY ACTUALLY DETERMINING
WHICH COSTS APPLY TO EACH PARCEL OF LAND OR INDIVIDUAL UNIT WITHIN THE
PROJECT.
RELATIVE VALUE, WHICH IS USED WHERE VARYING TYPES OF UNITS ARE TO
BE CONSTRUCTED RESULTING IN VARYING PROJECTED SELLING PRICES FOR UNITS OR
PARCELS, AND WHERE SUBSTANTIAL IMPROVEMENTS OR AMENITIES WILL BE
PROVIDED.
THE PURPOSE OF ALLOCATING COSTS TO PARCELS ON THE BASIS OF
RELATIVE VALUE IS TO PREVENT THE DISTORTION THAT MIGHT RESULT FROM THE
SALE OF CHOICE PROPERTY FIRST. THE TWO MOST COMMON MEASURES OF RELATIVE
VALUE ARE FAIR MARKET VALUE AND SALES VALUE
THE FAIR MARKET VALUE METHOD HAS COSTS ALLOCATED ON THE BASIS OF
THE RELATIVE FAIR MARKET VALUE OF THE LAND
BEFORE THE START OF
CONSTRUCTION.
THE SALES VALUE METHOD
ALLOCATES COSTS ON THE BASIS OF THE

37

EXPECTED SALES VALUE OF EACH UNIT SOLD TO THE TOTAL EXPECTED SALES VALUE
OF THE PROJECT.
THE ALLOCATION OF RENT UP COSTS
COSTS TO RENT REAL ESTATE UNDER OPERATING LEASES SHOULD BE DEFERRED AND
CHARGED TO EXPENSE IN FUTURE PERIODS IF THEY ARE INCURRED BEFORE THE
GOODS ARE USED OR THE SERVICES ARE PERFORMED WHEN THEIR RECOVERY IS
EXPECTED FROM FUTURE RENT REVENUE.
DEFERRED RENTAL COSTS THAT ARE DIRECTLY RELATED TO REVENUE FROM A
SPECIFIC OPERATING LEASE SHOULD BE AMORTIZED OVER THE LEASE TERM,
COMMENCING WITH THE BEGINNING OF THE RENTAL PERIOD.
IF NOT DIRECTLY
RELATED TO REVENUE FROM A SPECIFIC OPERATING LEASE, THEY SHOULD BE
AMORTIZED OVER THE PERIOD OF THE EXPECTED BENEFIT, COMMENCING FROM WHEN
THE PROJECT IS SUBSTANTIALLY COMPLETE AND UNOCCUPIED.
ESTIMATED
UNRECOVERABLE AMOUNTS OF UNAMORTIZED COSTS ASSOCIATED WITH A LEASE SHOULD
BE CHARGED TO EXPENSE WHEN IT BECOMES PROBABLE THAT THE LEASE WILL BE
TERMINATED.
SUBSTANTIALLY COMPLETE PROJECT (DEFINITION):
MEETS BOTH OF THE FOLLOWING CRITERIA:
CONSTRUCTION HAS REACHED THE LEVEL WHERE MAJOR CONSTRUCTION ENDS
AND MAINTENANCE OPERATIONS BEGIN.
TENANT IMPROVEMENTS HAVE BEEN COMPLETED, OR A PERIOD OF ONE YEAR
HAS ELAPSED FROM THE CESSATION OF MAJOR CONSTRUCTION ACTIVITY, WHICHEVER
OCCURS FIRST.
WHERE A LARGE PROJECT IS PHASED, SUBSTANTIAL COMPLETION IS DEFINED BY
PHASE, NOT BY THE WHOLE PROJECT (I.E. IN A SUPER-REGIONAL MALL).

FINANCING THE DEVELOPMENT

IN THE PROCESS OF COMPLETING A DEVELOPMENT OR PERFORMING CONSTRUCTION OR
REHABILITATION, WE HAVE THE APPROACH OF HOW TO FINANCE THE DEVELOPMENT.

38

IF BASED ON MORTGAGE PROCEEDS, WE HAVE TWO INTER-RELATED TYPES THAT PLAY

A ROLE:
CONSTRUCTION LOAN (SHORT TERM)
PERMANENT LOAN (LONG TERM)

NEEDED TO GET TO POINT OF GETTING

GENERALLY NOT 100% OF COST
PERMANENT FINANCING
MORTGAGE AFTER COMPLETION,
LESS SECURE, THEREFORE HIGHER
BUILDING READY TO BE RENTED
INTEREST FACTOR, GENERALLY SPEAKING
OR USED
INTEREST ONLY IN MOST CASES
USUALLY ADVANCED AS PART OF THE
CONSTRUCTION COSTS AS THEY PROCEED
THE INTEREST ACCRUES
GENERALLY NOT A GREATER AMOUNT
THAN PERMANENT LOAN, BECAUSE
CONSTRUCTION LOAN IS SHORT TERM AND
THEY FINANCIER IS LOOKING TO GET HIS
MONEY OUT

UPON COMPLETION, SAY WE NEED

12,000,000 FINANCING. THEY
AGREE GENERALLY THAT THEY
NEED A PERMANENT LOAN BEFORE
AN INSTITUTION WILL FINANCE
THE CONSTRUCTION LOAN.
USUALLY A LOCAL BANK WILL GIVE
CONSTRUCTION LOANS. THEY ARE
BASED UPON COST AND PROJECTED
VALUE

PERMANENT LOAN
BONGIORNO- A PERMANENT FINANCING COMMITMENT IS USUALLY OBTAINED VERY
EARLY IN THE DEVELOPMENT PROCESS, PROBABLY BEFORE GROUND-BREAKING.
PERMANENT FINANCING ALMOST ALWAYS TAKES THE FORM OF A FIRST MORTGAGE AND
OFTEN CONTAINS AN 'EXCULPATORY CLAUSE' THAT LIMITS LIABILITY UNDER THE
MORTGAGE TO THE RESPECTIVE PROPERTY. OCCASIONALLY, PERSONAL OR CORPORATE
GUARANTEES MAY BE REQUIRED.
PERMANENT FINANCING WILL NORMALLY
NOT BE
TAKEN DOWN UNTIL THE PROJECT IS COMPLETE, THE MAJORITY OF THE SPACE IS
RENTED, AND ALL TITLE DEFICIENCIES AND MECHANICS' LIENS HAVE BEEN
CLEARED. BECAUSE OF THE DIFFICULTY IN SECURING FINANCING FOR COMMERCIAL,
INDUSTRIAL AND MULTI-FAMILY PROJECTS, THE LAND UNDERLYING THE BUILDING IS
OFTEN SOLD AND LEASED BACK, THUS REDUCING THE FRONT-END CASH
REQUIREMENTS.
THE LAND IS PURCHASED BY THE PRIMARY LENDER AND LEASED
BACK. THE SALE LEASEBACK ENABLES THE LENDER TO FACTOR IN AN ADDITIONAL
RENT AND A PARTICIPATION IN THE GROSS INCOME OR NET INCOME OF THE
PROPERTY.
TAKEOUT COMMITMENT MEANS THERE IS A PERMANENT LENDER
COMMITMENT FEES ARE A FINANCING CHARGE THAT THE LENDER WILL APPLY. IT IS
A NON-REFUNDABLE FEE WHICH COVERS OUT-OF-POCKET EXPENSES.
INDIRECT CHARGES ARE CHARGED FOR FOREGONE INVESTMENT OPPORTUNITIES SINCE
FUNDS ARE COMMITTED TO YOU, THEREFORE YOU PAY FOR THE RIGHT TO THE
MONEY WHICH CAN NOT NOW GO TO SOMEBODY ELSE WHO MAY BE WILLING TO
PAY A GREATER RATE FOR THE MONEY.
THE PERMANENT LOAN HAS SOME DEGREE OF VARIABILITY, BUT NOT A GREAT DEAL

39

THE CONSTRUCTION LOAN HAS QUITE A BIT OF FLUIDITY.

IT COULD BE 12
PERCENT
PLUS 2 POINTS OVER A GIVEN VARIABLE, SUCH AS ONE YEAR
TREASURY
BILLS.
THE BANK WILL REQUIRE FINANCIAL STATEMENT AND PERHAPS PERSONAL GUARANTEES
OF THE INDIVIDUALS INVOLVED IN THE CORPORATION BUILDING THE DEVELOPMENT.
YOU WILL NEED:
DETAILED COST BREAKDOWN, THEN, AS A REQUIREMENT OF THE LOAN, THE BANK MAY
APPOINT AN ARCHITECT TO GO OVER A PROJECT, AND MAY APPOINT SOMEONE TO
INSPECT IT AS IT IS COMPLETED, BEFORE PERCENTAGE OF COMPLETION PAYMENTS
ARE MADE.
PAYMENT BONDS AND COMPLETION BONDS AS INSURANCE THAT ONCE STARTED, THE
PROJECT WILL BE COMPLETED IF THE DEVELOPER DEFAULTS.
TITLE INSURANCE IS CERTIFICATION THAT THE PERSON ASSERTING TITLE TO LAND
HAS TITLE TO THE LAND. FURTHER, IT INSURES THE LENDER THAT IF AN ERROR
WAS MADE, THAT HE WILL KNOW ABOUT IT.
THE TITLE SEARCH CONTINUES THROUGHOUT THE CONSTRUCTION, SO THAT THE
LENDER IS ASSURED THAT NO OTHER LIENS OR ENCUMBRANCES ARE APPLIED TO THE
DEVELOPMENT BY THE BUILDER. IF IT DOES HAPPEN THAT A LIEN IS DISCOVERED,
THE BONDS MAY BE TRIGGERED AND THE LENDER MAY BACK OUT OF THE DEAL AFTER
RECALLING THEIR INVESTMENT.
GLOBAL DEVELOPMENT CORPORATION HANDOUT , BACKGROUND INFO (SEE PACKET)
END OF CLASS NINE
11/16/89
A DEPOSIT ON PROPERTY IS NOT A CURRENT ASSET ( THAT IS, AN ASSET OF CASH
OR OTHER ITEMS TO BE TURNED INTO CASH WITHIN ONE YEAR ). THIS IS BECAUSE
IT HAS BOUGHT A CLAIM ON THE PROPERTY. IT IS AN "OTHER ASSET". OTHER
ASSETS ARE A NEBULOUS ASSET CHARACTERISTIC BETWEEN FIXED ASSETS AND
CURRENT ASSETS.
A FIXED ASSET IS AN ITEM THAT IS USED IN THE COURSE OF BUSINESS, AND THAT
HAS VALUE.
ACCOUNTING FOR CONSTRUCTION
WE START WITH THE POSITION THAT WE HAVE CONSTRUCTION FINANCING.
CONSTRUCTION RULES ARE BROKEN INTO TWO MAIN TYPES OF ACCOUNTING METHODS.
PERCENTAGE OF COMPLETION METHOD (PREFERRED BY FASB)
AND
COMPLETED CONTRACT METHOD (THE METHOD CHOSEN BY MOST BUILDERS)

40

THE RULES:
PERCENTAGE OF COMPLETION METHOD
RECOGNITION IS GIVEN TO EXPENSE AND INCOME AS PROGRESS IS COMPLETED ON
CONTRACTS (PERCENTAGE OF COMPLETION METHOD)
THE CONTRACTOR'S ABILITY TO MAKE REASONABLE ESTIMATES UNDERLIES THE
ASSUMPTION THAT THE PERCENTAGE OF COMPLETION METHOD IS BEST.
SEE PAGE 139-40 OF WILEY
SEE PG 10.34, BONGIORNO, P.O.C. METHOD
COST INCURRED TO DATE
THE PERCENTAGE OF COMPLETION =
ESTIMATED TOTAL COST
FORMULA FOR PROFIT RECOGNITION (P.O.C. METHOD)
GROSS PROFIT FOR THE UNIT x PERCENT OF COMPLETION = RECOGNIZABLE PROFIT
COMPLETED CONTRACT METHOD
ALL COMPLETED REVENUE AND EXPENSE ON JOBS IN PROGRESS IS DIFFERED WITH
RECOGNITION ON THE INCOME STATEMENT ONLY WHEN THE PROJECT IS COMPLETED.
WHEN IS IT ACCEPTABLE?

ONLY IN TWO INSTANCES.

WHEN THE FINANCIAL POSITION AND RESULTS OF OPERATION WOULD NOT

DIFFER SIGNIFICANTLY FROM THOSE USING THE PERCENTAGE OF COMPLETION
METHOD.
WHERE THERE ARE INHERENT HAZARDS RELATING TO CONTRACT CONDITIONS OR
FACTORS THAT RAISE QUESTIONS ABOUT A COMPANY'S ABILITY TO
ACCURATELY ESTIMATE A CONTRACT.
I.E. WHEN A CONTRACT IS UNDER CHALLENGE BY A COURT ACTION OR
BY LEGISLATION.
WHEN THE CONTRACT CAN NOT BE ESTIMATED DUE TO FACTORS
WHICH DO NOT EASILY GIVE WAY TO ESTIMATION SUCH AS THE USE OF
A NEW CONSTRUCTION TECHNIQUE.
WHY BOTHER?
SO THAT WE CAN ACCURATELY REFLECT BUSINESS HEALTH AS PER
GENERALLY ACCEPTED ACCOUNTING PRINCIPLES.
TO RECAPITULATE:
% OF COMPLETION DEPENDS ON THE PRECISION IN ESTIMATING THE FULL COSTS.
COMPLETED CONTRACT IS USED WHEN ESTIMATE NOT POSSIBLE.
ACCRUAL ACCOUNTING
IS BAD BECAUSE IT INCREASES THE INCOME RECOGNITION
BEYOND REASONABLE LIMITS.

41

GENERAL NOTES:
BEGINNING OF CONSTRUCTION IS DEFINED BY CONTRACT FOR FINANCING.
IF YOU SEE THE COMPLETED CONTRACT METHOD BEING USED, ASK QUESTIONS AND BE
SUSPICIOUS.
FOR NOV. 30, REVIEW SYNDICATION, CHAPTERS 13 AND 14. YOU CAN SKIP CHAPTER
18 ON SYNDICATION OF TAXATION.
ALSOACCOUNTING FOR LEASING.
END OF CLASS TEN

11/30/89
IF GIVEN A CLAIM FOR ONE MILLION DOLLARS IN 15 YEARS, DO YOU PUT AN ENTRY
IN THE NOTES RECEIVABLE SECTION OF THE FINANCIAL STATEMENT SAYING
"1,000,000? NO. CONSIDERING THE TIME VALUE OF MONEY, TO DO THIS WOULD BE
MISLEADING, AND SHOULD NOT BE SO ENTERED ON THE BALANCE SHEET.
A LONG TERM ASSET (LONGER THAN ONE YEAR) MUST BE CALCULATED USING PRESENT
VALUE . ON LIABILITY SIDE, YOU STATE THE WHOLE LIABILITY, WHILE STATING
IN THE NOTES THAT IT IS 15 YEARS IN THE FUTURE AND ITS VALUE IS SO AND
SO.
SHORT TERM COMMERCIAL LOANS ARE NOT AMORTIZABLE. INTEREST AND PRINCIPLE
IS OWED ON THE DATE OF THE LOAN.
I.E. I BORROWED 48,000 FROM THE BANK WHICH ISSUED A 90 DAY NOT PAYABLE
WITH A STATED INTEREST RATE OF 15 PERCENT.
ASSETS

LIABILITIES

48,000

48,000

INTEREST IN NOT MENTIONED BECAUSE IT HAS NOT YET ACCRUED.

PURCHASED LAND FOR 92,000 MAKING A CASH DOWNPAYMENT OF 20,000 AND ISSUING
A ONE YEAR NOTE PAYABLE FOR THE BALANCE. THE FACE AMOUNT OF THE NOTE WAS
78,480 DOLLARS.
DEBT

CREDIT

LAND
92,000

CASH

20,000
NOTE PAYABLE

78,480
PREPAID INTEREST

INTEREST EXPENSE

42

CURRENT ASSET

6,480

98,480
98,480

HOW DOES A CONSTRUCTION MORTGAGE

WORK?

PEOPLE WHO GIVE YOU A LOAN TO SEE YOUR INTEREST IN THE PROPERTY, OR YOUR
EQUITY. RARELY DO THEY RELEASE 100 PERCENT.
CONSTRUCTION LOANS ARE ONLY FOR CONSTRUCTION COSTS. THEY ARE NOT TO PAY
FOR THE LAND.
TO GET LAND, YOU NEED EQUITY FINANCING.
CONSTRUCTION LENDERS INTERESTED IN SHORT TERM WHILE EQUITY INVESTORS ARE
INVESTED FOR A LONG PERIOD OF TIME, THEREFORE THEY ARE TWO DIFFERENT
CLASSIFICATIONS OF FINANCING.
KEY POINTS OF SYNDICATION. (SEE BONGIORNO CHAPTER 14 FOR DETAILS)
SYNDICATION IS THE RAISING OF CAPITAL FROM INVESTORS TO ACQUIRE AN
INVESTMENT IN REAL ESTATE.
I.E. PARTNERSHIP, CORPORATION, JOINT VENTURE
BENEFITS
1.

SMALL INVESTORS CAN INVEST AT SMALL SUMS IN REAL ESTATE, AND

PURCHASE EXPERTISE.

BENEFITS OF SYNDICATION CONTINUED...

2.

THE DEVELOPER HAS A BROADER CAPITAL POOL TO GATHER MONEY. IT IS THE

EQUIVALENT OF GOING PUBLIC FOR A CORPORATION WITH STOCK.

3.

DECREASED AND DIVERSIFIED RISK

4.

EQUITY CAPITAL, NOT DEBT CAPITAL

5.

HELPS THOSE WHO ARE NOT EXPERTS TO MAKE MONEY IN REAL ESTATE

6.

TAX BENEFITS, PASSIVE INCOMES AGAINST PASSIVE LOSSES.

THE INITIAL PHASES OF SYNDICATION MUST BE CAPITALIZED.
I.E.
MARKETING COSTS, FINANCING, AND DEVELOPMENT (SEE BONGIORNO 14)

SEE HANDOUT BULLETINS IF NEEDED (GUIDE 5) GUIDE FOR REGISTRATION

STATEMENT RELATED TO INTEREST IN THE REAL ESTATE PARTNERSHIP.
PRINCIPAL OBJECTION:
CHOOSING TO EXPENSE.

FAILURE TO CAPITALIZE FORMATION COSTS, RATHER THAN

43

PASSIVE INCOME MAY ONLY OFFSET PASSIVE LOSSES

PORTFOLIO INCOME

EARNED INCOME

10,000

90,000

8,000 PASSIVE LOSS

BEFORE 1986:
10,000 + 90,000 = 100,000 - 8,000 = 92,000 TAXABLE INCOME
AFTER 1986:
10,000 + 90,000 = 100,000 = TAXABLE INCOME
FASB ETF - REAL ESTATE STATEMENT FOR ACCOUNTING AND CAPITALIZATION FOR
LIMITED PARTNERSHIPS AND SYNDICATIONS
END OF CLASS ELEVEN
12/7/89 SUMMARY OF THE COURSE
FINANCIAL VS. MANAGERIAL ACCOUNTING
FINANCIAL IS FOR EXTERNAL USE
MANAGERIAL IS FOR INTERNAL USE
FINANCIAL: A.K.A. COMPLIANCE ACCOUNTING
MANAGERIAL:
A.K.A.
ACCRUAL IS THE METHOD OF ACCOUNTING USED
THE PREFERRED METHOD OF FASB.

CONTROL
ACCOUNTING
MOST BY BUSINESSES, AND IT IS

CASH METHOD IS NOT AVAILABLE FOR BUSINESSES WITH INVENTORY.

FOR TAX
PURPOSES, THERE IS AN ADDITIONAL RESTRICTION, THAT IS THAT C CORPORATIONS
CAN NOT USE IT IF THEY HAVE GROSS REVENUE GREATER THAN 5,000,000 DOLLARS.
INSTALLMENT METHOD IS USED TO ALLOW THE REPORTING OF INCOME IN ACCORDANCE
WITH THE COLLECTION OF SALES PROCEEDS. REPORTED AS A PERCENTAGE OF THE

44

ENTIRE RECEIPT.
PERCENTAGE OF COMPLETION METHOD IS USED ALMOST EXCLUSIVELY
CONSTRUCTION INDUSTRY, PREFERABLE TO COMPLETED CONTRACT METHOD.

BY

COMPLETED CONTRACT METHOD ALL COMPLETED REVENUE AND EXPENSE ON JOBS IN

PROGRESS IS DIFFERED WITH THE RECOGNITION ON THE INCOME STATEMENT ONLY
WHEN THE PROJECT IS COMPLETED.
YOU WANT TO USE THE METHOD WHICH WILL PUT YOU IN ACCORDANCE WITH GAAP.
THESE PRINCIPLES ARE APPLIED SO THAT YOU CAN SAY STATEMENTS ARE IN
ACCORDANCE WITH GAAP, WHICH IS THE ACCEPTED STANDARD AS DEFINED BY FASB.
REAL ESTATE MAY BE OWNED BY AN INDIVIDUAL, OR BY A LIMITED PARTNERSHIP
CORPORATION (C OR S) JOINT VENTURE (A MIX OF TWO TYPES).
THE ENTITY IS A CONDUIT FOR THE RECOGNITION AND DISTRIBUTION OF INCOME OR
LOSS.
PARTNERSHIPS
GENERAL
LIMITED
CORPORATION
C A CORPORATION FOR ALL PURPOSES
S A REGULAR CORPORATION FOR ACCOUNTING PURPOSES, A PARTNERSHIP FOR
TAX PURPOSES.
SYNDICATION IS A MEANS BY WHICH INVESTORS POOL AND INVEST MONEY FOR THE
ACQUISITION OF REAL ESTATE. ANY OF THE FOUR TYPES OF OWNERSHIP MAY BE
USED.

ACCOUNTING ISSUES OF SYNDICATION

MUST CAPITALIZE MANY OF THE COSTS IN THE BEGINNING, THE COST OF RAISING
CAPITAL IS ALSO CAPITALIZED.
UNACCEPTABLE ACCOUNTING PRACTICES
MINIMUM DOWNPAYMENT
BUDGETS; PROJECTED, REVIEW OF PAST PERFORMANCE
SEE WILEY 116 TO 118
CAPITAL LEASE, THE DEFINITION OF A CAPITAL LEASE
FOR ACCOUNTING PURPOSES, THE LEASING OF REAL ESTATES IS A CAPITAL
INVESTMENT RATHER THAN AN OPERATING EXPENSE UNLESS THE TRANSACTION MEETS

45

CERTAIN GUIDELINES, IN ORDER TO BE IN COMPLIANCE WITH GAAP.

KNOW THE DIFFERENCE BETWEEN A CAPITAL LEASE AND AN OPERATING LEASE
BOTH ASSETS AND LIABILITIES ARE INCLUDED
EXCLUSIVITY OF USE FOR A PERIOD OF TIME IS AN ATTRIBUTE OF OWNERSHIP
WHEN YOU HAVE EXCLUSIVE USE , YOU GET A DEDUCTION FOR DEPRECIATION.
PAYMENT OF LEASE OBLIGATION, AND IMPUTED INTEREST.
YOU PAY ONE AMOUNT WHICH INCLUDES PAYMENT AND INTEREST.
THE PERSON WHO LEASES THE BUILDING TO YOU GETS AN INTEREST INCOME. THE
TENANT HAVING EXCLUSIVE USE GETS THE DEPRECIATION, THOUGH THE LESSOR OWNS
THE ASSET.
CAPITALIZATION METHOD: USING THE CAP RATE. BASED ON NOI (NET OPERATING
INCOME). KNOW HOW TO DEFINE NOI. SOME ADVANTAGES AND DISADVANTAGES.
ADVANTAGES
DISADVANTAGES

EASY TO APPLY
NO ELEMENT OF PRESENT VALUE,
INFLATION IS NOT CONSIDERED,
NOT SENSITIVE TO PAYMENT
PERIODS,
REGARDS ALL PAYMENTS, EVEN
THOSE
MADE IRREGULARLY, AS EQUAL
KNOW THE METHOD AND THE ADVANTAGES AND DISADVANTAGES.

FINANCIAL REPORTING
THE ACCOUNTANT GIVES AN OPINION CONCERNING FINANCIAL STATEMENTS.
STATEMENTS ARE PRESENTED AND OPINIONS HAVE SIGNIFICANCE.

THE WAY

BEST
CERTIFIED FINANCIAL STATEMENT (CLEAN) - STATEMENT REPRESENTS THE STATE OF
THE COMPANY ON A DATE, NO EXCEPTIONS, ACCORDING GAAP.
CERTIFIED FINANCIAL STATEMENT WITH EXCEPTIONS - SAME AS ABOVE, BUT WITH
EXCEPTIONS.
REVIEW REPORT - CIRCUMVENTS THE C.F.S. THE ACCOUNTANT SIMPLY STATES THAT
HE HAS NO RESPONSIBILITY FOR THE STATEMENT, ONLY THAT HE PRESENTS IT TO
YOU.

46

COMPILATION REPORT - "WE TAKE NO POSITION AS TO ACCORDANCE WITH GAAP, WE

JUST PRESENT THE REPORT TO YOU".
WORST
THE COMPUTATION OF DEPRECIATION
KNOW METHODS: STRAIGHT LINE, ACCELERATED (I.E. SYD AND DB AND DDB)
DECLINING BALANCE (DB) AND DOUBLE DECLINING BALANCE (DDB) HAVE NO SALVAGE
VALUE.
STRAIGHT LINE (SLN) HAS A SALVAGE VALUE
ONLY TANGIBLE PROPERTY IS SUBJECT TO DEPRECIATION.
LAND IS NOT SUBJECT TO DEPRECIATION, BECAUSE IT HAS NO LIMITED ECONOMIC
LIFE.
BOOK VALUE OF ASSET IS COMPUTED
DEPRECIATION, WHICH IS ACCUMULATED.

AS

ADJUSTED

BASIS

OR

COST,

LESS

BALANCE SHEET (EXAMPLE)

ASSET
LIABILITY

LAND
500,000
500,000
BUILDING
2,500,000
ACCUMULATED DEPRECIATION
500,000
2,000,000
DEPRECIATION:

OVER A PERIOD OF TIME, WE ARE EXPENSING THE ASSET.

THE PROPERTY IS SOLD:

SALES PROCEEDS
LESS BASIS OF LAND
BOOK VALUE

5,000,000
(500,000)
(2,000,000)
---------GAIN ON DISPOSAL OF LAND AND BUILDING
2,500,000
KEEP CAPITAL ASSETS SEPARATE FROM OTHER ASSETS.
TAXATION AND DEPRECIATION
PRIOR TO 1981, BASED ON ESTIMATED ECONOMIC LIFE OF THE ASSET.
1/1/81 TO 12/31/86 - 5, 10, OR 15 YEAR CATEGORIES, A POLICY WHICH LASTED
ONE YEAR.
"ECONOMIC LIFE WAS THROWN OUT THE WINDOW" BY THE REAGAN ADMINISTRATION,
WHO INSTITUTED THE CONCEPT OF (ACRS), OR ACCELERATED COST REDUCTION
SYSTEM.
THIS WAS PART OF ERTA, OR THE ECONOMIC RECOVERY TAX ACT, 1981.

47

IN 1982, THE DEPRECIATION OF REAL ESTATE WAS RAISED FROM 15 TO 18 YEARS.

IN 1984, IT BECAME 19 YEARS.
IN 1987, IT BECAME 27.5 YEARS FOR RESIDENTIAL, AND 31.5 FOR COMMERCIAL
PROPERTIES.
SO, TO RECAPITULATE:
THE PREVIOUS SYSTEM WAS ACRS.
THE PRESENT SYSTEM IS MACRS, OR MODIFIED ACCELERATED COST REDUCTION
SYSTEM. THIS HAS BEEN THE METHOD FOR TAX ACCOUNTING SINCE 1987.
FOR TAX ACCOUNTING PURPOSES, YOU CAN DEPRECIATE OVER A LONGER PERIOD OF
TIME THAN 31.5 YEARS, BECAUSE OF THE "ALTERNATIVE MINIMUM TAX" CLAUSE,
WHICH APPLIES TO ADJUSTMENTS MADE TO PAST TAX PREFERENCE TO THE WEALTHY.
BECAUSE THE OWNER HAS TO PAY A MINIMUM TAX ANYWAY, IT MAKES SENSE TO
ADVANCE THE DEPRECIATION TO TAKE ADVANTAGE OF THE DEPRECIATION, BECAUSE
OTHERWISE THE ALTERNATIVE MINIMUM TAX WOULD WASTE IT AWAY.
THE CONSTRUCTION PROCESS
KNOW HOW THE CONSTRUCTION MORTGAGE, PERMANENT MORTGAGE, AND TAKE-OUT
COMMITMENT ARE INTER-RELATED.
WRAP AROUND MORTGAGES ARE A SECOND MORTGAGE, WHICH IS A RESULT OF A
CHANGE IN INTEREST RATES FLUCTUATED TO THE DEGREE THAT THE FIRST MORTGAGE
HOLDER MAY NOT WANT TO RELEASE IT BECAUSE OF FAVORABLE RATES. SO HE GETS
A SECOND MORTGAGE TO MAKE ONE PAYMENT THAT INCLUDES THE FIRST MORTGAGE,
AND COVERS THE ADDITIONAL FUNDS THE BORROWER WANTS.
WITH ESCALATING LEASES THE FASB SAYS THAT IT HAS TO BE TAKEN OVER THE
ENTIRE TERM OF THE LEASE ON A STRAIGHT LINE BASIS. SEE BONGIORNO.
SALE LEASEBACK - KNOW THAT MUST QUALIFY, AND IF SELLER HAS CONTINUING
INVOLVEMENT, YOU HAVE ANOTHER TRANSACTION
THE SALE LEASEBACK
THE SALE LEASEBACK OCCURS WHEN A PROPERTY IS SOLD BY THE OWNER AND THE
SELLER THEN LEASES IT BACK FROM THE BUYER.
IF THE LEASEBACK COVERS SUBSTANTIALLY ALL OF THE USE OF THE PROPERTY SOLD
AND IF ANY ONE OF THE FOUR CRITERIA FOR TREATMENT AS A CAPITAL LEASE IS
MET, THEN THE SELLER WILL ACCOUNT FOR THE LEASE AS A CAPITAL LEASE.
THE DEFERMENT OR AMORTIZEMENT OF PROFIT ON A SALE LEASEBACK.
IF THE LEASE IS A CAPITAL LEASE, IT IS AMORTIZED IN PROPORTION TO THE

48

AMORTIZATION OF THE LEASED ASSET OR OVER THE LEASE TERM IF LAND IS

INVOLVED.
IF THE LEASE IS AN OPERATING LEASE, IT IS AMORTIZED IN
PROPORTION TO THE RELATED GROSS RENTAL CHARGED TO EXPENSE OVER THE LEASE
TERM (SEE EXAMPLE 5 2.36.2). IF THE FAIR VALUE OF THE PROPERTY AT THE
TIME OF THE TRANSACTION IS LESS THAN ITS UNDEPRECIATED COST, THEN AN
IMMEDIATE LOSS IS TO BE RECOGNIZED FOR THE DIFFERENCE.
IF THE SELLER RETAINS ONLY A MINOR PORTION OF THE USE OF THE PROPERTY
SOLD, THE SALE AND THE LEASEBACK ARE ACCOUNTED FOR AS SEPARATE
TRANSACTIONS ON A STAND-ALONE BASIS. MINOR PORTION IS DEFINED AS A
PRESENT VALUE OF A REASONABLE RENTAL FOR THE LEASEBACK WHICH IS LESS THAN
10 PERCENT OF THE FAIR VALUE OF THE ASSET SOLD.
UNREASONABLE RENTAL
TERMS AS PER MARKET CONDITIONS AT THE INCEPTION OF THE LEASE REQUIRE THAT
AN APPROPRIATE AMOUNT BE DEFERRED OR ACCRUED BY ADJUSTING THE PROFIT OR
LOSS ON THE SALE AND AMORTIZING THE SAID ADJUSTMENT INTO INCOME SO AS TO
ADJUST THOSE RENTALS TO A REASONABLE AMOUNT (SEE EXAMPLE 6 2.36.2).
IF THE SELLER RETAINS MORE THAN A MINOR PART BUT LESS THAN SUBSTANTIALLY
ALL OF THE USE OF THE PROPERTY THROUGH THE LEASEBACK AND REALIZES A
PROFIT ON THE SALE IN EXCESS OF:
THE PRESENT VALUE OF THE MINIMUM LEASE PAYMENTS (IF THE LEASEBACK
IS CLASSIFIED AS AN OPERATING LEASE); OR,
THE RECORDED AMOUNT OF THE LEASED ASSET (IF THE LEASEBACK IS
CLASSIFIED AS A CAPITAL LEASE).
THE EXCESS OF THE PROFIT ON THE SALE IN EXCESS OF EITHER OF THE ABOVE,
WHICHEVER IS APPROPRIATE, WILL BE RECOGNIZED AT THE DATE OF THE SALE (SEE
EXAMPLE 7 2.36.2).
THE SELLER IS CONSIDERED TO HAVE LEASED BACK SUBSTANTIALLY ALL OF THE
PROPERTY IF THE LEASE QUALIFIES AS A CAPITAL LEASE UNDER FASB 13,
ACCOUNTING FOR LEASES.
ACQUIRING PROPERTY THROUGH THE SALE LEASEBACK
A SALE LEASEBACK TRANSACTION CAN BE USED AS A SUBSTITUTE FOR MORTGAGE
DEBT FINANCING.
TYPICALLY, SELF-CONSTRUCTED PROPERTY IS SOLD BY THE
BUILDER, WHO SIMULTANEOUSLY ENTERS INTO A LEASE WITH THE BUYER LESSOR IN
ORDER TO SECURE CONTINUED USE OF THE PROPERTY. THE SELLER LESSEE OBTAINS
CASH TO PAY OFF THE CONSTRUCTION LOAN AND RELATED COSTS AND RETAINS USE
OF THE PROPERTY FOR THE DURATION OF THE LEASE.
THE TAX ADVANTAGE OF A SALE LEASEBACK OVER PERMANENT MORTGAGE FINANCING
IS THAT ALL LEASE PAYMENTS ARE DEDUCTIBLE, WHILE ONLY THE INTEREST
PORTION OF DEBT SERVICE IS DEDUCTIBLE. MOREOVER, IF PROPERTY IS OWNED,
NO DEPRECIATION IS ALLOWED FOR THE COST ALLOCABLE TO LAND, BUT LEASE
PAYMENTS ON A SALE LEASEBACK (INCLUDING THE PORTION ATTRIBUTABLE TO LAND)
ARE DEDUCTIBLE. CAVEAT: UNDER CERTAIN CIRCUMSTANCES, THE IRS MAY FIND A
SALE LEASEBACK TO BE A FINANCING TRANSACTION AND CONTINUE TO TREAT THE
SELLER LESSEE AS THE OWNER OF THE PROPERTY.

49

THE TAX DISADVANTAGES OF THE SALE LEASEBACK INCLUDE THE FACT THAT THE TAX
LIABILITY MAY HAVE BEEN INCURRED UPON THE INITIAL SALE OF THE PROPERTY,
AND THE DEDUCTIBLE LEASE PAYMENTS MAY BE LESS THAN THE INTEREST AND
DEPRECIATION DEDUCTIONS GIVEN UP.
SUBLEASES AND TERMINATIONS - SEE BONGIORNO 2.37.1 AND 2.37.2
THE EXAM WILL HAVE MULTIPLE CHOICE AND 4 ESSAY QUESTIONS, WITH 30 SHORT
ANSWER QUESTIONS.
END OF COURSE

50

FEDERAL TAXATION OF REAL ESTATE

PROFESSOR MICHAEL F.X. WATERS
SUMMER 1990

CLASS ONE 5/24/90

FEDERAL TAX
MICHAEL F.X. WATERS
NEW BOOK AVAILABLE NEXT WEEK AT THE BOOK STORE:
ABRIDGED INTERNAL REVENUE CODE, WEST PUBLISHING
READING ASSIGNMENT:
SEC 8.02 ALL
SEC 11.02 TO 11.07
INTERNAL REVENUE CODE:
SECTIONS 301, 316, 317, 351, 357, 358, 362, 368C, 61, 1001, 118
NEXT WEEK A HANDOUT WILL BE GIVEN TO US WITH THE SEMESTER'S READING
ASSIGNMENTS.
*******************
CLASS PROBLEMS ARE PROBLEMS FOR HOMEWORK (3 TO 5 OF THEM)
WHICH ARE ADJUNCT TO WHAT IS DONE IN CLASS (25%)
CLASS PROJECT - A RESEARCH PAPER ON TAXATION (25%).
IT IS TO BE OF
BENEFIT BOTH TO YOUR CAREER, AS WELL AS BEING ACADEMICALLY SOUND.
MY
REPORT WILL BE ON THE TAX CONSEQUENCES OF DENSITY GRANTS FOR AFFORDABLE
HOUSING ON THE DEVELOPER AND BUYER.
THE TERM PAPER SHOULD NOT BE LENGTHY - NO MORE THAN TEN TO ELEVEN DOUBLE
SPACED PAGES. CERTAINLY NO MORE THAN 20 TO 25 PAGES.
********************
THE COURSE IS ONE IN TAX IDENTIFICATION- WE IDENTIFY THE ISSUES, AND
LEARN WHERE TO GO TO SOLVE THEM.
********************
TAXATION
1. WHAT ARE THE RULES?
2. WHAT SHOULD YOU KNOW?
*******************
INCOME TAXATION IS ON MANY LEVELS.
INCOME TAXATION.

IN THIS COURSE WE COVER FEDERAL

THE FIRST INCOME TAX WAS IN 1913, BY CONSTITUTIONAL AMENDMENT. FEDERAL

TAXES PREVIOUS TO THEN WERE NOT PERMISSIBLE, AS EXPLICITLY STATED IN THE
CONSTITUTION.
THE LOBBYING EFFORT BEGAN IN THE 1880'S WHEN ACTIVISTS
REALIZED THAT THE EXISTING PREVALENT SYSTEM WAS HELPING THE RICH GET
RICHER WHILE THE POOR GOT EVEN MORE POOR. IT WAS DESIGNED TO RAISE MONEY

48

FROM THE RICH AND TO GIVE IT TO THE POOR.

GOVERNMENT RAISED MONEY THROUGH CUSTOMS ALONE.

PREVIOUS

TO

THEN

THE

ONCE THE AMENDMENT WAS PASSED, THE CONGRESS PASSED THE INTERNAL REVENUE
CODE. REVENUE BILLS (CHANGES TO THE REVENUE CODE) MUST FIRST START IN HE
THE HOUSE OF REPRESENTATIVES. THE COMMITTEE IN THE HOUSE THAT DISCUSSES
REVENUE IS THE WAYS AND MEANS COMMITTEE. IN THE SENATE, THE COUNTERPART
IS THE SENATE FINANCE COMMITTEE. THE BILL IS DRAFTED IN THE HOUSE AND
SHUTTLED TO THE WAYS AND MEANS COMMITTEE FOR CONSIDERATION. A VOTE IS
TAKEN, AND MAJORITY RULE SENDS IT TO THE FULL HOUSE FOR A VOTE.
IT IS
THEN SENT TO THE HOUSE FINANCE COMMITTEE AND THEN SENT TO THE SENATE
FINANCE COMMITTEE. AFTER PASSAGE BY THE SENATE FINANCE COMMITTEE IT GOES
TO THE SENATE FOR A VOTE, AND THEN GOES TO THE PRESIDENT FOR A VETO OR A
SIGNATURE.
THE RULES OF TAXATION COME TO US THROUGH LEGISLATION LEADING TO STATUTES.
A STATUTE IS A LEGISLATIVE ENACTMENT.
IT SOMETIMES BEGINS WITHIN THE
GOVERNMENT, AND IT IS SOMETIMES INITIATED BY CONSTITUENTS APPROACHING
THEIR REPRESENTATIVES.
OUR LEGAL SYSTEM IS THE COMMON LAW SYSTEM. IT IS OUR HERITAGE AS PART OF
THE COLONIES OF GREAT BRITAIN. BY INTENTION, WE ADOPTED THE LEGAL SYSTEM
EXTANT IN THE COLONIES AT THE TIME OF AMERICAN INDEPENDENCE. THE COMMON
LAW SYSTEM IS BASED ON PRECEDENT, AND GIVES THE POWER OF REVIEW (JUDICIAL
REVIEW) TO THE COURTS. THE COURTS HAVE THE POWER TO REVIEW LEGISLATION
AND ANNUL IT IF IT IS DEEMED INCONSISTENT WITH PRECEDENT OR THE
CONSTITUTION.
THE INTERPRETATION OF RULES IN THE CODE ARE OFTEN NOT
KNOWN UNTIL THERE IS A COURT CASE. TAXATION LAW HAS A TWO-SIDED NATURE;
LEGISLATIVE AND JUDICIAL. JUDICIAL REVIEW IS, OF COURSE, THE LAST WORD IN
TAXATION.
BECAUSE BOTH CONGRESS AND THE COURTS ARE SOURCES FOR THE RULES AND
RULINGS, IT IS DIFFICULT TO KEEP UP WITH CHANGES IN THE CODE.
OTHER
SOURCES OF RULINGS ARE THE INTERNAL REVENUE CODE.
IN THE IRC, CONGRESS MAY PROVIDE THAT A GIVEN RULE WILL BE "DETERMINED
UNDER REGULATIONS TO BE ISSUED BY THE SECRETARY". HERE THE CONGRESS IS
SAYING THAT THEY ARE NOT TAX EXPERTS, SO THE SECRETARY OF THE TREASURY
WILL DECIDE WHAT MEANS TO EMPLOY IN CARRYING OUT THE INTENT OF THE LAW.
THE INTERNAL REVENUE SERVICE COMMISSIONER AND HIS STAFF, WORKING FOR THE
SECRETARY, DETERMINE THE REGULATIONS. THE PURPOSE OF THE REGULATIONS ARE
TO GUIDE THE TAXPAYER AS TO , FOR EXAMPLE, "WHAT IS PORTFOLIO INCOME",
AND "HOW DO WE CALCULATE DEPRECIATION", ETC.
WHAT HAPPENS IF THE IRS
COMMISSIONER INTERPRETS THE CODE IN A WAY WHICH IS NOT IN LINE WITH THE
LEGISLATION? SOMEONE SUES SAYING THE REGULATION IS UNFAIR,A ND THE COURT
MAY INSIST THAT THE REGULATION BE ELIMINATED OR CHANGED.
BECAUSE MOST ACCOUNTANTS FOLLOW THE REGULATIONS SLAVISHLY DUE TO LACK OF
LEGAL EXPERTISE, THEY MAY CAUSE THEIR CLIENTS TO PAY MORE TAXES THAN THEY
NEED TO PAY. THIS IS BECAUSE TAX ACCOUNTANTS ARE NOT FAMILIAR WITH THE

49

"CODE" WHICH IN A FEW SENTENCES EXPLAINS THE "INTENT" OF THE LEGISLATION.

"INTENT" IS THE PURVIEW OF THE TAX ATTORNEY IN THE MIND OF THE TAX
ACCOUNTANT.
AFTER CODES AND REGULATIONS, WE LOOK TO "TAX CASES" FOR GUIDANCE IN
INTERPRETING THE TAX CODE.
TAX CASE EVOLUTION
TAX CASES FORM AS FOLLOWS:
YOU GO TO FILE YOUR TAXES AND ARE AUDITED.
YOU ARE NOT IN COMPLIANCE.

THE AGENT AUDITING YOU SAYS

YOU GO TO THE SUPERVISOR. HE AGREES.

YOU GO TO THE APPELLATE COURT, WHICH IS 5 PEOPLE WITH EXPERTISE IN TAX.
THEY ARE THE SENIOR TAX OFFICIALS IN THE DISTRICT. THEY AGREE.
YOU GET A 90 DAY LETTER. START COUNTING! UNLESS YOU FILE A PETITION IN
TAX COURT, THIS BILL BECOMES FINAL AND YOU HAVE NO FURTHER RECOURSE.
YOU FILE THE PETITION IN TAX COURT, STAYING THE COLLECTION OF THE TAXES.
THE TAX COURT HEARS YOUR CASE AS YOU PROTEST THE IRS DETERMINATION. YOU
DO NOT PAY THE TAX UNTIL YOUR CASE IS DECIDED.
(SEE CONTINUATION BELOW)
**************
TAX COURT- UNDER 50,000 DOLLARS, AN INDIVIDUAL CAN REPRESENT HIMSELF IN
TAX COURT. SINCE YOU WILL BE UP AGAINST PROS, YOU WILL NOT LIKELY WIN IF
YOU REPRESENT YOURSELF.
TAX COURT IS A FEDERAL COURT APPOINTED BY THE PRESIDENT. THEY ARE WELL
QUALIFIED TAX PRACTITIONERS AND DECIDE TAX LAW FOR THE U.S.
IF YOU GO TO TAX COURT AND WIN, YOU DO NOT PAY THE TAX.
IF YOU GO TO TAX COURT AND YOU LOSE YOU MAY APPEAL TO THE FEDERAL COURT
OF APPEALS.
IF YOU LOSE IN THE FEDERAL COURT OF APPEALS YOU MAY APPEAL TO THE SUPREME
COURT OF THE UNITED STATES. THEY DO NOT USUALLY TRY TAX ISSUES UNLESS IT
IS A NOVEL ISSUE.
***************

50

IF YOU MISSED THE DEADLINE ON YOUR 90 DAY LETTER, YOU CAN PAY THE TAX AND
SUE FOR A REFUND IN THE FEDERAL CLAIMS COURT OR THE FEDERAL DISTRICT
COURT.

A REVENUE RULING IS A PRONOUNCEMENT BY THE IRS WHICH IS CITED SUCH AS:

REV RUL 90-151 (151ST RULING OF 1990)
CB-1-P.230 (CUMULATIVE BULLETIN, VOLUME ONE PAGE 230)
IT IS SELF GENERATED BY THEIRS, AND IS USED TO KEEP TRACK OF POLICY.
THERE ARE ALSO PRIVATE REVENUE RULINGS. THEY CANNOT BE APPEALED AND MUST
BE PAID FOR (300.00). THEY ARE GOTTEN BY STATING THE CASE TO THE IRS,
AND GETTING THEM FOR THE RECORD HOW THE IRS FEELS ABOUT A CERTAIN
SCENARIO. IT IS A GUIDE, AND IS NOT DEFINITIVE. IF YOU GOT A NEGATIVE
REVENUE RULING AND YOU PROCEED ANYWAY, YOU MAY HAVE PROBLEMS SINCE THE
IRS MAY LOOK STRONGER IN APPEAL.
THERE ARE TAXES WHICH YOU DEAL WITH WHICH ARE NOT INCOME TAX RULES SUCH
AS:
GIFT TAX - FEDERAL LEVEL
ESTATE TAX -FEDERAL LEVEL
SALES TAX - LOCAL LEVEL
THESE ARE CALLED EXCISE TAXES.
CRITICAL AND DEFINITIVE EVENT.

THEY ARE IMPOSED ON A HAPPENING OF A

"INCOME" AS DEFINED FOR TAX PURPOSES IN REAL ESTATE MAY BE DISTINCT FROM
INCOME AS DEFINED BY FASB. WE MUST BE FAMILIAR WITH IT TO DECIDE WHAT
OUR COURSE OF ACTION SHOULD BE.
END OF CLASS ONE
CLASS TWO, 5/31/90, NOT ATTENDED, NOTES INCORPORATED IN CLASS THREE
END OF CLASS TWO

CLASS THREE 6/7/90

CORPORATION; S AND C
PARTNERSHIP; LIMITED AND GENERAL

51

CONDUIT - FLOW THROUGH TO INVESTORS. THE REASON WHY A C CORPORATION IS

NOT USED.
THERE ARE SOME CAREFULLY CONSTRUCTED EXCEPTIONS.
S CORPORATION STARTS OUT AS A C CORPORATION, THEN THERE IS AN ELECTION TO
CHANGE TO AN S CORPORATION AT A LATER POINT IN TIME. 2 1/2 MONTHS AFTER
THE TAX YEAR BEGINS IS THE LIMIT, AND ELECTION MUST BE MADE BY ALL OF THE
INVESTORS.
THE S CORPORATION IS USED AS OF 1959.
NOT REALLY ACTIVE USE IN REAL
ESTATE UNTIL 1982. THE 1986 CODE AGAIN MADE IT EVEN MORE VALUABLE FOR
USE IN REAL ESTATE.
BETWEEN 1959 AND 1982, USED PRIMARILY BY SMALL
BUSINESSES.
IN 1982, THE TAX RATES CHANGED MAKING THE S CORPORATION
ATTRACTIVE DUE TO CHANGE IN PERSONAL TAX RATE.
PARTNERSHIP VS. S CORPORATION
BOTH PASS THROUGH ENTITIES. A LOSS IS PASSED THROUGH FOR BOTH, IN THE
LATER CASE TO THE SHAREHOLDERS, AND IN THE PARTNERSHIP TO THE PARTNERS.
THERE ARE LIMITS TO THE PASS THROUGH OF LOSS HOWEVER.
AN S CORPORATION WOULD BE PREFERRED WHEN LIABILITY IS A SEVERE ISSUE.
THE PARTNERS CAN NOT ACT AS MUCH IN A LIMITED PARTNERSHIP WITHOUT
INCREASING THEIR EXPOSURE TO LIABILITY, AND AN S CORPORATION ALLOWS SOME
MORE ACTIVITY ON THE PART OF THE PARTNERS, WITH LIABILITY TAKEN ON BY THE
CORPORATION.
THE EXCEPTION BETWEEN THE SIMILARITY BETWEEN HE TWO IS THE LIMITATION ON
LOSSES. FOR EXAMPLE;
A LOSS IS PASSED THROUGH THE ABC COMPANY, A PARTNERSHIP.
THE ABC COMPANY HAS 300,000 IN LOSSES, AND EACH OF THE THREE PARTNERS, A,
B, AND C GET A 100,000 LOSS DEDUCTION ON THEIR PERSONAL TAXES.
BASIS - YOUR BASIS IS WHAT YOU PUT INTO THE BUSINESS.
YOU MAY DEDUCT
LOSSES UP TO YOUR BASIS. YOU CAN INCREASE BASIS, IN A PARTNERSHIP, BY
TAKING ON ADDITIONAL OBLIGATIONS, WHICH WOULD BE SPLIT AMONGST THE
PARTNERS.
FOR EXAMPLE;
EACH INVESTOR, A, B, AND C PUT IN 250,000 EACH FOR VALUE OF 750,000.
THEN THERE IS A LOSS OF 300,000 FOR THREE STRAIGHT YEARS. YOU WOULD RUN
OUT OF BASIS IN THE THIRD YEAR, AND THE LOSS BEYOND THE 750,000
INVESTMENT WHICH IS THE BASIS.
IF ADDITIONAL MORTGAGE OBLIGATIONS OR
LOANS WERE TAKEN ON BY THE PARTNERSHIP, HOWEVER, THIS BASIS COULD HAVE
BEEN ADJUSTED TO TAKE THE LOSS. IN AN S CORPORATION, THE BENEFIT IS THAT
BEYOND THE 750,000 LOSS, EACH PARTNER ISN'T LIABLE FOR THE ADDITIONAL
LOSS IN THE COMPANY.

52

THE PARTNERSHIP IS MORE FLEXIBLE THAN AN S CORPORATION.

IN A LIMITED PARTNERSHIP, YOU ONLY TAKE ONT
INVESTMENT, PLUS ADDITIONAL SHARE OF OBLIGATION.

HE

LIABILITY

OF

YOUR

A LIMITED PARTNERSHIP IS FINE AS AN INVESTMENT VEHICLE BUT IT IS A

DIFFICULT AND EXPENSIVE WAY TO DO BUSINESS.
**********

INVESTMENT ENTITIES
THREE PARTNERS CONTRIBUTE 300,000 EACH.
PROPERTY AND THE THIRD IN SERVICES.

ONE IN

CASH, THE

SECOND IN

HOW IS BASIS MEASURED, AND WHAT RESTRICTIONS DOES THE IRS PLACE ON
PROPERTY AND SERVICE CONTRIBUTIONS IN ORDER THAT GAIN NOT BE RECOGNIZED?
PROPERTY DONATIONS VALUE IS MEASURED AT FAIR MARKET VALUE. WHEN YOU TAKE
PROPERTY YOU BOUGHT FOR 100,000 (THE BASIS) AND TRANSFER IT TO THE
CORPORATION AS A 300,000 SHARE, THEIR IS A GAIN OF 200,000 WHICH IS NOT
TAXABLE IF THE GROUP OF WHICH YOU ARE PART OWNS AT LEAST 80% OF THE
CORPORATION STOCK (SECTION 351). THE SAME IS TRUE WITH A PARTNERSHIP
UNDER SECTION 721.
IF THE 300,000 FAIR MARKET VALUE PROPERTY IS SUBJECT TO A 50,000 DOLLAR
MORTGAGE, SAY, THE CORPORATION TAKES LIABILITY FOR THE MORTGAGE. HE IS
STILL NOT TAXED EVEN THOUGH HE HAS BEEN RELIEVED OF THE LIABILITY. IF THE
ENTITY TAKES OVER HIS 100,000 DOLLAR BASIS AND 50,000 MORTGAGE, HIS
CAPITAL GAIN BECOMES HIS BASIS, OR 50,000 DOLLARS.
WHEN YOU INVEST PROPERTY, YOU CARRY OVER THE BASIS OF YOUR INVESTMENT.
B HAS A 100,000 BASIS, AND THE PROPERTY IS WORTH 300,000, HIS BASIS IS
100,000. IF IN THE SAME SITUATION HE HAS A 50,000 MORTGAGE TAKEN OVER BY
THE CORPORATION HIS BASIS IS STILL 100,000.
WHEN IN THE SAME SITUATION, HIS MORTGAGE EXCEEDS HIS BASIS, HE MUST PAY
TAX ON THE GAIN. I.E. WHEN THE MORTGAGE IS 150,000, HIS GAIN IS 50,000,
OR 150,000 MORTGAGE MINUS 100,000 BASIS EQUALS 50,000.
SERVICES- A DIFFICULT PROBLEM
WHEN A PERSON GETS STOCK IN EXCHANGE FOR SERVICES, THOSE SERVICES MUST BE
AT FAIR MARKET VALUE.
THE BASIS FOR SERVICES IS A "SUBJECT TO" ISSUE.

53

IF THERE IS NO GUARANTEE

OF INCOME, THEN SERVICES TO BE RENDERED IN EXCHANGE FOR SHARES IS NOT

TAXABLE WHEN THE FUNDS FOR THOSE SERVICES ARE TRANSFERRED TO THE PERSON
PERFORMING SERVICES IN THE FORM OF SHARES. THE TAX IS LEVIED WHEN THE
SHARES ARE EXCHANGED FOR CASH VALUE. THE FEES MUST BE, IN OTHER WORDS,
SUBJECT TO FORFEITURE IN ORDER TO NOT BE TAXABLE.
THE CAMPBELL CASE
WHEN IN PRODUCING A VENTURE THE FUTURE GAIN IS CERTAIN, AND THERE IS NO
RISK OF NO RETURN ON THE MONEY, THE TAXES MAY BE PAYABLE IN THE BEGINNING
OF THE VENTURE BASED UPON ITS DISCOUNTED CASH FLOW VALUE.
BASIS - USUALLY "WHAT YOU PAY FOR SOMETHING", BUT THERE ARE WAYS TO
ADJUST IT.
IT IS USED TO DETERMINE GAIN OR LOSS ON DISPOSITION.
YOU
WILL HAVE A TAXABLE GAIN OR LOSS BASED UPON THE PROCEEDS OF SALE AND YOU
TAX BASIS SUBTRACTED FROM EACH OTHER. TAX BASIS PUTS A LIMIT ON YOUR GAIN
OR LOSS EACH YEAR. IF YOU HAVE A LOSS YOU CAN TAKE IT AGAINST YOUR OTHER
INCOME ONLY UP TO YOUR BASIS. YOUR BASIS WILL SHIFT AND CHANGE, AND MUST
BE DETERMINED WHEN YOU ENTER THAT INVESTMENT.
THE BASIC FORMULA FOR BASIS IS THE SAME IN A S CORPORATION AND A
PARTNERSHIP BUT THE LATER HAS GREATER FLEXIBILITY ON ADDING BASIS.
INVESTMENT PLUS OR MINUS GAIN OR LOSS PER YEAR, EACH YEAR, EQUALS THE
BASIS.
BY GAIN OR LOSS, YOUR INVESTMENT BASIS WILL EITHER INCREASE OR DECREASE.
ANY WITHDRAWALS OF CAPITAL REDUCE THE BASIS. ANY CASH ENTRIES OF CAPITAL
INCREASE BASIS. DIVIDENDS IN AN S CORPORATION ARE CONSIDERED WITHDRAWALS.
END OF CLASS THREE
CLASS FOUR
6/14/90
PROFESSOR WATERS HAD A SUBSTITUTE
EXERCISES REVIEWED IN CLASS
UNADJUSTED BASIS = COST - THAT WHICH YOU PAY OR THE AMOUNT OF LIABILITY
INCURRED OR BOTH
IE. 1 MILLION DOLLAR PROPERTY; 800K LOAN 200K CASH...BASIS IS 1 MILLION
ADJUSTED BASIS = UNADJUSTED
DEPRECIATION SUBTRACTED FROM IT.

BASIS

CONSIDERING

DEDUCTIONS

UNADJUSTED BASIS STAYS THE SAME

ADJUSTED BASIS IS ALWAYS CHANGING.
SECTION 4-69 AND SECTION 1-68 ESPECIALLY A AND B ARE READING

54

AND

************
END OF CLASS FOUR
CLASS FIVE 6/21/90
TEXT 6.14

DEPRECIATION

TO DATE, THE FOLLOWING HAVE BEEN THE REQUIRED READINGS

THE READING LIST HAS NOT YET BEEN DISTRIBUTED TO THE CLASS.
TEXT
8.02
11.02 TO 11.07
6.08
7.06
6.14
READINGS (CONT.)
CODE SECTIONS; 301, 316, 317, 351, 358, 362, 368(C), 61, 1001, 118, 469,
465, 704, 705, 721, 722, 723, 731, 732, 752
TOPIC OF TODAY'S LECTURE; BASIS RULES AND PASSIVE LOSS RULES
THESE RULES INTERCONNECT, ALTHOUGH THEY ARE COMPUTED SEPARATELY.
SHOULD NOT BE CONSIDERED AS ONE AND THE SAME RULE.

THEY

RULE ONE - WHAT EVER THE PROPERTY COST YOU, THAT IS YOUR "ORIGINAL
BASIS", WHICH IS YOUR COST AT ACQUISITION.
RULE TWO - THE RULES OF BASIS ARE CUMULATIVE.
CAPITALIZATION OR CONSTRUCTION PERIOD INTEREST
ADDITIONS) LEAD TO THE "ADJUSTED BASIS".

DEPRECIATION
(SUBTRACTIONS

AND
AND

THE UNDERSTANDING OF BASIS LEADS YOU TO COMPUTE THE GAIN OR LOSS FOR A
TRANSACTION, AND THEREFORE THE TAX EXPOSURE.
WHAT RENDERS A "TAXABLE EVENT"?
WHEN YOU HAVE A "DISPOSITION" OF THE
PROPERTY. THE DISPOSITION LEADS TO A TAXABLE GAIN OR A TAXABLE LOSS. WE
KNOW WE HAVE IT BY ANALYZING WHETHER WE HAVE CAPITAL GAINS OR LOSS AS
OPPOSED TO ORDINARY GAINS OR LOSS.
THE COMPUTATION OF GAIN OR LOSS (TEXT 11.03)
DISPOSITION IS THE TRANSFER OF AN OWNERSHIP INTEREST.
COMPUTE THE ADJUSTED BASIS AND MATCH IT WITH THE PROCEEDS OF SALE.
************************************
THE FORMULA FOR TAXABLE GAIN OR LOSS:

55

************************************
PROCEEDS OF SALE - ADJUSTED BASIS = THE TAXABLE GAIN OR LOSS
11.04 TO 11.05 ARE EXAMPLES OF PITFALLS FOR GAIN AND LOSS.
SUPPOSE WE HAVE A LOSS ON DISPOSITION OF A PROPERTY. WE HAVE A TAXABLE
LOSS OF 6 MILLION AND ON ANOTHER PROPERTY A GAIN OF 5 MILLION. WE DO NOT
HAVE TO PAY TAXES.
BEWARE HOWEVER THAT ANY LOSS WILL STAND UP UNDER THE CODE, SINCE THERE
ARE LAWS GOVERNING THE CIRCUMSTANCES UNDER WHICH THE LOSS IS RECOGNIZED.
(SEE TEXT 11.05

VERY IMPORTANT)

1. YOU CAN ONLY DEDUCT TRANSACTIONS ENTERED FOR PROFIT.

PERSONAL
TRANSACTIONS SUCH AS THE SALE OF A RESIDENCE ARE NOT DEDUCTIBLE. WHEN
YOU SELL A PERSONAL ASSET AT A LOSS, YOU MAY NOT DEDUCT IT AS A LOSS. A
GAIN ON PERSONAL PROPERTY IS TAXABLE AS A CAPITAL GAIN, HOWEVER.
A PERSONAL PROPERTY WHICH IS TURNED TO A BUSINESS PROPERTY CAN TRANSFER
THE LOSSES UPON SALE OF THE BUSINESS.
IF YOU SELL TO A CORPORATION THAT YOU OWN AT LEAST 50 PERCENT OF THE
SHARES, YOU MAY NOT DEDUCT THE LOSS.
TO PREVENT THE DEDUCTION OF ARTIFICIAL LOSSES THE SECTION DENIES LOSSES
AT EXCHANGES BETWEEN RELATED PARTIES (IE. MOM AND DAD OR OTHER BLOOD
RELATIVES).
CAPITAL GAIN (LOSS) SECURED IN A TRANSACTION WHEN THERE IS A DISPOSITION
OF A CAPITAL ASSET. WE HAVE CAPITAL GAIN IF WE DISPOSE OF AN ASSET WHICH
IS CALLED A SECTION 1231 ASSET.
A LOSS UNDER SECTION 1231 IS AN ORDINARY LOSS.
SECTION 1231 GIVES YOU THE BEST OF ALL WORLDS.
WE HAVE A DISTINCTION
BETWEEN ORDINARY AND CAPITAL ASSETS, BUT THE RATE OF TAX FOR THE TWO IS
THE SAME AS OF 1/1/87.
A CAPITAL ASSET IS (ON P 1113) ANY PROPERTY HELD BY THE TAXPAYER WHETHER
FOR BUSINESS OR NOT EXCEPT:
1. STOCK IN TRADE (INVENTORY). INVENTORY IS NEVER A CAPITAL ASSET.
2. PROPERTY USED IN THE TRADE OF BUSINESS SUBJECT TO DEPRECIATION OR REAL
PROPERTY USED IN BUSINESS. HERE SECTION 1231 COMES INTO PLAY.. IT SAYS
THAT YOU WILL GET CAPITAL GAIN TREATMENT IF YOU SELL YOUR PROPERTY FOR
USE AS A FACTORY. IT APPLIES TO ANY REAL PROPERTY USED IN BUSINESS. THE
INTENT OF THE GOVERNMENT IS TO ENCOURAGE THE TRANSACTION OF BUSINESS.

56

LOSSES ARE CONSIDERED ORDINARY LOSSES.

IF YOUR ARE DEALING IN INVENTORY "SAY GOODBYE" TO CAPITAL GAINS TAX
RATES. IF YOU ARE CLASSIFIED AS A DEALER IN REAL ESTATE, YOU ARE DEALING
IN INVENTORY. IF THE REAL ESTATE IS HELD PRIMARILY FOR THE SALE TO AN
INVESTOR, IT IS INVENTORY.
READ THE SECTIONS ON "DEALERS IN REAL ESTATE". CAPITAL GAINS AND LOSSES
OF INDIVIDUALS AND CORPORATIONS.
CAPITAL AND ORDINARY GAINS AND LOSSES
I.E. INDIVIDUAL WITH

50,000 SALARY
6,000 INTEREST AND DIVIDENDS

HE BUYS AND SELL REAL ESTATE AS AN INVESTOR, NOT A DEALER. HE BUYS A

PROPERTY, PARCEL A, FOR HIS BASIS OF 100K. HE SELLS IT FOR 110K. PARCEL
B WAS BOUGHT AT A BASIS OF 200K, AND SOLD FOR 197K.
10000 GAIN ON A
3000 GAIN ON B
NOW WE NEED TO DESCRIBE IT AS A SHORT TERM OR LONG TERM LOSS OR GAIN.
IF THE PERIOD IS LONGER THAN ONE YEAR, IT IS LONG TERM.
IF BOTH ARE LONG TERM, WE CAN MATCH THEM.
10000 MINUS 3000 EQUALS 7000.

THIS IS CALLED MATCHING LIKE ASSETS.

THEREFORE THE TAX STATEMENT WILL REGISTER 50000 SALARY

6000 DIVIDENDS
7000 GAIN ON SALE
ESTATE
(LONG
TERM
GAINS)

OF REAL
CAPITAL

THE TAXABLE INCOME WILL THEREFORE BE 63000 DOLLARS.

IN THE NEAR FUTURE, PROFESSOR WATERS PREDICTS LONG TERM CAPITAL GAINS
HAVE THE MOST FAVORABLE POSITION.
THIS IS WHERE YOU GET MAXIMUM TAX
FAVOR.
REMEMBER THAT CERTAIN CAPITAL GAINS ARE TREATED BETTER.
LONG
TERM CAPITAL GAINS ARE ONE OF THESE TYPES. IF YOU HOLD FOR MORE THAN ONE
YEAR, YOU ARE NOT A "SPECULATOR". AS OF THIS DATE, HOWEVER, THERE IS NO
BENEFIT TO CAPITAL GAINS AS OPPOSED TO ORDINARY GAINS SINCE BOTH ARE
TAXED AT THE SAME RATE.
IF IN THE SAME SITUATION AS ABOVE, WITH THE EXCEPTION THAT THEY WERE HELD
LESS THAN A YEAR, BOTH ARE SHORT TERM CAPITAL GAINS. SHORT TERM CAPITAL
GAINS ARE TREATED AS ORDINARY INCOME.
ANOTHER EXAMPLE;

57

PARCEL A

100K BOUGHT
80K SOLD
20K LOSS (LONG TERM CAPITAL GAIN)

PARCEL B

200K BOUGHT
205K SOLD
5K GAIN (LONG TERM CAPITAL GAIN)

TOTAL LOSS IS 15K

AS AN INDIVIDUAL, IT IS NOT TRANSFERABLE TO THE 50K SALARY AND THE 6K
INTEREST AND DIVIDEND IN THE PREVIOUS EXAMPLE. YOU CAN NOT DEDUCT THE
15K LOSS BECAUSE YOU CAN NOT DEDUCT MORE THAN 3K IN CAPITAL LOSS AGAINST
ORDINARY INCOME.
56K - 3K = 53K WHICH IS THE TAXABLE INCOME. 12K REMAINS IN CAPITAL LOSS
WHICH CAN BE APPLIED BACKWARDS 5 YEARS, AND FORWARD UNLIMITEDLY.
THE 3K LOSS LIMIT ALSO APPLIES TO SHORT TERM LOSSES; THE 3K LOSS IS ONLY
ALLOWED TO INDIVIDUALS. NOTHING IS PERMITTED TO THE CORPORATION, SINCE
THEY MAY NOT MATCH CAPITAL GAINS WITH ORDINARY GAINS SUCH AS THAT FROM
INCOME, INTEREST AND DIVIDENDS.
SAY THE SAME
CORPORATION.

SITUATION

AS

ABOVE,

BUT

THE

ENTITY

IS

SCHEDULE

50 K EARNINGS + 6K DIVIDEND AND INTEREST = 56K

THE LOSS CAN BE CARRIED BACK 3 YEARS AND CARRIED FORWARD 5 YEARS. AFTER
5 YEARS, THE LOSS IS LOST.
THE LOSS MUST BE "MATCHED" WITH LIKE KIND
GAINS. ORDINARY GAINS AND CAPITAL GAINS MAY NOT BE MATCHED, UNLIKE
INDIVIDUALS WHO MAY MATCH UP TO 3K ANNUALLY.
THE C CORPORATION CAN NOT USE THE LOSSES UNLESS THEY CAN MATCH AGAINST A
CAPITAL GAIN.
THE S CORPORATION UNDER THE SAME CIRCUMSTANCES IS CALCULATED AS SHOWN
BELOW:
50 K EARNINGS AND NET INCOME + 6K INTEREST AND DIVIDENDS =56 K
56K TAXABLE ORDINARY INCOME - 15K TAXABLE CAPITAL LOSS
THE 3 STOCKHOLDERS WILL SEE THE FOLLOWING
ON THE K-1;
50000 / 3 = 16,666 INCOME PER SHAREHOLDER
6000 / 3 = 2K DIV. AND INT. PER SHAREHOLDER
-15K / 3 = 5K CAPITAL LOSS PER SHAREHOLDER

58

EACH INDIVIDUAL WOULD BE ABLE TO DEDUCT UP TO 3K ON THIS YEARS PERSONAL

TAX FORM.
PROBLEMS HANDED OUT
NEXT WEEK CLASSMATE BY CLASSMATE INTERROGATIONS ON ANSWERS
END OF CLASS FIVE
CLASS SIX 6/29/90
SECTION 267 OF THE IRC HANDED OUT
RELATED PARTIES-LOSS
TODAY'S LECTURE ON;
DEPRECIATION
PASSIVE LOSSES
BASIS RULES
AT RISK RULES
NON-RECOURSE DEBT - A DEBT FOR WHICH YOU ARE NOT PERSONALLY LIABLE, SINCE
THE CREDITOR AGREES TO LOOK TO THE PROCEEDS OF THE PROPERTY TO EXTINGUISH
THE DEBT AND NOT THE ASSETS OF THE OWNER.
THE TAX CONSEQUENCE IS
THAT YOU DO NOT GENERALLY GET BASIS FOR NON
RECOURSE LOANS. IN ORDER TO HAVE BASIS, THERE MUST BE RECOURSE. IN A
SINGLE LOAN, THERE MAY BE SOME FOR WHOM THE CREDITOR HAS RECOURSE AND
SOME FOR WHOM HE DOES NOT (IE. IN A PARTNERSHIP).
I.E. A NON-RECOURSE MORTGAGE ON A 100K PROPERTY WITH 10K DOWN AMOUNTS IN
A 10K BASIS, NOT A 100K BASIS.
WHEN THE NON-RECOURSE DEBT WAS TAKEN PRIOR TO 10/22/86, THE DEBT APPLIES
TO BASIS. THIS IS THE GRANDFATHER CLAUSE.
SEE THE BOOK FOR QUALIFICATIONS NEEDED FOR A BANK TO GIVE NON-RECOURSE
LOANS.
*****
AT RISK RULES
*****
INVESTED CASH, PROPERTY, SERVICES, OR DEBT FOR WHICH ONE IS PUT AT RISK
OF LOSING IT.
THE AT RISK BASIS IS COMPRISED OF PRECISELY THESE
ELEMENTS.
THE ADJUSTED BASIS:
MINUS:
DISTRIBUTIONS, DIVIDENDS (IN AN S CORP.), REPAYMENT OF DEBT
PRINCIPAL.

59

PLUS: NET INCOME, ADDITIONAL INVESTMENT, ADDITIONAL QUALIFIED DEBT.

PASSIVE LOSS RULES:
THREE TYPES OF INCOME
PASSIVE INCOME- MOST REAL ESTATE DERIVED INCOME. ANY ACTIVITY WHERE YOU
DO NOT TAKE AN ACTIVE ROLE.
ACTIVE INCOME - SALARY, COMMISSIONS, FEES...WHAT YOU EARN FROM THE SWEAT
OF YOUR BROW (ALSO CALLED EARNED INCOME).
PORTFOLIO INCOME - INTEREST, DIVIDENDS, T-BILLS, STOCKS, ETC.
THE
DISTINCTION WITH PASSIVE INCOME IS THAT PORTFOLIO INCOME IS PRIMARILY
FROM INVESTMENTS. ALSO CALLED UNEARNED INCOME.
ADDITIONALLY, THERE IS IMPUTED, OR PHANTOM INCOME.
IT IS INCOME THAT IS
NOT EARNED PER SAY, BUT EXISTS BY DEFINITION DUE TO A SPECIFICALLY
CONSTRUCTED TRANSACTION. FOR EXAMPLE, IN A LOAN TO A FROM B AT 6 PERCENT
WHEN LOANS MARKET AT 10 PERCENT, THE 4 PERCENT DIFFERENCE IS IMPUTED
INCOME.
P.I.G.
A.G.I.

=
=

PASSIVE INCOME GENERATOR

ACTIVE GROSS INCOME

ACTIVE EARNED INCOME

PASSIVE
PORTFOLIO
AGI
********************************************************************
100K
(50K)
20K
7OK
YEAR ONE
100K
SOLD FOR
20K
80K
YEAR TWO
10K -LOSS OF
40K
40 K OF LOSSES IS GENERATED AT SALE IN YEAR TWO. AFTER THE LOSSES ARE
OFFSET AGAINST ANY PASSIVE INCOME, THE REMAINING AND OUTSTANDING LOSSES
MAY BE APPLIED AGAINST THE OTHER TYPES OF INCOME.
PASSIVE LOSSES OTHERWISE STAY ONLY WITH PASSIVE GAINS, AND SINCE 10/22/86
CAN NOT BE APPLIED AGAINST ANY OTHER TYPE OF INCOME.
IN THE YEAR OF DISPOSITION THE PASSIVE LOSS IS MATCHED AGAINST ANY OTHER
INCOME IN THE PASSIVE CATEGORY, THEN IT IS FREE TO BE MATCHED AGAINST
OTHER INCOME. THE ENTIRE PROPERTY, NOT SHARES OF IT, MUST BE SOLD
HOWEVER, AND THE PASSIVE LOSS MAY BE MATCHED FOR ALL INCOME BACKWARD AND
FORWARD AS PER THE RESTRICTIONS IN THE INTERNAL REVENUE CODE.
**********
PHASE IN RULES
PASSIVE LOSSES CAN BE USED ONLY AGAINST GENERATED PASSIVE INCOME, EXCEPT

60

UNDER THE PHASE IN RULES. IN 1987, YOU COULD TAKE 65% OF YOUR LOSS, IN
1988, 40 PERCENT, IN 89, 20 PERCENT AND IN 1990, 10 PERCENT, WHEN THE
LOSSES COME FROM PROPERTY PURCHASED BEFORE 10/22/86.
IF YOU BOUGHT
BEFORE THIS DATE, THEN THE PASSIVE LOSSES MAY, UNDER THE PERCENTAGE
LIMITS, BE OFFSET BY ANY TYPE OF INCOME GAIN, NOT JUST PASSIVE.
DEPRECIATION - THE HISTORY OF DEPRECIATION RATES
FOR COMMERCIAL PROPERTY - 31.5 YEARS.
FOR RESIDENTIAL PROPERTY - 27.5 YEARS.
STARTING IN 1981, WE BEGAN THE ACRS METHOD OF DEPRECIATION (THE
ACCELERATED COST REDUCTION SYSTEM).
SINCE 1987, IT HAS BEEN THE MACRS
(THE MODIFIED ACRS).
1981 - 15 YEARS DEPRECIATION
1982 - 84 18 YEARS OF DEPRECIATION
1985 - 86 19 YEARS OF DEPRECIATION
PRIOR TO 1981, THE ESTIMATED ECONOMIC LIFE WAS USED.
A.M.T.
- THE ALTERNATIVE MINIMUM TAX.
A PERSON WHO HAS REDUCED HIS
TAXABLE INCOME BY REASON OF DEDUCTIONS SUCH AS ACRS, YOU MUST ADD BACK
THE ACCELERATED DEPRECIATION WHEN COMPUTING TAXABLE INCOME.
THEREFORE
TAX PLANNING CALLS FOR AN OPTION OF 40 OR 50 YEARS OF DEPRECIATION,
DEPENDING ON THE TYPE OF BUILDING, RATHER THAN 27.5 OR 31.5 YEARS.
END OF CLASS SIX

CLASS SEVEN
7/5/90
FINAL EXAM IS ON THURSDAY, AUGUST 9TH, 1990
TERM PAPER IS DUE THURSDAY, AUGUST 2ND, 1990
TERM PAPER
10 PAGES DOUBLE SPACED
GIVE CITATIONS, IE. SECTION XXX, IRC. 1986
MENTION THE CODE AND REGULATIONS IN A CITE AT LEAST ONCE.
COURT CASES SHOULD BE MENTIONED AS APPLICABLE.
RESEARCH

61

THREE JOURNALS IN LIBRARY:

1. THE JOURNAL
2. REAL ESTATE
3. REAL ESTATE
SOURCES MAY BE

OF REAL ESTATE TAXATION QUARTERLY

ACCOUNTING AND TAXATION
LAW JOURNAL (HAS A DEPARTMENT OF TAXATION IN EVERY ISSUE)
FOUND AT:

THE N.Y.U LAW LIBRARY

THE STERN MBA LIBRARY
THE JOURNAL OF TAXATION (MONTHLY, HAS A REAL ESTATE CORNER)
"THE BEST TAX JOURNAL PUBLISHED" ACC. TO PROF. WATERS
THE TAX ADVISOR (AMERICAN INST. OF CPA'S)
MONTHLY, 50-70 PERCENT OF ISSUES HAVE ARTICLES ON REAL ESTATE.
TAXES (PUT OUT BY CCH)
THE JOURNAL OF ACCOUNTANCY
THE CPA JOURNAL
(BOTH PUT OUT ARTICLES ON ACCOUNTANCY)
THE AMERICAN BAR ASSOCIATION JOURNAL
THE AMERICAN BAR ASSOCIATION TAX BULLETIN
(BOTH DEAL WITH TAX LAW)
TRY TO KEEP ARTICLES AS RECENT AS POSSIBLE IN ORDER THAT THE ITEMS BE
CURRENT.
TYPICAL TOPICS:
THE SALE LEASEBACK TRANSACTION AND THE LAW OF TAX DEDUCTIBILITY OF REAL
ESTATE TAXES FOR THE COOP APARTMENT OWNER
DEFINING ACTIVITY UNDER THE NEW PASSIVE ACTIVITY LOSS RULES
TYPICAL TOPICS (CONT)_
CAPITAL GAINS IN REAL ESTATE
AT RISK RULES APPLICATION
COOP HOUSING AND SECTION 216 OF THE CODE
THE LOW INCOME HOUSING
AFFORDABLE HOUSING

CREDIT

AND

ITS

IMPACT

SECTION 263 AND CONSTRUCTION COST CAPITALIZATION

62

ON

THE

PROVISION

OF

PASSIVE LOSS AND AT RISK RULES

UNTIL 1986, REAL ESTATE WAS EXEMPTED FROM AT-RISK RULES.
NON-RECOURSE
LOANS WERE PERMISSIBLE FOR PURPOSES OF DETERMINING BASIS FOR OFFSETTING
LOSS BEFORE 10/22/86.
FOR PROPERTY PURCHASED BEFORE 10/22/86, INVESTMENT IN REAL ESTATE MUST BE

OR

RECOURSE DEBT,
QUALIFIED NON RECOURSE DEBT.
QUALIFIED NON RECOURSE DEBT:
SECURED (EQUIVALENT OF A MORTGAGE) BY THE REAL PROPERTY USED IN THE
ACTIVITY.
SEE THE LISTING OF THE FOUR QUALIFICATIONS IN SECTION 7.062, PAGE 7-33 OF
THE TEXT.
PASSIVE LOSS RULES - EXCEPTION (SEE TEXT 6.08[2])
THE 25,000 LOSS (FOR MOM'S AND POP'S)
UP TO 25,000 IN PASSIVE LOSS MAY BE APPLIED TO OTHER TYPES OF INCOME,
ANNUALLY, UNDER THE FOLLOWING CONDITIONS.
1. MUST BE FROM RENTAL REAL ESTATE ACTIVITIES
2. ACTIVE PARTICIPATION
"ACTIVE PARTICIPATE" MEANS THAT YOU REVIEW THE LEASES, THE PEOPLE
WHO RENT FROM YOU OR SUMMATIONS TO THIS EFFECT FROM YOUR AGENT,
ETC. YOU CAN NOT GIVE TOTAL AUTONOMY TO YOUR MANAGER IN ORDER TO QUALIFY
AS ACTIVE PARTICIPATION.
3. 10 PERCENT OR MORE OF THE PROPERTY IS OWNED BY YOU.
4. ADJUSTED GROSS INCOME CAN NOT EXCEED 100,000 . IF IT DOES, THE 25,000
IS REDUCED 50 CENTS FOR EVERY DOLLAR OVER 100,000 UP TO 150,000
DOLLARS.
PASSIVE LOSS "GOES OUT" AFTER YOU DISPOSE OF THE ACTIVITY.
FREES UP YOUR LOSS.

DISPOSITION

PASSIVE LOSS IS COMPUTED EACH YEAR. FOR EACH ACTIVITY YOU MUST DETERMINE
WHETHER
YOU HAVE GAIN OR LOSS.
IN OTHER WORDS, FOR EACH SEGMENTED
PROPERTY, YOU MUST DETERMINE GAIN OR LOSS SEPARATELY.
EACH UNIT MUST
REPORT NET GAIN OR LOSS, AND THEN YOU COMBINE THEM.
IE.

LOSS
20K
30K
40K
50K

YEAR
87
88
89
90 YEAR OF DISPOSITION, 200K GAIN

63

HISTORY OF PROPERTY:
PAID 3.2M FOR PROPERTY.

BASIS IS 2M. SOLD FOR 2.2M

GAIN IS 200K

THE LOSS COMES FROM INCOME MATCHED AGAINST EXPENSES.

LOSS EXCEEDED THE GAIN.

IN THIS CASE, THE

THE LOSSES ARE FIRST APPLIED TO THE SALE TRANSACTION AND ONLY THEN IS IT
FREED TO COVER OTHER PROPERTIES.
SECTION 469 - PASSIVE LOSS RULES
REGULATION 1.469, MARCH 89, AND MARCH 90 130 PAGES, VERY COMPLEX
THE CAMPBELL CASE (REFER TO LECTURE ONE) HAS BEEN WRITTEN ABOUT IN THE
JOURNAL OF TAXATION, JULY ISSUE
WHO DO PASSIVE LOSS RULES APPLY TO?
1. TO INDIVIDUALS
2. TO PARTNERSHIPS
1065 FORM SHOWS THE BOTTOM LINE TAXABLE INCOME.
IT WILL BE
DISTRIBUTED TO THE PARTNERS AS PER SHARE, SHOWN ON THE K-1. THE
K-1 STATES WHETHER LOSS IS ACTIVE OR PASSIVE.
3. S CORPORATION
THE 1120-S FORM SHOWS THE BOTTOM LINE TAXABLE INCOME. THE K-1 IS
GENERATED SHOWING THE SHAREHOLDER'S PORTION OF LOSS OR INCOME
4. C CORPORATION
THOSE CALLED "CLOSE CORPORATIONS", THAT IS WITH 5 OR LESS
STOCKHOLDERS.
READ SECTION 7.06 TO 7.12 IN TEXT ON DEDUCTION OF INTEREST
END OF CLASS SEVEN
CLASS EIGHT
7/12/90
FORM 1065 (K-1) PASSED OUT
K-1 - THE PARTNER'S SHARE OF INCOME, CREDITS, DEDUCTIONS, ETC.
ALL PARTNERSHIPS, BE THEY REAL ESTATE INVESTMENT, ACCOUNTING, LAW, SMALL
BUSINESSES, ETC., MUST FILE THE K-1.
ITEM A: GENERAL PARTNER? TRY TO GET A COPY OF RECENT TAX RETURNS FOR THE
PAST YEARS WHEN EVALUATING THE PURCHASE OF AN INTEREST IN THE
PARTNERSHIP.
ITEM B: NON-RECOURSE?
ITEM C: TRUST? ESTATE? CORPORATION?

64

ITEM D: FOREIGN PARTNER?

ITEM E: PROFIT SHARING...........PERCENT OF TOTAL
LOSS SHARING.............
"
"
"
OWNERSHIP OF CAPITAL.....
"
"
"
ITEM G: 50.00 DOLLAR FINE FOR NOT INCLUDING THE REGISTRATION NUMBER.
ITEM I: PTP? PUBLICLY TRADED PARTNERSHIP
IF SO, LOSSES MUST BE SEGREGATED FROM OTHER PASSIVE LOSSES. PTP'S
ARE A DIFFERENT BREED OF PASSIVE LOSSES THAN TYPICAL PASSIVE
LOSSES.
DURING 1987, PTP'S BENEFITTED FROM A LOOPHOLE THAT ALLOWED A PARTNERSHIP
WITHOUT THE APPLICATION OF PASSIVE LOSS RULES.
IT RESEMBLED A
CORPORATION. AS OF 1/1/88, PTP'S, "A PARTNERSHIP TRADED OVER THE COUNTER
ON AN EXCHANGE", LOSSES FOR THE ENTITY WERE SEGREGATED FROM OTHER PASSIVE
LOSSES.
ITEM K: CAN THE PERSON TAKE ADVANTAGE OF ANY LOSS APPEARING FURTHER ON IN
THE FORM? DO THEY HAVE ADDITIONAL BASIS?
RENTAL REAL ESTATE ACTIVITIES ARE PASSIVE LOSSES.
QUESTION:

DO YOU HAVE POSITIVE BASIS

DOES THE FINANCING THAT YOU HAVE QUALIFY FOR BASIS?

DURING THE ACTIVITY OF REAL ESTATE INVESTMENT, MONEY COMING IN IS

INVESTED, EARNS INCOME, AND IS NOT OFFSET BY PASSIVE LOSSES UNDER THE
PASSIVE LOSS RULES.
ADVANTAGE OF SECTION 1231 GAIN IS THAT IT IS TREATED AS A CAPITAL GAIN
-SEE ITEM K(6) OF K-1 FORM. THIS IS IMPORTANT IF CAPITAL GAINS TAX IS
EVENTUALLY REDUCED.
K-1 DEDUCTIONS - CHARITABLE DEDUCTIONS FLOW THROUGH TO THE PARTNERS AS
A PER SHARE OF PARTNERSHIP, AS DO THE OTHER DEDUCTIONS.
THE "S" CORPORATION K-1 (FORM 1120 S)
ITEM A - SHAREHOLDER'S PERCENTAGE OF STOCK.
OTHER ITEMS PRETTY MUCH THE SAME AS OTHER PARTNERSHIP'S K-1 FORM.

DEPRECIATION - SECTION 179

SECTION 6.06 OF THE TEXT

65

PERTAINS TO PERSONAL PROPERTY, NOT REAL PROPERTY.

PERTAINS TO THE
REPORTING ON THE K-1 FORM.
PUT IN TEN YEARS AGO, AND UPGRADED IN THE
1986 ACT. AN INDIVIDUAL ENTITY IN OPERATING A BUSINESS, MAY CHOOSE TO
CAPITALIZE THE ITEM THAT BENEFITS THE BUSINESS FOR A PERIOD OF OVER ONE
YEAR WHEREAS BEFORE IT HAD TO BE DEPRECIATED.
APPLIES
UP TO 10,000
DOLLARS. NOT FOR PERSONAL USE (SECTION 38) ITEMS SUCH AS CARS. IF YOUR
COMPANY SPENDS MORE THAN 200,000 DOLLARS FOR EQUIPMENT IN A TAX YEAR, IT
LOSES THE SECTION 179 DEDUCTION.
K-1 FOR PARTNERSHIPS, ITEM 9
SECTION 179 - IF THE PARTNERSHIP TAKES THE 10,000 DOLLAR CAPITALIZATION
OF THE ITEM, AND YOU HAVE PARTNERS, EACH PARTNER HAS 2,500 DOLLARS PASSED
THROUGH TO THEM AS A DEDUCTION AGAINST INCOME. THIS AMOUNT IS LISTED AT
ITEM 9.
THE SECTION 179 LOSS IS ALLOWABLE ONLY TO THE EXTENT THAT YOU HAVE INCOME
FROM YOUR ACTIVITIES. SEE SECTION 6.06 OF THE TEXT.
IF YOU DON'T USE IT, YOU LOSE IT.
KNOW THE FOLLOWING; IT WILL APPEAR ON THE EXAM.
YOU CAN GET THE DEDUCTION IF YOU HAVE A LOSS IN YOUR REAL ESTATE
PARTNERSHIP AS LONG AS YOU CAN OFFSET IT WITH INCOME FROM ANOTHER
ACTIVITY, EVEN EARNED SALARY INCOME.
IF YOU OWN SHARES IN TEN PARTNERSHIPS, FOR EXAMPLE, EACH WITH 2,500
DOLLARS IN SECTION 179 DEDUCTIONS (25,000 TOTAL), YOU CAN TAKE 10,000
THIS YEAR AND CARRY OVER THE REST TO FUTURE TAX YEARS.
DEDUCTIONS (CONT)
ITEM 11 (OTHER DEDUCTIONS)
MEDICAL INSURANCE PREMIUMS - A PARTNER
INSURANCE PREMIUMS, AS HE DOES FOR HIS
PARTNERS HAVE A DEDUCTION OF UP TO 25%
DOLLARS IN PREMIUMS YIELDS A 750 DOLLAR

MAY NOT FULLY DEDUCT HIS MEDICAL

EMPLOYEES. UNDER THE 1986 CODE,
OF INSURANCE PREMIUMS. IE. 3000
DEDUCTION.

THIS IS NOT TRUE IN C CORPORATIONS.

IF YOU OWN MORE THAN 2 PERCENT OF AN S CORPORATION, YOU ARE NOT ENTITLED
TO MEDICAL INSURANCE PREMIUM DEDUCTIONS.
AS OF 1990, ITEM 10 OF THE
1120S FORM WOULD ALLOW A 25 PERCENT DEDUCTION OF PREMIUMS, THE SAME AS IN
THE PARTNERSHIP.

QUALIFIED NON-RECOURSE DEBT

66

SECTION 7.06[2] OF THE TEXT

4 TESTS:
ONCE INDEBTED IN OBLIGATION, TO GET BASIS THE NON-RECOURSE LOAN MUST;
1. BE BORROWED BY THE TAXPAYER WITH RESPECT TO THE ACTIVITY OF
OWNING REAL PROPERTY ( INCLUDES HOTELS, MOTELS, INCOME
PRODUCING
RESIDENTIAL USES, DOES NOT INCLUDE MINERAL RIGHTS ).
2. MUST BE BORROWED FROM A QUALIFIED PERSON AS DEFINED IN THE ATRISK RULES. IT SHOULD NOT BE ANY RELATED PERSON OR CORPORATION IN
WHICH YOU OWN SHARES. A BANK WOULD BE GOOD AS LONG AS YOU DO NOT
OWN 20 PERCENT OR MORE OF THE BANK. PURCHASE MONEY MORTGAGE IS NOT
QUALIFIED BECAUSE THE LAND SALE IS RELATED TO THE LENDER, WHO IS AT
ONCE THE PAST OWNER OF THE TITLE AND THE MORTGAGEE.
THE LENDER MUST NOT RECEIVE A FEE OR EQUITY PARTICIPATION ON THE
INVESTMENT FOR WHICH THE LOAN IS MADE.
AN AGENCY OF GOVERNMENT GUARANTEEING THE OBLIGATION IS QUALIFIED
NON-RECOURSE DEBT.
3. NO OTHER
FINANCING.

PERSON

MAY

BE

RESPONSIBLE

FOR

REPAYMENT

OF

THE

4. CAN NOT BE CONVERTIBLE DEBT.

KNOW THAT IT IS RELATIVELY EASY TO QUALIFY FOR QUALIFIED NON-RECOURSE
DEBT.
KNOW WHERE TO FIND THE TESTS IN THE CODE (SECTION 465).
EXAMPLE: GEN A 20M PROPERTY WITH A MORTGAGE OF 5M. ABC PARTNERSHIP WANTS
TO BORROW 5M MORE; THEIR BASIS IS 5M, AND THEY BOUGHT FOR 5M. THEY WANT
TO GET A NEW 10M QUALIFIED NON-RECOURSE LOAN AND PAY OFF THE OLD 5M
UNQUALIFIED NON-RECOURSE DEBT.
THE 1986 CODE EXPLANATIONS BY THE JOINT WAYS AND MEANS COMMITTEE, CALLED
THE "BLUE BOOK" (2 VOLS. PAPERBACK) IS THE "CONFERENCE COMMITTEE
EXPLANATIONS".
READ SECTION 11.06, CAPITAL GAINS
11.30 TAX CREDITS (LOW INCOME HOUSING CREDIT)
7.06, 7.10 TO 7.12 TAX DEDUCTIONS FOR INTEREST
6.02 CONSTRUCTION PERIOD INTEREST AND TAXES
6.05 REAL ESTATE EXPENSES (START UP COSTS)
11.01 TO 11.02 DISPOSITION OF REAL ESTATE
11.11
KNOW HOW TO IDENTIFY HOW YOU CAN COMPUTE A GAIN OR LOSS UPON THE
DISPOSITION OF A PROPERTY.

67

TWO WEEKS FROM TODAY, ONE OF THE MOST IMPORTANT LECTURES; LIKE-KIND
EXCHANGES.
SECTION 10.31 OF THE IRC, ITEM C, ON PAGE 2, 7 AND 8.
LIKE-KIND EXCHANGES CAN BE FOUND IN SECTION 12.04 OF THE TEXT.
EXTREMELY IMPORTANT, YOU WILL SEE IT ON THE FINAL.
********
RECOGNITION OF GAIN OR LOSS
X, AN INDIVIDUAL, STARTS THE X CORPORATION.
IN SO DOING HE CONVEYS
PROPERTY, AN OFFICE BUILDING, WITH X'S TAX BASIS OF 1 MILLION DOLLARS TO
THE CORPORATION. UPON TRANSFERENCE X, WHO OWNS 100 % OF THE CORPORATION,
TRANSFERS THE BASIS AS CARRYOVER BASIS, AND THE CORPORATION'S BASIS IS 1
MILLION DOLLARS. IF 5 YEARS FROM NOW THE ADJUSTED BASIS AFTER
DEPRECIATION IS 500,000 AND THE PROPERTY IS SOLD BY THE CORPORATION FOR 5
MILLION. TAX PAID BY THE CORPORATION ON 4,500,000 DOLLARS.
IF YOU HAVE A TRANSFER BY WAY OF A GIFT:
A IS DAD, WHO BUYS A BUILDING FOR 5 MILLION.
MILLION. HE GIFTS IT TO B, HIS SON.

HE DEPRECIATES IT TO 2

AS A RECEIVER OF THE GIFT, B TAKES THE BASIS OF THE DONOR, A, HIS DAD.
ON THE DATE OF THE GIFT (OR DEATH, SEE BELOW), THE FMV IS 20,000,000
MILLION DOLLARS. IF THE PROPERTY IS CEDED THROUGH WILL, THE FORM 706 FOR
ESTATES WILL BE USED. THE FMV ON THE DATE OF DEATH IS THE BASIS FOR THE
SON. THE ADJUSTED BASIS FOR B IS NOW 20 MILLION. THE "ESTATE TAX" TAXES
THE PROPERTY BASED ON THE FMV AT 55%.
QUESTIONS FOR NEXT WEEK HANDED OUT.
END OF CLASS NINE
CLASS TEN
7/19/90
READING FROM THE TEXT: LEASES; 5.02, 5.07, 5.05, 2.03, 2.04
THE FACT THAT A PROPERTY WAS PURCHASED WITH A MORTGAGE DOES NOT CHANGE
THE FACT THAT ORIGINAL BASIS IS THE PURCHASE PRICE.
PURCHASE PRICE = THE ORIGINAL BASIS = MORTGAGE + CASH DOWNPAYMENT
LET'S ASSUME THAT THE VALUE OF THE LAND INCREASES TO A FMV OF 1.5 M, AND
HE TAKES OUT A 2ND MORTGAGE FOR 200K. THE BASIS IS STILL EQUIVALENT TO

68

THE ORIGINAL BASIS.

CHAPTER 11 NOTES:
DATE OF SALE - WHEN DOES THE PROPERTY BECOME "OWNED"? GENERAL RULE: WHEN
THE TITLE PASSES; A DEED SHOULD BE DELIVERED.
ALTERNATIVE MINIMUM TAX - KNOW WHAT IT IS AND HOW IT IMPACTS REAL ESTATE.
IT APPLIES TO ALL ENTITIES.
ITS PURPOSE IS TO CAPTURE TAXPAYERS (AN
ENTITY REQUIRED TO FILL OUT A RETURN) WHO DO NOT PAY ANY TAX. THEY HAVE
RECEIVED DIVIDENDS, INTEREST, ROYALTIES, AND COMPENSATION, YET STILL
REALIZE A TAX LOSS DUE TO LOSSES USED TO OFFSET GAINS. WHEN THE REGULAR
TAX DOES NOT RESULT IN A TAX, THE ALTERNATIVE MINIMUM TAX (A.M.T.) KICKS
IN.
11-27, 11-28
4 STEPS TO THE A.M.T.
1. TAKE TAXABLE INCOME
2. ADJUST PREFERENCES, ADD BACK PERSONAL EXEMPTIONS, THE TYPE OF INCOME
AND LOSS IS DIFFERENT FOR A.M.T. PURPOSES.
3. TAKE A SPECIFIC A.M.T. EXEMPTION.
4. ARRIVE AT THE A.M.T. INCOME TAX, CALCULATED AT 21%.
COMPARE THE REGULAR TAX AND THE A.M.T.; WHICHEVER IS HIGHER, YOU PAY.
THE EXEMPTION AMOUNT:
40,000 WHEN MARRIED FILING JOINTLY; 115,000 IS THE PHASE OUT AMOUNT.
30,000 WHEN SINGLE; 112,500 IS THE PHASE OUT AMOUNT.
20,000 WHEN MARRIED FILING SEPARATELY; 75,000 IS THE PHASE OUT AMOUNT.
11-29
PASSIVE LOSSES ALLOWED FOR A.M.T. PURPOSES, YET THERE ARE RESTRICTIONS ON
THEM THAT MAKE THEM LESS VALUABLE.
ACCELERATED DEPRECIATION IS A TAX PREFERENCE THAT IS ADDED BACK INTO THE
TAX INCOME.
DEPRECIATION PERIOD IS EXTENDED TO 40 YEARS SPECIFICALLY FOR A.M.T.
PURPOSES. NO ACCELERATED DEPRECIATION TAKES PLACE, IT IS STRAIGHT-LINE.
TAX EXEMPT INTEREST - I.E. MUNICIPAL BONDS. NON-TAXABLE FOR REGULAR TAX
PURPOSES, BUT IS TAXABLE FOR A.M.T. PURPOSES.
SOME BONDS ARE FOR
GOVERNMENTAL PURPOSES, SUCH AS SCHOOLS, ROADS, ETC. SOME BONDS ARE FOR
NON-GOVERNMENTAL PURPOSES, SUCH AS A BASEBALL STADIUM OR CONFERENCE
CENTER. THESE ARE CALLED PRIVATE ACTIVITY BONDS.
CHARITABLE CONTRIBUTIONS - IF YOU GIVE PROPERTY TO A CHARITABLE GROUP,
YOU DEDUCTION IS FOR THE FMV OF THE PROPERTY UNLESS THE PROPERTY IS

69

INVENTORY. IN THE CASE OF INVENTORY, THE DEDUCTION IS AT COST.

THE FMV CREDIT IS THEN AN "ADD BACK" SUBJECT TO THE ALT. MIN TAX. SEE
11.13 AND PAGE 11-37. APPRAISALS ARE REQUIRED WHEN THE VALUE EXCEEDS 5000
DOLLARS. EXAMINE THE CONTENTS OF 11.13. PENALTY OF 30% OF THE TAX IF
APPRAISALS ARE WITHOUT MERIT. THE PENALTY IS UPON THE APPRAISER.
REHABILITATION -THE INVESTMENT CREDIT WAS DONE AWAY WITH AS OF 1/1/86.
REHAB EXPENDITURES SAVED BY THE '86 ACT:
A TEN PERCENT CREDIT FOR NON-RESIDENTIAL BUILDINGS PLACED IN
SERVICE BEFORE 1936.
A TWENTY PERCENT CREDIT FOR CERTIFIED HISTORIC STRUCTURES.
CERTIFICATION MUST BE FROM AN INDEPENDENT RECOGNIZED LOCAL HISTORICAL
SOCIETY.
SEE PAGE 11-33; READ PARAGRAPH CAREFULLY AND UNDERSTAND!
11.14
FOREIGN INVESTORS REPORTING TAX ACT (FIRPTA)
* A FOREIGN CITIZEN RESIDING IN THE U.S. IS TAXED AS IF A U.S. CITIZEN
(RESIDENT ALIEN).
* A FOREIGN BUSINESS IS TAXED IN THE U.S. IF IT HAS U.S. CONNECTED
INCOME. NOTHING IS MORE "CONNECTED" THAN U.S. REAL ESTATE. (NON-RESIDENT
ALIEN)
IF YOU BUY PROPERTY FROM A NON-RESIDENT ALIEN, AND YOU ARE BUYING U.S.
PROPERTY, YOU MUST DETERMINE IF HE IS LIABLE FOR TAX, SINCE IF HE DOES
NOT PAY THE TAX YOU ARE LIABLE FOR IT. YOU MUST HAVE AN AFFIDAVIT FROM
THE SELLER THAT HE HAS COMPLIED WITH FIRPTA - YOU CAN GET CLEARANCE FROM
THE INTERNATIONAL TAX DIVISION IN PHILADELPHIA. THIS APPLIES EVEN WHEN A
MEMBER OF THE PARTNERSHIP YOU PURCHASED FROM IS A NON-RESIDENT ALIEN.
A U.S. ENTITY OWNING THE BUILDING AND PASSING INCOME TO THE FOREIGN
ENTITY IS TAXED ON THE GAIN AT SALE AND AGAIN AT THE LIQUIDATION OF THE
COMPANY. IF A U.S ENTITY IS NOT INTERCEDING, THEN THE TAX IS PAID ON THE
GAIN, AND NOT ON THE LIQUIDATION ALSO.
END OF CLASS TEN

CLASS ELEVEN 7/26/90

NEXT WEEK CLASS PROJECT DUE
FOLLOWING WEEK IS THE FINAL
C CORPORATIONS ARE NOT

UNDER PASSIVE LOSS RULES

70

UNLESS IT IS A CLOSELY

HELD C CORPORATION SUBJECT TO PASSIVE LOSS RULES.

FINAL EXAMINATION
2 TO 3 ESSAY TYPE QUESTIONS OF THE SORT IN CLASS ASSIGNMENT DUE 7/19/90
5 PROBLEMS OF THE TYPE HANDED OUT 7/26
TOPICS:
INSTALLMENT SALES
LIKE-KIND EXCHANGES
BASIS
PASSIVE LOSS RULES
CHOICE OF ENTITY
OPEN BOOK EXAM
WILL COVER THE ENTIRE COURSE, TO BE SUMMARIZED IN CLASS NEXT WEEK.
READ SECTION 10.31 OF THE IRC - NON-RECOGNITION OF GAIN
*********************************************************
NON-TAXABLE TRANSACTIONS: 3 TYPES
1. INSTALLMENT SALES
2. LIKE-KIND EXCHANGES
3. SALE OF A PERSONAL RESIDENCE
DETERMINE WHETHER OR NOT THE GAIN IS A REALIZED GAIN OR A RECOGNIZED
GAIN.
A REALIZED GAIN IS FROM SALES PROCEEDS MATCHED AGAINST A
DETERMINED BASIS. A RECOGNIZED GAIN IS THAT PORTION OF THE REALIZED GAIN
THAT IS RECOGNIZED IN A GIVEN TAX YEAR.
KNOW ABOUT REALIZED AND RECOGNIZED GAINS, KNOW HOW THEY INTERACT, AND HOW
THEY ARE USED.
SECTION 12 OF THE TEXT, PAGES 12-2, AND 12-3 INSTALLMENT SALES
FIRST YOU HAVE TO QUALIFY FOR INSTALLMENT SALE. IF YOU ELECT TO QUALIFY
FOR INSTALLMENT REPORTING, YOU WILL RECOGNIZE GAIN IN PARTS BY POSTPONING
TAX PAYMENTS.
IF YOU LIKE, YOU MAY PAY THE TAX BY NOT ELECTING THE
INSTALLMENT REPORTING METHOD.
THE PRINCIPLE OF THE INSTALLMENT METHOD OPTION IS THAT IT IS UNFAIR TO
TAX US ON PROCEEDS ARE NOT RECEIVED WHEN THE SALE FROM WHICH YOU RECEIVE
THE GAIN IS AN INSTALLMENT SALE.

71

IF YOU SELL A PROPERTY IN ONE YEAR, TO QUALIFY FOR INSTALLMENT ELECTION,

YOU HAVE TO RECEIVE AT LEAST ONE PAYMENT IN ANOTHER YEAR.
IE. SALE 1990, PROCEEDS TO BE PAID WITH INTEREST OVER 5 YEARS WITH 10
PERCENT INTEREST FOR 1 MILLION DOLLARS AND WITH A BASIS OF 500K.
WE
HAVE A 500K GAIN. IN THE YEAR OF SALE WE RECEIVED 100K CASH AS ONE OF THE
PAYMENT INSTALLMENTS.
TAX GAIN = 500K. IF WE DO NOT ELECT THE INSTALLMENT METHOD, IN THE CASE
OF AN INDIVIDUAL, IF WE DO NOTHING ABOUT THIS, WE WILL BE TAXED ON THE
ENTIRE GAIN AT 28 PERCENT, AND WILL BE PAYING MORE THAN WE RECEIVE. IF
WE MEET CERTAIN CONDITIONS (DISPOSITION OF REAL PROPERTY, NO INVENTORY,
INVESTMENT PROPERTY) WE MAY ELECT THE INSTALLMENT METHOD.
NOTE: TEST FOR WHETHER PROPERTY IS INVENTORY... YOU DO NOT HOLD THE LAND
FOR INVENTORY, YOU HOLD IT FOR INCOME GAIN.
READ SECTION 12.02 OF THE TEXT
12-5, 12-13
THE GAIN ON THE SALE IS PAID RATABLY. THE AMOUNT OF INCOME IS FIGURED BY
MULTIPLYING THE PAYMENT RECEIVED BY THE GROSS PROFIT RATIO TO EQUAL THE
ANNUAL GAIN.
GROSS PROFIT RECEIVED
__________________________
GROSS PROFIT RATIO =
CONTRACT PRICE
500,000 (THE REALIZED GAIN) / 1,000,000 (THE CONTRACT PRICE) = 50%
100,000 (THE INSTALLMENT
RECOGNIZED GAIN)

PAYMENT)

50%

(THE

GPR)

50,000

(THE

THE PURPOSE OF USING GPR IS THAT PAYMENT IS DIVIDED INTO "PROFIT" AND
"PAYMENT ON BASIS".
YOU
CAN ADJUST GROSS PROFIT BY ANY COST OF SALE SUCH AS BROKERAGE
COMMISSION. ADD SELLING COSTS TO BASIS.
ANY INTEREST COMPENSATION ON THE INSTALLMENT IS INTEREST INCOME AND HAS
NOTHING TO DO WITH ADJUSTMENTS TO THE GROSS PROFIT RECEIVED.
EXAMPLE:
INTEREST RATE PREVALENT AT 10%
SUPPOSE YOU FIND SOMEONE WHO WILL BY THE PROPERTY AT 3% FOR INTEREST ON
THE BALANCE. WATCH OUT FOR TAX RULE OF IMPUTED INTEREST. IF YOU SELL
PROPERTY SUBJECT TO A NOTE, MORTGAGE, OR DIFFERED PAYMENT, INTEREST IS

72

EXPECTED TO BE CHARGED AT MARKET RATE.

YOUR IMPUTED INTEREST EXPENSE WILL BE BASED ON THE MARGIN BETWEEN 3 AND
10 PERCENT. THEREFORE, YOU WILL BE PAYING INTEREST INCOME GAINS TAX ON
7%.
12-19 INSTALLMENT SALES
AT ANY TIME, YOU CAN ELECT TO CANCEL FURTHER MEANS OF DEFERRAL AND PAY
THE TAXES ON THE REMAINING GAINS.
POSTPONE TAX - GOOD?

NOT ALWAYS TRUE.

IE. IF WE HAVE A 28 PERCENT RATE NOW AND 1991 SEES A 33 TO 38 PERCENT TAX
RATE, IT MIGHT MAKE SENSE TO ACCELERATE TAX PAYMENTS RATHER THAN DIFFER
THEM WITH THE INSTALLMENT METHOD.
SECTION 10.31 OF THE CODE - THE EXCHANGE OF LIKE-KIND PROPERTY
PG. 12-32 SECTION 12.04 OF THE TEXT
INSTEAD OF PAYING TAX ON THE SALE OF PROPERTY YOU CAN POSTPONE
RECOGNIZING THE GAIN WHEN YOU GO THROUGH AN EXCHANGE OF LIKE-KIND
PROPERTY NOT EXCHANGEABLE INTO CURRENCY.
SINCE YOU HAVE NOT RECEIVED
MONEY, NO GAIN IS REALIZED AND THEREFORE THE GAIN IS NOT TAXABLE BUT IS
DIFFERED.
HOW DOES IT QUALIFY?

THREE CONDITIONS:

1. PROPERTY MUST BE HELD FOR PRODUCTIVE USE IN A BUSINESS OR INVESTMENT.

RULES OUT PERSONAL USE PROPERTY, SUCH AS A HOME.
ALSO, INVENTORY
ELIMINATED, AS ARE PARTNERSHIP INTEREST SALES.
2. MUST BE AN ACTUAL EXCHANGE. THERE MUST BE CONVEYANCE OF TITLE.
OF OWNERSHIP MUST BE TRANSFERRED.

RISK

PROPERTY MUST BE IDENTIFIED WITHIN 45 DAYS BETWEEN THE TIME OF THE

TRANSACTION AND THE LOCATION OF THE PROPERTY TO BE SWAPPED. THEY MUST BE
CONVEYED WITHIN 180 DAYS.
SEE PAGE 12-36 "BOOT"; 12-42 "3 PARTY EXCHANGES"; 12-46 NON-SIMULTANEOUS
EXCHANGES.
BOOT - PROPERTY OTHER THAN THE PROPERTY BEING EXCHANGED AS PART OF THE
DEAL. ANY BOOT MUST BE RECOGNIZED TO THE POINT THAT THERE IS GAIN.
3. PROPERTIES THAT ARE EXCHANGED MUST BE OF LIKE-KIND.
END OF CLASS ELEVEN

73

CLASS TWELVE
8/2/90
FINAL EXAMINATION INFORMATION
EXPECT QUESTIONS ON:
FORECLOSURE
RESIDENTIAL SALE
COOPS AND CONDOS
SECTION 1031 EXCHANGES OF LIKE KIND PROPERTIES
CONDEMNATIONS
TAX GAIN RECOGNIZED VS. TAX GAIN REALIZED
1. LIKE KIND EXCHANGES - TAX CONCEPT (TAX GAIN REALIZED VS. TAX GAIN
RECOGNIZED) NOT THE SAME! SECTION 1031 TRANSACTION
2. INSTALLMENT SALES - SAME IDEA (REALIZED NOT THE SAME AS RECOGNIZED)
3. SALE OF RESIDENCE
4. INVOLUNTARY
TRANSACTION)

CONVERSION

INCLUDES

CONDEMNATION

(SECTION

1033

***************
DISCUSSION OF QUESTIONS CALLING FOR COMPUTATION -- RECOGNIZING THE REAL
ESTATE TAX PROBLEM IS CRITICAL! SAY WHAT THE PROBLEM IS BEFORE ANSWERING
THE QUESTION.
IE. "THIS INVOLVES A LIKE-KIND EXCHANGE", OR "THIS
INVOLVES A CONDEMNATION". SHOW WORK, ALTHOUGH THE COMPUTATION IS NOT AS
IMPORTANT AS SHOWING YOU UNDERSTAND THE CONCEPT.
EXPECT TO SEE ON FINAL:
INSTALLMENT SALES
BASIS
PASSIVE LOSS RULES
DEPRECIATION
YOU WILL LOSE CREDIT ON THE EXAM BY NOT EXPLAINING YOUR ANSWER. IF IT
HAS TO, FOR EXAMPLE, BE A CERTAIN KIND OF PROPERTY IN ORDER TO QUALIFY,
YOU MUST STATE THIS FACT.
*************************************************************************
***********************************************************************
FORECLOSURE - SECTION 9.1 AND 10.1 OF THE TEXT: THE BORROWER'S AND
LENDER'S VIEWPOINT.

74

IF YOU HAVE FORGIVENESS OF DEBT, THAT AMOUNTS TO AN EARNING OF INCOME.

ALTHOUGH YOU HAVE NOT ACQUIRED AN ASSET, YOU HAVE DECREASED YOU
LIABILITIES.
IF YOU HAVE NON-RECOURSE DEBT THAT IS FORGIVEN, IF IT
IDENTIFIES AS QUALIFIED NON-RECOURSE DEBT AND LATER THE MORTGAGE IS
FORECLOSED AND THE PROPERTY IS PUT UNDER BID AND THE MORTGAGE IS
CANCELED, YOU HAVE FORGIVENESS OF DEBT INCOME AMOUNTING TO THE DIFFERENCE
OF THE SALES PRICE AND THE MORTGAGE AMOUNT.
EXCEPTIONS:
1. IF THIS OCCURS OUTSIDE BANKRUPTCY WHEN THE PERSON IS INSOLVENT,
SECTION 108 APPLIES AND YOU DO NOT HAVE TAXABLE INCOME IN THE FORGIVENESS
OF DEBT.
2. BANKRUPTCY.
THE QUALIFICATIONS FOR INSOLVENCY: IN ORDER TO QUALIFY UNDER THE FIRST
EXCEPTION, YOU MUST BE INSOLVENT BEFORE AND AFTER THE APPLICATION OF THE
TAX. IF WHEN THE TAX BECOMES FORGIVEN YOU BECOME SOLVENT, THE TAX WILL
BE REINSTITUTED TO THE DEGREE NECESSARY TO TAKE BACK WHAT WAS GIVEN TO
YOU IN THE WAIVER OF TAXES. UNDER THE CODE, YOU MUST BE INSOLVENT BEFORE
AND AFTER THE TAXABLE EVENT IN ORDER TO BE CONSIDERED TRULY INSOLVENT.
END OF THE COURSE

75

MARKET ANALYSIS IN REAL ESTATE

PROFESSOR ROBERT BJORKLUND
AUTUMN 1989

MARKET ANALYSIS
PROFESSOR ROBERT BJORKLUND
INVESTOR, REALTOR
609-737-1717,1695
MARKET ANALYSIS AND SITE SELECTION
NOT INVESTMENT ANALYSIS, IT IS MARKET ANALYSIS
TRIVIA: 1ST MOST EXPENSIVE RETAIL IS ON THE GINZA IN TOKYO
2ND IS 57TH STREET IN NEW YORK CITY
BOB'S RULE:

BROKERS ARE INCOMPETENT

TYPES OF DATA, HOW THE INFORMATION IS USED, AND WHO ARE THE INFORMATION
USERS; THIS IS THE QUESTION YOU MUST ANSWER.
DATA:
SIMILAR INVENTORIES
POPULATION
INCOME
HOUSEHOLDS
AGE
SEX
GROWTH OF POPULATION
PUBLIC TRANSPORTATION
VACANCY RATE
RENTAL RATES
ABSORPTION RATE
FUTURE DEVELOPMENT
EXISTING ANCHORS
NEED FOR SPECIFIC STORES
LEASE TERMS IN AREA
LARGE USERS NEARBY
SQUARE FOOTAGE
CAPTURE RATE
CLIENT:

GENERAL TRANSPORTATION
SALES PER SQUARE FOOT
TENANT NEEDS
POLITICS AND POLITICAL CLIMATE
COMPETITIVE LAND RENT
COMPARATIVE LAND ACRE SALES
DEVELOPING INDUSTRIES
ENVIRONMENTAL RESTRICTIONS
SITE IMPROVEMENT COSTS
TRAFFIC STUDIES
HAZARDOUS WASTES
WETLAND
ENVIRONMENTAL ISSUES
PARKING
STREAMS
BUILDABLE AREA
MARKET USE CATEGORIES
HOW USED:

DEVELOPERS
IDENTIFY
TENANTS
COLLECT
BANKS (FINANCIERS, CREDITORS)
INTERPRET
MUNICIPALITY
EVALUATE
ADJACENT OWNERS
CITIZENS
COMPETITORS

75

INVESTORS
HOW TO COMPARE STUDIES
FOCUS
SPECIFIC TO SITE
SPECIFIC TO USE
LOCAL
REGIONAL
LARGER REGIONS
TYPES OF STUDIES
URBAN ANALYSIS - COULD BE AS LARGE AS A STATE
REGIONAL
ECONOMIC TRENDS
POPULATION TRENDS
EMPLOYMENT TRENDS
COMMUNITY ANALYSIS - SUB REGIONAL
ECONOMIC BASE ANALYSIS
MARKET ANALYSIS - LIMITED LOCALE
SUPPLY OF EXISTING REAL ESTATE WITHIN A DEFINED MARKET AREA
DEMAND OF EXISTING REAL ESTATE WITHIN A DEFINED MARKET AREA
MARKETABILITY
SITE SPECIFIC
USE SPECIFIC
NEED APPRAISAL, FEASIBILITY STUDY,
PROJECT SPECIFIC
AND STUDY OF HIGHEST AND BEST USE,
I.E.
THE HIGHEST DOLLAR RETURN PER USE
ACCEPTABLE IN THE COMMUNITY.
GIVEN SIMILAR INVENTORY AND ABSORPTION RATE, HOW DO WE IMPROVE AND
ENHANCE OUR CAPTURE RATE AND YIELD IN DOLLARS PER SQUARE FOOT?
A REAL ESTATE ANALYSIS FOCUSES ON THE MARKET.
IT IS A STUDY OF SUPPLY AND OF DEMAND FOR REAL ESTATE.
DETERMINANTS:
INVESTMENT PROFITABILITY
MARKETPLACE EVENTS

POPULATION
SALES
HOUSEHOLDS
RENTALS
EMPLOYMENT
OCCUPANCY/VACANCY RATES
USER'S PSYCHOGRAPHIC CHARACTERISTICS FORTHCOMING SUPPLY
ATTITUDES
TASTES

76

PREFERENCES
A MARKETABILITY ANALYSIS IS A SUBSET OF MARKET ANALYSIS. IT ANALYZES THE
USER'S PREFERENCES AND THE COMPETITION TO MAKE RECOMMENDATIONS WHICH
MAXIMIZE ABSORPTION RATES AND PROFITS.
LOCAL ECONOMIC ANALYSIS PRINCIPAL VARIABLES (MARKET FOCUS)
POPULATION
HOUSEHOLDS
EMPLOYMENT

PAST TRENDS AND FORECASTS FOR A GIVEN GEOGRAPHICAL AREA

FEASIBILITY ANALYSIS (INDIVIDUAL DECISIONS FOCUS)
IS PROJECT BUILDABLE UNDER GIVEN PROGRAM GIVEN THE FINANCIAL OR SITERELATED CONSTRAINTS?
INVESTMENT ANALYSIS
EVALUATE MOST APPROPRIATE FINANCING
EVALUATE VALUE AS AN INVESTMENT
EVALUATE TAX CONSIDERATIONS
RISK/REWARD ANALYSIS
MOST MARKET STUDIES ARE LOCAL BECAUSE THAT IS WHERE THE COMPETITION
GENERALLY IS.
DISAGGREGATION AND SEGMENTATION ARE PROCESSES WHICH HELP US TO FOCUS ON
SPECIFIC USES AND THEREBY AVOID EXTRANEOUS DATA.
DISAGGREGATION IS USE DEFINED INTO CATEGORIES OR CATEGORY.
SEGMENTATION IS USER DEFINED INTO CATEGORIES OR CATEGORY.
EXTERNALITIES ARE THOSE MATTERS WHICH ARE EXTERNAL TO THE SUBJECT
PROPERTY YET IMPACTED BY THE SUBJECT PROPERTY. I.E. TRAFFIC, POLLUTION,
INFRASTRUCTURE, SOCIAL PATTERNS, LAND USES, ETC. ALL OF THESE CAN IMPACT
THE PROFITABILITY OF A DEVELOPMENT.
BE AWARE OF THEM
THEY MAY IMPACT THE SUPPLY AND DEMAND DETERMINANTS.
OTHER DETERMINANTS OF ECONOMIC PRODUCTIVITY
FINANCING
SUBSIDIES AND GRANTS (I.E. UDAG)
TAXES AND TAX INCENTIVES

77

PRIMARY DATA IS THAT GATHERED BY THE ANALYST

SECONDARY DATA IS THAT GATHERED BY OTHERS.
PRIMARY DATA IS IMPORTANT SINCE THE USE OF SECONDARY DATA MAY NOT BE
SEGMENTED ENOUGH, AND THEREFORE IT IS AN ARMCHAIR APPROACH.
PRIMARY DATA OFFERS SPECIFICS
SECONDARY DATA COLLECTIONS.

WHICH ARE NOT AVAILABLE IN GENERALIZED

THE HIGHEST AND BEST USE

TO THE APPRAISERS:
REASONABLE AND PROBABLE USE SUPPORTING THE HIGHEST
PRESENT VALUE, OR THE USE FROM AMONG REASONABLE, PROBABLE, AND LEGAL
ALTERNATIVES, APPROPRIATELY FINANCED AND SUPPORTED, THAT RESULTS IN THE
HIGHEST VALUE.
TO THE INVESTOR:
MAXIMUM PROFIT.

NOT ONLY PROVIDING A "SATISFACTORY PROFIT", BUT THE

INVESTMENT ANALYSIS IS BASED ON AFTER TAX INCOME GENERATION

INVESTMENT ANALYSIS EVALUATES A SPECIFIC PROPERTY AS A POTENTIAL
INVESTMENT BASED ON:
RISK/REWARD RATIO
AFTERTAX CASH FLOW
AFTERTAX CASH REVERSION
THIS INFORMATION IS USED TO GAIN A MEASURE
INVESTMENT
INTERNAL RATE OF RETURN
NET PRESENT VALUE
PROFITABILITY INDEX
FINANCIAL MANAGEMENT RATE OF RETURN
OTHERS

OF

THE

RETURN

ON

THE

RISK ASSESSED BY :
PARTITIONING THE RATE OF RETURN
SENSITIVITY ANALYSIS
COMPUTER-BASED SIMULATION ANALYZING THE BEST MIX OF FINANCING AND
TAX CONSIDERATIONS
CASH FLOW DUE TO RENT RECEIVABLES ANALYZED IN MARKETABILITY
ANALYSIS.
MARKET ANALYSIS FOIBLES
A MARKET ANALYSIS CAN BE PROBLEMATIC DUE TO MATTERS OF:

78

DATA
STATISTICAL ANALYSIS
ANALYST/CLIENT RELATIONSHIP
LACK OF EXPERIENCE
USING OPTIMISTIC FIGURES WHEN LESS OPTIMISTIC FIGURES EXIST.
AVOID PITFALLS BY GIVING BEST, WORST, AND MOST PROBABLE SCENARIOS.
DATA PROBLEMS:
USING HISTORICAL DATA WITHOUT BEING ABLE TO PREDICT THE FUTURE.
USING DATA WHICH IS NOT SPECIFIC ENOUGH (I.E. METRO AREA AS OPPOSED
TO NEIGHBORHOOD).
SOURCES NOT CREDITED
DATA PROBLEMS (CONT)
DATA OUT OF DATE
DATA NOT GATHERED BY SAME METHOD
MARKET DATA MAY NOT COVER ENTIRE MARKET AREA (I.E. MARKET IN TWO
COUNTIES FOR SITE NEAR COUNTY BORDER.
ONLY PURE MARKET ISSUES CONSIDERED, NOT SUCH AS GEOLOGY OR TRAFFIC.
INAPPROPRIATE TECHNIQUES
UNWARRANTED OR UNSPECIFIED ASSUMPTIONS
MANAGEMENT CAPABILITIES NOT TAKEN INTO ACCOUNT
UNNECESSARY LIMITING ASSUMPTIONS
UNWARRANTED RECOMMENDATIONS
ECONOMIC OVERVIEW
QUESTIONS TO THE HEAD OF ECONOMIC DEVELOPMENT FOR A MUNICIPALITY:
PROSPECTS FOR NEW INDUSTRY LOCATION AND RELOCATION (WHAT ARE YOU DOING TO
ATTRACT INDUSTRY).
HOUSING TRENDS: WHERE IS HOUSING, HOW IS IT SECTORED, WHERE IS NEW
CONSTRUCTION TAKING PLACE.
LOCAL REGULATIONS
LIFE STYLES
NET MIGRATION
EMPLOYMENT, INCOME, S.F. RENTALS
5 YEAR PLAN, WHAT ARE DETAILS
ABSORPTION RATE OF OFFICE SPACE
POLITICAL CLIMATE FOR DEVELOPMENT IN THE NEAR TERM FUTURE
SIC CODES - CENSUS INFO WHICH BREAKS DOWN AREA INDUSTRY AND INCOME.
BASE INDUSTRIES, POPULATION, AND SERVICE INDUSTRY ARE TIED TOGETHER.
MARKETING OVERVIEW
QUESTIONS TO AN AREA BROKER

79

WHAT IS THE SITUATION IN FIVE YEARS

DEMAND VS. SUPPLY, ABSORPTION, INVENTORY
RENTAL GRADIENTS
BUILDING AMENITIES
RENTAL TERMS, CONDITIONS, AND TRENDS
WHAT IS BROKER'S CLIENT BASE, WHEN WILL LEASES EXPIRE
QUALITY OF EXISTING SPACE

PRODUCT OVERVIEW
QUESTIONS TO AN AREA DEVELOPER
DEVELOPMENT COSTS/COMPLICATIONS IN AREA
POLITICAL CLIMATE
LEASE UP ISSUES
DESIGN FACTORS, AMENITIES, AREAS AND SHAPE OF FLOOR SPACE
CONTRACTORS
PROFESSIONAL CONSULTANTS IN AREA WITH A TRACK RECORD
INFRASTRUCTURE
BUILDING SPECIFICATIONS
WHAT ARE SOME OF THE PROJECTS THAT YOU ADMIRE AND WHY
MEGATRENDS
REAL ESTATE CYCLES ARE LONG BECAUSE OF LIFE OF BUILDINGS.
ELEMENTS OF MARKET:
GROSS NATIONAL PRODUCT
WHAT DRIVES THE G.N.P.?
CONSUMPTION PRODUCTION
TAXES
INVESTMENT
DEFICIT SPENDING
GOVERNMENT EXPENDITURES
INFLATION
FOREIGN IMPORTS AND EXPORTS
INTEREST RATES
SAVINGS (AS SAVINGS GO UP, INTEREST COMES DOWN, AND INVESTMENT GOES UP)
ORGANIZATIONAL BEHAVIOR:
DECENTRALIZATION AND CENTRALIZATION
INVESTMENT PATTERNS
LONG TERM VS. SHORT TERM DECISIONS
SOCIAL BEHAVIOR:

80

COMMUTING
PERSONAL COMPUTERS
WORKING MOTHERS
EDUCATION
DAY CARE
POST INDUSTRIALISM
ENVIRONMENTAL AWARENESS
RECREATION
HOMELESSNESS
SHORTER WORK WEEKS
CHANGES IN THE DISTRIBUTION OF DEMOGRAPHICS
LIVE LONGER
LESS BABIES
X

X X

--------------------
__

XSSSX
WHY DOES A CITY GROW WHERE IT IS?

__

WHY DID IT GROW AFTER BEING FOUNDED?

WHERE IS THE CITY IN ITS HISTORIC CYCLE? WHY?

X X X

WHAT IS THE FUTURE? WHAT TRENDS AFFECT THIS?

MULTIPLE NUCLEI

WHY? BECAUSE OF :

HISTORIC REASONS

MILITARY REASONS
______
GOVERNMENT REASONS

AXIAL GROWTH

MANUFACTURING AND TRADE

TRANSPORTATION

SERVICE
GEOPHYSICAL CHARACTERISTICS
__

CONCENTRIC
* X

GROWTH
X

XX

XX

__

SECTOR GROWTH
__
EXAMPLES OF DIFFERENT CITIES:

CONCENTRIC GROWTH.......WASHINGTON, D.C.

SECTOR GROWTH...........MILWAUKEE
MULTIPLE NUCLEI.........LOS ANGELES
AXIAL GROWTH............LONG ISLAND
AXIAL GROWTH IS DRIVEN BY TRANSPORTATION, AND MULTIPLE NUCLEI GROWTH IS
DRIVEN BY COMMUTING DISTANCE.
IN THE DEVELOPMENT OF CITIES EXAMINE:
FUNCTIONS
HISTORIC TRENDS
PHYSICAL CHARACTERISTICS
SHAPES (PATHS OF PROGRESS)
ECONOMIC

BASE

ANALYSIS

TO

SHOW

THE

81

RELATIONSHIP

BETWEEN

COMMERCIAL

ACTIVITIES.
WHAT INDUSTRIES TAKE WHAT PERCENTAGES OF AN AREA'S BUSINESS?
LOCATION QUOTIENT = AREA % OF SIC / NATION % OF SIC
IF GREATER THAN ONE, INDUSTRY IS CALLED A BASE INDUSTRY.
IT IS AN IMPORTER OF CAPITAL FROM OTHER PLACES IN THE WORLD.
EXPERTS SAY THAT A LQ OF 0.85 TO 1.15 IS PROBABLY DEFINABLE AS A BASIC
INDUSTRY.
IF BASE INDUSTRY OF A COMMUNITY IS STEEL FABRICATION, YOU COULD PREDICT
THAT DUE TO NEW TECHNOLOGY, NEW USES, AND COMPETITIVE MATERIALS, YOUR
INDUSTRY'S NON RESPONSE WILL DETERMINE ITS INEVITABLE DECLINE.

SIC CODES
STANDARD INDUSTRIAL CLASSIFICATION
0123
01 = MAJOR CATEGORY
2 = SUB CATEGORY
3 = SUB-SUB CATEGORY
FIRST TOW DIGITS ENOUGH FOR NON-COMPLICATED PROJECTS
LAST TWO DIGITS ARE USED AS PROJECTS BECOME MORE COMPLEX.
PRELIMINARY FINANCIAL FEASIBILITY
HANDOUT PASSED OUT
ONE YEAR ANALYSIS OF THE PROPERTY OPERATING DATA LEADING TO A FIGURE
CALLED:
NET OPERATING INCOME (NOI)
YOU TAKE GROSS RENTAL INCOME, DEDUCT LOSSES FROM VACANCIES AND BAD DEBT,
WHICH EQUALS NET RENTAL INCOME.
YOU TAKE NET RENTAL INCOME AND DEDUCT OPERATING EXPENSES (EXCLUDING DEBT
SERVICE) TO EQUAL NOI. OPERATING EXPENSES USUALLY AMOUNT TO BETWEEN 40
AND 60 PERCENT OF NOI.
THE GROSS LEASE: YOU PAY THE LANDLORD MONEY, HE PAYS ALL EXPENSES.
THE NET LEASE:

TENANT PAYS ALL EXPENSES.

C.A.M.
IS A COMMON AREA MAINTENANCE CHARGE WHICH EQUALS THE TENANT'S
SHARE OF COMMON AREA EXPENSES.

82

VERY COMMON FOR TENANT TO PAY CAM, RENT, AND EXPENSES.

NOI - ADS = BOTTOM LINE
NOI = NET OPERATING INCOME
ADS = ANNUAL DEBT SERVICE
DCR = DEBT COVERAGE RATIO - LESS THAN 1.0 IS A PROBLEM. CASH SHORTFALL
WONT FINANCE DEBT. THIS IS OK IF IT FITS YOUR INVESTMENT STRATEGY. AN
EXAMPLE IS BUYING RAW LAND AND SEEKING APPROVALS, WHILE PAYING TAXES AND
UPKEEP.
THE MAJOR FACTOR IS FINANCING.
TO 1.3.

A TYPICAL FACTOR FOR BANK APPROVAL IS 1.1

DCR = NOI / ADS

THE BASIC FINANCIAL FEASIBILITY MODEL:

SEE PAGE 184, 187

IT IS POSSIBLE FOR GROSS INCOME TO BE SMALLER THAN NET RENT DUE TO

ADDITIONAL FEES, SAY FOR BASEMENT OR ROOF RENT.
WHEN YOU CREATE NEW SPACE, YOU DO SO FOR THOSE WHO CAN AFFORD IT.
NOT SEE A USED BOOK STORE, FOR EXAMPLE, IN NEW RETAIL SPACE.

YOU DO

QUALITY IS DETERMINED BY
1. TYPE OF CENTER
AND
2. TYPE OF OUTLET.
TYPES OF CENTERS:
COMMUNITY
CLUSTERED
NEIGHBORHOOD
REGIONAL
FREESTANDING
NEIGHBORHOOD CENTERS, TYPICALLY 30 TO 100,000 S.F., WITHIN SHORT DRIVING
TIME OF CONSUMER.
INCLUDES CONVENIENCE
NEEDS RESIDENTS

STORE,

DRUG

STORE,

SUNDRIES,

IMMEDIATE

STAPLES,

KEY TENANT IS A SUPERMARKET, KEY CONSIDERATION IS ACCESSIBILITY.

COMMUNITY CENTERS; TYPICALLY 10 TO 30 ACRES, 100 TO 250,000 S.F., 40 TO
150,000 CONSUMERS IN PRIMARY MARKET, MIGHT HAVE A SUPERMARKET, MAY HAVE
MINOR DEPARTMENT STORE, CONVENIENCE IS STILL IMPORTANT, BUT NOT AS MUCH
AS IT IS IN THE NEIGHBORHOOD CENTER.
HAS MORE VARIETY THAN A

83

NEIGHBORHOOD CENTER.
SUPER REGIONAL CENTERS; SHOPPING GOODS (PRIMARY AND SECONDARY)
PRIMARY INCLUDES APPAREL, SHOES, AND CLOTHING
SECONDARY INCLUDES FURNITURE AND APPLIANCES, WHICH TAKE A LOT OF
FLOOR SPACE.
QUANTITY: HOW MUCH WILL BE ABSORBED?
COST OF SPACE AND THE ABILITY TO FINANCE THAT COST BY RENTS RECEIVABLE IS
RELATED TO THE SALES PER S.F.
NATIONAL CHAIN RETAIL, MEDIAN SIZE, (150,000 S.F.), AVERAGES 100 DOLLARS
PER S.F., AND PAYS ABOUT 2 PERCENT OF THE RENT IN A SMALL STRIP MALL.
HOW BIG WILL THE STORES BE?
WHAT WILL THE TENANT MIX BE?
UPI'S DOLLARS AND CENTS OF SHOPPING CENTERS IS A GOOD GUIDE.
WHERE IS THE COMPETITION?
TRADE AREAS ARE IMPORTANT.
PRIMARY - ONCE A WEEK
SECONDARY - ONCE A MONTH
TERTIARY - ONCE A YEAR
THE COMPANY THAT HAS DONE MORE RESEARCH ON THIS THAN ANY OTHER IS THE
ROUSE COMPANY.
AT THE SOUTH STREET SEAPORT, THEY LOOKED AT THE WORKING POPULATION WITHIN
A TEN MINUTE WALK.
THE TRADE AREA MUST BE DEFINED BY WHO SHOPS THERE, AND WHO IS NEARBY.
WHAT DO WE DO FIRST?
THERE IS A CORRELATION BETWEEN ANCHORS S.F. AND TOTAL MALL SIZE.
SURVEY PEOPLE AFTER THEY COME OUT OF THE MALL.
WHERE DO YOU LIVE? WHERE IS THE CLOSEST INTERSECTION TO WHERE YOU
LIVE? (RESPECT THEIR PRIVACY)
WHERE DID YOU LAST SHOP?
WHERE DID YOU LAST BUY A SUIT, DRESS, SHOES, FURNITURE, ETC.?
(DO NOT ASK WHICH SHOPPING CENTER THEY ARE GOING TO, GET MORE
SPECIFIC INFORMATION).
INCOME?
WHAT SIZE PURCHASE?
REILLY'S LAW

84

SCRIBNER USES THIS, BUT HE IS CAUTIOUS WITH IT.

REILLY'S LAW

LARGE CENTER

SMALL CENTER

MAIN HIGHWAY

WHERE IS THE TRADE AREA BOUNDARY FROM THE SMALL CENTER?

THE TRADE AREA BOUNDARY FOR THE SMALL CENTER = X
DISTANCE BETWEEN CENTERS
X =

1/2
SIZE OF LARGER CENTER
1 +
SIZE OF SMALLER CENTER

X IS MEASURED IN TIME
WHEN YOU ARE STUDYING A SHOPPING CENTER TO DETERMINE ITS PRIMARY TRADE
AREA AND COMPETITION, EXPECT TO SPEND A WEEK TO DO THE FIELD WORK.
A SPECIALTY CENTER IS USUALLY ON THE WAY TO ANOTHER CENTER.
THE McGAFFNEY PROCESS

CT = 02

CT = 01

SHOPPING CT = 03
CENTER

CT = 04

CT = 05

CT = CENSUS TRACT
NEED:

NUMBER OF HOUSEHOLDS OF EACH CT

TIMES
AVG. HOUSEHOLD INCOME

85

EQUALS
AGGREGATE HOUSEHOLD INCOME
TIMES
PERCENT CAPTURE
EQUALS
INCOME AVAILABLE TO THE SUBJECT PARCEL
START BY DEALING WITH THE ANCHORS - SAY, 4 ANCHORS OF 100,000 S.F. =
400,000 S.F.
TRUST YOUR JUDGEMENT AFTER DOING THE FIELD WORK AS TO HOW CAPTURE TAKES
PLACE.
WHAT IS THE PERCENT CAPTURE FOR EACH SEPARATE CENSUS TRACT.
PERCENT CAPTURE (CAPTURE RATE)IS THE ONLY MATTER OF JUDGEMENT IN THE
EQUATION.
ADD UP ALL THE INCOME AVAILABLE TO THE SUBJECT FROM EACH CT.
MULTIPLY THE PROPENSITY TO SPEND TIMES THE INCOME AVAILABLE TO EQUAL THE
GROSS VOLUME OF EXPECTANCY, OR THE G.V.E.
FOR PROPENSITY TO SPEND, LOOK IN THE RETAIL TRADE CENSUS WHICH LISTS
THE NUMBER OF DEPARTMENT STORES
DOLLARS IN SALES
S.F. OF STORES
TAKE DOLLARS IN SALES, DIVIDE BY THE NUMBER OF HOUSEHOLDS, MULTIPLY BY
THE AVERAGE INCOME PER HOUSEHOLD IN EACH CT.
TAKE THE G.V.E.;
DIVIDE BY SALES PER SQUARE FOOT

SQUARE
FOOTAGE
BE CAREFUL TO NOTE WHETHER SALES PER S.F. IS FOR GROSS LEASABLE OR
SALEABLE AREA. SOLVE ALL FIGURES THE SAME WAY (MAKE THE METHODS MATCH).
ECONOMIC MARKET ANALYSIS
EMPLOYMENT INFORMATION _POPULATION INFORMATION

_
_

INDUSTRIAL
RESIDENTIAL
OFFICE
RETAIL

_HOTEL _

86

RUEBEN ROKA OF ROUSE COMPANY HAS A BOOK ON MARKETING METHODS, WORTH

LOOKING INTO.
USERS IN SEARCH OF LOCATIONS
BUILDING RELATED:
COST AND EFFICIENCY FACTORS
FOR SOME COST NOT AN ISSUE, I.E. THEY WILL TOP DOLLAR FOR A
PRIME LOCATION.
EFFICIENCY IS MOST IMPORTANT FOR WAREHOUSING.
SIZE
WHAT ARE THE BUYER'S REQUIREMENTS?
DOES HE NEED EXPANDABLE SPACE?
WHAT IS THE DIFFICULTY WITH EXPANDABILITY?
S.F.
HIS

AS A TENANT, HE MAY NOT BE ABLE TO GET SMALL 10,000

BUILDING WITH 20,000 EXPANSION WHEN DEVELOPER CAN MAXIMIZE
PROFIT MOST LIKELY BY NOT GUARANTEEING FUTURE SPACE WHEN THE
LOT IS PRIME.
INDUSTRIAL PARK
FREE STANDING
LARGE SUBDIVIDED BUILDING

EXPANDABILITY
SHAPE OF THE BUILDING
ELECTRICITY AVAILABLE
TRAIN TRACK ACCESSIBLE
CLEAR SPAN SPACE
WAREHOUSING, LONG AND RECTANGULAR
MANUFACTURING, SQUARE
LOCATION CONSIDERATIONS
CLOSE TO VENDORS
SOME COMPANIES WANT TO BE CLOSE TO VENDORS
CUSTOMERS
SOME
CUSTOMERS

COMPANIES

WANT

TO

ACCESSIBILITY VS. FRICTION

87

BE

CONVENIENT

DISTANCE

FROM

LOT

LINKAGES
BEYOND ROAD ACCESSIBILITY, INCLUDES BUSINESSES OF A SIMILAR
TYPE. (I.E) DO YOU NEED TO BE IN AN AREA WHERE THERE ARE A
OF BUSINESSES AROUND TO CREATE BUSINESS FOR YOU.
SHIPPING CHARGES
LABOR MARKETS
EXISTENCE OF TRANSPORTATION SERVICES
I.E. RAILROAD ACCESSIBILITY
COMPETITORS
SUPERMARKETS DO
THEY HAVE
THEY HAVE
THEY RENT

NOT WANT COMPETITION

LOW MARK UPS
HIGH EXPENSES
A LOT OF SPACE

EXECUTIVE RESIDENCES
HOUSING COSTS, SCHOOLS, SERVICES
DEMOGRAPHIC CONSIDERATIONS
POPULATION STATISTICS
TRAFFIC PATTERNS
INCOME STATISTICS
HOUSING PATTERNS
EXAMPLE:
A BREWERY
NEEDS:
WATER
PRIORITY TWO
LABOR FORCE
PRIORITY FOUR
SHIPPING AND TRANSPORTATION
PRIORITY THREE
CONSUMERS
PRIORITY ONE
SINCE BEER IS MOSTLY WATER AND EXPENSIVE TO SHIP, THE BREWERY FINDS IT
MOST IMPORTANT TO BE NEAR THE CONSUMER.
AUTO PARTS MANUFACTURER
NEEDS:
LABOR AND CUSTOMERS
VENDORS
BUILDING COST EFFICIENCY

PRIORITY ONE
PRIORITY THREE
PRIORITY TWO

HOUSING:
DEMOGRAPHICS
GROWTH TRENDS
UTILITIES
PRICE
WHAT KIND OF PRODUCT CAN BE SOLD? 25% OF THE COST OF THE HOME IS IN THE
LAND DEVELOPMENT.

88

STRIP CENTERS:
CAR TRAFFIC
VISIBILITY
APARTMENT HOUSE INVESTOR:
DEMOGRAPHICS
RETAIL LAUNDROMAT:

FAST FOODS AND GAS STATIONS:

PROXIMITY TO RENTERS
2500 TO 3000 APARTMENTS

TRAFFIC
VISIBILITY
CORNER LOCATION PREFERABLE
SOME LIKE TO BE ON THE WAY TO
WORK, SOME LIKE TO BE ON THE WAY
BACK.

MOTEL:
LOW LAND COST
1-4 ACRES OF LAND
NEAR TRANSPORTATION
END OF COURSE

89

REGULATION OF REAL ESTATE

PROFESSOR SHELDON LOBEL
AUTUMN 1990
NEW YORK UNIVERSITY

REGULATION OF REAL ESTATE

CLASS ONE
9/10/90
SHELDON LOBEL (pronounced "low-bell")
687-1133
RM. 427
THE TEXT IS A COLLECTION OF ESSAYS AND NOTES WHICH ARE AVAILABLE FOR
ROUGHLY 25 DOLLARS FROM UNIQUE COPY CENTER, 252 GREEN STREET (212) 7779690.
THE SYLLABUS WILL BE GIVEN OUT NEXT WEEK.
ON TUESDAY, NOVEMBER 20TH, SYLVIA DEUTCH AND THE DIRECTOR OF PLANNING FOR
PHILADELPHIA WILL BE AT NYU FOR A CONFERENCE BETWEEN 3 AND 6 PM. PLAN TO
BE THERE.
READ ALL READINGS. WHEN YOU GET THE BOOK READ THE FIRST FOUR READINGS
(UP TO JEROME ROSE).
THE FIRST 3 SECTIONS DEAL WITH GOVERNMENT POLICY ON REGULATION. "HOW FAR
CAN GOVERNMENT GO TO STOP OR IMPEDE YOU FROM USING YOUR PROPERTY?
THE 14TH AMENDMENT STATES THAT A PERSON CANNOT BE DENIED THE USE OF HIS
PROPERTY. WHY CAN GOVERNMENT IMPEDE YOUR USE OF YOUR OWN PROPERTY? IN
1916 THE EUCLID V. AMBLER DECISION WAS HANDED DOWN BY THE U.S. SUPREME
COURT. IT HELD THAT THE GOVERNMENT CAN IMPEDE USE WHEN IN DOING SO
SOCIETAL HEALTH, SAFETY, MORALS AND WELFARE IS ADVANCED.
SESSIONS 4-6
DEVELOPMENT.

PERTAIN

TO

ZONING;

HOW

DIFFERENT

AGENCIES

CONTROL

SESSION 7 PERTAINS TO THE BOARD OF STANDARDS AND APPEALS

SESSION 8 & 9 PERTAIN TO ENVIRONMENTAL LAW AND THE ENVIRONMENTAL PROCESS.
SESSION 10 PERTAINS TO LANDMARK DESIGNATION
SESSION 11 PERTAINS TO RESIDENTIAL RENT REGULATIONS.
IS DUE AT THIS SESSION.

THE MAJOR PROJECT

THE MAJOR PROJECT IS TO EVALUATE A PROJECT, SHOWING THE REGULATORY

PROCESS THE DEVELOPMENT WENT THROUGH IN ARRIVING AT A BUILDING PERMIT.

89

TYPICAL TABLE OF CONTENTS FOR THE MAJOR PROJECT:

I.
II.
III.
IV.
V.
VI.
VII.
VIII.
IX.
X.
XI.
XII.
XIII.
XIV.

NATURE OF ASSIGNMENT
EXECUTIVE SUMMARY
PROJECT HISTORY
PROJECT DESCRIPTION
PROJECT GOALS AND OBJECTIVES
PROJECT FINANCING AND ECONOMIC INCENTIVES
ENVIRONMENTAL IMPACT / MITIGATION
ARCHEOLOGICAL AND HISTORICAL ISSUES
REGULATORY ISSUES
AS-OF-RIGHT ALTERNATIVES
CONCLUSION
BIBLIOGRAPHY
APPENDIX
EXHIBITS

"KNOW WHAT HAPPENS WITH THE REGULATION OF PROPERTY WHEN YOU ARE
DEVELOPER; IGNORANCE OF REGULATION COULD STOP YOU IN YOUR TRACKS."

IN 1916, NEW YORK DEVELOPED THE NATIONS FIRST ZONING ORDINANCE. IT WAS IN
RESPONSE TO A GROUNDSWELL OF ANGER GENERATED BY THE EQUITY LIFE INSURANCE
BUILDING AT 120 BROADWAY.
ITS HEIGHT AND BULK WERE NOT REGULATED IN
1914, PERMITTING DEVELOPMENT IN A MANNER THAT CAUSED LOSS OF LIGHT AND
AIR.
THE NEW YORK CITY BOARD OF STANDARDS AND APPEALS (BSA)
IT IS LOCATED AT 161 6TH AVENUE.

GRANTS VARIANCES.

THE NEW YORK CITY PLANNING COMMISSION DECIDES ON OVERALL ZONING ISSUES.
DOWNZONING IS TAKING A USE AND MAKING IT LESS INTENSE.
UPZONING IS TAKING A USE AND MAKING IT MORE INTENSE.
AS-OF-RIGHT PROJECT - ONE THAT DOES NOT GO THROUGH THE APPROVAL PROCESS.
YOU CAN BUILD IT WITHOUT SPECIAL PERMITS, AND WITHOUT SPECIAL EXCEPTIONS.
HOW DO YOU KNOW WHERE YOU STAND AS A DEVELOPER?
1. LOOK AT THE ZONING MAPS; WHAT ZONE ARE YOU IN?
2. CAN YOU BUILD WHAT YOU WANT?
3. IF YOU CAN NOT, YOU NEED TO GO THROUGH THE SPECIAL PERMIT AND VARIANCE
PROCESSES,
OR DO NOT COUNT ON DEVELOPING THE PARCEL IN YOUR DESIRED
FASHION.
END OF CLASS ONE

90

CLASS TWO
9/17/90

CONDEMNATION

GOVERNMENT

REGULATION

^
"BALANCE"
OF THE FORCE OF LAW
THERE IS A MID-LEVEL OF CASES, REPRESENTED BY SEAWALL, NOLLAN, PENN
CENTRAL, ETC. THAT ANSWER THE QUESTION OF "WHEN" REGULATIONS ARE SEVERE
ENOUGH TO BE CONFISCATORY, IN EFFECT EVIDENCING CONDEMNATION.
IN EFFECTIVELY CONDEMNING DOES COMPENSATION CONSIST OF ALLOWING TRANSFER
OF DEVELOPMENT RIGHT BONUSES, TAX CREDITS, ETC. ( SUCH AS WITH LANDMARK
BUILDINGS )?
***************
HOW DO BUILDINGS BECOME LANDMARKS?
THE BUILDING IS PLACED ON THE REGISTER OF A RECOGNIZED HISTORICAL GROUP
SUCH AS THE NATIONAL HISTORIC REGISTRY. IN NEW YORK CITY, THE MUNICIPAL
ART SOCIETY OR OTHER GROUP COULD SUGGEST TO THE LANDMARKS COMMISSION THAT
IT ELECT A GIVEN BUILDING AS A LANDMARK.
IT MUST BE 30 YEARS OLD OR
OLDER, AND HAVE A SPECIAL FEATURE OR HISTORY SUGGESTING SOCIAL OR
ARCHITECTURAL IMPORTANCE.
****************
WHY WOULD THE GOVERNMENT HAVE EVER THOUGHT THAT THEY COULD FORCE OWNERS
IN SEAWALL TO BUILD SRO'S WITHOUT GIVING THEM COMPENSATION? BECAUSE BASED
ON THE PRECEDENT OF LAW AT THE TIME AND THE LEANINGS OF THE SUPREME
COURT, THEY THOUGHT THEY COULD GET AWAY WITH IT.
****************
SCOTT MARKOWITZ - GUEST LECTURER
CONSTITUTIONAL ASPECTS OF LAND USE REGULATION
HANDOUTS - RENT STABILIZATION CODE (PROPOSED) WITH EXPANDED FAMILIAL

91

RIGHTS,

AND 520 E 81ST. STREET (THE LENOX HOSPITAL CASE).

THE FIFTH AMENDMENT - PRIVATE PROPERTY SHALL NOT BE TAKEN FOR PUBLIC USE
WITHOUT JUST COMPENSATION.

TAKINGS COULD BE EFFECTUATED BY:

1. PHYSICAL INVASION CAUSED BY GOVERNMENT ACTION (IE. AIRPORT NOISE,
FLOODING FROM DAM).
2. REGULATORY INVASION.
REGULATORY INVASION'S FIRST TEST CASE WAS IN THE 1920'S WITH PENNSYLVANIA
COAL V. MAHAN.
A LAW WAS PASSED PROHIBITING MINING UNDER HOMES,
CEMETERIES, ETC., IN ORDER TO PREVENT COLLAPSE OF FOUNDATIONS ETC.
JUSTICE HOLMES WROTE FOR THE MAJORITY WHEN HE SAID THAT SUCH A RULE GOES
TOO FAR IN REDUCING MINING RIGHTS, WITHOUT JUST COMPENSATION.
IN 1978, PENN CENTRAL V. NEW YORK CITY, THE OWNERS OF GRAND CENTRAL
STATION WANTED TO BUILD A 55 STORY TOWER.
THE LANDMARK COMMISSION
REFUSED TO ALLOW IT. THE OWNERS CLAIMED THIS WAS A REGULATORY TAKING,
AND THE COURT RULED AGAINST IT SAYING THE ECONOMIC IMPACT OF THE
LANDMARKS COMMISSION RULING WAS NOT SEVERE AND THAT IT DID NOT INTERFERE
WITH EXPECTATIONS FOR PROFIT. THEREFORE IT WAS A REASONABLE REGULATION
IN THE COURT'S MIND.
IN 1987, 2 DECISIONS. NOLLAN V. STATE OF CALIFORNIA COASTAL COMMISSION:
PROPERTY OWNERS WANTED TO BUILD A HOUSE ON A BEACH.
THE COASTAL
COMMISSION GRANTED APPROVAL ON THE CONDITION THAT AN ACCESS EASEMENT BE
GRANTED TO THE PUBLIC.
NOLLAN SUED SAYING THAT IT WAS AN UNJUSTIFIED
TAKING AND THE COURT AGREED. JUSTICE SCALIA SAID THAT LAND REGULATIONS
MUST "SUBSTANTIALLY ADVANCE" AS OPPOSED TO "RATIONALLY SUPPORT" THE
PUBLIC INTEREST.
SEAWALL V. N.Y.C. SRO MORATORIUM LAW OVER RULED BY THE SUPREME COURT OF
NEW YORK. BASED ON PRECEDENTS, THE COURT FOUND THE LAW TO BE A PHYSICAL
AND REGULATORY TAKING, DID NOT SUBSTANTIALLY ADVANCE PUBLIC INTEREST AND
DEPRIVED THE OWNERS OF THEIR EXPECTATIONS FOR PROFIT.
IN 520 E. 81ST STREET, LENOX HILL HOSPITAL IS A TENANT OF STABILIZED
APARTMENTS. THE LEASE STATES THAT EMPLOYEES OF LENOX HILL COULD OCCUPY
THE APARTMENT. WHEN BUILDING WAS CONVERTED TO A COOPERATIVE, SOME WANTED
TO BUY, SOME WANTED RENEWAL LEASES. LANDLORD SAYS THAT LENOX HILL, BEING
A PERPETUAL CORPORATION, HAD PERPETUAL OCCUPATION AND THEREFORE DENIED
THE LANDLORD OF THE RIGHT TO EVER GET HIS PROPERTY BACK.
THEREFORE,
UNDER SEAWALL, THE LANDLORD CLAIMED THAT IT WAS A REGULATORY TAKING TO
FORCE HIM TO MAINTAIN THE CORPORATION AS A TENANT.

92

END OF CLASS TWO

CLASS THREE
9/24/90
TRANSFER OF DEVELOPMENT RIGHTS - THE TRANSFERENCE OF DENSITY FROM ONE
LOCATION TO ANOTHER THROUGH THE SALE OF THE RIGHTS, OR THROUGH THE
TRANSFERENCE TO OTHER PROPERTIES OF THE DEVELOPER.
DEPARTMENT OF CITY PLANNING - 22 REED STREET
GREEN BOOK - THE "BIBLE" FOR PEOPLE WORKING WITH CITY AGENCIES. GIVES
THE TELEPHONE NUMBERS, LOCATION, AND PEOPLE INVOLVED WITH CITY AGENCIES,
COMMUNITY BOARDS, ETC. PUBLISHED ANNUALLY.
UNIFORM LAND USE REVIEW PROCEDURE (ULURP) - THE APPARATUS SET UP BY THE
CITY TO REVIEW ZONE CHANGES, ETC., AND WORK THEM THROUGH THE PLANNING
PROCESS.
THE CITY RECEIVES A SUBMISSION AND MAKES CERTAIN IT IS IN
PROPER FORM (CERTIFICATION) BEFORE BEING SENT THROUGH ULURP. ZECKENDORF
MET WITH THE COMMUNITY PRIOR TO SUBMISSIONS TO SPEED THE PROCESS. IT IS A
PROCESS OF GIVE AND TAKE.
THE OLD METHOD OF ULURP, PRIOR TO THE ABOLITION OF THE BOARD OF ESTIMATE,
CALLED FOR A TWO MONTH REVIEW FOR EACH OF THE FOLLOWING BOARDS, TOTALLING
SIX MONTHS:
1. COMMUNITY BOARD
2. CITY PLANNING BOARD
3. BOARD OF ESTIMATE
OLD ULURP PROCESS FOUND UNCONSTITUTIONAL BY THE U.S. SUPREME COURT DUE TO
THE BOARD OF ESTIMATE'S VIOLATION OF THE PRINCIPLE OF ONE MAN, ONE VOTE.
BEFORE THE SIX MONTH REVIEW, PROJECTS WENT THROUGH PRE-CERTIFICATION. IN
MOST CASES THIS TOOK TWO YEARS AND REQUIRED AN ENVIRONMENTAL IMPACT
STATEMENT.
THE PROCESS:
FILE APPLICATION > PRECERTIFICATION > CERTIFICATION > ULURP > APPROVAL OR
DISAPPROVAL.
THE COMMUNITY BOARDS WERE IN OPERATION SINCE THE 1970'S.
A BODY OF
APPROXIMATELY 50 TO 60 PEOPLE, THEY ARE APPOINTED BY THE MAYOR, BOROUGH
PRESIDENT, AND LOCAL COUNCIL MEMBERS.
THERE ARE APPROXIMATELY 50
COMMUNITY BOARDS. THEY ARE NOT PAID POSTS, AND HAVE COMMITTEES RANGING
FROM ZONING TO TRANSPORTATION AND POLICE PROTECTION.
THEY ARE ONLY ADVISORY.
THEY VOTE AFTER THE FIRST TWO MONTHS FOR OR
AGAINST A CHANGE. THE VOTE IS NOT BINDING ON THE PLANNING COMMISSION.
MARTY GALLENT, GUEST SPEAKER

93

"LESS THAN ONE TENTH OF ONE PERCENT OF NEW YORK CITY'S CITIZENS KNOW
ANYTHING ABOUT THE WAY THE CITY HANDLES ITS PLANNING ISSUES".
MARTY
GALLENT.
PLANNING COMMISSION ORGANIZED IN 1937 BY LaGUARDIA.
"GOOD GOVERNMENT"
GROUPS INSISTED THAT THERE SHOULD BE A NON-POLITICAL GROUP DIRECTING THE
PLANNING FOR THE CITY. A CHARTER REVISION WAS INSTITUTED PROPOSING THAT
SEVEN MEMBERS BE APPOINTED THE CITY PLANNING COMMISSION. THE COMMISSION
SELECT A CHAIRMAN, WHO REPORTS TO THE MAYOR.
HE LOOKS AT FRANCHISES,
ZONINGS, ETC.
PLANNING COMMISSION MEMBERS WERE PART TIME AND HAD EIGHT YEAR TERMS.
THEY COULD NOT BE REMOVED EXCEPT FOR MISFEASANCE OR MALFEASANCE, AS
CHARGED BY THE MAYOR.
THE CHAIRMAN EVENTUALLY BECAME AN APPOINTEE OF THE MAYOR WITHOUT TENURE.
THE RELATIONSHIP DETERMINED WHETHER THE COMMISSION WOULD BE STRONG OR
WEAK.
THE YEAR 1964 SAW A NEW CHARTER. THE COMMISSION STAYED THE SAME, BUT THE
1964 CHANGE WAS NOT WELL THOUGHT OUT SO 1976 SAW A NEW CHARTER THAT
SOUGHT TO ELIMINATE THE CITY PLANNING COMMISSION.
PEOPLE BLAMED THE
CITY'S PROBLEMS ON THE PLANNERS, CLAIMING THAT THE PLANNING SHOULD HAVE
FORESEEN AND PREVENTED THE PROBLEMS. THE PEOPLE THOUGHT THAT RATHER THAN
ELIMINATE THE COMMISSION, THEIR POWERS SHOULD BE RECONFIGURED.
DIRECTOR OF CITY PLANNING
THEY ARE THE SAME PERSON.

CHAIRMAN OF CITY PLANNING COMMISSION.

BEFORE 1976 YOU COULD FILE AN APPLICATION AND NOTHING WOULD HAPPEN.
ULURP SOUGHT TO FINISH OFF THE DECISION WITHIN 6 MONTHS.
THE COMMUNITY PLANNING
BOROUGH PRESIDENT.

BOARDS

REPORT

TO

COMMISSION

OF

PLANNING

AND

IN 1989, THE CHARTER REVISION COMMISSION INJECTED CONFLICTS INTO THE

REVIEW PROCESS, IN THE ATTEMPT TO INSURE MORE INVOLVEMENT OF CITIZENS AND
TO ASSURE A BETTER PLAN.
"1989"
13 COMMISSIONERS (BOARD OF ESTIMATE ELIMINATED)
5 APPOINTED BY THE BOROUGH PRESIDENT. THEY OWE ALLEGIANCE TO BOROUGH
PRESIDENT AND CAN ONLY BE REMOVED BY HIM.
6 APPOINTED BY THE MAYOR
1 APPOINTED BY THE PRESIDENT OF THE CITY COUNCIL
THE ABOVE HAVE 5 YEAR TENURES
1 CHAIRMAN APPOINTED BY THE MAYOR

94

THE CITY COUNCIL IS SUBSTITUTED FOR THE BOARD OF ESTIMATE.

ZONING, REAL ESTATE MATTERS (IE. TAKINGS), URBAN
DECISIONS ARE MADE DIRECTLY BY THE CITY COUNCIL.

RENEWAL

THESE

OTHER MATTERS, SPECIAL PERMITS, ETC. - THESE DECISIONS ARE PASSED BY THE
CITY PLANNING COMMISSION.
IF THE COUNCIL DOES NOT CALL UP A VOTE OF THE COMMUNITY BOARDS WITHIN 30
DAYS FOR DISCUSSION, THE NON-ELECTED PLANNING COMMISSION CAN VOTE IT
DOWN.
THE PROCESS:
IF A MATTER IS IN THE ULURP PROCESS IT GOES,
1. TO THE COMMUNITY BOARD...IF THEY SAY NO,
IT TAKES A SIDE TRIP TO THE BOROUGH COUNCIL, CHAIRED BY THE BOROUGH
PRESIDENT AND COUNTY BOARDS & COUNCILMEN.
IF THE BOROUGH PRESIDENT SAYS NO,
IT GOES TO THE CITY PLANNING COMMISSION. IF THEY VOTE YES, THE BOROUGH
PRESIDENT CAN VOTE THAT IT BE SENT DIRECTLY TO THE COUNCIL FOR A
VOTE.
IF ALL OF THE THREE VOTES WERE "NO", THE DECISION CAN NOT GO TO THE
COUNCIL.
IF THE COMMUNITY BOARD VOTES YES AND THE BOROUGH PRESIDENT
VOTES NO, IT CAN'T GO TO THE COUNCIL.
END OF CLASS THREE
CLASS FOUR
10/1/90
EUCLID V. AMBLER
CHALLENGED ZONING RESOLUTION
RESOLUTION WAS CONFIRMED.

WENT

TO

THE

SUPREME

COURT.

ZONING

OCT. 29TH IS THE MIDTERM.

TESTED THROUGH 7 SESSIONS (LAST IS BOARD OF STANDARDS AND APPEALS).
*************************************************************************
*
TERMS:
ULURP : UNIFORM LAND USE REVIEW PROCESS

95

WHEN YOU WANT TO GO THROUGH THE ZONING CHANGE, OR WHEN YOU WISH TO BE
GRANTED SPECIAL RELIEF FROM THE ORDINANCE BY THE CITY PLANNING COMMISSION
YOU ENTER THE ULURP PROCEDURE. IT IS A SIX MONTH PROCESS.
YOU GET CERTIFIED PRIOR TO THE SIX MONTH PERIOD. AS THE APPLICATION IS
REVIEWED, COMMENTED ON, REVIEWED ONCE AGAIN IT WILL EVENTUALLY BE SIGNED
OFF ON (CERTIFIED) AND THE ULURP PROCEDURES CAN BEGIN.
EIS :

ENVIRONMENTAL IMPACT STATEMENT

STATE REQUIREMENT
IF AN APPLICATION, REQUEST DISCRETIONARY RELIEF.
NON-DISCRETIONARY APPROVAL IS AS-OF-RIGHT.
PDS : PROJECT DATA STATEMENT
FILED WITH THE LEAD AGENCIES - EPA & CPC
DONE WHEN GOING FOR DISCRETIONARY RELIEF.
NEGATIVE DECLARATION - STATES THERE ARE NO NEGATIVE ENVIRONMENTAL
CONSEQUENCES TO THE PROPOSED ACTION. NO DRAFT ENVIRONMENTAL IMPACT
STATEMENT (DEIS) WILL BE REQUIRED.
CONDITIONAL NEGATIVE DECLARATION - STATES THAT NO DEIS IS REQUIRED, AND
THAT CERTAIN STATED ITEMS SHOULD BE ADDRESSED IN ORDER TO PERMIT
DEVELOPMENT.
POSITIVE DECLARATION - TO PROCEED WITH APPLICATION INTO ULURP, A DEIS
MUST BE DONE SINCE THE PROJECT MAY BE ENVIRONMENTALLY SENSITIVE.
WHEN EIS IS COMPLETE AND ACCEPTED, IT CAN GO THROUGH THE ULURP PROCESS.
VESTING RIGHTS - GETTING THE FOUNDATIONS OF THE STRUCTURE INTO THE GROUND
TO DEMONSTRATE SIGNIFICANT EFFORT AND INTENT IN BUILDING A PROJECT. THIS
ACTION OF VESTING RIGHTS PRESERVES THE ZONING UNDER WHICH THE PROJECT WAS
APPROVED, AND DISQUALIFIES A MUNICIPALITIES ATTEMPT TO FURTHER LIMIT
DEVELOPMENT ON A PROPERTY.
SPECIAL DISTRICTS - GOVERNS CHANGE IN AN EXISTING SINGLE USE DISTRICT.
FOR EXAMPLE, WHEN THE DEMOGRAPHIC AND ECONOMIC TRENDS SUGGESTED THAT THE
ABANDONED MANUFACTURING DISTRICT COULD BE USED FOR RESIDENTIAL OR OFFICE
USES, A SPECIAL DISTRICT CAN BE DESIGNED TO ENCOMPASS AN AREA THAT COULD
ACCOMMODATE THIS AS OF RIGHT WHILE MAINTAINING CERTAIN OF THE OBJECTIVES
THAT THE PRIOR USES HAD, THEREBY NOT REDUCING THE LAND ALLOCABLE TO
MANUFACTURING.
USE GROUP SIX - SPECIAL DISTRICT DESIGNED TO PRESERVE PARTICULAR AREAS.

96

TRANSFER OF DEVELOPMENT RIGHTS ( AS USED IN NEW YORK CITY) * ZONING LOT MERGER: CREATES GREATER BULK.
* SELL AIR RIGHTS TO CONTIGUOUS PROPERTIES TO CREATE ONE ZONING LOT.
* CAN'T "JUMP OVER" BUILDINGS.

3
* LOT DIAGRAM *

IF "3" WANTS TO SELL TO "1", THEN "2" MUST SELL ALSO TO TRANSFER THE
DEVELOPMENT RIGHTS. THERE MUST BE AT LEAST TEN FEET OF CONTIGUITY AND
ADJACENCY IN ORDER TO TRANSFER DEVELOPMENT RIGHTS IN AN AS-OF-RIGHT MODE.
*IF YOU HAVE A LANDMARK BUILDING, YOU CAN TRANSFER ACROSS THE STREET.
THIS IS NOT AS-OF-RIGHT.
WHEN THESE TYPES OF TRANSFERS OCCUR, THE
LANDMARKS COMMISSION HAS THE RIGHT TO DETERMINE WHETHER OR NOT THE
PROPOSED DEVELOPMENT IS IN CONSONANCE WITH THE ARCHITECTURAL STATEMENT
MADE BY THE LANDMARK.
AMENITIES: PLAZAS GET UP TO 20 PERCENT BONUS ON FLOOR AREA
IMPROVED SUBWAY STATIONS GET INCREASED F.A.R.'S OF UP TO 3.0.
END OF CLASS FOUR
CLASS FIVE
10/8/90
INCLUSIONARY HOUSING BONUS - AN EXAMPLE OF ZONING BEING ENLISTED TO
REDRESS A SOCIAL OR ENVIRONMENTAL ISSUE.
IF WITHIN A COMMUNITY BOARD
DISTRICT (OR WHEN ON THE EDGE OF A DISTRICT, WITHIN A 0.5 MILE DISTANCE
OF THE BORDER TO THE SITE) DEVELOPERS PUTTING UP A DEVELOPMENT OR
RENOVATIONS TO BENEFIT LOW INCOME FAMILIES ARE GRANTED BONUS POINTS THAT
CAN BE BOUGHT TO INCREASE DENSITY FOR A LUXURY BUILDING ELSEWHERE. THIS
IS DIFFERENT FROM THE SECTION 421a PROGRAM IN THAT IT IS NOT A PROGRAM OF
TAX DEFERMENT.
SECTION 421a BEGAN IN 1972. WHEN BUILDING ON VACANT LAND, THE LAW ALLOWS
A TEN YEAR LIMITED EXEMPTION FROM TAXES.
SEE LAW NOTES FOR FURTHER
DETAILS.
EXCEPT FOR NORTH OF 96TH STREET, 421a BENEFITS ARE NO LONGER AVAILABLE IN
MANHATTAN AS OF YEAR END 1985. FOR THE AREA NORTH OF 96TH STREET, THE
LIMITED EXEMPTION WAS INCREASED FROM TEN TO FIFTEEN YEARS IN DURATION.
EUCLID V. AMBLER
THE FIRST SUPREME COURT DECISION DELINEATING CONSTITUTIONAL LEGITIMACY OF
PUBLIC POLICY THAT LIMITS AN INDIVIDUAL'S PROPERTY RIGHTS IN PROTECTING

97

PUBLIC HEALTH, SAFETY, MORALS AND WELFARE. IT STATES THAT A ZONING LAW
MUST NOT BE ARBITRARY OR CAPRICIOUS, AND THAT IT MUST PROTECT THE HEALTH,
SAFETY AND WELFARE OF RESIDENTS SURROUNDING THE AFFECTED PARCEL.
GUEST SPEAKER, MICHAEL ZENREICH - ARCHITECT
EXAMPLE OF DEVELOPMENT PROJECT AND ITS REGULATORY PROCESS.
KALIKOW HOTEL, 195 BROADWAY, THE FORMER AT&T BUILDING.
LOCATED OPPOSITE THE WORLD TRADE CENTER, ACROSS FROM CITY HALL PARK.
AN EXISTING 1 MILLION S.F. BUILDING, INVOLVING A DEIS AND DEMAPPING.
REQUIRED ARCHEOLOGICAL STUDIES, SHADOW IMPACT STUDIES, HORTICULTURAL
IMPACT STUDIES AND CULTURAL IMPACT STUDIES.
*******************************************
TWO PAGE OUTLINE FOR PROJECT DUE NEXT WEEK
*******************************************
END OF CLASS FIVE

CLASS SIX
10/15/90
TODAY, WE REVIEWED THE PROPOSED CLASS PROJECTS.
A SAMPLING INCLUDED:
WORLDWIDE PLAZA
CITY SPIRE
MT. LAUREL DECISION
CARNEGIE CENTER
TIMES SQUARE REDEVELOPMENT
COLISEUM CENTER
ENVIRONMENTAL REVIEW PROCESS
ORIGINALLY, AS OF RIGHT BUILDINGS DID NOT REQUIRE REVIEW. ANY BUILDING
REQUIRING DISCRETIONARY APPROVAL REQUIRED AN ENVIRONMENTAL IMPACT
STATEMENT.
YOU MUST FILE A PROJECT DATA STATEMENT FOR ANY DISCRETIONARY PROJECT
UNDER CEQRA (CITY ENVIRONMENTAL QUALITY REVIEW AGENCY) WHICH DETERMINES
THE NEED FOR A STATEMENT. THEY ISSUE A POSITIVE DECLARATION, NEGATIVE
DECLARATION OR CONDITIONAL NEGATIVE DECLARATION STATEMENT.
THE STATE
AGENCY FOR ENVIRONMENTAL REVIEW IS THE STATE ENVIRONMENTAL QUALITY REVIEW
AGENCY (SEQRA).
TYPICAL SECTIONS IN A DRAFT ENVIRONMENTAL IMPACT
STATEMENT MUST INCLUDE SUCH THINGS AS:
AUTO EMISSIONS
TRANSPORTATION
SUBWAY

98

SCHOOLS
WATER SUPPLY
SEWER
TAXES
POLICE AND FIRE PROTECTION
LANDMARKS
END OF CLASS SIX
CLASS SEVEN
10/22/90
SECTION 72-21
THIS IS THE SECTION OF THE ZONING RESOLUTION
JURISDICTION OF THE BOARD OF STANDARDS AND APPEALS.

PERTAINING

TO

THE

FIVE FINDINGS MUST OCCUR BEFORE THE BOARD OF STANDARDS AND APPEALS MAY
ISSUE A VARIANCE.
1. THE PROPERTY IS UNIQUE WITH RESPECT TO PHYSICAL CONDITIONS, AND THIS
UNIQUENESS IS WHAT MAKES IT DESIRABLE TO GRANT A VARIANCE. IE. A
TRIANGULAR PARCEL
2. TO DEVELOP THE PROPERTY WITHOUT THE VARIANCE WOULD CAUSE HARDSHIP DUE
TO THE UNIQUENESS OF THE PARCEL. HARDSHIP IS DECIDED BY THE RETURN
OF AN ACCEPTABLE CASH FLOW, AS MEASURED BY INTERNAL RATE OF RETURN
BASED ON MARKET BOND RATES FOR CONFORMING USE AS COMPARED TO THAT
OCCURRING AFTER A VARIANCE WOULD BE GRANTED.
THE LACK OF A
REASONABLE RETURN CANNOT BE RELATED TO MARKET CONDITIONS, BUT ONLY
TO THE UNIQUENESS OF THE LOT.
3. THE HARDSHIP WAS NOT SELF-CREATED.
4. THE VARIANCE IS AS MINIMAL AS IS PRACTICAL.
A 20 STORY BUILDING
SHOULD NOT BE GRANTED WHEN 15 STORIES WOULD BE ADEQUATE AND SOLVE
THE HARDSHIP. VARIANCES SHOULD MITIGATE NEGATIVE IMPACTS AS MUCH
AS IS POSSIBLE.
5.

IF

THE VARIANCE IS GRANTED, IT WILL

NEIGHBORHOOD SURROUNDING THE PARCEL.

NOT

ADVERSELY

AFFECT

THE

THE CHOICE OF SEEKING A VARIANCE OR A CHANGE OF ZONE OFTEN DEPENDS ON THE

INTENSITY OF THE CHANGE, AND ITS CONSPICUOUS RESEMBLANCE TO A USE
PERMISSIBLE IN ANOTHER ZONE.
SPECIAL PERMIT - GRANTED UNDER SECTION 73-00, SPECIAL PERMITS ARE ISSUED
BY THE BOARD OF STANDARDS AND APPEALS. THEY ALLOW USES SPECIFIED IN THE
RESOLUTION TO BE PLACED IN CERTAIN ZONES BY PERMIT FOR A SPECIFIC PERIOD
OF TIME.

99

BULK VARIANCE - PERTAINS TO VARIANCES FOR YARD SETBACKS, HEIGHT, ETC.

USE VARIANCE - PERTAINS TO VARIANCES FOR USES NOT OTHERWISE PERMITTED ASOF-RIGHT, SUCH AS PUTTING A DENTAL OFFICE ON A SECOND FLOOR OF A
RESIDENCE WHEN THIS WOULD NORMALLY BE PERMITTED ON THE FIRST FLOOR ONLY
ACCORDING TO THE RESOLUTION.
WHEN YOU GO FOR A BULK VARIANCE,
CHARACTER OF THE NEIGHBORHOOD.
YOU
WITHOUT CHANGING THE ZONING. WITH A
OF THE NEIGHBORHOOD AS PLANNED IN THE

YOU GENERALLY DO NOT CHANGE THE

MAY BE LOOKING TO INCREASE DENSITY
USE VARIANCE YOU CHANGE THE NATURE
ZONING MAPS.

WHEN YOU ASK FOR A BULK VARIANCE THE DEGREE OF PROOF REQUIRED IS LESS
THAN THAT REQUIRED FOR A USE VARIANCE.
IE. A 2-FAMILY
APARTMENTS.

ZONE:

YOU

WANT

TO

BUILD

BUILDING

WITH

TO

ARTICLE 78 - STATE OF NEW YORK CIVIL PRACTICE LAW AND RULES - ALLOWS YOU
TO APPEAL A BOARD OF STANDARDS AND APPEALS DECISION BASED ON THE
PERCEPTION OF AN ARBITRARY AND CAPRICIOUS ACTION.
GUEST SPEAKER:
ROGER BENNETT - CHAIRMAN OF THE BOARD OF STANDARDS AND
APPEALS, 33 YEARS WITH THE CITY. PROFESSIONAL ENGINEER BY TRADE.
CAROL SLATER - COUNCIL TO THE DEPARTMENT OF BUILDINGS AFTER SERVING WITH
THE CORPORATION COUNCIL'S OFFICE AND THE BOARD OF STANDARDS AND APPEALS.
ZONING RESOLUTIONS REGULATE DEVELOPMENT AND TELLS A PROPERTY OWNER WHAT
HE CAN EXPECT TO BE ALLOWED TO DO ON HIS PROPERTY.
THE BOARD OF STANDARDS AND APPEALS, IN ADDITION TO ITS ROLE AS GRANTOR OF
VARIANCES, ALSO APPROVES METHODS OF CONSTRUCTION FOR MATERIALS THAT ARE
NOT GOVERNED BY THE BUILDING CODE.
END OF CLASS SEVEN
CLASS EIGHT
10/30/90
MIDTERM EXAMINATION GIVEN TODAY
TONIGHT'S TOPIC IS ENVIRONMENTAL REVIEW.
EACH PROJECT IN NEW YORK STATE REQUIRES A LEAD AGENCY. A LEAD AGENCY IS
AN AGENCY OF THE STATE OR MUNICIPAL GOVERNMENT THAT TAKES THE LEAD IN
ARRANGING FOR THE ENVIRONMENTAL REVIEW. THE STATE OF NEW YORK WILL HAVE
ITS OWN LEAD AGENCY THROUGH WHICH STATE AGENCIES ARE DIRECTED, AND

100

MUNICIPAL GOVERNMENTS WILL HAVE THEIR OWN LEAD AGENCIES THROUGH WHICH
MUNICIPAL AGENCIES ARE DIRECTED.
IN NEW YORK CITY, THERE ARE AT LEAST TWO LEAD AGENCIES FOR EACH PROJECT.
THEY ARE THE DEPARTMENT OF CITY PLANNING AND THE DEPARTMENT OF
ENVIRONMENTAL PROTECTION.
A PROJECT DATA STATEMENT IS FILED WITH THE LEAD AGENCIES. THIS IS THE
SAME AS AN ENVIRONMENTAL ASSESSMENT FORM, WHICH IS THE PROJECT DATA
STATEMENT REQUIRED UNDER THE STATE ENVIRONMENTAL QUALITY REVIEW ACT. FOR
VARIANCES IN NEW YORK CITY, THE BOARD OF STANDARDS AND APPEALS REPLACES
THE PLANNING BOARD AS LEAD AGENCY, TEAMING UP WITH THE DEPARTMENT OF
ENVIRONMENTAL PROTECTION.
AN ADMINISTRATIVE DETERMINATION IS A STATEMENT BY THE LEAD AGENCY THAT AN
ENVIRONMENTAL IMPACT STATEMENT IS NOT REQUIRED.
THIS DETERMINATION IS
CHALLENGEABLE UP TO 4 MONTHS FROM ISSUE. THIS IS THE SAME AS A NEGATIVE
DECLARATION.
END OF CLASS EIGHT
CLASS NINE
11/5/90
GUEST SPEAKER, KEVIN CARRIGAN
THE GUEST SPEAKER WAS PREVIOUS COUNCIL TO CONGRESSMAN TOM MANTON. HE IS
A MEMBER OF THE COMMUNITY BOARD IN QUEENS THAT CONTAINS THE NEW COMPLEX
BUILT BY CITIBANK.
THE COMMUNITY BOARD PLAYS AN IMPORTANT ROLE IN CITY GOVERNMENT. IT IS
THE MOST BASIC LEVEL OF GOVERNMENT THAT A CITIZEN CAN INVOLVE HIMSELF IN.
THERE ARE 59 COMMUNITY BOARDS WITH UP TO 50 PEOPLE IN EACH, CONSISTING OF
RESIDENTS AND LOCAL BUSINESSMEN. YOU NEED NOT RESIDE IN THE PARTICULAR
DISTRICT IF YOU ARE A BUSINESSMAN THERE. IT IS ONLY REQUIRED THAT YOU
LIVE IN ONE OF THE FIVE BOROUGHS.
THERE MUST BE A "BALANCE" ON THE BOARD. THIS MEANS THAT ALL PARTS OF THE
DISTRICT MUST BE REPRESENTED FAIRLY, AS WELL AS HAVING A FAIR
REPRESENTATION OF BUSINESS OWNERS AND RESIDENTS (ACCORDING TO THE REVISED
CITY CHARTER). THE COUNCIL PEOPLE FROM THE DISTRICT CAN RECOMMEND UP TO
ONE-HALF OF THE MEMBERS OF THE COMMUNITY BOARD, WHICH MUST BE APPROVED
FOR APPOINTMENT BY THE BOROUGH PRESIDENT.
THE BOROUGH PRESIDENT CAN
APPOINT UP TO ONE-HALF OF THE MEMBERS WITHOUT THE APPROVAL OF THE
COMMUNITY BOARD.
THERE ARE THREE FUNCTIONS OF THE COMMUNITY BOARD.

THEY ARE:

1. MONITOR THE DELIVERY OF CITY SERVICES TO THE DISTRICT.

2. ENABLES THE DISTRICT TO GET ITEMS FUNDED FROM THE
EXPENSE BUDGETS OF THE CITY.

101

CAPITAL

AND

3. HAS A FORMAL ROLE IN THE URBAN LAND USE REVIEW PROCESS (ULURP).
COMMUNITY BOARDS NOW HAVE A FORMAL ROLE IN SITTING IN ON ENVIRONMENTAL
REVIEW SCOPING SESSIONS.
THE ULURP PROCESS AND THE COMMUNITY BOARD - AFTER THE APPLICATION FOR
DEVELOPMENT IS CERTIFIED, IT GOES TO THE COMMUNITY BOARD FOR A 60 DAY
REVIEW. THE BOARD DECIDES WHETHER TO HOLD A PUBLIC HEARING AND/OR TAKE A
POSITION ON THE ISSUE. AFTERWARDS, IT GOES TO THE BOROUGH PRESIDENT, WHO
HAS THE SAME OPTIONS.
LIKEWISE THIS FOLLOWS WITH THE CITY PLANNING
COMMISSION, WHICH HAS THE SAME OPTIONS.
BEAR IN MIND THAT THE COMMUNITY BOARD IS MADE UP OF VOLUNTEER CITIZENS.
WHEN THEY HEAR AN APPLICATION, THEY FEEL THAT EVERYBODY IS AGAINST THEM.
THEY FEEL EXCLUDED FROM THE PROCESS, AND FEEL THAT "DEALS" ARE BEING
STRUCK ALL AROUND THEM WITHOUT THEIR NOTICE. THEY DO NOT FEEL A PART OF
THE 9 TO 5 CITY GOVERNMENT, WHO GET PAID TO REVIEW THE PROJECT DURING THE
DAY. THEY ARE AT A DISADVANTAGE THEREFORE, SINCE THEY ARE NOT ABLE TO BE
FULLY INVOLVED OR INFORMED ABOUT THE PROCESS.
THEY WILL USUALLY BE
DEFENSIVE, WILL DEMAND INVOLVEMENT IN THE PROCESS, AND WILL MAKE IT CLEAR
TO YOU THAT THEY KNOW THEIR COMMUNITY BEST AND WHAT IS GOOD FOR IT.
END OF CLASS NINE
CLASS TEN
11/12/90
LANDMARK - A BUILDING, PARK OR OTHER ELEMENT OF HISTORICAL, SOCIAL OR
AESTHETIC IMPORTANCE THAT IS DESIGNATED A LANDMARK BY THE LANDMARKS
COMMISSION, STATE OR NATIONAL HISTORICAL REGISTRY.
STATE, NATIONAL AND CITY HISTORICAL REGISTRIES ARE INDEPENDENT AND WHAT
MAY BE IN ONE REGISTRY IS NOT AUTOMATICALLY CONTAINED IN THE OTHER
REGISTRIES.
NATIONAL REGISTRATION QUALIFIES YOU FOR SPECIAL TAX CREDITS.
REGISTRATION, UNLIKE NEW YORK'S, CANNOT BE FORCED UPON YOU.

NATIONAL

NATIONAL HISTORIC DISTRICTS CANNOT BE FORCED ON AN AREA WITHOUT THE

CONSENT OF AT LEAST 50 PERCENT OF THE AREA'S MEMBERS.
NATIONAL REGISTRATION, STATE OR CITY REGISTRATION DOES NOT AUTOMATICALLY
QUALIFY YOU FOR REGISTRATION IN THE REMAINING REGISTRIES. EACH REGISTRY
IS COMPLETELY AUTONOMOUS.
NATIONAL REGISTRATION DOES NOT LIMIT DEVELOPMENT ACTIVITY.
LIABILITIES TO BEING AN NATIONALLY REGISTERED LANDMARK.

THERE ARE FEW

THERE ARE THREE CRITERIA TO BEING LISTED IN THE CITY'S LANDMARK REGISTRY:

102

1. ARCHITECTURAL UNIQUENESS
2. SOCIAL UNIQUENESS
3. AESTHETIC UNIQUENESS
NOTHING ELSE SHOULD BE CONSIDERED BY THE LANDMARKS COMMISSION. IF A SITE
IS THREATENED BY DEVELOPMENT, LANDMARKS DESIGNATION SHOULD NOT BE A
PRETEXT FOR PREVENTING IT.
WHEN A LANDMARKS COMMISSION LOOKS AT A PROPERTY, THEY EITHER DECIDE IT IS
A LANDMARK, OR THEY PASS ON A DECISION SO AS NOT TO FOREGO A POTENTIAL
LANDMARK STATUS AT A FUTURE DATE.
THE LANDMARKS COMMISSION IS FORMED OF ELEVEN PEOPLE, APPOINTED BY THE
MAYOR, ONE OF WHOM IS THE PAID POSITION OF CHAIRMAN. THE CHAIRMAN HOLDS
A FULL TIME POSITION WITH THE CITY, WHILE THE OTHER MEMBERS ARE NOT PAID
FOR THEIR TIME OR SERVICES.
GIVEN THE NATURE OF SOME NON-PROFIT INSTITUTIONAL FINANCES, THE LANDMARKS
COMMISSION HAS A 5 PERSON PANEL THAT REVIEWS LANDMARKS DECISIONS THAT
WOULD CAUSE UNBEARABLE HARDSHIPS.
THIS PANEL IS MADE UP NOT ONLY OF
HISTORIANS AND ARTISTS (LIKE THE LANDMARKS COMMISSION), BUT ALSO CONTAINS
BUSINESSMEN AND OTHER PROFESSIONS. THEY ARE APPOINTED BY THE MAYOR.
END OF CLASS TEN
CLASS ELEVEN
11/19/90
RENT REGULATION
THE FEDERAL GOVERNMENT INSTITUTED RENT REGULATIONS AFTER THE SECOND WORLD
WAR. THE AGENCY OF THE FEDERAL GOVERNMENT RESPONSIBLE FOR THIS WAS THE
OFFICE OF PRICE ADMINISTRATION (OPA).
IN 1948, THE CITY ADOPTED A RENT CONTROL LAW AFTER THE FEDS GOT OUT OF
REGULATING RENTS.
IT AFFECTED RETAIL AND RESIDENTIAL DEVELOPMENT.
IN
1952, THE END OF RENT CONTROL FOR RETAIL REAL ESTATE HAD TAKEN PLACE.
THE DEPARTMENT OF HOUSING AND COMMUNITY RENEWAL (DHRC), A STATE AGENCY,
REGULATES ALL RENTAL UNITS IN THE CITY AND STATE, OR ANY OTHER
MUNICIPALITY THAT WISHES TO HAVE RENT CONTROL.
THE MAXIMUM BASE RENTAL FORM (MBR) IS FILED ANNUALLY BY THE LANDLORD AS
THE PROCEDURE FOR GETTING RENT INCREASES UNDER RENT CONTROL.
IT LISTS
THE EXPENSES OF THE BUILDING AND GOVERNS THE DEGREE OF RENT INCREASE.
THE RENT STABILIZATION ASSOCIATION WAS AN INDUSTRY GROUP THAT VOLUNTARILY
OVERSAW RENT STABILIZATION. WHEN IT FAILED TO DO SO, THE DHRC ENFORCED
IT.

103

YOU ARE UNDER RENT CONTROL IF YOU WERE IN YOUR APARTMENT BEFORE 1961.
AFTER 1969, ALL NEW BUILDINGS WERE UNDER RENT STABILIZATION. ONCE A RENT
CONTROLLED APARTMENT IS VACATED, IT BECOMES A RENT STABILIZED APARTMENT.
IN A RENT STABILIZED APARTMENT, YOU CAN NOT BE EVICTED NOTWITHSTANDING
NONPAYMENT OF RENT, ILLEGAL ACTIVITY, OR DAMAGE TO BUILDING.
IF YOU TAKE A 421a ABATEMENT FROM THE CITY ON YOUR RENTAL BUILDING, YOU
MUST PUT ITS APARTMENTS UNDER RENT STABILIZATION.
THE RENT GUIDELINES BOARD DECIDES ON ANNUAL OR BIANNUAL INCREASES IN
RENTS TO TENANTS.
IF YOU HAVE A BUILDING WITH 20 PERCENT OF THE UNITS SOLD, IT IS AN
EFFECTIVE CONDOMINIUM AND THE REMAINING 80 PERCENT CAN BE RENTED WITHOUT
REGULATION.
-UNLESSIF YOU OWN MORE THAN TEN UNITS IN ONE BUILDING, THE UNITS ARE UNDER
REGULATION. IN A PROJECT WITH 100 UNITS AND YOU OWN ONE UNIT IN EACH OF
THE TEN BUILDINGS OF TEN UNITS, THEY ARE NOT UNDER REGULATION.
HOW TO INCREASE RENTS
IN A RENT CONTROLLED BUILDING, THROUGH IMPROVEMENTS.
IN A RENT STABILIZED BUILDING, THROUGH THE FOLLOWING METHODS:
MAJOR CAPITAL IMPROVEMENT INCREASE
(MCI) - A PROGRAM TO IMPROVE THE
BUILDING. WHEN COSTS ARE PASSED ON TO RENTERS, THE NEW EXPENSE OF RENT
COMES IN LINE WITH MORTGAGE AND MAINTENANCE PAYMENTS REQUIRED TO PURCHASE
THE UNIT. THE NEW COST PROVIDES THE INCENTIVE TO PURCHASE RATHER THAN
RENT.
IMPROVEMENTS MUST BE DONE TO THE ENTIRE BUILDING, IE., THE ROOF,
ELEVATOR, WATERPROOFING AND WINDOWS MUST BE FOR THE ENTIRE BUILDING, NOT
JUST PART OF IT.
IN DOING THE IMPROVEMENTS, THE MAJOR CAPITAL IMPROVEMENTS DO NOT INCLUDE
THE COST OF USING MONEY OR BORROWING IT. J-51 ABATEMENTS ARE GIVEN FOR
THESE IMPROVEMENTS AS WELL.
HARDSHIP
IE. IN EVICTIONS AND RENT INCREASES DUE TO DEMOLITION AND IMPROVEMENTS.
WHEN TENANTS ARE IN PLACE, THEY ARE USUALLY BOUGHT OUT BY THE LANDLORD.
ONLY WHEN PROOF IS GIVEN TO THE DHRC THAT:

104

1. THE PROJECT CAN BE FINANCED

2. THE TENANT CAN BE RELOCATED
3. THE PLAN FOR IMPROVEMENTS ARE APPROVABLE BY THE BUILDING DEPT.
THE PROCESS:
DHRC > APPEAL > ETC. (LOOPS AGAIN AND AGAIN)
TAKES 7 TO 8 YEARS, POTENTIALLY.
DEMOLITION FOR A RENT STABILIZED BUILDING IS EASIER TO SECURE THAN FOR A
RENT CONTROLLED BUILDING IN A RENT CONTROLLED BUILDING, A FOURTH ITEM IS
REQUIRED.
4.

THAT A 8.5 PERCENT RETURN IS

VALUATION OF THE PROPERTY.

NOT

POSSIBLE

AGAINST

THE

ASSESSED

THE ASSESSED VALUATION IS OFTEN FAR LESS THAN THE ACTUAL VALUE.
MAY NOT INCLUDE INTEREST.

EXPENSES

END OF CLASS ELEVEN

CLASS TWELVE
11/26/90
ADMINISTRATIVE APPEAL - AN APPEAL OF THE DECISION OF THE BUILDING
DEPARTMENT TO REVOKE A PERMIT.
THE BUILDING DEPARTMENT UNDER THE OLD
CITY CHARTER (WHICH PROVIDED THAT WORK COULD PROCEED AT YOUR OWN RISK
WHEN THE PERMIT WAS REVOKED) COULD HAVE ITS DECISIONS TO REVOKE A PERMIT
APPEALED TO THE BOARD OF STANDARDS AND APPEALS.
ADMINISTRATIVE APPEALS ARE OFFERED IN THE MORNING SESSION OF THE BSA
MEETING WHEREAS VARIANCE APPEALS ARE HEARD IN THE AFTERNOON SESSION.
ADMINISTRATIVE APPEALS ARE DIFFERENT THAN VARIANCE APPEALS IN THAT THE
"FIVE FINDINGS" DO NOT APPLY.

TAXATION ISSUES
ASSESSMENTS
VINCENT PATRERO, GUEST SPEAKER
3 MAJOR PROGRAMS: ONE RELATES TO NON-COMMERCIAL USES AND THE OTHERS TO
RESIDENTIAL USES.
IN 1984 INDUSTRIAL / COMMERCIAL INCENTIVE PROGRAM REPLACED THE ICI BOARD,
WHICH WAS FORMED IN 1977.
THE ICIB CAME UNDER FIRE BECAUSE OF ITS DISCRETIONARY NATURE.

105

THEREFORE,

IN 1984 AN AS OF RIGHT PROGRAM CALLED THE ICI PROGRAM WAS BROUGHT ON LINE
TO REPLACE IT.
YOU MUST FILE THE PRELIMINARY APPLICATION TO THE ICIP
BEFORE GETTING A BUILDING PERMIT IN ORDER TO BENEFIT FROM THE INCENTIVES.
THE INCENTIVES VARIED FOR INDUSTRIAL AND COMMERCIAL USES. FOR INDUSTRIAL
USES, THE INCENTIVES COULD BE EARNED ANYWHERE IN THE CITY.
FOR
COMMERCIAL DEVELOPMENT IT WAS LIMITED IN SCOPE BETWEEN TWO TYPES OF
INCENTIVES DEPENDING ON LOCATION IN THE CITY. AS AN IDEA OF THE TYPE OF
INCENTIVE THE ICIP PROVIDES, FOR INDUSTRIAL USES THERE IS A 13 YEAR TAX
EXEMPTION WITH A 9 YEAR PHASE-OUT. THE ICIP COVERS RENOVATIONS AS WELL
AS NEW CONSTRUCTION.
THERE ARE 421a AND 421b INCENTIVES. THEY ARE NAMED AFTER THE SECTIONS
FROM THE STATE REAL PROPERTY TAX LAW WHERE THEY CAN BE FOUND.
SECTION 421b RELATES TO 1 AND 2 FAMILY HOMES BEGUN BY JUNE 30, 1984 AND
COMPLETED BY JULY 1, 1986. IT APPLIED TO NEW CONSTRUCTION AND CERTAIN
ENLARGEMENTS AND IMPROVEMENTS.
IN THE TWO FAMILY HOMES, ONE OF THE
INHABITANTS MUST BE THE OWNER. IT FEATURES A TWO YEAR EXEMPTION AND A 7
YEAR PHASE-OUT. THIS INCENTIVE WAS AVAILABLE OVER THE ENTIRE CITY.
SECTION 421a APPLIES TO THE ENTIRE CITY. CONSTRUCTION MUST BEGIN BY DEC.
31 1993 AND BE COMPLETED BY DEC. 31, 1995.
IT APPLIES TO RESIDENTIAL
DEVELOPMENT WITH 3 OR MORE FAMILIES PER BUILDING.
THE SITES IT IS
APPLIED TO MUST BE VACANT OR UNDERUTILIZED. IF YOU BUILD MORE THAN ONE
HUNDRED UNITS, A CERTAIN BREAKDOWN OF ONE AND TWO BEDROOM UNITS WILL BE
REQUIRED TO AVOID THE BUILDING OF ALL STUDIOS, FOR EXAMPLE.
THE J-51 PROGRAM IS A TAX EXEMPTION PROGRAM. THE INCREASE IN ASSESSED
VALUE IS ABATED FOR A TIME. THE ABATEMENT IS ONE DOLLAR OF TAX REDUCTION
PER DOLLAR OF IMPROVEMENTS. WHEN YOU ARE GETTING BOTH J-51 BENEFITS AND
RENT INCREASES, YOU AGREE TO WAIVE 50 PERCENT OF THE INCREASES IF YOU
TAKE BOTH THE ABATEMENT AND THE INCREASE.
END OF CLASS TWELVE
CLASS THIRTEEN
DECEMBER 3, 1990
ASSIGNMENTS TURNED IN.
END OF CLASS THIRTEEN AND COURSE

106

ANALYTICAL TECHNIQUES
PROFESSOR ED MADSEN
SPRING 1990

NOTES FROM ANALYTICAL TECHNIQUES

1/22/90
WHEN ALLOCATING VALUE TO A PROPERTY, IT MUST BE DONE BY RELATING IT TO
SOME UNIT OF MEASUREMENT:
DOLLARS PER ROOM
DOLLARS PER SQUARE FOOT
DOLLARS PER ......
CONSUMPTION DRIVES THE SUCCESS OF MALLS
HOTELS ARE MEASURED FOR VALUE BY A PER ROOM BASIS
CONRAD HILTON SAID, "FOR EVERY 1000 DOLLARS INVESTED, I NEED 1 DOLLAR IN
ROOM RATE."
FOR EXAMPLE, A 100 ROOM HOTEL WITH 95 DOLLAR PER NIGHT RATES COULD HAVE
HAD AS MUCH AS 95,000,000 DOLLARS INVESTED IN IT.
ANY AMOUNT LESS IN
INVESTMENT WOULD RESULT IN A GREATER RETURN ON THE INVESTMENT.
HOTELS
COULD COST AS MUCH AS 140,000 TO 150,000 PER ROOM TO BUILD AND EQUIP,
INCLUDING FACILITIES IN COMMON.
TWO RULES OF LENDING:
1.
2.

DO NOT LEND MORE MONEY THAN THE PROPERTY IS WORTH.

DO NOT LEND MONEY TO A DEAD-BEAT

ALSO:
THERE ARE TWO TYPES OF PEOPLE INVOLVED IN REAL ESTATE:
1. DREAMERS, AND
2. LIARS.
OF NOTE:
IN CANADA; MONTHLY PAYMENT LOANS MAY NOT HAVE INTEREST COMPOUNDING MORE
FREQUENTLY THAN TWICE YEARLY. IN CANADA, THE PERSON TAKING OUT THE LOAN
IS OBLIGATED TO BE LIABLE FOR DEFICIENCY JUDGEMENT IN THE CASE OF
DEFAULT.
IN THE UNITED STATES, THIS IS NOT THE CASE.
WE HAVE "NONRECOURSE" LOANS, WHICH DO NOT ALLOW THE ENTITY LENDING THE MONEY TO HOLD
THE PERSON TAKING OUT THE LOAN LIABLE FOR MONIES OUTSTANDING AFTER THE
PROPERTY IS FORECLOSED AND SOLD AT A LOSS TO THE LENDING INSTITUTION.
ASSIGNMENT IN CLASS
ANOTHER URBAN NEW BRUNSWICK DEVELOPMENT OF H.K. ASSOC.
NET INCOME OF HOUSING...............1,440,000

106

DEBT SERVICE........................ 950,000

CASH FLOW........................... 490,000
VALUE IS DEDUCED FROM NET INCOME BY USING A CAP RATE, SAY 10%.
1,440,000 / 10% = 14,400,000
LAND AND LAND IMPROVEMENTS = 2.2M
CONSTRUCTION
= 9.5M
14.4 - 11.7 = 2.4M

..
..EQUALS 11.7M

IS THIS THE EQUITY?

LET US SEE.

DID BANKER GIVE 9.5M CONSTRUCTION LOAN AT 80% RATE?

9,500,000 / 80% = 11.88 M
THIS IS AN ESTIMATE OF VALUE OF DEBT
14.4 - 11.88 = 2.5M

; ANOTHER ESTIMATE OF VALUE OF EQUITY.

OR, VALUE COULD BE DETERMINED PER SQUARE FOOT. FOR THE HOUSING, 62,000
S.F. WAS DIVIDED INTO 14.4M TO YIELD 230 DOLLARS PER S.F.
COMPARE THIS TO A TYPICAL YIELD AT 100 DOLLARS PER S.F. AND YOU START TO
GET SUSPICIOUS.
THEREFORE, WITH 230 -100 = 130 DOLLARS, THE PREMIUM IS 130 DOLLARS PER
SQUARE FOOT. PREMIUMS COME FROM INCOME.
130 DOLLARS X 62,000 S.F. = 8,060,000, THIS EQUALS THE PREMIUM, WHICH
AMOUNTS TO A "GIFT" FROM RUTGERS, WHICH IS HIGHLY UNLIKELY.
HOW CAN THE UNIVERSITY IN ITS PRESENT STATE AFFORD TO GIVE SUCH HIGH
PREMIUMS? LIKELY, THEY CAN NOT.
FOR THE STUDENT, A COMPARATIVE TABLE:
250 DOLLARS PER STUDENT PER MONTH IN RENT.
4 STUDENTS PER APARTMENT
1000 DOLLARS PER APARTMENT PER MONTH
12 MONTHS PER YEAR
12,000 DOLLARS PER YEAR PER APARTMENT
EACH BEDROOM IS 12 X 16
12 X 16 BEDROOM X 2 = 192 X 2= 384
8 X 8 KITCHEN
= 64
100 SQUARE FOOT LIVING ROOM = 100
6 X 8 BATHROOM
= 48
TOTAL
APPROX. 600 S.F.
12,000 PER YEAR / 600 S.F. = 20.00 PER S.F. PER YEAR
COMPARE TO 23.23 PER YEAR FROM DEVELOPER'S FIGURES
1.44M / 62,000 S.F. = 23.23
IF THE PROJECT COST IS 100 PER SQUARE FOOT, HOW MUCH NET RETURN DO YOU
HAVE TO EARN TO MAKE IT VIABLE? ANSWER IS 10.00 PER S.F. THE DEVELOPER
SAYS THAT HE WILL GET 23.23 PER S.F.
THE BANK MAKES LOAN AT 75% OF

107

VALUE. THIS IS $23.23 / 10% = 232.30 X 75% = 174.23 X 62,000 = 10,801,950

LOAN FROM THE BANK.
IF THE SUBJECT PROPERTY IS WORTH 232.30 PER SQUARE FOOT WHEN COMPLETE,
AND COST OF CONSTRUCTION, PROFIT, AND OTHER COSTS IS 132 DOLLARS PER
SQUARE FOOT, ISN'T THE LAND WORTH 100 DOLLARS PER SQUARE FOOT OF BUILDING
AREA? THIS IS CALLED THE FAR METHOD OR FLOOR/AREA RATIO METHOD FOR
DETERMINING THE RESIDUAL LAND VALUE.
THE VALUE OF THE PROPERTY WOULD
THEREFORE BE;
100 DOLLARS/FAR
62,000 X 100 = 6,200,000 = LAND VALUE AS DEDUCED FROM THE DEVELOPER'S
NUMBERS. IF THE VALUE IS 6.2M, MULTIPLY BY 75% AND THE BANK LOAN WOULD
AMOUNT TO 4.65M DOLLARS.
IN TERMS OF DOLLARS PER ACRE, TAKE 6,200,000 / 14.28 ACRES = 434,000 PER
ACRE IS THE VALUE OF THE PROPERTY.
SUBTRACT MONEY FOR GETTING VARIANCES, FLOOD PLAINS, WETLANDS, ETC.
END OF CLASS ONE
CLASS TWO 1/29/90
TODAY'S CLASS:
1.
HISTORY OF REAL ESTATE MARKET; WHAT HAS A BEARING ON REAL
ESTATE
VALUES.
2. WHAT IS THE PROCESS FOR APPRAISAL
PARENTHETICALLY SPEAKING
CONSIDER: LAST WEEK'S CLASS NOTES:
A PROPERTY WITH A NOI OF 1.44 MILLION
VALUE METHOD WAS TO CAPITALIZE NOI AT 10% OVERALL.
1,440,000
10%

= 14.4 MILLION

THIS PROCESS IS KNOWN AS "DIRECT

"CAPITALIZATION AT AN OVERALL RATE".

CAPITALIZATION".

ALSO

KNOWN

AS

THE INDICATED VALUE IS 14.4 MILLION FOR THE LAND AND THE BUILDING. TO
DETERMINE THE VALUE OF THE LAND, YOU DEDUCT THE VALUE OF THE BUILDING.
ESTIMATED COST @ 100.00 PER S.F. X 62,000 S.F.
THEREFORE BUILDING COST IS 6,200,000 DOLLARS.
THEREFORE 14.4 M - 6.2 M = 8.2 M = LAND VALUE
CASE TWO:
GIVEN A 60,000 S.F. BUILDING AT 12.00 PER S.F. NET
LEASE:

"IN THE EVENT THAT, IN WHOLE OR IN PART, THE MUNICIPALITY

108

CONDEMNS THE PROPERTY, THE TENANT SHARES IN THE AWARD".

HOW DO YOU EVALUATE THE LEASEHOLD POSITION OF THE TENANT AND THE VALUE OF
THE AGREEMENT, IN TERMS OF A TEN YEAR LEASE.

CONDITION ONE:
CONDEMNATION ON DAY ONE: TENANT HAS AN AGREEMENT TO OCCUPY SPACE UNTIL
YEAR 2000 AT 12 DOLLARS PER S.F. WHEN THEY LOCATE ANOTHER LOCATION, THEY
GET AN EQUIVALENT LEASE AS PER TIME PERIOD AND RENT COST, THEREFORE THERE
ARE NO DAMAGES OTHER THAN THE MONEY EXPENSE OF SEEKING AND MOVING TO A
NEW LOCATION.
CONDITION TWO:
SUPPOSE THAT MARKET RATE INCREASES TO 24 DOLLARS PER S.F. AT A STRAIGHT
LINE BASIS OVER THE TEN YEARS FROM NOW TO THE YEAR 2000. A CONDEMNATION
OCCURS IN THE YEAR 1997. MARKET RENT IS AT 18 DOLLARS PER S.F. NET, AND
FOR THE NEXT THREE YEARS TO YEAR 2000 THEY MUST THEREFORE PAY 6 DOLLARS
MORE PER S.F., WHICH IS THE PRESUMED DAMAGES.
THE DAMAGE TO THE LESSEE IS 6 DOLLARS PER S.F. FOR THREE YEARS. ANOTHER
WAY OF STATING THIS IS THAT "IN 1997, THE VALUE OF THE LEASEHOLD ESTATE
IS EQUAL TO THE PRESENT VALUE OF 6 DOLLARS PER SQUARE FOOT PER YEAR FOR
THREE YEARS.
CALCULATOR ENTRY:
1. 360000
2. ENTER
3. CHS
4. PMT
5. 3
6. N
7. 10.5
8. I
9. PV
ANSWER IS IN REGISTER (887,444.45)
THE DISCOUNT RATE IS BASED UPON THE PRESENT DISCOUNT RATE ON THE US
TREASURY BONDS, OR IN THIS CASE 3 YEAR TREASURY BILLS.
U.S 3 YEAR T-BILL IS AT 8 PERCENT.
ADD 250 TO 300 BASIS POINTS WHICH IS 2.5 TO 3.0 PERCENT TO THE 8 PERCENT
TO CONSIDER THE PREMIUM FOR RISK AND LIQUIDITY INVOLVED IN THE
TRANSACTION; THE ANSWER RESULTING WOULD BE THE VALUE OF THE INTEREST RATE
FOR THE LEASEHOLD ESTATE IN 1997.

EXAM QUESTION *************

*******************************************************************

109

THE RULE OF 72'S

72 / RATE OF INTEREST = YEARS TO DOUBLE THE VALUE OF THE INVESTMENT.
see also the rule of 70's for monthly compounding, below
*******************************************************************
I.E. AT 6% PER ANNUM, IT WOULD TAKE 12 YEARS TO DOUBLE MONEY.
AT 8% PER ANNUM, IT WOULD TAKE 9 YEARS TO DOUBLE MONEY.
A VARIANT ON THE ABOVE RULE:
DIVIDE TIME INTO 72 TO GET THE RATE OF INTEREST REQUIRED TO DOUBLE YOUR
MONEY. FOR EXAMPLE, TO DOUBLE YOUR MONEY IN TEN YEARS, YOU WOULD REQUIRE
A 7.2% PERCENT INTEREST COMPOUNDED ANNUALLY.
THE RULE OF 70'S IS THE SAME CONCEPT, BUT YIELDS MONTHLY COMPOUNDING.
EXAMPLE CASE;
A BUILDING BUILD IN 1984
64,390 S.F.
14.5 PERCENT VACANCY
METROPARK, N.J.
RENTS HAVE BEEN LEVEL AT BETWEEN 21 AND 22.5 SINCE 1984, WHICH COMPARES
UNFAVORABLY WITH THE INCREASE IN INFLATION.
ACCORDING TO HUGH KELLY, WE CAN EXPECT THE INCREASE IN OFFICE RENTS TO
OCCUR AT ABOUT THE SAME RATE AS THE CONSUMER PRICE INDEX (CPI); HOWEVER,
IN THE REAL ESTATE MARKET WE PERIODICALLY RUN INTO PERIODS OF OVERSUPPLY, WHERE THE MARKET TENDS TO MOVE SIDEWAYS OR DOWNWARD, AND PRESSURE
INCREASES ON INFLATING RENTS, CAUSING IN TURN AN INCREASE IN NEW
CONSTRUCTION.
^ ^ ^
^
^DO NOT
2000
^ BUILD
*1999
^
*1998

5 % INCREASE
* 1997

*1996

24.00 DOLLARS
* 1995
39.00 DOLLARS

* 1994
^

* 1993

* 1992
^DEMAND INCREASES AS EXCESS
BUILD
SUPPLY DIMINISHES. DEVELOPERS NOTICE QUICK

110

*1991^ ^
^
^
^ INCREASE IN RENTS AND BUILD BUILDINGS TO
*1990
THE LEVEL OF OVERSUPPLY, RETURNING THE CYCLE
DIAGRAM OF HUGH KELLY'S THEORY
BILL ZECKENDORF'S HAWAIIAN TECHNIQUE
B.Z. OWNS A BUILDING IN MANHATTAN WITH A PARTNER WHO RARELY AGREES WITH
HIM. AS A 50 PERCENT PARTNER, HE OFFERS HIS SHARE FOR SALE, OF A 10 M
PROPERTY. HE SAID "PAY 5 MIL FOR MY HALF INTEREST, OR I WILL PAY 6 MIL
FOR YOUR INTEREST. I WANT TO OWN THE BUILDING AND PROPERTY ALONE".
IT WAS KNOWN THAT THE BUILDING WAS NOT WORTH 11 MILLION DOLLARS.
ON
PAPER, HE SEPARATED THE BUILDING FROM THE LAND THROUGH A DEVICE CALLED
THE GROUND LEASE WITH A NOI OF 1.1 MILLION, HE BROKE UP THE PROPERTY
ALLOTTING 50 % OF NOI TO THE LAND AND 50% TO THE BUILDING.
ZECKENDORF KNEW THAT INSURANCE COMPANIES LOVE CERTAINTY.
HE COULD
GUARANTEE THE GROUND LEASE WITH A GROUND RENT OF 0.55 MILLION AT 8%,
VERSUS THE 6% THEY COULD GET IN THE BOND MARKET.
550,000 / 8% =
6,875,000 VALUE FOR THE LAND AS AN ANNUITY.
HE THEN CAP RATED THE
BUILDING AT 9 PERCENT, OFFERING THE LEASEHOLD WITH ITS BENEFIT OF FULL
DEPRECIATION ON THE LEASE, SINCE NO LAND VALUE IS CONSIDERED IN A LEASE.
HE THEN SOLD THE PROPERTY FOR THE 13 MILLION WHICH WAS THE NEWLY COMPUTED
COMBINED VALUE OF THE LAND AND THE LEASEHOLD.
APPRAISALS:
THE STEPS OF APPRAISAL;
1.
LAYOUT THE PURPOSE; GENERALLY SPEAKING, PEOPLE WANT TO KNOW THE
MARKET VALUE OF THE PROPERTY FOR MORTGAGE LENDING PURPOSES.
2. GET THE IDENTITY OF THE PROPERTY (I.E. ADDRESS, TAX NUMBERS, BLOCK,
LOT, ETC.)
3. DEFINITION OF MARKET VALUE; MARKET VALUE IS THE MOST PROBABLE PRICE
AT WHICH THE PROPERTY SHOULD SELL WITH AN ALL CASH PURCHASE PRICE.
4.

THE PROPERTY RIGHTS APPRAISED MUST BE DESCRIBED

THE VALUE OF A LEASED FEE
THE VALUE OF A LEASEHOLD
THE VALUE OF A FEE SIMPLE INTEREST
ETC.
WHAT ARE THE BUNDLE OF RIGHTS INVOLVED IN FEE-SIMPLE OWNERSHIP?
USE THE ACRONYM; D. O. S. L. U. G.
DO NOTHING
OCCUPY

1. POLICE POWER; ZONING,

SELL

BUILDING CODES, SPECIAL

LEASE
AS LIMITED BY
DISTRICTS
USE

2. TAXATION
GIVE AWAY
3. ESCHEAT (INHERITANCE BY

111

STATE WHEN NO HEIRS CLAIM

4. EMINENT DOMAIN

(CONDEMNATION)
5. ZONING; USES AND BULK REQUIREMENTS
6. HIGHEST AND BEST USE
7. LAND
8. IMPROVEMENTS
9. LOCATION
*************************************************************************
*

"VALUE IS A THREE-LEGGED STOOL"

1. THE COST APPROACH
COMPUTE THE VALUE BY COMPARISON
PARCEL ONE.
64,398 FAR (TIMES)
35 DOLLARS PER FAR
EQUALS
MILLION
DIVIDED BY 2.2 ACRES
= 1.024 MILLION PER ACRE

PARCEL TWO
3 ACRE SITE
180,000 FAR
TIMES 35/FAR
2.253
EQUALS
6.3 MILLION, DIVIDED BY 3
ACRES EQUALS 2.1 MILLION
PER ACRE

THE COST APPROACH IS THE LEAST ACCURATE. IT ANSWERS THE QUESTION "WHAT
WOULD IT COST TO ACQUIRE A SITE OF SIMILAR SUITABILITY TO THE ONE
STUDIED".
IT CONSIDERS LAND VALUE AND BUILDING COST. THE INDICATED VALUE IS THE
REPLACEMENT COST OF THE BUILDING.
DEPRECIATION IS A LOSS OF VALUE
ATTRIBUTABLE TO FACTORS SUCH AS AGE, USE, ETC.
THE MARKET APPROACH
THE MARKET APPROACH ANSWERS THE QUESTION "WHAT ARE SELLING PRICES FOR
SIMILAR PROPERTIES".
THE GAP BETWEEN A FIGURE DERIVED BETWEEN MARKET APPROACH
APPROACH IS OFTEN MADE UP BY THE "DEPRECIATION FIGURE".

AND

COST

IF MARKET VALUE IS 32 DOLLARS PER SQUARE FOOT AND REPLACEMENT IS 100

DOLLARS, THEN THE PROPERTY WOULD BE DEPRECIATED BY 68 DOLLARS PER SQUARE
FOOT.
THE INCOME APPROACH

112

THE INCOME APPROACH ANSWERS THE QUESTION "WHAT WOULD THE PROPERTY BE
WORTH TO AN INVESTOR BASED UPON ITS INCOME PRODUCTION".
GIVEN A SITUATION:
COST APPROACH VALUE..................5 MILLION
MARKET APPROACH VALUE................10 MILLION
INCOME APPROACH......................9 MILLION
IF YOU SEE THIS, SOMETHING IS WRONG.
IF THIS WERE TRUE THEN YOU WOULD SEE LOTS OF ACTIVITY IN THE MARKET TO
REAP THE PROFITS FROM THE GAP.
THE RECONCILIATION APPROACH
AVERAGING THE APPROACHES TO GET A VALUE.
LIMITING CONDITIONS OF AN APPRAISAL;
"I AM NOT AN EXPERT IN MATTERS PERTAINING TO CONTAMINATION ABOVE OR BELOW
THE GROUND."
THE APPRAISAL IS CERTIFIED AS OF A SPECIFIC "POINT IN TIME".
END OF CLASS TWO
CLASS THREE 2/5/90
HOWARD GELBTUCH, HISTORICAL SURVEY
HANDOUT GIVEN SHOWING 1974 THROUGH 1976 MANHATTAN LEASABLE SPACE COMPARED
TO DOW INDUSTRIAL RISES AND FALLS, AND HISTORICAL OCCASIONS.
WHY DOES NOT THE DOW INDUSTRIALS RELATE TO THE REAL ESTATE CYCLE IN THE
NEW YORK MARKET?
1. PSYCHOLOGICAL SENTIMENT AND HERD INSTINCT.
2. DOWS REFLECT NATIONAL MARKETS AND ARE DAILY RESPONSIVE TO WORLD
EVENTS.
3. REAL ESTATE IS DEPENDENT ON CONDITIONS THAT ARE FOR THE MOST PART
LOCAL.
4. REAL ESTATE REQUIRES A LEAD TIME FOR ACTIVITY. THEREFORE A GOOD AND
PROSPEROUS PERIOD OF TIME FOLLOWED BY A LESS PROSPEROUS TIME MAY SEE
DECISIONS MADE IN THE PROSPEROUS PERIOD ENTER REALITY IN THE DEEPEST
PARTS OF THE LEAST PROSPEROUS PERIODS.
TYPES OF VALUE ESTIMATION AND APPRAISAL.
TECHNIQUE ONE:

THE CENTRAL MANUFACTURING DISTRICT FORMULA (CMD)

THIS FORMULA REFLECTS THE CMD THEORY.

WE WANT TO EARN A REASONABLE
RETURN ON OUR LAND IN RENT.
A RATE WAS CONCOCTED WHICH DID THIS; 6
PERCENT. AT THE SAME TIME, THEY WISHED TO GET REIMBURSED FOR THE LOSS OF

113

VALUE (DEPRECIATION) OF THE BUILDING WHILE BEING OCCUPIED BY THE TENANT

OVER TIME. CONSIDER THE PERIOD 50 YEARS AS A LIFESPAN, DEPRECIATING 2
PERCENT PER YEAR UNTIL THE 50TH YEAR WHEN 100 PERCENT IS REACHED. USING
A 6 PERCENT RETURN IN RENT ON THE BUILDING, ADD ON THE 2 PERCENT
DEPRECIATION FACTOR TO GET 8 PERCENT. THEREFORE THE ANNUAL RETURN ON THE
BUILDING CONSTRUCTION EXPENSE NEEDS TO BE 8 PERCENT.
EXAMPLE:
LAND VALUE= 100,000 X 6% = 6,000 (not 8% because
depreciate)
BUILDING COST = 400,000 X 8% = 32,000
TOTAL RENT = 6,000 + 32,000 = 38,000 NET ANNUALLY

land

does

not

IS THERE AN EASIER AND MORE DIRECT WAY OF LOOKING AT LAND VALUE THAN CMD?
EXAMINE THE FOLLOWING.
IF THE TOTAL INVESTMENT IS 500,000 AS IN THE ABOVE CASE, THEN;
38,000 / 500,000 = 7.6%, WHICH IS THE RELATIONSHIP BETWEEN THE NET (NOI)
(38,000) AND THE VALUE (500,000).
THE 7.6% WOULD BE THE OVERALL CAPITALIZATION RATE (OCR), WHICH BRINGS US
TO THE SECOND TECHNIQUE.
TECHNIQUE TWO:

THE OVERALL CAPITALIZATION RATE (OCR)

THE PROCESS OF
CAPITALIZATION.

USING

THE

OVERALL

CAPITALIZATION

RATE

IS

DIRECT

DIRECT CAPITALIZATION WAS THE METHOD OF PREFERENCE IN THE 1960'S.

YOU
ESTIMATE GROSS INCOME, DEDUCT VACANCY ALLOWANCE (VA) AND COLLECTION LOSS
ALLOWANCE (CLA) TO ARRIVE AT EFFECTIVE GROSS INCOME (EGI).
GROSS INCOME - (VA + CLA) = EGI
(VA + CLA) = THE NET OPERATING EXPENSE (NOE)
EGI IS THE FORECASTED
COLLECTION LOSS.

GROSS

INCOME

AFTER

ALLOWING

FOR

VACANCY

AND

EXAMPLE:
100,000 =EGI
-5,000 =NOE
-------95,000 =RESULT
-47,500 =48 TO 50 PERCENT EXPENSES
-------47,500 =NET OPERATING INCOME (NOI)
IN THE 1960S, THE PREVALENT CAP RATE WAS 0.085, OR 8.5 PERCENT.

114

NOI / 8.5% = VALUE

47,500 / 8.5% = 560,000
THE VALUE OF THE ABOVE PROPERTY IS $560,000 ACCORDING TO THIS METHOD.
IN THE 1960'S, APPRAISERS STABILIZED EXPENSES, AND DID NOT CONSIDER
INFLATION OR COST INCREASES INTO THE FORMULAS DETERMINING VALUE. SINCE
IT WAS RECOGNIZED THAT THIS WAS INADEQUATE, TECHNIQUE THREE, THE GROSS
INCOME MULTIPLIER WAS UTILIZED.
TECHNIQUE THREE: THE GROSS INCOME MULTIPLIER (GIM)
FORMULA: 5.6 X GROSS INCOME = VALUE
EXAMPLE: 100,000 X 5.6 = 560,000 DOLLARS.
WHERE DID GROSS INCOME MULTIPLIERS COME FROM? FROM OBSERVATION. SINCE
NET IS NOT CONSIDERED, SOME SAID IT WAS NOT PREFERRED. SO WHY WAS IT
USED?
ANSWER: WHEN YOU HOLD THE ASSUMPTIONS PREVALENT AT THE TIME, THAT THERE
IS AN ASSUMED 5 PERCENT VACANCY, AND A 50 PERCENT OPERATING EXPENSE, AND
AN 8.5% CAPITALIZATION RATE, YOU MUST BY NECESSITY AND BY MATHEMATICS GET
A 5.6 GROSS RENT MULTIPLIER. SO, IN ACTUALITY, THIS METHOD IS AS GOOD AS
DIRECT CAPITALIZATION, IS SIMPLER AND REFLECTS THE ASSUMPTIONS HELD IN
COMMON UNDER THE DIRECT CAPITALIZATION METHOD.
TECHNIQUE FOUR:

THE ELLWOOD FORMULA

PETE ELLWOOD OF EQUITABLE LIFE INSURANCE COMPLAINED THAT WE NEED TO TAKE

MORE INTO ACCOUNT IN VALUE THAN THE FIRST YEAR OF INCOME. HE SAID THAT
IF, GIVEN A PROPERTY WITH:
NOI = 10,000
LOAN = 75,000
INTEREST = 10 PERCENT CONSTANT, INTEREST ONLY
DEBT SERVICE = 7,500
CASH FLOW = 2,500 (ALSO CALLED THE EQUITY DIVIDEND BY ELLWOOD)
COST = 100,000
SUPPOSE YOU INVEST EQUITY OF 25,000, WHAT DO YOU GET IN EXCHANGE.
IN
THIS EXAMPLE YOU GET EQUITY DIVIDEND FOR 2,500 PER YEAR, OR 10 PERCENT.
IF OVER A TEN YEAR TIME FRAME THERE IS NO INCREASE OR DECREASE IN THE
PROPERTY VALUE ( WHAT YOU PAID ), WHAT IS THE EQUITY YIELD ON THE
INVESTMENT? A TEN PERCENT EQUITY YIELD IS THE ANSWER.
HP CALCULATION
25000, chs, g, Cfo
2500, g, Cfj

115

9, g, Nj
27500 (which is the last year income added to the sale price), g, Cfj
f, IRR
IF YOU WANT TO CHANGE THE PROPERTY VALUE TO REFLECT A TEN PERCENT
INCREASE THE VALUE WOULD BE 110,000, SO THE NEW LAST VALUE (THE Cfj
entry) WOULD CHANGE FROM THE 27,500 TO 37,500 TO REFLECT THE ADDITIONAL
10,000 PROFIT.
TO ENTER THIS INTO THE HP WITHOUT RE-ENTERING THE OTHER INFORMATION,
ENTER:
37500, STO, 2
THIS IS BECAUSE CELL 2 HOLDS THE LAST Cfj VALUE.
THE NEW COMPUTATION RESULTS IN A 12.25 PERCENT INTERNAL RATE OF RETURN IN
THE FIRST YEAR.

DOING THE SAME FOR A TWENTY PERCENT INCREASE IN PROPERTY VALUE, THE
INTERNAL RATE OF RETURN WOULD BE 14.11 PERCENT.

#14.11% (20% INCREASE)

10%
#

#
*12.25% (10% INCREASE)

*
5%
#
*

#
*

#
*
*
SALE DATE
0.#*----------------------------------------------*-- 10% EQUITY LINE

= \
=\

=
-5%
\ =

\
=

= 7.12% (10% DECREASE)

-10%

\ 3.03% (20% DECREASE)

*INFLATION IN VALUE
*YEARS*

116

O YEARS

10 YEARS
THE ELLWOOD FORMULA (FAN GRAPH)

THE ELLWOOD FORMULA WAS AN

INVESTOR'S POINT OF VIEW.
DISCOUNTED CASH FLOW.

ATTEMPT TO LOOK AT A PROPERTY FROM AN

THIS LEADS US TO THE FIFTH TECHNIQUE,

TECHNIQUE FIVE: THE DISCOUNTED CASH FLOW (DCF)

THE LACK OF DEBT COVERAGE CONSIDERATION GIVES RISE TO THIS TECHNIQUE.
GIVEN:
PROPERTY VALUE 10,000,000 DOLLARS BASED ON 10% OVERALL CAP RATE.
LOAN OF 7,500,000 BASED ON 75% LOAN RATIO
NOI OF 1,000,000 DOLLARS PER YEAR
ANNUAL INTEREST AND PRINCIPAL PAYMENT STATED AS A PERCENT ON TOTAL LOAN
IS CALLED A CONSTANT WHICH IS 10 PERCENT IN THIS CASE.
750,000 DEBT
SERVICE RESULTS IN A 250,000 DOLLAR CASH FLOW.
COVERAGE = NOI / DEBT SERVICE
COVERAGE SHOULD BE APPROXIMATELY 1.3 TO BE ACCEPTABLE.
1,000,000 / 750,000 = 1.3
WHERE DID THE 1.3 FIGURE DERIVE FROM?
WHEN THE CONSTANT IS PRECISELY THE SAME AS THE OVERALL RATE, AND YOU HAVE
A 75% LOAN RATIO, THE COVERAGE WILL ALWAYS BE 1.3. THE GLUE THAT MAKES
THIS ALL STICK TOGETHER IS THE RELATIONSHIP BETWEEN THE OVERALL RATE
(OAR) AND THE CONSTANT.
MADSEN'S RULE: FOR EVERY BASIS POINT AT WHICH THE OVERALL RATE SLIPS
BELOW THE CONSTANT, THE CASH ON CASH RATIO SLIPS 4 POINTS. WHEN OAR AND
THE CONSTANT ARE THE SAME RATE, THEN IT WILL BE IDENTICAL TO THE CASH-ONCASH RATIO.
COC = CASH FLOW / CASH EQUITY
COC = 250,000 / 2,500,000 = 10%
TO APPLY MADSEN'S RULE, A 9.99 OAR WITH A 10 PERCENT CONSTANT WOULD
RESULT IN A 9.96 COC.
IF YOU HAVE A 9 PERCENT OAR WITH A 10 PERCENT
CONSTANT, THEN YOU HAVE A 6.00 COC.
100,000 PROPERTY
10% CONSTANT
7,500 DEBT SERVICE ANNUALLY
10% OAR
2,500 CASH FLOW = NOI
LOAN = 75,000
EQUITY = 25,000

117

COC = 2500
IF OAR SLIPS TO 9.99 PERCENT, THEN THE NOI IS 9990.00
9990 - 7500 = 2490
2490/25000 = 0.0996
EXAMPLE OF DISCOUNTED CASH FLOW:
PROPERTY IS 21,000
CASH IN (INVESTMENT) IS 4,800
PERIOD IS 3 YEARS
CASH OUT (WHAT YOU WALK AWAY FROM CLOSING WITH) IS 9,600
CASH FLOW IS NIL.
THE RATE OF RETURN IS 26 PERCENT.
EXAMPLE:
CASH IN IS 25,000
CASH FLOW IS 2,500 (10% GAIN)
CASH OUT IS 26,250 (1,250 GAIN) (5% GAIN)
10% + 5% = 15% = THE INTERNAL RATE OF RETURN.
THE TOTAL RETURN DERIVED FROM:
CASH FLOW
GAIN ON EQUITY
REVERSION IS WHAT THE INVESTMENT SELLS FOR AT THE END OF THE INVESTMENT
PERIOD. IT IS THE CASH FLOW IN THE INTERNAL RATE OF RETURN THAT ASSUMES
THE SALE OF THE INVESTMENT.
THE ABILITY TO SIMPLY ADD THE GAINS PERCENTAGES FROM CASH FLOW AND CASH
OUT TO ARRIVE AT THE CALCULATED INTERNAL RATE OF RETURN FALLS APART AFTER
THE FIRST YEAR BECAUSE THE PERCENTAGE OF GAIN RELATIVE TO THE PROPERTY'S
VALUE PRIOR TO THE PERIOD HAS BEGUN TO VARY, THROWING THE CALCULATION
OFF.
CASH FLOW IS NOT THE SAME AS NET OPERATING INCOME. NET OPERATING INCOME
IS THE CASH FLOW ADDED TO THE LEASING COSTS AND TENANT IMPROVEMENTS.
CASH FLOW IS THE LEASING COSTS AND TENANT IMPROVEMENTS SUBTRACTED FROM
THE NET OPERATING INCOME.
NOI - LEASING COSTS AND TENANT IMPROVEMENTS = CASH FLOW
HOW DO WE FORECAST THE VALUE OF THE PROPERTY AT REVERSION? WE TAKE THE
NOI AND DIRECT CAPITALIZE IT AT A PERCENTAGE (SAY, 8.5%). THE REVERSION
IS BASED ON A CAP RATE ON THE PREVIOUS YEAR TO THE REVERSION'S NOI,
THOUGH SOME ADVANCE IT TO THE NEXT YEAR.
END OF CLASS THREE

118

CLASS FOUR 2/12/90

NO CLASS NEXT WEEK
ETHICS IN REAL ESTATE
3 TYPES OF PEOPLE... WHAT IS MINE IS MINE SO I'LL KEEP IT
WHAT IS MINE IS MINE SO I'LL SHARE IT
WHAT IS MINE IS YOURS SO I'LL TAKE IT
HOW DO YOU AVOID GETTING YOURSELF INTO AN ETHICAL MORASS?
THE CONCEPT OF TRUSTEESHIP - A TRUST; A THIRD PARTY ACTOR WHO MAKES AN
EFFORT TO BE A CARETAKER OF SOMEONE ELSE'S PROPERTY, AND TO ACT IN THEIR
INTEREST.
A TRUST IS AN ARRANGEMENT MADE BY A "CREATOR" WHO HAS THE
WEALTH. HE CREATES A "TRUST" WHICH IS THE REPOSITORY OF THE WEALTH. THE
TRUST HAS SEVERAL PARTIES: THE TRUSTEE AND THE BENEFICIARY.
THE TRUSTEE TAKES CARE OF THE WEALTH IN THE TRUST FOR THE BENEFIT OF THE
BENEFICIARY, ACCORDING TO THE OBJECTIVES OF THE CREATOR.
SEE YOURSELF AS A TRUSTEE AND YOU WONT GO WRONG.
IN INVESTMENTS THE INVESTOR CONCERNS HIMSELF WITH YIELD TO RISK RATIOS.
YOU INVEST SAFELY AT THE HIGHEST RETURN POSSIBLE WITH THE LEAST RISK; THE
TRUSTEE HAS THE RESPONSIBILITY FOR DETERMINING THE LIMITS OF BOTH.
AUTHORITY - TO WHOM IS THE AUTHORITY TO INVEST DELEGATED TO, AND UNDER
WHAT CONDITIONS?
AUTHORITY IS A DELEGATED RESPONSIBILITY.
PRESENT WORTH VS. FUTURE WORTH
GIVEN;
LOAN AT 6.25 DOLLARS
AT 8%
FOR 9 YEARS
PAYMENT IS 1.00 PER YEAR ANNUITY
(SEE MADSEN HANDOUT FROM WEEK 3, IN THE 5 X 8 FORMAT)
CASH FLOW EXERCISE
PV=?
CASH FLOW = 100,000 ANNUALLY
INTEREST = 10%
TERM = 5 YEARS
ANSWER IS 379,078.68
HOW DO YOU KNOW WHEN COMPUTING IRR ON A CALCULATOR THAT YOU GOT THE
CORRECT ANSWER?
BY DOING THE FOLLOWING;
PV=400,000

119

INTEREST=?
TERM=5
PAYMENT = 100,000
ANSWER = 7.93 =INTEREST & IRR

CALCULATE THE FV OF THE 100,000 PAYMENT

YEAR ONE = 92,653

TWO = 85,845

THREE= 79,538

FOUR= 73,693

FIVE= 68,279

TOTAL = 400,000
THEREFORE THE 7.93 FIGURE IS CONFIRMED
SOLVING THE SAME PROBLEM WITH THE "BLUE KEY" REGISTERS;
100,000 PER YEAR PAYMENT
5 YEARS
PV=400,000
400,000, CHS, G, Cfo
100,000, G, Cfj
5, G, Nj
F, IRR, READ REGISTER 7.93
ANOTHER EXAMPLE
100,000 PAID IN THE FIRST YEAR
200,000 IN YR. TWO
400,000 IN YR. THREE
800,000 IN YR. FOUR
1,600,000 IN YR. FIVE
INTEREST = 10%

SOLVE FOR PV
0, G, Cfo
100,000, G, Cfj
F, NPV, READ REGISTER 2,096,609.15
200,000, G, Cfj

400,000, G, Cfj

800,000, G, Cfj

1,600,000, G, CfJ
ANOTHER EXAMPLE
YEAR ONE TO THREE 200,000
YEAR FOUR TO SIX 400,000

120

YEAR SEVEN 500,000

10% INTEREST
0, G, Cfo
200,000, G, Cfo
3, G, Nj
400,000, G, Cfj
3, G, Nj
500,000, G, Nj
F, NPV, = 1,501,312.94
ANOTHER EXAMPLE
10% INTEREST
NPV = 481,593
CASH FLOW
100,000
200,000
300,000
-------600,000
END OF CLASS FOUR

0% INTEREST
NPV = 600,000
YEAR
1
2
3

CLASS FIVE 2/26/90

A SINKING FUND IS A REGULAR PERIODIC PAYMENT REQUIRED TO ACCUMULATE 1.00
DOLLAR AT THE END OF A GIVEN TERM, INCLUDING PAYMENT AND COMPOUNDED
INTEREST.
EXAMPLE:
OBJECTIVE; TO HAVE 10,000 DOLLARS AT THE END OF 4 YEARS AT 8% PER ANNUM,
THE ANNUAL SINKING FUND PAYMENT WOULD BE 2,200 DOLLARS.
10,000 X .22 (FROM TABLE) = 2,200.00
CALCULATED ON HP12C = 2219.21

POP QUIZ GIVEN. EXPECT CONTENT TO REAPPEAR ON THE MIDTERM AND FINAL
THE INFORMATION BELOW IS BASED UPON THE POP QUIZ HANDOUT
PORTION OF
INVESTMENT

ANNUAL CLAIM ON
INCOME STREAM

DEBT

121

RATE
COMPONENT

SERVICE
(DEBT)
EQUITY
YIELD
(DEBT)

75% (LOAN
RATIO)

X
11.76% (MORT.
CONSTANT)

25% (DOWN
PAYMENT)
X

AMORTIZATION 75% (OF THE

(CREDIT)
INVESTMENT)*X
VALUE
APPRECIATION 100%
(CREDIT)

8.82%

15% (IRR)

3.75%

9.7%** X 6.53***

-0.48%

32.07%****X6.53%

-2.10%

OVERALL RATE............................................ + 10.00%

THE OVERALL RATE IS A COMPOSITE OF INCOME REQUIRED FOR DEBT SERVICE AND
EQUITY YIELD WHILE FOLDING IN AMORTIZATION AND VALUE APPRECIATION.
*
= PAYMENT AGAINST THE LOAN WHICH IS 75%
** = PERCENTAGE OF THE TOTAL INVESTMENT PAID OFF AT 8 YEARS, PAID OFF ON
THE AMORTIZED PORTION OF THE INVESTMENT
*** = THE SINKING FUND FACTOR. HOW DO YOU GET THIS FIGURE? .005445 FROM
COLUMN 3, PAGE 934, 15%, YEAR 8 . .005445 X 12 = 0.06534
****= INCREASE OF INVESTMENT AGAINST THE BUYING PRICE AT 8 YEARS (SEE
QUESTION NINE IN HANDOUT)

***CALCULATION METHOD
8,g,n; 15,g,i; 1,FV; PMT, read register; 12, x, 100, x; end of operation
MORE INFLATION RESULTS IN A SMALLER OAR. CONVERSELY, IF INFLATION TAKES
A NOSE DIVE, THE OAR INCREASES TO COMPENSATE. AS OAR GOES UP, PROPERTY
VALUE GOES DOWN.
AS INTEREST RATES GO UP, THEN OAR GOES UP, AND VALUE GOES DOWN.
UNDERSTAND HOW THE ABOVE TABLE DERIVES THESE CONCEPTS ABOVE.
EXPECT QUESTIONS ON THE MIDTERM ON;
BETTER TO BUY OR RENT?
NOI
CASH ON CASH RATES
END OF CLASS FIVE

122

CLASS SIX

3/5/90

CLASSES FOR NEXT SEMESTER

LEGAL ISSUES; SMITH, 5:45 TO 9:15 ON MONDAY
FEDERAL TAX; WATERS, 5:45 TO 7:30 ON THURSDAY
FORMULA FOR FUTURE VALUE
(1+i)n = FUTURE VALUE
EXAMPLE; 8 PERCENT INTEREST
YEAR ONE; (1+.08)1 = 1.08
YEAR TWO; (1+.08)2 = 1.166
YEAR NINE; (1+.08)9 = 1.999
FORMULA FOR PRESENT VALUE
1
(1+i)n

= PRESENT VALUE

EXAMPLE;

8 PERCENT INTEREST
1
= 0.926
YEAR ONE;
(1+.08)1
1
(1+.08)2

= 0.858

YEAR TWO;

1
(1+.08)9

= 0.5

YEAR NINE;

NET OPERATING INCOME

123

 OVERALL

RATE

VALUE

STATED DIFFERENTLY, VALUE = I/R,

OR,
VALUE = NET OPERATING INCOME / OVERALL RATE
FOR EXAMPLE:
GROSS OPERATING INCOME = 19000
LESS EXPENSES
= 11000
8000
THEN 8,000 / 10% = VALUE = 80,000
EXAMPLE
108,000 LOAN AT 12.5% PER ANNUM
TERM

MONTHLY P&I

20 YEARS
30 YEARS

1227.03
1152.64
74.39

TOTAL PAYMENTS
294,487.00
414,949.19
120,462.19

TOTAL INTEREST
186,487.63
306,949.82
120,462.19

REFINANCING
104,000 REMAINING IN BALANCE ON A LOAN
12.5% INTEREST, 17 YEARS LEFT
VS.
108,000 AT 9 3/8%, 15 YEAR TERM
TERM
17 YEARS
15 YEARS

MONTHLY P&I
12.5% (1227.03/MO.)
9 3/8% (1119.64/MO.)

TOTAL PAYMENTS
250,314
201,535

THERE IS AN INTEREST DEDUCTION OVER THE LIFE OF THE LOAN

REDUCTION IN INTEREST EXPENSE OVER THE LIFE OF THE LOAN
WITH A 100 DOLLAR PRE-PAYOUT (accelerated payment)
REMAINING TERM
28 YEARS
30 YEARS

12.5%
2K
4K

FIXED INTEREST RATES

14%
15%
3K
4K
6K
8K

END OF CLASS SIX

CLASS SEVEN ; 3/19/90

124

16%
5K
10K

EXAM:
50 QUESTIONS
2:30 TO 4PM IS EXAM
4:15 TO 5:30 IS DEBRIEFING
OPEN BOOK
OPEN NOTES
BRING CALCULATOR
*********************
EXAM CONTENT
*********************
25% OAR/IRR/CASH-ON-CASH
20% DCF/FUTURE VALUE/PRESENT WORTH
20% LEVEL RENT ANNUITY
15% COMPOUND INTEREST/ RULE OF 72'S
10% MORTGAGE FINANCING
5% LEVERAGE
5% ETHICS
QUESTIONS WILL BE BASED ON ANNUAL RATHER THAN MONTHLY PAYMENTS.
*************************************************************************
*
GIVEN A LEASE OF 10 YEARS;
5 YEARS AT 100,000 PER YEAR AT 10 PERCENT
5 YEARS AT 125,000 PER YEAR AT 10 PERCENT
PROVIDES SIX MONTHS FREE RENT UP FRONT
EXPENSES PAID BY TENANT
YEAR ONE = 50,000
YEAR TWO THROUGH FIVE = 100,000 EACH
YEAR SIX THROUGH TEN = 125,000 EACH
NET PRESENT VALUE (NPV) = 627,846.67 (enter as PV, then enter period n,
then enter the discount rate and solve for the equivalent level rent per
annum, which is the payment).
example:
627,846.67 ,PV
10, i
10, n
PMT
READ ANSWER, 102,179.15
IF THE BUILDING IS 100,000 S.F., THEN THE AVERAGE LEVEL RENT PER SQUARE

125

FOOT PER ANNUM IS 1.022 DOLLARS.

MORTGAGES AND MORTGAGE LOANS
WHAT IS A MORTGAGE?
500 YEARS AGO, YOU BORROWED MONEY IN PLEDGE FOR COLLATERAL. VIFGAGE WAS
GIVEN TO THE LENDER AS A FEE.
VIFGAGE MEANS "LIVE PLEDGE" AND WOULD
GENERALLY RESULT IN MOVING OUT OF A PROPERTY WHILE THE LENDER MOVES IN.
MORTGAGE MEANS "DEAD PLEDGE". THE OWNER'S RIGHT TO OCCUPY YOUR PROPERTY
REMAINED "DEAD" AND PASSIVE AS LONG AS PAYMENTS WERE KEPT UP-TO-DATE.
FORECLOSURE, GENERALLY RESULTING IN SALE OF PROPERTY, TAKES PLACE TO
SETTLE THE DEBT TO THE LENDER.
A SALE BELOW THE DEBT REMAINING CAUSES YOU TO BE PERSONALLY LIABLE FOR
THE REMAINDER OF THE AMOUNT.
SOME STATES (GENERALLY RURAL STATES)
PROVIDE FOR "REDEMPTION", WHICH ALLOWS A PERSON TO "BUY BACK" HIS
PROPERTY. IT IS A LIMITED PERIOD (GENERALLY SIX WEEKS) WHERE YOU CAN PAY
OFF THE ENTIRE DEBT, PLUS COURT COSTS AND OTHER COSTS.
THE LENDER HAS FIRST PRIORITY AND LEANING ON THE PROPERTY, AND IS IN A
MORE SECURE POSITION THAN THE BORROWER.
FOR EXAMPLE:

WHEN GOLDMAN-DELORENZO TOOK TITLE TO THE LAND UNDER 1166 AVENUE OF THE AMERICAS THE GROUND RENT PAID BY

TISHMAN COVERED LOAN PAYMENTS ON THE 32.5 MILLION FIRST FEE MORTGAGE TO THE NEW YORK STATE EMPLOYEES RETIREMENT SYSTEM
AND THE 3.5 MILLION SECOND FEE MORTGAGE TO JAMAICA SAVINGS BANK.

TISHMAN OBTAINED A 45 MILLION CONSTRUCTION LOAN

(LEASEHOLD FIRST MORTGAGE LOAN) IN ADDITION TO INVESTING 25 MILLION DOLLARS IN THE LEASEHOLD EQUITY.

FOR YOUR ANSWERS TO

THE FOLLOWING QUESTIONS, PRIORITIZE EACH OF THE INVESTMENT POSITIONS WITH "1" BEING MOST SECURE, AND 5 BEING LEAST
SECURE.
1. FIRST MORTGAGE ON THE LEASED FEE. 2. SECOND MORTGAGE ON THE LEASED FEE.

3. FEE EQUITY

4. FIRST MORTGAGE ON THE

LEASEHOLD. 5.LEASEHOLD EQUITY.

WHERE DO THE MORTGAGE PAYMENTS COME FROM?

WHAT IS THE LOAN BALANCE AT THE END OF TEN YEARS ON A LOAN WHICH HAD:
AN INITIAL LOAN AMOUNT OF 100,000
INTEREST RATE OF 10 PERCENT
MONTHLY PAYMENT PERIOD OVER 25 YEARS
PAYMENT PER MONTH OF 908.70.
100,000, PV
10,g,i
25,g,n
PMT, READ REGISTER
120,n
FV, READ REGISTER
ANSWER IS 84,561.36.
WHAT IS THE FUTURE VALUE OF 100,000 IF AT 10 PERCENT AND 10 YEARS?
FV = 270,704.15 (COMPOUNDED MONTHLY)
FV OF PAYMENT OF 908.70 FOR TEN YEARS AT 10% PER ANNUM COMPOUNDED MONTHLY
= 186,142.63.
270,704.15

126

-186,142.63
------------84,561.52
THE DIFFERENCE OF THE FUTURE VALUE COMPOUNDED WITH NO PAYMENTS AND THE
FUTURE VALUE OF THE PAYMENTS = THE LOAN BALANCE
LEVERAGE
BUY A PROPERTY FOR 100,000 AND IT INCREASES TO 200,000 OVER TEN YEARS.
THE AVERAGE ANNUAL INCREASE WAS 7.2% COMPOUNDED OVER THE TEN YEARS (LAW
OF 72'S).
SAY YOU HAVE AN AVERAGE LOAN BALANCE OF 80,000 BORROWED AT 6%, AND YOUR
AVERAGE EQUITY IS 20,000.
100,000 X 7.2% = 7,200
80,000 X 6.0% = 4,800
-----------------------20,000 = EQUITY:2,400 = DIFFERENCE
2400 / 20,000 EQUITY = LEVERAGED ANNUAL INCREASE OF 12%, WHICH IS THE
AVERAGE EQUITY RETURN.
END OF CLASS SEVEN
CLASS EIGHT
EXAMINATION GIVEN WITH DEBRIEFING
3/26/90
IN THE EARLY 70'S WHEN TOO MUCH MONEY WAS CHASING TOO FEW INVESTMENTS, A
MYSTERIOUS DEAL WAS MAKING THE ROUNDS OF NEW YORK LENDING INSTITUTIONS.
THROUGH INTERMEDIARIES, AN UNNAMED INVESTOR WAS OFFERING TO DEPOSIT 500
MILLION IN EXCHANGE FOR THE PROMISE TO RETURN 1 BILLION DOLLARS AT THE
END OF TEN YEARS.
USING THE RULE OF 72'S, THE INVESTORS REQUIRED RATE OF RETURN WAS 7.2%.
USING THE HP12C, THE REQUIRED ANNUAL RATE OF RETURN BASED ON ANNUAL
COMPOUNDING IS 7.177%.
USING THE HP12C, THE REQUIRED ANNUAL RATE OF RETURN BASED ON MONTHLY
COMPOUNDING IS 6.952%.
BASED ON THE ABOVE ANSWERS, DOES THE RULE OF 72'S IMPLY ANNUAL OR MONTHLY
COMPOUNDING? IT IMPLIES ANNUAL COMPOUNDING. THE RULE OF 70'S RELATES TO
MONTHLY COMPOUNDING.
ON AUGUST 22,1965, THE NEW YORK TIMES CARRIED THE FOLLOWING ANNOUNCEMENT
ABOUT A DEVELOPMENT IN WILLINGBORO, NEW JERSEY:

127

LEVITT AT GARFIELD PARK ANNOUNCES 3 NEW HOME DESIGNS RANGING IN

PRICE FROM 13,500 TO 16,990.

LAST SUMMER (AUGUST 22, 1989), ONE OF THE GARFIELD PARK HOUSED ORIGINALLY
PRICED AT 15,000 WAS SELLING FOR 125,000.
THE MORTGAGE LOAN USED TO
FINANCE THE HOUSE HAD AN AVERAGE BALANCE OF 5000 (FROM THE TIME OF
PURCHASE THROUGH LAST SUMMER) AT AN INTEREST RATE OF 6%.
IF THE BROKERAGE COMMISSION FOR SELLING THE HOUSE LAST SUMMER WAS 5%,
WHAT WOULD THE SALE PROCEEDS HAVE BEEN (BEFORE PAYING OFF THE REMAINING
BALANCE ON THE MORTGAGE LOAN)? 118,750.
BASED ON THE INITIAL HOME PURCHASE PRICE IN 1965, AND THE SALE PROCEEDS
LAST SUMMER (AFTER PAYMENT OF THE BROKERAGE COMMISSION BUT BEFORE THE
REPAYMENT OF THE MORTGAGE LOAN BALANCE), WHAT IS THE IMPLIED AVERAGE
ANNUAL RATE OF RETURN ON THE GROSS INVESTMENT? 9%.
WHAT WAS THE IMPLIED LEVERAGED RATE OF RETURN ON THE EQUITY? (IGNORE THE
RENTAL VALUE OF THE HOME OCCUPANCY FOR THE SOLUTION TO THIS PROBLEM).
10.5%.
IF THE BUYER WHO PAID 125,000 LAST SUMMER IS FACED WITH THE PROSPECT OF
HOME VALUES INCREASING AT AN AVERAGE RATE OF 5% PER ANNUM (NET OF RESALE
COMMISSION) OVER THE NEXT 10 YEARS AND HAS FINANCED THE PURCHASE WITH A
LOAN WHICH WILL HAVE AN AVERAGE BALANCE OF 100,000 OVER THE NEXT 10 Years
AT AN INTEREST RATE OF 10% PER ANNUM, WHAT IS THE PROSPECTIVE LEVERAGED
RATE OF RETURN ON THE EQUITY (IGNORE THE RENTAL VALUE OF HOME OCCUPANCY
FOR THE SOLUTION TO THIS PROBLEM). 15%
WHAT WOULD YOUR ANSWER BE TO THE FOREGOING QUESTION IF THE AVERAGE LOAN
BALANCE WAS 50% OF THE PURCHASE PRICE? 0%.
WHAT DO THE ANSWERS TO THE PREVIOUS TWO QUESTIONS IMPLY WITH RESPECT TO
THE CONVENTIONAL WISDOM OF THE LAST THREE DECADES THAT HIGH LEVERAGE IS
THE ROAD TO HIGH EQUITY RETURNS?
GREATER EQUITY INVESTMENTS PROVIDE
BETTER INTERNAL RATES OF RETURN BECAUSE INTEREST RATES ON DEBT HAVE RISEN
TO A LEVEL HIGHER THAN ANNUAL VALUE INCREASES IN THE INVESTMENT WHICH IS
BEING LEVERAGED.
IF YOU ARE GIVEN THE FACT THAT THE PRESENT WORTH OF 1 DOLLAR DEFERRED 9
YEARS IS 50 CENTS, USING ANNUAL COMPOUNDING:
WHAT IS THE IMPLIED DISCOUNT RATE?

8.006%

WHAT IS THE FUTURE WORTH OF $1 FOR THE SAME RATE AND TERM?

$2.00.

WHAT IS THE RELATIONSHIP BETWEEN THE FUTURE WORTH FACTOR AND THE PRESENT
WORTH FACTOR? THEY ARE THE INVERSE OF EACH OTHER. NOTE THE FORMULAS FOR

128

PRESENT WORTH AND FUTURE WORTH IN THE NOTES TO CLASS SIX.

DEMONSTRATE THE CORRECTNESS OF YOUR ANSWER TO THE ABOVE QUESTION BY
SHOWING YOUR SOLUTION OF THE EQUATION (1+i)n. (1+0.08006)9 = 2.00.
WHAT IS THE COEFFICIENT FOR AN ANNUITY OF 1 DOLLAR PER ANNUM FOR THE SAME
RATE AND TERM? 12.491
WHAT IS THE MORTGAGE LOAN CONSTANT FOR THE SAME RATE AND TERM?
WHAT IS THE RELATIONSHIP BETWEEN THE TWO ABOVE NUMBERS?
SAME.

12.491.

THEY ARE THE

HOW MUCH MONEY WOULD YOU HAVE TO SET ASIDE EACH YEAR TO ARRIVE AT A
FUTURE WORTH OF 1 DOLLAR FOR THE SAME RATE AND TERM? 8 CENTS.
WHAT IS THE FACTOR CALLED THAT YOU PRESENTED AS THE ANSWER TO THE
PREVIOUS QUESTION? SINKING FUND FACTOR.
WHAT IS THE RELATIONSHIP OF THE ANSWER TO THE QUESTION BEFORE LAST AND
THE FACTOR FOR FUTURE WORTH OF 1 DOLLAR PER ANNUM? IT IS THE INVERSE OF
IT.
BASIC ASSUMPTIONS:
NOI OF 125,000
OAR OF 10 PERCENT
LOAN RATIO OF 75 PERCENT
INTEREST RATE OF 10 PERCENT
LOAN TERM OF 8 YEARS
AMORTIZATION IS BY INTEREST ONLY PAYMENTS ANNUALLY
SELLING EXPENSES ARE 5% AT THE END OF 8 YEARS.
THE PRESENT PROPERTY VALUE BASED ON OAR IS 1,250,000
THE PRESENT VALUE OF THE EQUITY IS 312,500
THE LOAN AMOUNT IS 937,500
THE ANNUAL CONSTANT IS 10 PERCENT
THE ANNUAL DEBT SERVICE IS 93,750, SINCE ONLY INTEREST IS PAID (INT.
ONLY)
ANNUAL CASH FLOW IS 31,250.00
FUTURE LOAN BALANCE AT THE END OF 8 YEARS IS 937,500
SALE PROCEEDS AT THE END OF 8 YEARS (PRIOR TO LOAN PAYOFF) IS 1,781,250.
FUTURE VALUE OF EQUITY AT THE END OF 8 YEARS ( AFTER PAYOFF) IS 843,750.
PROJECTED 8 YEAR IRR (ANNUAL COMPOUNDING) IS 20.22%
CASH ON CASH IS CASH FLOW / CASH EQUITY WHICH IS 10 PERCENT
THE COVERAGE IS NOI / DEBT SERVICE WHICH IS 1.333
IF THE CONSTANT IS RAISED BY 100 BASIS POINTS AND ALL OTHER FACTS REMAIN
THE SAME WHAT WILL THE CASH-ON-CASH BE (COMPUTE TO TWO DECIMAL PLACES)?
7.00 PERCENT. IF THE CONSTANT IS RAISED FROM 10 PERCENT TO 11 PERCENT,
THEN THE ANNUAL DEBT SERVICE WILL INCREASE TO 103,125.00, WHICH WILL

129

CAUSE THE CASH ON CASH RATIO TO BE (125,000-103,125) / 312,500 =7

PERCENT.
THE CONSTANT IS THE ANNUAL INTEREST AND PRINCIPAL PAYMENTS AS A
PERCENTAGE OF THE TOTAL LOAN.
WHAT DOES THE 100 BASIS POINT CHANGE IN THE CONSTANT (SPECIFIED IN THE
PREVIOUS QUESTION) DO TO THE COVERAGE (COMPUTE TO TWO DECIMAL PLACES)?
THE COVERAGE WOULD BE ADJUSTED TO 1.212 WHICH IS 125,000 / 103,125.
IN FEBRUARY, 1989 A 119,349 SQUARE FOOT OFFICE BUILDING IN NEW JERSEY'S
ROUTE 1 CORRIDOR NEAR PRINCETON SOLD FOR 17,600,000 SUBJECT TO A 10 YEAR
LEASE FOR THE ENTIRE BUILDING AT A RENTAL OF 16.35 S.F. NET WITH FREE
RENT (EXCEPT EXPENSES) FOR THE FIRST 8 MONTHS.
WHAT IS THE PRICE PER SQUARE FOOT?

147.47.

WHAT WILL THE NOI BE IN THE FIRST YEAR? 650,452.05

WHAT IS THE OVERALL RATE BASED ON THE FIRST YEAR NOI? 3.7%
WHAT WILL THE NOI BE IN THE SECOND YEAR? 1,951,356.15
WHAT IS THE OVERALL RATE BASED ON THE SECOND YEAR NOI? 11.1%
USING ANNUAL DISCOUNTING AT 10% PER ANNUM, WHAT IS THE NET PRESENT VALUE
OF THE LEASE CONTRACT? 10,807,598.72
USING ANNUAL DISCOUNTING AT 10% PER ANNUM AND YOUR ANSWER TO THE PREVIOUS
QUESTION, WHAT IS THE EQUIVALENT LEVEL ANNUAL NET RENTAL? 1,758,886.92
BASED ON THE EQUIVALENT LEVEL ANNUAL NET RENTAL WHICH YOU COMPUTED IN THE
PREVIOUS QUESTION, WHAT IS THE INDICATED OVERALL RATE? 10 PERCENT WHICH
IS 1,758,886.92 / 17,600,000.
WHAT ARE THREE GUIDELINES TO FOLLOW DURING COURT TESTIMONY?
1. ADVOCATE THE TRUTH
2. TREAT THE COURT WITH RESPECT
3. TREAT EACH QUESTION WITH RESPECT
END OF CLASS EIGHT
CLASS NINE
4/2/90
HOWARD GELBTUCH PRESENTS...
THE WORLD ACCORDING TO A REAL ESTATE MAVEN
BROUGHT TO YOU BY....MADSEN PRODUCTIONS
THE FRANK RUSSEL REPORT

130

MEAN RETURN
TRADE OF LACK OF VOLATILITY FOR LESS RETURN WHEN COMPARING REAL ESTATE TO
STOCKS AND BONDS. THE REPORT DID A SURVEY WHICH PERCEIVED THE RISK OF
REAL ESTATE RELATIVE TO COMMON STOCK TO BE ABOUT HALF THAT OF COMMON
STOCK.
NEW TRENDS IN REAL ESTATE:
THE HIGHEST AND BEST USE OF CAPITAL
SOME PRICES FOR TROPHY BUILDINGS ARE NOT JUSTIFIABLE BASED ON DOLLARS
RENT PER SQUARE FOOT, CAP RATE, IRR, OR OTHER MEANS. THE PHENOMENON OF
GIVEN PROPERTIES BEING UNIQUE, SUCH AS THE PAN AM BUILDING ABOVE GRAND
CENTRAL STATION DUE TO ITS UNEQUALED LOCATION, CAN PARTIALLY EXPLAIN THE
PHENOMENON. INVESTORS ARE BUYING ASSETS AND NOT RETURNS. PEOPLE ARE
BUYING THE IRREPLACEABLE. PAN AM WENT FOR 177 PER S.F. AND THE BELAIRE
HOTEL WENT FOR 1.1 MILLION PER ROOM.
WHAT IS THE VALUE OF AN ASSET? MANY TIMES SET BY FOREIGN INVESTORS. 2
BILLION WAS INVESTED BY GREAT BRITAIN IN PARIS, AND 1 BILLION BY JAPAN IN
PARIS.
INCREASING COSTS ARE CAUSING SHIFTS GLOBALLY.
SHIFTS TO LOW COST LOCATIONS BY HEADQUARTERS:
CHEMICAL BANK TO N.J.
MOBIL TO VIRGINIA
JC PENNEY TO DALLAS
MITSUBISHI FROM TOKYO TO N.Y.
SEARS FROM DOWNTOWN TO SUBURBAN CHICAGO
NASA FROM WASHINGTON D.C. TO HOUSTON
MIDTOWN LONDON TO CANARY WHARF
ECONOMY HAS GLOBALIZED
SHERATON IS BUILDING A 450 ROOM HOTEL IN MOSCOW
LAND IN TOKYO COSTS 10 TO 12,000 DOLLARS PER S.F.
LONG SHOT CITIES ARE BEIJING, SHANGHAI, WARSAW,
MOSCOW, AND LENINGRAD

BUDAPEST,

ISTANBUL,

VULTURE FUNDS ARE BUYING DISTRESSED PROPERTIES WITH POTENTIAL AND TURNING
THEM AROUND.
THERE HAS BEEN A DEMISE IN THE DESIRABILITY OF REGIONAL MALLS. IN THE
LAST TEN YEARS, ONE OF THE BEST IRR RETURNS WAS FROM MALLS, BUT THEY DO
NOT ALWAYS WORK WELL FOR RETAILERS ECONOMICALLY SPEAKING.
COMMON AREA MAINTENANCE (CAM)

131

HIGH CAP RATES LEAVE NO ROOM FOR ERROR ON DEBT SERVICE

TOYS R US, CIRCUIT CITY, HOME DEPOT, & FAR MORE DRUGS ARE ALL IN STRIP
CENTERS AND NOT MALLS.
THEY ARE CATEGORY KILLERS IN THAT THEY ARE
DEPARTMENT STORES THAT ARE SUCCESSFUL WHILE BEING PRIMARILY IN STRIP
CENTERS.
MEMBERSHIP/WAREHOUSE CLUBS ARE ALSO GOOD PERFORMERS.
100,000 S.F. INDUSTRIAL BUILDINGS

THEY REQUIRE:

BUSINESS IS A MAJOR CUSTOMER, OFTEN WITH SPECIAL SHOPPING HOURS.

MEMBERSHIP IS PAID FOR THE PRIVILEGE OF DOING SHOPPING AT THE CLUB.
MANY OF THE CLUBS ARE THE OWNERS OF THE REAL ESTATE BELOW THEIR
BUILDINGS, BUT OPPORTUNITIES ARE AVAILABLE TO LEASE LAND TO THEM. SOME
ARE REALIZING THAT THEY ARE GREAT DRAWS, SO THEY ARE BUYING LAND AROUND
THEMSELVES AND BUILDING FURTHER RETAIL AROUND THEM. IN N.Y. IT IS ONE
STORE PER 3.6 MILLION PEOPLE. COSCO IS LOOKING FOR 35 SITES. SEATTLE
HAS 1 PER 1.3 MILLION PEOPLE. SHOPPING CLUBS SIGN 20 YEAR LEASES, AND
ARE VERY SENSITIVE TO THE COSTS OF OCCUPANCY. RENTS ARE PAID AT 3 TO 6
DOLLARS PER S.F., AND ARE USUALLY FLAT LEASES, AND SOME HAVE PERCENT OF
RENT CLAUSES.
THEY NEED 10 ACRES.
NO LESS THAN 18 FEET OF CEILING
HEIGHT. THEY DO NOT LIKE TO COMPETE WITH OTHER WAREHOUSE CLUBS SO DON'T
PUT THEM TOGETHER. THEIR MARKET AREA SIZE IS 100 MILES IN DIAMETER.
*********
THE ADVENT OF HIGHER PROPERTY TAXES:
CHICAGO, CLASS B OFFICE = 9.00 PER S.F. PER YEAR
MINNEAPOLIS IS 18.6% OF RENT
NEW YORK IS 18.1% OF RENT
CLEVELAND IS 7.3% OF RENT
CINCINNATI IS 3.6% OF RENT
A SHIFTING FROM RESIDENTIAL TO NON-RESIDENTIAL USES OF TAXES IS TAKING
PLACE.
*********
INFORMATION
WALL STREET RESEARCH IS THE SOURCE OF MUCH OF INFORMATION
TOTAL COST/SALES = COST OF OCCUPANCY RATIO
15 TO 20 PERCENT MAXIMUM FOR RETAILER.
BUST THE RETAILER IN A MALL.

ANYTHING ABOVE 20 PERCENT WILL

TO ESTIMATE SUPER-MARKET SALES, COUNT THE CHECKOUT COUNTERS AND MULTIPLY

BY 1.5 TO 2 MILLION DOLLARS, AND YOU WILL BE VERY CLOSE.
WHEN YOU ARE FOLLOWING A TOP GUN, YOU DO NOT KNOW IF YOU ARE BEHIND A

132

WINNER OR IF YOU ARE BEHIND A KAMIKAZE PILOT....LES WEXNER, THE LIMITED

HYPERMARKETS' DRAW IS SO POWERFUL THAT BUYERS DO NOT GO TO MOM & POP
STORES WHEN A HYPERMARKET ANCHORS THEIR STRIP MALL.
INVEST-TEXT - CALL BY INDUSTRY OR RETAILER (I.E. HOTELS IN NEW ORLEANS,
OR CASINOS) AND THEY WILL GIVE YOU ALL THE REPORTS FOR THESE ITEMS.
SUPERMARKETS, WAREHOUSE SHOPPING CLUBS, DISCOUNT STORES, AND DEPARTMENT
STORES ARE SOLID.
CLASSIC GOLF COURSES ARE POPULAR, BUT THERE ARE GOLF COURSES, AND THEN
THERE ARE GOLF COURSES.
BAA BOND YIELDS AND IRR ARE COMPARABLY SIMILAR. RETAIL HAS TRADED PLACES
WITH INDUSTRIAL AS A FAVORED PROPERTY TYPE. SALES PER S.F. AND THE COST
OF OCCUPANCY ARE FACTORS OF RETAIL PROFIT, AND ARE KEY MEASURES OF
DETERMINING IT.
THE NEW DRAW TO MALLS ARE THE SMALLER RETAIL CHAINS SUCH AS : GAP, THE
LIMITED, AND BANANA REPUBLIC. 13,000 S.F. STORES REALIZING THAT THEY ARE
PART OF THE DRAW TO MALLS AND NOT JUST THE MAJOR.
THEY ARE THEREFORE
DEMANDING THAT RENTS BE ADJUSTED TO REFLECT THIS, AND THE RESULT WILL BE
THAT THE MALLS WILL NOT BE AS PROFITABLE. THE LIMITED SEES THEIR STORES
AS "DOMINATING THE INTERIOR REAL ESTATE" WHEREAS A TRADITIONAL DEPARTMENT
STORE MAY DOMINATE THE EXTERIOR.
THEY ARE CHALLENGING THE VIEW THAT
SPECIALTY STORES DRAW THEIR TRAFFIC FROM ANCHORS.
WHEREAS THE PRESENT
INCOME PER S.F. OF MALL MAY BE 600 PER ANNUM, THIS MAY DECREASE WITH RENT
CONCESSIONS.
THE TRICK TO RETAIL IS TO GET A GOOD MIX OF STORES THAT ARE NOT PRICE
SENSITIVE, AND HAVE GOODS THAT ARE ALWAYS IN DEMAND, SUCH AS LECTOR'S, A
HOUSEWARES AND KITCHEN GADGET STORE, WHICH HAS SALES GENERATED AT 200
DOLLARS PER SQUARE FOOT.
CLASS TEN
4/16/90
CLASS NOT ATTENDED.

NOTES REFLECTED IN FOLLOWING LECTURE

END OF CLASS TEN

CLASS ELEVEN
4/23/90

ADD CHAPTER 19 TO READING, SUBTRACT CHAPTERS AFTER 19 FROM LIST.

CONDOS

133

TOWNHOMES
SINGLE FAMILY DETACHED RESIDENCES
THREE TYPES OF HOUSING. WHICH ARE BEING AFFECTED BY THE DOWNTURN IN THE
METRO AREA REAL ESTATE MARKET? THE CONDOS AND TOWNHOMES SINCE THEY WERE
BOUGHT BY INVESTORS. THE INVESTOR'S MENTALITY IS TO SELL WHEN THE GOING
GETS TOUGH TO MINIMIZE YOUR LOSSES. THEY ARE NOT LONG TERM INVESTORS IN
THE WAY A HOME OWNER INVESTS. THEY DUMPING OF CONDOS AND TOWNHOMES ONTO
THE MARKET TO AVOID A LOSS IS CAUSING THE GREATER DROP IN THEIR PRICES
RELATIVE TO THAT OF DETACHED HOMES.
IN LEASE ANALYSIS, BE AWARE OF THE WAY "SQUARE FOOTAGE" IS DEFINED.
THERE ARE DIVERSE WAYS OF MEASURING THIS.
PERSONAL FINANCE DISCIPLINE:
CASH CONTROL AND BUDGETING
CREDIT CONTROL: AVOID CREDIT
AUTOMOBILES: MAINTAIN IT AND CHANGE THE OIL
BUYING ADVICE: DO NOT SPEND FOOLISHLY, BUT BUY GOOD...BUY QUALITY.
TITHING; DO YOUR SHARE
QUIZ:
LAST YEAR, UNITED JERSEY BANK IS REPORTED TO HAVE SIGNED A 5 YEAR LEASE
IN SOUTH BRUNSWICK, NJ FOR A 28,885 S.F. OFFICE BUILDING AT 18.50 DOLLARS
PER SQUARE FOOT GROSS WITH ONE YEAR OF FREE RENT UP FRONT.
1. DISCOUNTING ANNUALLY AT 12% PER ANNUM, WHAT IS THE NET PRESENT VALUE
PER SQUARE FOOT OF SCHEDULED RENT PAYMENTS?
28,885 x 18.50 = 534,372.50
12,i;O,g,Cfj;534,372.50,g,Cfj;4,g,Nj;f,NPV; read answer, and divide by
28,885 which equals 50.17 dollars per square foot.
2. WHAT IS THE EQUIVALENT LEVEL RENT PER SQUARE FOOT BASED ON A DISCOUNT
RATE OF 12% PER ANNUM?
12,i;5,n;50.17,PV;press PMT; read answer = 13.92 dollars per square foot.
3.IF ANTICIPATED LESSOR EXPENSES ARE 5.00 DOLLARS PER SQUARE FOOT, WHAT
IS THE INDICATED EQUIVALENT NET RENT PER SQUARE FOOT?
13.92-5.00 = 8.92

THE ANSWER IS 8.92 PER SQUARE FOOT.

4. ASSUMING THAT THE FOREGOING LEASE IS INDICATIVE OF MARKET RENT FOR THE
ENTIRE BUILDING, AND FURTHER ASSUMING THAT A 9 PERCENT OVERALL RATE WOULD
BE APPROPRIATE, WHAT WOULD THE MARKET VALUE PER SQUARE FOOT BE (ASSUMING
100 PERCENT OCCUPANCY).

134

8.92 / .09 = 99.11

THE ANSWER IS 99.11 PER SQUARE FOOT.

5. IF THE CURRENT COST OF CONSTRUCTION AND DEVELOPING THE BUILDING IS 100

DOLLARS PER SQUARE FOOT, WHAT DOES YOUR ANSWER TO QUESTION 4 IMPLY ABOUT
THE LAND VALUE OF THE UNDERLYING SITE?
99.11 - 100.00 = - 0.89

THE VALUE IS NEGATIVE 89 CENTS PER SQUARE FOOT.

+++++++++++++++++++++++
YOU ARE PRESENTED WITH THE FOLLOWING FORECAST FROM THE APPRAISAL OF A
32,000 S.F. OFFICE BUILDING VALUED AT 3,300,000.

NOI

YR.ONEYR. TWO
YR.THREE
YR.FOUR
YR.FIVE
YR.SIX
___________________________________________________________________
265,458
337,132
245,455
339,871
368,443
382,886

LEASE
COM, -31,490
&TI

-62,541

32,455-26,486

-23,825

____________________________________________________________________
CASH 233,968
337,132
182,914
307,416
341,957
359,061
FLOW
6. WHAT IS THE IMPLIED INTERNAL RATE OF RETURN BASED ON THE 5 YEAR
FORECAST (WITH 6TH YEAR NOI CAPPED AT 9.5%)?
3,300,000,CHS,g,Cfo;233,968,g,Cfj;337,132,g,Cfj;182,914,g,Cfj;307,416,g,C
fj;382,886,enter,0.095,/;(answer is 4,030,378.95),enter,341,957,+,g,Cfj;
f,IRR;read answer = 11.877
7. DOES YOUR ANSWER TO QUESTION 6 REPRESENT THE LEVERAGED IRR?
no, since there is no mortgage, it cannot be leveraged.
8. WHAT IS THE IMPLIED 1ST YEAR OVERALL RATE?
NET OPERATING INCOME
SALES PRICE

OVERALL RATE

265,458 / 3,300,000

8.0442

ALWAYS BE CAREFUL TO COMPUTE WITH THE NOI AS OPPOSED TO THE CASH FLOW.
9. WHAT PERCENTAGE OF NPV IS DERIVED FROM THE 5 YEAR CASH FLOW?
COMPUTE THE NET PRESENT VALUE OF THE CASH FLOWS.

135

233,968,g,Cfj;337,132,g,Cfj;182,914,g,Cfj;307,416,g,Cfj;341,957,g,Cfj;
11.88(the computed IRR),i;f,NPV,read answer = 1,000,360.80
1,000,360,80 / 3,300,000 = 30.3%
10. WHAT PERCENTAGE OF THE NPV HINGES ON ASSUMPTIONS EXTENDING BEYOND THE
5TH YEAR?
70%. CASH FLOWS ARE: 233,968;337,132;182,914;307,416;341,957
THE NPV OF THE NOI OF 382,886 (NOT THE CASH FLOW OF 341,957) CAPPED AT
9.5% IS 4,030,378.95
WHEN YOU ADD THE FINAL CASH FLOW OF 341,957 FOR THE REVERSION, YOU RESULT
IN 4,372,236.
THE OPERATION IS DONE THUS;
3,300,000,g,Cfo;233,968,g,Cfj;337,132,g,Cfj;182,914,g,Cfj;307,416,g,Cfj;4
,372,236,g,Cfj;f,IRR; READ ANSWER 11.88.
NOW, PARTITION THE IRR INTO TWO COMPONENTS:
THE NPV OF THE CASH FLOW AT 11.88% = 1,000,360.81
THE NPV OF THE REVERSION AT 11.88% = 2,299,231
THE TWO ADDED TOGETHER
= 3,299,591
THE ANSWER IS 2,299,231 / 3,299,591 = 70 PERCENT

****************
LOOK VERY CLOSELY AT LEASE ANALYSIS INFORMATION PROVIDED IN PROF.
MADSEN'S MAILING OVER PASSOVER VACATION. IT HAS IMPORTANT INFORMATION ON
THE USE OF STATISTICS IN SPREADING RISK OF VACANCY AND THE NEED FOR
TENANT IMPROVEMENTS AND LEASING COMMISSIONS OVER THE ENTIRE LEASEHOLD.
END OF CLASS ELEVEN
CLASS TWELVE
4/30/90
REVIEW:
LEASE YEAR
1
2
3
4
5

DEAL A
10
11
12
13
14

136

DEAL B
14
13
12
11
10

10 PERCENT DISCOUNT RATE USED

EFFECTIVE RENT PER S.F.
EQUIVALENT LEVEL RENT
NPV

12
11.81
44.77

12
12.19
46.21

*ASSUMES THE COST OF CAPITAL IS 10 PERCENT

FROM AN OWNER'S POINT OF VIEW, YOU THINK OF VALUE, THE RENTER FROM THE
POINT OF VIEW OF THE RENT PAID.
AT 11 PERCENT ON A LOAN, WHAT ARE THE MONTHLY AND TOTAL PAYMENTS FOR A
30, 40, AND 99 YEAR LOAN?

MONTHLY PAYMENT
TOTAL PAYMENTS (k)

30
40
99
952.32928.29916.69 (10%)
342.8
445.6
1,089

MONTHLY PAYMENT
TOTAL PAYMENTS (k)

536.82482.2
419.7 (5%)
193.2
231.5
498.6

THE DIFFERENCE BETWEEN A 30 AND 99 YEAR LOAN AT 10 PERCENT HAS AN AMOUNT

OF 4% DIFFERENCE IN PAYMENTS, AND 3.17 TIMES THE AMOUNT PAID.
THE DIFFERENCE BETWEEN A 30 AND 99 YEAR LOAN AT 5 PERCENT HAS AN AMOUNT
OF 22% DIFFERENCE IN PAYMENTS, AND 2.58 TIMES IN AMOUNT PAID.

LEASE ANALYSIS:
YEAR
1
mkt rent per s.f. 10
contract
rent per s.f.
7

2
11

3
12

4
13

5
14

6
15

3.50 13
13
13

NEW 5 YEAR LEASE BEGINS
VACANT SIX MONTHS AS LEASE

ENDS(ASSUMPTION)
LEASING COMMISSIONS (LS. COM.) = 3.00 PER S.F.
TENANT IMPROVEMENTS (T.I.) = 10.00 PER S.F.
CASH FLOW
ASSUMING NO
DEBT SERVICE 7
7
9.50 13
13
13
PROBABILITY IN LEASE BY LEASE ANALYSIS : TWO FACTORS

137

1. VACANCY
2. TENANT IMPROVEMENTS
EXPECTATION: IF THE TENANT DECIDES TO LEAVE, AFTER EXPIRATION OF LEASE,
IT WILL TAKE 6 MONTHS TO FIND A NEW TENANT.
HOWEVER, IT IS ALSO
REASONABLE TO ASSUME THAT NOT ALL TENANTS WILL LEAVE, THEREFORE, ONLY 1
OUT OF 3 WILL LEAVE (AN ARBITRARY ASSUMPTION BASED ON EXPERIENCE), WHILE
TWO OF THE 3 WILL STAY. WE HAVE TWO PROBABILITIES:
1. A PROBABILITY OF 6 MONTHS VACANCY AT LEASE EXPIRATION
2. A 1 CHANCE IN 3 PROBABILITY THAT THIS VACANCY WILL OCCUR
THEREFORE THERE IS A 100 PERCENT PROBABILITY OF 2 MONTHS VACANCY AT EVERY
EXPIRATION OF A LEASE.
THEREFORE, ON A CASH FLOW, WHEN AN EXPIRATION
TAKES PLACE, SLAP ON THE TWO MONTHS VACANCY AS A DEDUCTION TO ACCOUNT FOR
THE POTENTIAL OF VACANCY.
YEAR
MKT. RENT
LEASE EXPIRES

3
4
5
6
12
12/31 10

SUBTRACTED TWO MONTHS FROM THE ABOVE

PROBABILITY CALCULATION

IF THE FACTS OF THE CASE WARRANT A DIFFERENT ASSUMPTION THAN 1:3 FOR
VACANCY FOR A USE, THEN YOU CAN USE IT, EVEN ON A LEASE BY LEASE BASIS
RATHER THAN ON A GLOBAL BASIS.
THE ABOVE IS PART OF AN OVERALL VACANCY ASSUMPTION, AND IS ADDED TO
TYPICALLY, A 2% OF EFFECTIVE GROSS INCOME AS A VACANCY ALLOWANCE.

POINTS
BUYING DOWN MORTGAGES
1 POINT PER 1/8 PERCENT DISCOUNT ON A 30 YEAR LOAN (RULE OF THUMB)
A POINT IS THE ONE TIME CHARGE EQUALING ONE PERCENT OF THE LOAN AMOUNT.
A LOAN OF 100,000
25 YEAR LOAN
11 PERCENT PER ANNUM
WHAT ARE THE PAYMENT PER MONTH?

980.11

100,000 AT 10% FOR 25 YEARS = 908.70

138

EFFECTIVE RATE = .93

NOMINAL ANNUAL YIELD 11.11 % (BECAUSE EFFECTIVELY THE BANK HAS LOANED
92,000 BECAUSE OF $8000 IN POINTS TO BUY DOWN THE LOAN 1 PERCENT.
END OF CLASS TWELVE
CLASS THIRTEEN
FINAL CLASS

5/7/90

NEXT WEEK IS THE FINAL

EXERCISE ONE
ASSUMPTIONS:
1. CAP RATE APPLIED TO 6TH YEAR NOI IS 10%
2. 12% DISCOUNT RATE
3. 5 PERCENT SELLING COSTS
YEAR
CASH FLOW
NOI
--------------------------------------------------------------1
20,000
NA
2
22,000
NA
3
26,000
NA
4
28,000
NA
5
30,000
NA
6
NA
100,000
COMPUTE THE NPV
0,g,Cfo;20k,g,Cfj;22k,g,Cfj;26k,g,Cfj;28k,g,Cfj;*980k,g,Cfj;12,i;f,NPV;
READ ANSWER, 627,775
* 100,000/10% = 1,000,000
LESS 5% SELLING COSTS = 950,000
950,000 = 5TH YEAR REVERSION, ADD 30,000 CASH FLOW TO ARRIVE AT 980,000
SUPPOSE YOU HAVE SOLVED THE ABOVE PROBLEM, WITH 627,774 AS NPV, HOW DO
YOU KNOW THAT YOU HAVE DONE IT PROPERLY?
ANOTHER WAY TO SOLVE THE
PROBLEM AS A CHECK IS:
FV = 20K
i = 12 percent
n = 1 year
solve for PV, = 17,857.14
FV = 22k
n = 2
solve for PV = 17,538.27

139

FV = 26k
n = 3
solve for PV = 18,506.29
FV = 28k
n = 4
solve for PV = 17,794.51
FV = 30k
n = 5
solve for PV = 17,022.86
taking the NPV for 950,000 at five years it should equal the some of the
PV's above at 12%.
WHAT IS THE INTERNAL RATE OF RETURN?
12 PERCENT , WHICH IS THE INITIAL EQUITY INVESTMENT
88,719 = NPV OF CASH FLOWS
88,719, CHS, Cfo
PUT IN CASH FLOWS AT g,Cfj;f,IRR; READ REGISTER, 12%
THE INTERNAL RATE OF RETURN IS THE DISCOUNT RATE IN THIS CASE.
WHAT IS THE EQUIVALENT RENT ANNUITY OF THESE CASH FLOWS?
24,612
LOOK FOR A QUESTION ON THE PARTITIONING OF THE IRR, WHICH DETERMINES THE
PERCENTAGE OF THE PURCHASE PRICE THAT IS IN THE CASH FLOW.

140

ECONOMICS AND REAL ESTATE

PROFESSOR HUGH KELLY
SPRING 1990

ECONOMICS NOTES
1/22/90 HUGH KELLY
REGIONAL ECONOMICS = SUBSET OF ECONOMIC GEOGRAPHY
CLASS 1/22/90 STRUCTURE
1.
2.
3.
4.
5.

INTRODUCTION
SYLLABUS
DREAMER'S SCALE
URBANOLOGY BREAK
REGIONAL ISSUES

ECONOMIC CONCEPT > FILTERED THROUGH> LOCATION OR CITY>

PROPERTY TYPE. THIS IS THE CLASS STRUCTURE.

SEGMENTED BY

A 15 TO 20 PAGE PAPER WITH TOPIC OF CHOICE RELATING TO REAL ESTATE AND

ECONOMICS WILL BE REQUIRED. FOR EXAMPLE: ISLAND IN CRISIS?: THE EFFECTS
OF DEFENSE INDUSTRY LAYOFFS ON THE LONG ISLAND ECONOMY AND REAL ESTATE
MARKET.
SOURCES:

LONG ISLAND ASSOCIATION

LONG ISLAND NEWSDAY
DEFENSE DEPARTMENT REPORTS
GRUMMAN STATISTICS

WHAT SECTORS OF DEFENSE WILL BE HARDEST HIT BY CUTS?

WHAT SECTORS OF
DEFENSE ARE PRODUCED ON LONG ISLAND?
WHAT PLACE DO THESE PLAY IN THE
LONG ISLAND ECONOMY?
WHAT ELSE IS SIGNIFICANT IN THE LONG ISLAND
ECONOMY?
REGIONAL ISSUES:
"THE MOST IMPORTANT SENTENCE OF THE SEMESTER", ACC. TO PROF. KELLY.
REAL ESTATE IS A RESIDUAL ECONOMIC PRODUCT.
REAL ESTATE SHELTERS
ECONOMIC ACTIVITY.
REAL PROPERTY AS A PRODUCTIVE ASSET RECEIVES ITS
VALUE FROM ECONOMIC ACTIVITY. THEREFORE WITHOUT ECONOMIC ACTIVITY REAL
ESTATE CAN NOT GROW IN VALUE.
THE COURSE IS AN ELABORATION OF THIS CONCEPT.
ALSO:
ALL ECONOMIC FUNCTIONS ARE "SPACE EATERS", THEREFORE THEY ALL HAVE A
SPATIAL DIMENSION, BECAUSE ALL ECONOMIC ACTIVITIES ARE SPACE USERS.
ALSO:
IT IS THE NATURE OF CITIES TO BE CENTRAL PLACES OF REGIONS, AND ACT TO
FORM ITSELF INTO A HIERARCHY OF SYSTEMS WHICH ACT TO DISTRIBUTE GOODS AND
SERVICES.

139

END OF CLASS ONE.

CLASS TWO
1/29/90
1.
2.
3.
4.
5.

NAME GAME
PRESENTATION DETAILS
THEORIES OF URBANIZATION
GARREAU ON NEW ENGLAND
HOUSING IN BOSTON

THE PRESENTATION: 15 POINTS

5 POINTS EACH FOR COMMUNICATION, ANALYSIS, AND RESEARCH
SHOULD ANSWER; "WHAT DOES IT MEAN" AND "HOW DOES IT LAND ON A CITY AND
HOW DOES IT DESCRIBE A PROPERTY TYPE".
SUGGESTIONS:
1. KNOW THE TOPIC
2. STATE THE TOPIC UP FRONT
3. STICK TO THE TOPIC

S I M P L I C I T Y

REMEMBER
4. TIME - KNOW THAT YOU ONLY HAVE 7 TO 10 MINUTES.
5. COMMUNICATION - REMEMBER THAT THE PROCESS IS A TWO-WAY STREET. YOU DO
NOT NEED TO DO A MONOLOGUE.
6. DELINEATE, CORRELATE, AND ELABORATE. LINE UP, TIE TOGETHER, AND FILL
IN THE POINTS WHICH COMBINED SUPPORT YOUR THESIS.
7. KNOW WHAT YOUR LAST SENTENCE IS.
OVERHEAD PROJECTORS WILL BE AVAILABLE.
HANDOUTS ARE GOOD IF YOU HAVE A LOT OF INFORMATION THEM, AND DO NOT USE THEM IN THE VISUALS.

DO NOT RECITE FROM

IF YOU USE A HANDOUT, 1. KNOW WHEN TO USE IT.

2. KNOW WHEN NOT TO USE IT.
3. AND KNOW WHEN TO STOP USING IT.
USE THEM BRIEFLY AND MANAGE THEM IN CLASS, OR USE THEM FOR ADDITIONAL
INFORMATION.
AND LASTLY,

BE YOURSELF
THEORY OF URBANIZATION
THE GATHERING OF PEOPLE INTO CITIES IS IN ITSELF A SIGN OF ECONOMIC

140

DEVELOPMENT.

IT IS THE FIRST PROVABLE INSTANCE OF A DIVISION OF LABOR.

CITIES IMPLY:

DIVISION OF LABOR (SPECIALIZATION)

MEDIUM OF EXCHANGE
- HOW DO YOU KNOW THE VALUE OF WHAT YOU ARE

BARTERING?
- ADAM SMITH SAYS "IF IT TAKES TWO DAYS TO HUNT A
DEER AND ONE DAY TO FASHION A HORSESHOE, THEN A DEER IS WORTH TWO
HORSESHOES. THIS IS THE LABOR THEORY OF VALUE, AND WE FIND EVIDENCE OF
THIS IN THE CITY.
DIVISION OF LABOR AND URBAN SPECIALIZATION
ORDERING OF SOCIETY IS LAW, WHICH PERTAINS TO INTERNAL RELATIONS.
DEFENSE OF SOCIETY PERTAINS TO EXTERNAL RELATIONS.
FOUR ELEMENTS ARE CONTRIBUTED BY THE CITY;
LAW, THE CODIFICATION AND ADMINISTRATION OF LAWS
DEFENSE, SAFETY IN NUMBERS, CONSOLIDATING FOR SELF-PROTECTION
COMMERCE, TRADING POST- EFFICIENCY OF BUYING AND SELLING BY BRINGING
GOODS TO A CENTRAL LOCATION
COMMUNICATION- EFFICIENCY OF EXCHANGING INFORMATION AND SOCIALIZATION
CONCENTRATION VERSUS CENTRALIZATION
CONCENTRATION IS THE MOVEMENT OF PEOPLE FROM THE RURAL AREAS TO URBAN
CENTERS.
CENTRALIZATION IS THE POPULATION CENTERING IN THE URBAN CORE, WITHIN THE
URBAN CENTER.
THREE PERIODS CAN BE DELINEATED WITH RESPECT TO URBANIZATION
1770 TO 1920 - HAD BOTH CONCENTRATION AND CENTRALIZATION WITH GROWTH OF
CENTER CITIES AT A RATE GREATER THAN THE PERIPHERY.
1920
TO
1970
DECENTRALIZES.

CONCENTRATION

CONTINUED,

BUT

URBAN

POPULATION

1980 AND BEYOND - SMALLER PROPORTION OF POPULATION LIVING IN URBANIZED

AREAS.
HOW DO DIFFERENT CITIES RESPOND TO THE CONDITION OF CONCENTRATION VERSUS

141

CENTRALIZATION?

FIVE FORCES THAT EFFECT CONCENTRATION AND CENTRALIZATION.

1. OVERFLOW EFFECT - "FILL UP NASSAU COUNTY?, MOVE TO SUFFOLK"
AND

2. TECHNOLOGICAL -AIRPLANES, FAXES, TELEPHONES, AUTOS, HIGHWAYS,

AIR CONDITIONING.
3. RISE IN LIVING STANDARDS -EFFORT SPENT TO GAIN LIVEABLE INCOME.
4. LIFESTYLE PREFERENCES - CHOICES FOR DISPOSING OF INCOME.

5. PUBLIC POLICY - GOVERNMENTAL DECISIONS WHICH REFORM THE PREVIOUS

FOUR FORCES.
GIVE LECTURE ON FEBRUARY 26 ON NEW YORK. SPECIFICS GIVEN NEXT WEEK.
THEORY OF SECTORAL SUCCESSION
"ONCE UPON A TIME USA WAS AN AGRICULTURAL COUNTRY; BUT AS CONCENTRATION
OCCURRED, THE NATION BECAME A MANUFACTURING INDUSTRIAL NATION.
IN THE
1980'S WE MOVED INTO A POST-INDUSTRIAL ERA WHERE SERVICE ECONOMIES
PREDOMINATED. THESE CHANGES ARE CALLED SECTORAL SUCCESSION, AS LABOR IS
RETRACKED INTO THE NEXT LEVEL OF ECONOMIC DEVELOPMENT.
AGGLOMERATION
THE TENDENCY OF ECONOMIES AND BUSINESSES OF A SIMILAR CHARACTER TO
CLUSTER IN A SMALL AREA AND SUPPORT INDUSTRIES TO CLUSTER AROUND THE CORE
INDUSTRIES.
AN EXAMPLE IS THE TRADERS, WHICH BRING SHIPPERS, WHICH
CAUSES HAZARDS, WHICH INVITE INSURANCE AGENCIES.
FIRMS AS A PACKET OF FUNCTIONS
THINK OF A BUSINESS AS A PACKET OF FUNCTIONS WHICH TIE INTO THE CONCEPTS
OF SECTORAL SUCCESSION AND AGGLOMERATION.
EXCESS AND OBSOLESCENCE
FACTORS INCLUDE:
o COMPARATIVE ADVANTAGE
o ECONOMIC STRUCTURE
o CYCLES; "EXCESS PROFIT BREEDS RUINOUS COMPETITION"

142

SOURCES FOR COLLECTION OF DATA ON ECONOMIES

1. LOCAL BUSINESS TRADE MAGAZINE OR NEWSPAPER SUCH AS ECONOMIC TIMES OF
LONG ISLAND.
2. LOCAL PAPER- SOURCE OF INFORMATION ON WHAT MAKES A COMMUNITY TICK.
LOOK AT THE HEADLINES FOR THE PAST TWO YEARS.
3. DATA RESOURCES VERSUS MARKETS REVIEW (MAJOR METRO AREAS)
LISTS EMPLOYMENT, DEMOGRAPHICS, PRICE STRUCTURE.
4. GOVERNMENT REPORTS
5. BEIGE BOOK- FEDERAL RESERVE SYSTEM- EVERY SIX WEEKS MONETARY POLICY
GETS COMPILED INFO FROM THE TWELVE FEDERAL RESERVE DISTRICTS ON THE
LOCAL ECONOMY.
6. TRADE ORGANIZATIONS
NATIONAL ASSOCIATION OF REALTORS "HOME SALES"
STATES AND METROPOLITAN AREAS AFFORDABILITY INDEXES
NATIONAL ASSOCIATION OF HOME BUILDERS "HOUSING ECONOMICS"
ECONOMY'S EFFECT ON NEW HOUSING CONSTRUCTION, PACE OF HOUSING CHANGE
VS. PACE OF JOB CHANGE.
7. SUMMARY DISCUSSION OF MARKETS
IE. LANDAUER
SALOMON BROTHERS
THE EQUITABLE - "EMERGING TRENDS IN REAL ESTATE"
8. ACADEMIC RESEARCH - HOUSING FINANCE REVIEW
MEASUREMENT FOR HOUSING AFFORDABILITY
MEDIAN SINGLE FAMILY HOUSE AT 183,300
MORTGAGE INTEREST RATE AT 9.5 PERCENT
PRINCIPAL AND INTEREST IS THEREFORE 1,236
QUALIFYING INCOME IS (1/.25)X 12 = 59,325
MEDIAN INCOME IS 39,000
AFFORDABILITY INDEX IS 39 / 59.325 = 65.7 PERCENT
ORDER OF HOUSING AFFORDABILITY FACTORS
INCOME AFFECTS HOUSING COST, AVAILABILITY OF
AVAILABILITY OF JOBS AFFECTS MORTGAGE INTEREST

143

HOUSING

AFFECTS

JOBS,

BOSTON, MASSACHUSETTS, USA

GARREAU DOES NOT FULLY EXAMINE THE FACTORS OF EXCESS AND OBSOLESCENCE IN
LOOKING AT NEW ENGLAND.
BOSTON HOUSING TRENDS HAVE BEEN VOLATILE. WHEREAS, FOR EXAMPLE, 1985 HAD
A 185,000 GAIN IN EMPLOYMENT 1987 GAINED ONLY 50,000.
THERE HAVE BEEN HUGE SURGES AND VALLEYS IN THE JOB GROWTH OF THE AREA
WHILE HOUSING STARTS HAVE BEEN RELATIVELY EVEN.
RELATIVE AFFORDABILITY IS A PROBLEM. THE MAPS SHOW DECENTRALIZATION DUE
TO THE LACK OF AVAILABILITY
OF LAND.
ALSO, THE CITY IS AGING AND
REDEVELOPMENT IS STRINGENTLY REVIEWED, CAUSING DELAYS IN CONSTRUCTION.
END OF CLASS TWO
CLASS THREE 2/5/90
1.
2.
3.
4.
5.
6.

HOUSE KEEPING
TERM PAPERS
BOSTON CATCH-UP
INTO TO PITTSBURGH AND INDUSTRIAL PROPERTIES
SOURCES FOR INDUSTRIAL PROPERTIES STUDIES
TAXONOMY OF INDUSTRIAL PROPERTY

TERM PAPER IS DUE THE 11TH WEEK OF THE COURSE.

NEXT MONDAY, HAVE A
PARAGRAPH TO EXPLAIN THE TOPIC. LATE PAPERS ARE ACCEPTABLE WITHOUT
PENALTY. PROF. KELLY ONLY ASKS FOR FAIR WARNING THAT PAPER WILL BE LATE,
AND HE CAN NOT GUARANTEE THAT THE PAPER WILL BE REVIEWED AND GRADED PRIOR
TO THE FINAL EXAM.
AS FOR THE TOPIC OF THE PAPER, IT SHOULD PERTAIN THE COURSE BY CONCERNING
ITSELF WITH AN ECONOMIC BASE AND A REAL ESTATE APPLICATION IN A FINITE
LOCATION, SUCH AS A METROPOLITAN AREA.
PAST TOPICS:
AFFORDABLE HOUSING AND RENTAL OPPORTUNITIES IN STAMFORD.
JAPANESE DOMINANCE IN THE U.S. REAL ESTATE MARKET.
LONG ISLAND CITY - THE REGENERATION OF AN INDUSTRIAL TOWN.
MACROECONOMIC INFLUENCES ON SHOPPING DEVELOPMENT.
IMPACT OF ZONING ON THE GARMENT DISTRICT.
AFFECT OF REAL ESTATE FAILURES ON THE SAVINGS AND LOAN INSTITUTIONS.
INTRODUCTION TO PITTSBURGH
STEEL MANUFACTURING IS IN PITTSBURGH BECAUSE ACCESS TO COAL IS GOOD,
WHICH REDUCED TRANSPORT COSTS IN PRODUCING STEEL.

144

FOUR YEARS AGO RAND MCNALLY RATED PITTSBURGH NUMBER ONE IN THE COUNTRY AS
A PLACE TO LIVE. TODAY, IT IS STILL HIGHLY REGARDED, THOUGH IT HAS
SLIPPED TO THIRD PLACE.
FACTORS WHICH WEIGH IN THIS CONSIDERATION
INCLUDE THE FOLLOWING:
THE COST OF LIVING
TRENDS IN JOBS
LOCAL CRIME
THE AMOUNT AND QUALITY OF HEALTH CARE
TRANSPORTATION
EDUCATION
ENVIRONMENT
ARTS AND RECREATION
THE COST OF LIVING IS ONE OF THE BIGGEST FACTORS. THE LOSS OF BLUE COLLAR
JOBS CONTINUES, BUT WHITE COLLAR AND SERVICE JOBS HAVE INCREASED QUITE A
BIT.
CHANGE IN BAD FORTUNE FOR PITTSBURGH CAME ABOUT TWENTY YEARS AGO WHEN THE
MAYOR SEVERAL MAJOR BUSINESSMEN TOGETHER TO FOUND THE "COUNCIL OF 24",
WHICH HAS AS ITS PURPOSE TO REPORT ON AND SUGGEST IMPROVEMENTS FOR
PITTSBURGH, WHILE SETTING GUIDELINES FOR PRIVATE INDUSTRY TO HELP ALONG.
SOURCES OF INFORMATION ON INDUSTRIAL PROPERTY
WHERE DO YOU FIND RELIABLE INFORMATION ON INDUSTRIAL PROPERTY?
SEE CHAPTERS 5 AND 6 OF STERNLIEB AND HUGHES'S AMERICA'S NEW MARKET
GEOGRAPHY.
ALSO SEE A BOOK FROM THE SUPPLEMENTAL READING LIST CALLED MANUFACTURING
MATTERS BY COHEN AND ZYSMAN.
ALSO, YOU CAN CONTACT PEOPLE AND RESEARCH HEADLINES AND ARTICLES IN
NEWSPAPERS TO GET THE LOCATIONAL BAROMETER OF INDUSTRIAL HEALTH IN A
LOCALE.
EQUITABLE REAL ESTATE DOES A SURVEY OF 100 TOP LEADERS IN THE U.S. TO SEE
HOW THEY PREDICT THE MAJOR TRENDS IN REAL ESTATE.
SALOMON BROTHERS HAS A SEMI ANNUAL REAL ESTATE MARKET REVIEW AND MORE
FREQUENT LOCAL MARKET REVIEWS.
THE AMERICAN ASSOCIATION OF INDUSTRIAL AND OFFICE PARKS PUTS OUT
AMERICA'S FUTURE IN INDUSTRIAL SPACE NEEDS. THE PUBLICATION IS WRITTEN
BY A WRITER FOR INC. MAGAZINE NAMED DAVID BIRCH. HIS METHODOLOGIES ARE
SUSPECT AND YOU CAN NOT TRUST HIS FIGURES FOR VACANCY RATES, BUT SOME OF
HIS CONCLUSIONS ARE WORTHWHILE.

145

THE SOCIETY OF INDUSTRIAL AND OFFICE REALTORS HAS A GUIDE TO INDUSTRIAL

AND OFFICE REAL ESTATE WHICH SUPPLIES RELIABLE DATA.
AREA DEVELOPMENT
EXECUTIVES.

MAGAZINE

IS

AVAILABLE

FOR

CORPORATE

REAL

ESTATE

BUSINESS FACILITIES MAGAZINE TARGETS THOSE INDUSTRIAL USES ON THE HIGH

END OF THE TAXONOMY SCALE.
DEVELOPMENT MAGAZINE
PLANTS, SITES, AND PARKS MAGAZINE SPECIALIZES IN HEAVY DUTY INDUSTRIAL
PARKS.
GOVERNMENT SOURCES ARE NOT RELIABLE SO DO NOT DEPEND HEAVILY ON THEM.
LOCAL ECONOMIC DEVELOPMENT GROUPS ARE VERY HELPFUL, HOWEVER.
LOCAL UTILITIES ARE GOOD SOURCES OF INFORMATION, PARTICULARLY LILCO, AND
PSE&G.
LOCAL CHAMBER OF COMMERCE
*****************************************
HANDOUT GIVEN ON INDUSTRIAL USES
*****************************************
THE TAXONOMY OF INDUSTRIAL PROPERTY
ANALYZE THE:
o CHAIN OF PRODUCTION
o SPECIFIC FACILITY REQUIREMENTS
o DIVERSE GEOGRAPHIC PROFILES
THERE ARE 5 KINDS OF INDUSTRIAL PROPERTY
1. RESEARCH AND DEVELOPMENT - WHAT DO I NEED TO MAKE, AND HOW DO I
MAKE IT.
2. FABRICATION - HOW; I GET THE MATERIALS TO CREATE A SEMIFINISHED
PRODUCT OR ITS PARTS.
3. ASSEMBLY - ASSEMBLE PARTS INTO A USEABLE PRODUCT .
LABOR
DRIVEN

************************************************************************
MARKET DRIVEN

4. DISTRIBUTION - WAREHOUSING; I HAVE GO TO GET IT TO THE MARKET

FROM WHERE I HAD IT ASSEMBLED.
5. DISPLAY - DISPLAY THE PRODUCT AND SELL IT ON THE WHOLESALE
LEVEL;
HOW DO I GET MY PRODUCT TO THE STORES IS THE QUESTION THAT
THE
DISPLAY LEVEL OF INDUSTRIAL BUILDING TAXONOMY ANSWERS.

146

RESEARCH AND DEVELOPMENT FACILITIES REQUIRE A RESEARCH ENVIRONMENT SUCH

AS THOSE PROVIDED IN RESEARCH INSTITUTIONS OF HIGHER LEARNING WHERE LARGE
GOVERNMENT GRANTS ARE SPENT IN RESEARCH. THEY REQUIRE THE HIGHLY SKILLED
WORKERS THAT THESE INSTITUTIONS USUALLY PRODUCE, AND NEED TO BE LOCATED
NEAR SOURCES OF VENTURE CAPITAL OR MONEY CENTERS.
RESEARCH AND
DEVELOPMENT FACILITIES HAVE BEEN OVERBUILT PRECISELY BECAUSE THEY ARE SO
GLAMOROUS, WHILE CONCURRENTLY HAVING BEEN BUILT IN AREAS WHICH DO NOT
HARBOR THE ABOVE QUALITIES. A MARKET MAY BE OPENING FOR REHABILITATION
OF THESE BUILDINGS INTO OFFICE USES OR OTHER TYPES OF INDUSTRIAL USES.
FABRICATION FACILITIES REQUIRE SKILLED BLUE COLLAR LABOR, GOOD ACCESS TO
TRANSPORTATION, GOOD SCHOOL EDUCATION, ACCESS TO MATERIALS, PROXIMITY
TO THE POPULATION CENTROID OF ITS MARKET. THE FURTHER YOU GET DOWN THE
CHAIN OF PRODUCTION, THE CLOSER YOU NEED TO BE NEAR A POPULATION
CENTROID. THE HISTORY OF LABOR RELATIONS IS A FACTOR.
ASSEMBLY - LOW LABOR COSTS ARE IMPORTANT, SKILLED LABOR IS NOT AS
IMPORTANT. HIGH SCHOOL GRADUATES AND BELOW. ONE OF THE MOST VULNERABLE
SECTORS OF INDUSTRIAL U.S.A. DUE TO WAGE STRUCTURE AND COMPETITION FOR
ASSEMBLY FROM OVERSEAS.
DISTRIBUTION WAREHOUSING; DO NOT NEED MANY WORKERS.
NEED EFFICIENT
AND CHEAP SPACE IN GOOD LOCATIONS. NEED EFFICIENCY IN REACHING THE END
MARKET. YOU WANT THE DISTRIBUTION CENTER TO BE NEAR THE SOURCE OF DEMAND,
NOT THE SUPPLY.
DISPLAY - CLOSENESS TO THE MARKET IS IMPORTANT. CONSISTS OF SHOWROOMS,
TRADE SHOWS, AND MERCHANDISE MARTS. PROXIMITY TO MARKET MAKERS (BUYERS)
OF AN INDUSTRY IS IMPORTANT.
CONVENIENT TRANSPORTATION, LOTS OF GOOD
HOTELS, AND LOTS OF AVAILABLE ENTERTAINMENT IS IMPORTANT.
END OF CLASS THREE
CLASS FOUR
2/12/90
AGENDA
1. QUIZ
2. MORE ON INDUSTRIALS
BREAK
3. PRESENTATION
4. THE TWO SOUTHS
5. ATLANTA; THEIR CAPITAL
QUESTIONS YOU ASK WHEN RESEARCHING FEASIBILITY FOR INDUSTRIAL LOCATIONS
INCLUDE;

147

WHY ARE THE INDUSTRIES WHERE THEY ARE?

HOW DO THEY FIT INTO THEIR LOCATION?
WHAT MAKES FOR A GOOD MARKET FOR INDUSTRIAL PROPERTIES?
REVIEW;
TWO TYPES OF INDUSTRY, LABOR DRIVEN AND MARKET DRIVEN.
5 CATEGORIES OF INDUSTRY;
RESEARCH AND DEVELOPMENT*
FABRICATION
ASSEMBLY*
DISTRIBUTION*
DISPLAY
* WE STUDY THESE CATEGORIES TONIGHT FOR SPECIFIC COMPARATIVE FACTORS FOR
ANALYSIS.

SOME ELEMENTS THAT SHOULD BE REVIEWED IN DETERMINING R&D LOCATIONS.

ABSORPTION
VACANCY RATE
JOB GROWTH
SCHOOLS
OCCUPATIONAL RATIO

QUALITY OF LIFE
HIGH TECH IND. LOCALLY
R&D "BALANCE"
FEASIBILITY
YIELDS

RESEARCH AND DEVELOPMENT PROPERTIES:

FLEXIBILITY
NICE ENVIRONMENT
STATE-OF-THE-ART EQUIPMENT
ALL OF THESE CAUSE LARGE AMOUNTS OF CAPITAL TO BE AT RISK WHEN
CONSTRUCTION R&D SPACE. IT COSTS 2 1/2 TO 3 TIMES THE AMOUNT OF PLAIN
VANILLA WAREHOUSING.
SYNONYMS FOR R&D SPACE; FLEX SPACE, HI-TECH SPACE.
MANY THINGS IMPACT THESE FACILITIES BECAUSE THEY ARE ASKED TO DO SO MUCH.
THEREFORE, THEY ARE SUBJECT TO GREATER AMOUNTS OF VARIABLES THAN EVEN
THAT FOUND IN A SKYSCRAPER MARKET, WHICH IN NEW YORK IS HOMOGENOUS AND
RELATIVELY PREDICTABLE.
FACTORS FOR R&D REAL ESTATE:
1. ABSORPTION- CRITICAL MASS- NEED A LOT OF INTERACTION WITH PEERS. NEED
TO BE NEAR ALL OF THE OTHER R&D MARKETS. THE GREATER THE ABSORPTION OF

148

R&D REAL ESTATE IN A GIVEN MARKET RELATIVE TO OTHER TYPES OF INDUSTRIAL

REAL ESTATE, THE BETTER IT IS AS A LOCATION FOR R&D.
2. VACANCY RATES: DIFFICULT TO GET INFORMATION ON THIS SPECIFIC TO
RESEARCH AND DEVELOPMENT MARKET. BUT THIS IS IMPORTANT.
3. R&D BALANCE: IS THE MARKET OVER-SUPPLIED, UNDER SUPPLIED, OR ABOUT
RIGHT.
IF YOU TAKE FIGURES ON THE BALANCE, YOU CAN COMBINE IT WITH
ABSORPTION RATES TO DETERMINE PRETTY GOOD ESTIMATES FOR THE VACANCY RATES
FOR RESEARCH AND DEVELOPMENT INDUSTRIAL REAL ESTATE.
4. JOB GROWTH IN THE MANUFACTURING SECTOR.
IF YOU SEE GROWTH IN
MANUFACTURING SECTOR, THEN THERE IS PROBABLY GROWTH IN THE R&D SEGMENT OF
THE MANUFACTURING SECTOR.
R&D WORKERS ARE COUNTED UNDER THE
MANUFACTURING SECTOR IN THE CENSUS. R&D LIKES TO BEAR SOME RELATIONSHIP
TO THE ASSEMBLY AND FABRICATION FUNCTIONS.
WHERE THE WIDGETS ARE MADE
AND GROWING, THE FIELD IS RIPE FOR R&D DEVELOPMENT.
5. OCCUPATIONAL RATIO: WHITE COLLAR WORKERS/BLUE COLLAR WORKERS
GROWTH IN MANUFACTURING AND A GREATER THAN NORMAL DISTRIBUTION OF WHITE
COLLAR WORKERS IS A GOOD MARKET FOR R&D.
WHEN TAKEN TOGETHER WITH
MANUFACTURING SECTOR GROWTH, THIS IS A GOOD INDICATION OF R&D POTENTIAL.
************************
S.O.C. = STANDARD OCCUPATION CLASSIFICATION; DESCRIBES BLUE COLLAR AND
WHITE COLLAR WORKERS BREAKDOWN.
WHITE COLLAR
MANAGERS AND ADMINISTRATION
PROFESSIONAL/TECHNICAL WORKERS
SALES
CLERICAL

BLUE COLLAR
SERVICES
LABORERS
OPERATIVES
TRADESMEN

IN EACH INDUSTRY IN THE SIC, THERE ARE BLUE COLLAR AND WHITE COLLAR
SOC'S.
ELEMENTS TO NOTE FOR GOOD R&D LOCATIONS:
SCHOOLS- SOURCE AND CHANNEL FOR RESEARCH GRANTS FROM GOVERNMENT.
(RESEARCH FUNCTIONS) LARGE SCIENCE AND ENGINEERING PROGRAMS WITH
FACILITIES, AND HIGHLY TRAINED STUDENTS.
HIGH TECH COMPANIES - DO OTHER HIGH TECH COMPANIES HAVE MAJOR PLANTS IN
THE LOCATION?
QUALITY OF LIFE RATING- UNSCIENTIFIC STUDY OF QUALITY OF LIFE.
PLACES
RATED ALMANAC USED AS A SOURCE WHICH IS AS GOOD AS ANY.
YOU HAVE TO
ATTRACT AND KEEP EMPLOYEES WHO CAN CHOOSE FROM MANY PLACES IN WHICH TO
LIVE.

149

FEASIBILITY AND YIELDS - HOW MUCH DOES IT COST TO BUILD THE FACILITY?
HOW MUCH WILL THE RETURN ON THE INVESTMENT BE, AND WILL THE INVESTMENT
MAKE SENSE? WHAT IS THE RENT OVER THE PRICE? (RENT/PRICE = YIELD)
**************************
ASSEMBLY PLANTS
ABSORPTION OF THE MANUFACTURING FUNCTION
AREAS OF CONCERN; R&D
MANUFACTURING
DISTRIBUTION
VACANCY; SAME MEASURE AS IN R&D, BUT FOR ASSEMBLY. (SEE ABOVE)
BALANCE; (SEE R&D "BALANCE" ABOVE)
JOB GROWTH; DRIVEN BY LABOR MARKET - SEE OCCUPATIONAL RATIO- THE MIRROR
IMAGE OF R&D...YOU PREFER GROWTH IN MANUFACTURING WITH DISPROPORTIONATE
REPRESENTATION OF BLUE COLLAR WORKERS AS OPPOSED TO WHITE COLLAR WORKERS.
OCCUPATIONAL RATIO; BLUE COLLAR PREPONDERANCE.
BUSINESS COSTS; NEED A LOW TAXING ENVIRONMENT, LOW ENERGY COSTS, LOW FEES
AND PERMITS AND INFRASTRUCTURE COSTS IMPOSED BY GOVERNMENT.
WAGES; CHEAP, SKILLED LABOR, THOUGH NOT HIGHLY SKILLED... NEED LOW WAGES
BECAUSE OF THE INTENSITY OF THE LABOR FUNCTION.
FEASIBILITY / YIELDS;

RENTS/SALES PRICES

*************************
WAREHOUSING AND DISTRIBUTION PLANTS
MARKET ORIENTED AS OPPOSED TO LABOR ORIENTED
ABSORPTION; SAME AS ABOVE BUT FOR THE DISTRIBUTION CLASS OF INDUSTRIAL
PROPERTY.
VACANCY; SAME AS ABOVE BUT FOR THE DISTRIBUTION CLASS OF INDUSTRIAL
PROPERTY.
JOB GROWTH; LOOK FOR SIGNS OF GROWTH IN WHOLESALE TRADE JOBS AND IN THE
TRANSPORTATION INDUSTRY.
WAREHOUSE BALANCE;

RELATIVE TO OTHER INDUSTRIAL USES.

WAGES;
STORING GOODS DOES NOT REQUIRE MANY EMPLOYEES, THEREFORE WAGES
ARE NOT AN IMPORTANT ELEMENT FOR WAREHOUSING TYPES OF INDUSTRIAL REAL

150

ESTATE.
CENTROIDS;
WHERE AND HOW IS THE MARKET DISTRIBUTED AND WHERE IS THE
MARKET'S GEOGRAPHIC CENTER. HOW DOES THE SITE RELATE TO THIS GEOGRAPHIC
CENTER?
POPULATION GROWTH; WHERE IS POPULATION GROWING OR SHRINKING AND WHERE IS
THE MARKET IN THE FUTURE?
INVENTORY/POPULATION RATIO; HOW MANY SQUARE FEET OF DISTRIBUTION SPACE
IS THERE IN THE MARKET TO SERVICE THE POPULATION? SQUARE FEET/POPULATION
AIDS IN MEASURING THE ABUNDANCE OF WAREHOUSING SPACE, AND CAN INDICATE IF
THE LOCATION UNDER CONSIDERATION IS APPROPRIATE FOR THIS TYPE OF
INDUSTRIAL USE.
HUB CITY;

FOR HIGHWAY INTERSECTIONS, RAIL LINES, AIRLINES.

FEASIBILITY / YIELDS;
CONSIDERED.

COST VS. PRICE AND RENT VS. PRICE SHOULD BE

BREAK***********
ATLANTA AIRPORT; CUSHMAN AND WAKEFIELD SAY THAT IT IS A KEY FACTOR IN
SELECTING LOCATION OF ATLANTA FOR CORPORATE MOVES.
2 HOUR FLY TIME TO 80 PERCENT OF THE POPULATION OF U.S.
PROXIMITY TO KEY INDUSTRIES
7.7 BILLION DOLLARS OF FOREIGN INVESTMENT RELATED TO AIRPORT
**********************
THE TWO SOUTHS
**********************
TEXAS, FLORIDA, VIRGINIA, GEORGIA; THE PROTOTYPES OF SOUTHER GROWTH, FAR
EXCEEDS THE 58% GROWTH OF U.S. AS A WHOLE FROM 1950 TO 1985.
LOUISIANA, OKLAHOMA, NORTH AND SOUTH CAROLINA; ON PAR WITH THE REST OF
THE COUNTRY.
TENNESSEE, ALABAMA, ARKANSAS;
THE LAGGING SOUTH.
THESE STATES ARE
LOSING POPULATION SHARE AND BECOMING POORER WITH RELATION TO THE REST OF
THE U.S.
ONLY THE EASTERN SEABOARD OF THE SOUTH SAW INCOMES GREATER THAN THE 7.2%
AVERAGE OF THE U.S., WITH THE EXCEPTION OF TENNESSEE WHICH IS CONTIGUOUS
TO THE SEABOARD STATES.
PER CAPITA INCOME PERCENTAGE OF U.S. AVG. WAS GREATER THAN THE AVERAGE
ONLY IN FLORIDA (101%) AND VIRGINIAN (107%); THE OTHERS WERE BELOW, AS

151

LOW AS 66% IN ALABAMA.

UNEMPLOYMENT RATE IN U.S. IS AVERAGE
CAROLINA ARE BELOW AT 3.7% AND 3.2%.

OF

5.4%.

VIRGINIA

AND

NORTH

***********
REAL ESTATE DIFFERENCES BETWEEN THE TWO SOUTHS IS THAT ONE HAS GONE THE
WAY OF IMPORT REPLACEMENT AND THE OTHER HAS GONE THE WAY OF REMAINING
RESOURCE BASED.
ATLANTA BECAME THE CAPITAL OF THE RESOURCE BASED AND
IMPORT REPLACEMENT ECONOMIES. IT HAD THE RAILROAD WHICH WAS A TERMINUS
ON THE CHATTANOOGA LINE, GIVING ACCESS TO THE REST OF THE U.S.

WHAT DOES IT TAKE TO MAKE THE CHOICE OF ATLANTA VS. SAVANNAH GEORGIA?
STATED ANOTHER WAY, WHAT DOES IT TAKE TO CHOOSE A RAIL TRANSPORT ECONOMY
VS. A WATER TRANSPORT ECONOMY?
1.
2.
3.
4.

MARKET NEED
TECHNICAL FEASIBILITY
CAPITAL
POLITICAL WILL

END OF CLASS 4

CLASS FIVE 2/26/90

1.
2.
3.
4.

PRESENTATIONS
SYNOPSIS OF REGIONAL CYCLES OF ECONOMY
BREAK
NUMBERS (HOW TO ESTIMATE, WITH STATISTICS, OFFICE EMPLOYMENT)

FOR NOTES ON PRESENTATIONS SEE NOTEBOOK

MONTREAL
LONG ISLAND
N.Y.C. OFFICE MARKET
MONTREAL
1.1 MILLION PEOPLE
MONTREAL URBAN COMMUNITY (MUC) 1.7 MILLION PEOPLE
3.8 MILLION IN CANADIAN CENSUS DISTRICT
MONTREAL IS AN ISLAND WITH 28 DISTRICTS AND 28 MAYORS UNITED UNDER THE

152

MUC.
BREAK.
*********
THE DEVELOPMENT OF MANHATTAN'S R.E. ECONOMY
1.
2.
3.
4.
5.

THE ERA OF URBAN OPTIMISM (1960 - 1967)

THE TIME OF STRESS AND STRAIN (1967 - 1973)
CRITICAL ERA (1974 - 1979)
RECOVERY PERIOD (1977 - 1987)
ADJUSTMENT TO EXCESS PERIOD (1987 - PRESENT - ?)

THE DIFFERENCES BETWEEN THE CRITICAL ERA AND THE ADJUSTMENT ERA IS THAT
THE FIRST WAS MARKED BY RECESSION OF OBSOLESCENCE, MANUFACTURING,
SHIPPING APPAREL INDUSTRIES LEFT FOREVER.
THE ADJUSTMENT PERIOD LOST
CORE JOBS WHICH WILL BE REBUILT WHEN THE ECONOMY BOUNCES BACK.
URBAN OPTIMISM
VISTA PROGRAM
LET'S SOLVE PROBLEMS ATTITUDE (I.E. MOON LAUNCH, CITY BEAUTIFUL MOVEMENT)
LOW UNEMPLOYMENT
NO RECESSION
1969- PEAK EMPLOYMENT LEVELS IN N.Y.C.
STRESS AND STRAIN
OCCUPANCY RATES LOW, RENTS RISE
1968- KENNEDY AND KING SHOT ; LONG HOT SUMMER
1969- DOW JONES FALLS SHARPLY
37% DECLINE IN STOCK MARKET-BAD NEWS FOR THE CITY
1971-100,000 JOB RATE IN FIRE INDUSTRIES
RESIGNATION OF PRESIDENT, INDICTMENT AND RESIGNATION OF V.P.
EMBARRASSING WITHDRAWAL FROM VIET NAM
INFLATION RISING TO 10%
OIL TRIPLES IN COST OVER NIGHT
IN N.Y.C. RISE IN RENTS IN 1967, AND DECLINE OF VACANCY CAUSED MANY TO BE
ENCOURAGED TO BUILD OFFICE BUILDINGS.
5.5 MILLION S.F. BUILT IN THE
YEARS 1969 TO 1972. VACANCIES ROSE AS EMPLOYMENT DROPPED. 35 MILLION
S.F. WAS EMPTY.
1969 - 100/S.F. SALE PRICE OF MANHATTAN R.E.
1975 - 54/S.F. SALE PRICE OF MANHATTAN R.E.
CRITICAL PERIOD
100,000 WALL STREET JOBS DROP TO 69,000.

153

CORPORATIONS LEAVE THE CITY.

DECENTRALIZATION.
BUSINESSES MOVE, DISCOURAGED BY UNAVAILABILITY OF SPACE IN MANHATTAN IN
1969.
CITY'S CREDIT IS ERODED BY "CREATIVE FINANCING"
REVENUE ANTICIPATION NOTES (RAN)
TAX ANTICIPATION NOTES (TAN)
MORAL OBLIGATION NOTES : NO GUARANTEES TO RAISE TAXES OR REVENUE, BUT WE
THE CITY RECOGNIZE OUR MORAL OBLIGATION TO PAY YOU BACK.
1974-76

TO U.S. GOVERNMENT: "WE NEED HELP"

TO N.Y.C. : FORD TO CITY; DROP DEAD

1974-75 RECESSION; WASHINGTON HAD NO CASH TO GIVE AWAY TO KEEP N.Y.C. OUT
OF BANKRUPTCY. OIL TRIPLED FROM 6 TO 18 DOLLARS PER BARREL. 50 BILLION
DOLLARS REMOVED FROM U.S. ECONOMY AND SENT TO OPEC.
RECOVERY
EXCESS OF OFFICE SPACE WAS ABSORBED, AND COST OF NEW BUILDINGS CAUSED
RENTS TO SKYROCKET. FROM 69,000 TO 160,000 IN SERVICE ECONOMY.
TAXES WERE REDUCED, INTEREST RATES WERE REDUCED, AND BENEFITS OF ECONOMY
HELPED THE RECOVERY OF N.Y.C.
END OF CLASS FIVE
CLASS SIX

3/5/90

1. NEW YORK CITY NUMBERS*

2. BREAK
3. MIAMI PRESENTATION
4. HOTELS
*EXPECT TO SEE THOUGHT PROCESS OF "NEW YORK CITY NUMBERS" ON TEST
LATIN AMERICA/MIAMI CONNECTIONS
1962-1980 CUBANS (27K ARRIVED PER YEAR)
1970 300,000 CUBANS
1985 780,000 CUBANS
1990 1,000,000 CUBANS
85% OF LATIN POPULATION OF MIAMI IS CUBAN
30% OF 3.25 MILLION PEOPLE IN MIAMI ARE LATINO
BUSINESS ATTRACTED TO MIAMI BECAUSE OF ITS CONNECTIONS TO LATIN AMERICA
120 MULTI-NATION CORPORATIONS IN SOUTH FLORIDA
AIRLINE CONNECTIONS AT AIRPORT HELP GROWTH
1987 REAGAN CARIBBEAN BASIN INITIATIVE

154

RESTRUCTURING OF LATIN DEBT THROUGH DEBTOR COMPANIES

FLORIDA EXPORTS FELL WHILE LATIN IMPORTS INCREASED
MIAMI IS BANKING CENTER OF LATIN AMERICA LARGELY BECAUSE SPANISH IS
SPOKEN AS A SECOND LANGUAGE IN MIAMI.
OLYMPIA AND YORK HAS A FINANCIAL CENTER IN MIAMI
BY 1985, MIAMI HAD CHANGED FROM A TOURISM CENTERED CITY TO A BUSINESS
LINK TO SOUTH AMERICA
*************************************************
***NEW YORK CITY NUMBERS*************************
*************************************************
THE LANDAUER MOMENTUM INDEX
N= MOMENTUM FIGURE
THE DEMAND SIDE
N= FORECAST OF OFFICE EMPLOYMENT
CURRENT OFFICE WORKFORCE

THE SUPPLY SIDE

X
MARKET INVENTORY
(VACANCY + RECENT CONSTRUCTION

WHICH IS TRUE IF THE INVENTORY IS GROWING FASTER THAN THE WORKFORCE. IF

THE WORKFORCE IS GROWING LARGE THAN THE INVENTORY, THE OPPOSITE IS TRUE.

ESTIMATED MANHATTAN OFFICE EMPLOYMENT

*************************************
IF FOR INDUSTRY A
W/T > M/T

AND W = WHITE COLLAR JOBS

T = TOTAL NEW YORK CITY JOBS
M = MANHATTAN JOBS IN THE INDUSTRY

THEN;
MANHATTAN OFFICE JOBS = {M*(W/T)} + [{M*(1-(W/T))}*{M/T}]
= MANHATTAN + OCCUPATIONAL * CONCENTRATION

155

BASIC SHARE

RESIDUAL

W/T = RATIO OF WHITE COLLAR JOBS

MANHATTAN BASIC SHARE IS THE 'FLOOR' OF YOUR ESTIMATE.
AMOUNT OF EMPLOYMENT IN INDUSTRY IN MANHATTAN

FACTOR

IT IS THE MINIMUM

OCCUPATIONAL RESIDUAL IS A BUNCH OF PEOPLE WHO WORK IN AN INDUSTRY IN

MANHATTAN WHOSE OCCUPATION YOU DO NOT KNOW YET. HOW MANY OF THEM WILL BE
MANHATTAN OFFICE WORKERS IS THE QUESTION THIS FORMULA TRIES TO ANSWER.
CONCENTRATION FACTOR IS THE DEGREE TO WHICH THE INDUSTRY IS PRESENT IN
MANHATTAN.
THE HYPOTHESIS IS THAT MANHATTAN HAS AT LEAST AS GREAT A SHARE OF AN
INDUSTRY AS ANOTHER AREA IN NEW YORK CITY. THE UPPER LIMIT IS THAT THERE
ARE NEVER MORE THAN THE TOTAL WHITE COLLAR EMPLOYMENT IN MANHATTAN, AND
THAT THERE ARE NEVER LESS THAN THE TOTAL WHITE COLLAR JOBS IN A
PARTICULAR INDUSTRY.
EXAMPLE;
GIVEN THE MEMBERSHIP ORGANIZATION INDUSTRY, WHICH ARE GROUPS LIKE TRADE
ASSOCIATIONS AND LOBBYISTS.
W= 148,800
T= 172,000
M= 74,300
W/T= 86.1%
M/T= 43.0%
(74,300 X 0.861) + ((74,300 X (1-0.861))) X (0.43)
= 63,972 + (10,328 X 0.43)
= 63,972 + 4,441
= 68,413 = ANSWER; THERE ARE 68,413 IN MEMBERSHIP INDUSTRY MANHATTAN
OFFICE EMPLOYMENT
NOTE THAT 68413>63,972

IF FOR INDUSTRY B; APPAREL

W/T < M/T
THEN;
MANHATTAN OFFICE JOBS = {M*(W/T)} + {(W-(M*(W/T)))*{M/T}}

= MANHATTAN
LOCATIONAL * CONCENTRATION

156

BASIC SHARE + RESIDUAL

FACTOR

THIS FORMULA IS USED WHEN THE LOCATION IS THE DOMINANT FACTOR IN THE
INDUSTRY.
IT SAYS THAT THE WHITE COLLAR WORKERS WILL BE IN MANHATTAN THE DEGREE
THAT THE INDUSTRY IS IN MANHATTAN.
THE FIGURES FOR MANHATTAN BASIC SHARE AND CONCENTRATION FACTOR ARE THE
SAME FORMULAE THAT WERE IN THE EXAMPLE FOR INDUSTRY A ABOVE.
W=34,800
M=71,600
T=102,000
W/T = 34.1%
M/T = 70.2%
(71,600 X .341) + ((34,800 - (71,600 X .341))) X 0.702)
24,415 + (34,800 - 24,415) X 0.702)
24,415 + (10,385 X 0.702)
24,415 + 7290 = 31,705
ANSWER; THERE ARE 31,705 APPAREL WORKERS IN MANHATTAN OFFICES
END OF CLASS SIX
CLASS SEVEN ; 3/19/90
CLASS HOSTED BY JACQUES GORDON
SUBSTITUTING FOR HUGH KELLY
MICRO ANALYSIS OF REAL ESTATE MARKETS
I. MARKET AREA CHARACTERISTICS
A. DEMOGRAPHICS
B. ECONOMIC BASE ANALYSIS
C. LOCAL GOVERNMENT/REGULATORY ENVIRONMENT
D. QUALITY OF LIFE ISSUES
E. INFRASTRUCTURE ISSUES
F. DETAILED ANALYSIS OF MICRO ENVIRONMENT
MICRO ANALYSIS DEALS WITH A SPECIFIC GEOGRAPHY
II. DEMAND ANALYSIS
III. SUPPLY ANALYSIS
IV. EVALUATION OF MICRO-MARKET RESEARCH
PART IV IS BECOMING MORE NECESSARY AND COMMON BY NECESSITY, THOUGH UNTIL
NOW WAS NOT OFTEN REQUESTED.
MICROECONOMICS IS FOR THE ECONOMIC PICTURE OF A SPECIFIC GEOGRAPHIC AREA.
MACROECONOMICS DESCRIBES THE TRENDS OF, FOR EXAMPLE, INTEREST RATES AND
EMPLOYMENT AND OTHER ISSUES WHICH GOVERN THE WELL-BEING OF THE GEOGRAPHIC
AREA UNDER CONSIDERATION IN THE MICRO ECONOMIC STUDY.

157

MACRO TRENDS
A NATION OF CONSUMERS
SAVINGS RATE VS. CONSUMPTION RATES; INTERNATIONAL COMPARISONS
RETAIL...A GOOD INVESTMENT?
THE DEPARTMENT STORE...FOR SALE
RETAILER LOYALTY VS. BRAND LOYALTY VS. NO LOYALTY
UNDERSTANDING THE CONSUMER
CYCLICAL DEMAND VS. RECESSION-RESISTANT DEMAND
LANCASTRIAN DEMAND FOR HETEROGENOUS DURABLE GOODS
REAL ESTATE SENSITIVITY TO THE CONSUMER; SELLING THROUGH LOCATION AND
ARCHITECTURE.
A NATION OF CONSUMERS
THE U.S. CONSUMER COMPARED TO OTHERS AROUND THE GLOBE CONSUME MORE, SAVE
LESS ON OUR OWN (WE SAVE THROUGH PENSION PLANS).
FOR REAL ESTATE
IMPACTS, WE HAVE MORE RETAIL S.F. PER CAPITA BY A FACTOR OF 3, AND ON A
GROSS BASIS BY A FACTOR OF 10. ASSET SIZE OF RETAIL IS GREATER IN THE
U.S. THAN ANYWHERE ELSE.
RETAIL INVESTMENTS
FROM AN INVESTMENT PERSPECTIVE, THE FRANK RUSSEL PERFORMANCE INDEX
MEASURING THE REAL ESTATE MARKET'S RETURN ON INVESTMENT SHOWS RETAIL AS A
GOOD PERFORMER. THE BEST OF ANY REAL ESTATE ASSET CLASS SUB-MARKET FOR
THE LAST FOUR YEARS WAS RETAIL. THIS WAS BECAUSE LEASES FOR RETAIL OFTEN
ARE BASED ON A BASE COST PLUS AN OVERAGE WHICH IS THE EQUIVALENT OF A
PERCENTAGE OF SALES.
SINCE PURCHASES HAVE BEEN UP, THE NET OPERATING
INCOME FROM RENTS AND OVERAGES IS UP, AND THE VALUE OF THE PROPERTIES
THEREFORE GOES UP.
PERCENT INTERNAL RATE OF RETURN
HOLD
RETAILOFFICEINDUSTRIAL OVERALL
------------------------------------------------------------------------1
9
6
7
7
3

12

8.5

15

11

12

DEPARTMENT STORE FOR SALE

ANCHORS CONTRIBUTE LESS THAN 5 TO 10 PERCENT OF CASH FLOW IN A MALL.

158

WHAT HAPPENS WHEN THE ANCHOR GOES BUST? THE SMALL STORES PRODUCING THE
90% OF CASH FLOW CAN NOT DRAW CUSTOMERS. NOBODY HAD A FORECAST THAT TOOK
INTO ACCOUNT THE POTENTIAL LOSS OF LARGE RETAIL STORES, AND THE IMPACTS
OF THIS MAY CAUSE THE INTERNAL RATE OF RETURN FROM RETAIL USES TO DIP
SLIGHTLY.
INVESTOR DEMAND VS. CONSUMER DEMAND; HOW DO THEY CORRELATE?
THE "POOR SHMUCKS" WHO WORK IN AN OFFICE HAVE NO DISCRETION ON WHERE THEY
WORK. WHERE THEY SHOP IS A MATTER WHICH IS UNDER THEIR DISCRETION.
CONSUMER LOYALTY HAS LESSENED DUE TO CONSUMER DISTRUST, AND THE TRADE-OFF
BETWEEN PRICE AND SERVICE. NO ONE WANTS TO PAY FOR SERVICE THEY ARE NOT
GETTING, AND THIS GIVES RISE TO THE DISCOUNTER WHICH IS A SELF-SERVICE
RETAILER. CONSUMERS ARE EITHER LOYAL TO BRANDS AS OPPOSED TO VENDORS, OR
GOODS, WHICH GIVES RISE TO GENERIC GOODS.
TO UNDERSTAND THE CONSUMER, YOU NEED TO SEPARATE THE CONSUMERS THAT ARE
DEPENDENT ON CYCLICAL DEMAND AS OPPOSED TO THOSE WHICH BUY PRODUCTS THAT
ARE BASED ON RECESSION-RESISTANT DEMAND. YOUR CAPITALIZATION RATES WILL
APPLY DIFFERENTLY TO A RETAIL STORE SPECIALIZING IN ONE AREA AS OPPOSED
TO ONE SPECIALIZING IN THE AREA, DUE TO THE STORES SENSITIVITY TO
ECONOMIC CYCLES.
WHEN YOU BUY AN AUTOMOBILE, YOU ARE REALLY BUYING ITS ATTRIBUTES. THIS
PHENOMENON IS ESPECIALLY TRUE WITH DURABLE GOODS. IN ORDER TO UNDERSTAND
DEMAND YOU NEED TO UNDERSTAND THE DEMAND FOR "ATTRIBUTES", NOT THE GOODS
WHICH MAY OR NOT HAVE THEM.
TRY TO UNDERSTAND THE DEMAND FOR BABY BOOMERS NEEDS WHEN THEY RETIRE, OR
SEND THEIR KIDS TO COLLEGE, OR WHATEVER, TO FORECAST DEMAND FOR SPECIFIC
GOODS OR FOR NEW GOODS. ALWAYS REMEMBER WHO YOUR CONSUMER IS.
DESTINATION VS. IMPULSE....WHERE DO WE SHOP?
SERVICE VS. PRIDE...A TRADEOFF?
SPECIALTY STORE VS. DEPARTMENT STORE...INTEGRATION OR DISINTEGRATION?
OFF-PRICE DISCOUNTER VS. MANUFACTURER'S OUTLET
SHOPPING VS. ENTERTAINMENT?
TRAFFIC: THE SINE QUA NON OF RETAILING
YOU HAVE
1.
2.
3.

GOT TO HAVE TRAFFIC TO GET YOUR LOCATION NOTICED.

START WITH THE RIGHT LOCATION
MAKE PROMOTIONS
PROVIDE SHOPPING AS ENTERTAINMENT

159

YOU CAN:

TRADE AREA ANALYSIS

MEASURING DEMAND:
DETERMINE TRADE
DISPOSABLE INCOME, DEMOGRAPHICS.

AREAS,

EFFECTIVE

BUYING

INCOME,

PSYCHOGRAPHICS, SEGMENTATION MODELS, MARKET SHARE, ZERO-SUM OR EXPANSION,

SHOPPER DEMAND VS. TENANT DEMAND VS. INVESTOR DEMAND.
MEASURING SUPPLY: IDENTIFYING CURRENT COMPOSITION. IDENTIFYING FUTURE
COMPETITION.
PERCENTAGE RENTS, BREAK POINTS, VACANCY RATES AND
ABSORPTION.
CHICAGO:
SUCCEEDED BECAUSE OF RAILROADS.
TWO MAJOR SHOPPING DISTRICTS:
NEW ONE IS NORTH MICHIGAN AVENUE
CHICAGO KNOWN FOR ITS LAW FIRMS AND ADVERTISEMENT AGENCIES AND FOR ITS
MERCHANDISING MARTS FOR THE MIDWEST.
4 MAJOR OFFICE MARKETS:
EAST-WEST TOLLWAY HIGH TECH CORRIDOR
SCHAUMBERG (CENTERED AROUND 2.5 M S.F. MALL)
O'HARE (AIRPORT CENTERED)
EDENS CORRIDOR (AROUND EXPRESSWAY)
RIVERVIEW SPACE HAS PREMIUM.
THEIR ARE NO LAKE VIEWS DUE TO PLANNING
DECISIONS BY DANIEL BURNHAM IN THE 1920'S.
3/26/90
CLASS EIGHT
1. MINNEAPOLIS
2. PRESENTATIONS
3. TECHNOLOGY
BREAK
4. RETAIL MATRIX
5. VARIABLES
THE SMART BUILDING: LIGHTING, HEATING, AIR CONDITIONING, VOICE AND DATA
COMMUNICATION ARE COORDINATED IN A SMART BUILDING TO MAXIMIZE OCCUPANT
PERFORMANCE.

160

MINNEAPOLIS CHARACTERISTICS
1.
2.
3.
4.
5.
6.

HEADQUARTERS CITY
REGIONAL CENTER
TECHNOLOGY EMPHASIS
EXCELLENT SCHOOLS
GOOD NATIONAL ACCESS
ANCILLARY SYSTEMS AND QUALITY OF LIFE

HI-TECHNOLOGY
PRODUCERS AND USERS....WHO ARE THEY?
PRODUCERS
ELECTRIC MACHINERY
INSTRUMENTS
TRANSPORTATION EQUIPMENT
COMMUNICATIONS
COMPUTER SERVICES
USERS
VIRTUALLY ANYONE
MANUFACTURING, ROBOTICS
TRADE, INVENTORY TRADING
F.I.R.E., E.F.T. (ELECTRONIC FUNDS TRANSFER)
AND ALL OPERATIONS
BIO-MEDICINE
LEXIS/NEXIS
ETC.
SMART BUILDINGS
TECHNOLOGY ENHANCED:
1. TENANT SERVICES
2. BUILDING SYSTEMS
TENANT SERVICES:
1. VIDEOCONFERENCING
2. PBX (PRIVATE BRANCHING EXCHANGE)
3. LEAST-COST LONG DISTANCE CALLING
4. DATA AND WORD PROCESSING
5. SYSTEMS CONSULTING
6. SERVICES AND MAINTENANCE
7. WIRING SCHEME
8. EXTERNAL COMMUNICATIONS
OLYMPIA & YORK IS KNOWN FOR ITS PROVISION OF CLASS A SMART BUILDINGS.
THEY OFFER, FOR EXAMPLE, TELECONFERENCING BETWEEN ITS LEASEHOLDS IN THE

161

FOLLOWING CITIES.
BOSTON, SPRINGFIELD,
ANGELES, AND SAN FRANCISCO.

HARTFORD,

N.Y.C.,

DALLAS,

PORTLAND,

TECHNOLOGICALLY ENHANCED PROJECTS SEEM TO CENTER IN LARGER CITIES.

THE FOLLOWING TABLE:

LOS
NOTE

NUMBER OF TECHNOLOGICALLY ENHANCED PROJECTS (N=118)

NYC
=19
DALLAS
=18
WASH. D.C.=14
CHICAGO
=12
S.FRANC
= 6
L.A.
= 5
__________________________
SUBTOTAL = 74
OTHERS
= 44
%

40

30

NUMBERS OF HIGH TECH PROJECTS

20

MOST CONCENTRATED IN OFFICE TYPES.

10

CBD
SUBURBS
N.C.
BUILDING SYSTEMS
1.
2.
3.
4.

HVAC
ENERGY MANAGEMENT
LIFE SAFETY / FIRE
SECURITY

ALL OF THESE SYSTEMS ARE BECOMING STANDARDS INDUSTRY-WIDE.

SERVICES COME FROM STREET AND EXTEND THROUGH THE BUILDING.
BRING IT UP THROUGH THE ELEVATOR CORE. THEY HAVE:
SINGLE TELEPHONE SYSTEMS
RISERS IN THE CORE ONLY
LONG CABLE RUNS
MINIMAL CLOSET CAPACITY

DUMB BUILDING

SMART BUILDINGS ARE DIFFERENT. THEY:

PUT RISERS AT THE PERIMETER, AWAY FROM ELEVATOR CORE VIBRATIONS
HAVE MULTIPLE SYSTEMS FOR REDUNDANCY
HAVE DISPERSED RISERS

162

HAVE SHORT CABLE LENGTHS

HAVE LARGE CAPACITY CLOSETS

**************
RETAIL MATRIX
**************
median
100

BEST (SEEK OUT)

GROWTH

WORST (AVOID)

0
VOLUME
100
THIS MATRIX IS A MODEL WHICH ALLOWS ONE TO USE CRITERIA TO PLOT AN
INVESTMENT, ENABLING US TO MAKE A DECISION OF THE INVESTMENT-WORTHINESS
OF ONE VERSUS ANOTHER PROPERTY.
ANY MODEL SHOULD HAVE 4 QUALITIES:
IT SHOULD BE
1. DEFENSIBLE 3. DISCUSSIBLE
2. DERIVABLE
4. DEBATABLE
THERE SHOULD BE A DIFFERENT STRATEGY FOR A LARGE MARKET GROWING SLOWLY
AND A SMALL MARKET GROWING QUICKLY.
THE MATRIX REDUCES DATA TO SEVEN CONCEPTS, WEIGHTS THEM AND PLACES THEM
INTO A MATRIX.
***************
RANKING SYSTEM
***************
CONCEPTS (VOLUME)
33% WEIGHT TO PER CAPITA INCOME (OR HOUSEHOLD INCOME, OR TOTAL OR FAMILY
INCOME). ANSWERS THE QUESTION; HOW MUCH IS AVAILABLE FOR SPENDING?
INFORMATION IS FOUND IN CACI, CENSUS, ETC.

163

33% WEIGHT TO AMOUNT OF INCOME THAT IS CAPTURED. (SALES & MARKETING

MANAGEMENT MAGAZINE)
33% WEIGHT GIVEN TO INVENTORY OF STORE AREA IN MARKET (DODGE, SHOPPING
CENTER DIRECTORY)
OFTEN, PER CAPITA INCOME AND RETAIL SALES MAY NOT CORRELATE.
(GROWTH)
30% WEIGHT GIVEN TO 5 YEAR GROWTH IN RETAIL SALES
30% WEIGHT GIVEN TO 5 YEAR GROWTH IN GENERAL APPAREL, FURNITURE SALES /
S.F. OF AREA.
20% OF WEIGHT GIVEN TO PROJECTED GROWTH IN INCOME (JOB GROWTH AND INCOME
MEASURE BASE BETTER THAN DEMOGRAPHIC)
20% GIVEN TO SCALE OF RATIO OF NEW STORES CONSTRUCTION AGAINST EXISTING
INVENTORY.
LESS IS BETTER BECAUSE THERE IS MORE BUSINESS TO SHARE.
(DODGE DATA)
MAKE THE SYSTEM BETTER BY TESTING PERFORMANCE OF ARRAY AGAINST THE ACTUAL
MARKET CONDITIONS.
THIS IS MEASURED BY "HOW GOOD IS THE INVESTMENT" AS MEASURED BY CAP RATE,
SALES PER S.F., AND IRR.
THE DIFFERENCE BETWEEN REVENUE AND INCOME IS:
MEASURE OF PRODUCTIVITY
MEASURE OF OPERATIONS

=
=

REVENUE
INCOME

END OF CLASS EIGHT

CLASS NINE
4/2/90
1.
2.
3.
4.
5.

PRESENTATIONS
ECONOMIC BASE
BACK TO EDEN ARTICLE
AGRIBUSINESS
DEVELOPMENT PRESSURES

***********************************
BREAK BULK WAREHOUSING VS. BULK WAREHOUSING
BREAK BULK WAREHOUSING IS USED WHEN GOODS ARE BROKEN DOWN AND DISTRIBUTED

164

TO RETAIL LEVEL.
BULK WAREHOUSING IS USED WHEN PRODUCTS ARE STORED FOR EVENTUAL SHIPMENT
TO BREAK-BULK FACILITIES. POINT-OF-PRODUCTION TENDENCY, TENDS TO LOCATE
IN THE CENTER OF THE COUNTRY.
HI-CUBE SPACE
MOST SPACE IS MEASURED FOR PRODUCTIVITY BY SQUARE FEET. WAREHOUSE SPACE
IS MEASURED IN CUBIC FEET. HI-CUBE SPACE MEANS 24 TO 36 FEET CLEAR FROM
FLOOR TO THE CEILING.
********************************************
COMPARISONS OF KANSAS CITY AND MINNEAPOLIS
********************************************
TOP EMPLOYERS
K.C.
MINNEAPOLIS
*********************************************************************
ALLIED BENDIX
HONEYWELL
HALLMARK
CONTROL DATA
FORD MOTORS
UNISYS
ARMCO STEEL
3M
OLIN
PILLSBURY
INDUSTRY
+++++++++++++++++++++++++++++++
MANUFACTURING
UNITED TELECOM
FARMLAND INDUSTRIES
ST. LUKES HOSPITAL
TWA MAINTENANCE
UTILITIES

CONTROL DATA
UNIVERSITY OF MINNESOTA
NORWEST BANK
NORTHWEST AIR
DAYTON HUDSON

KANSAS CITY HAS A BROAD ORIENTATION WHILE

TECHNOLOGICAL ORIENTATION.

MINNEAPOLIS HAS

A HIGHLY

::::::::::::::::::::::::::::::::::::
PART OF THE DIFFERENCE IN THE TWO CITIES IS SIZE....AS A LARGER CITY,
MINNEAPOLIS PERFORMS HIGHER ORDER FUNCTIONS, AS REFLECTED IN THE TYPES OF
EMPLOYERS.
PERCENTAGE TO PERCENTAGE, BROKEN DOWN, THE RELATIONSHIPS
INDUSTRY TO INDUSTRY ARE SIMILAR.
WHEN EXAMINING AN
ECONOMY.
AGRONOMISTS,

ECONOMY FOR

VETERINARIANS,

BREADTH, EXAMINE

CROP

DUSTERS,

165

THE LINKAGES

EQUIPMENT

OF THE

MANUFACTURERS,

EXTENSION AGENTS AND LAND BROKERS,

AS WELL AS HARVESTERS, TRUCKERS,
PROCESSORS, WHOLESALERS, AND COMMODITY BROKERS MAY APPEAR IN WIDELY
VARIANT SIC CODES, BUT ALL DEPEND ON AND ARE LINKED WITH THE WELL-BEING
OF FARMING, AND ARE AFFECTED BY IT.

A G R I B U S I N E S S
AGRIBUSINESS IN KANSAS CITY CREATES A LOT OF REAL ESTATE BUSINESS, THOUGH
MUCH IS MEASURED IN THE NON-AGRICULTURAL ECONOMY. WHEN YOU LOOK AT THE
LINKAGES YOU BECOME CONVINCED THAT THE KANSAS CITY ECONOMY IS A FARMING
ECONOMY. IF THE FARMING ECONOMY GOES DOWN, THEN SO DO THE OTHER ASPECTS
OF THE ECONOMY GOING INTO FARMING AND OUT-PUTTING FROM IT ARE ALSO
AFFECTED.. ************ALWAYS LOOK AT LINKAGES TO DEFINE WHETHER OR NOT
AN ECONOMY IS TRULY BROAD*************.
BACK TO EDEN ARTICLE DISCUSSED
SEE OUTLINED PARAGRAPH ON PAGE 57
********************************
"FARM STRUCTURE" FROM FEDERAL RESERVE BANK BULLETIN OF KANSAS CITY.
GREAT SOURCE OF LOCAL INFO FOR EACH FEDERAL RESERVE DISTRICT.

100
M
M

MED

75

MED

50

25

MED

S
NO. OF FARMS
DEBT
NET INCOME

166

M = MEGA; L = LARGE; MED = MEDIUM; S = SMALL

# OF FARMS
75%
12%
12%
1%

SIZE
SMALL
MEDIUM
LARGE
MEGA

% OF OVERALL FARM DEBT

20
CARRY 18% OF DEBT/10% OF INCOME
HAVE 40% OF DEBT/40% OF INCOME
HAVE 22% OF DEBT/40% OF INCOME

SALES GROSS
UP TO 40,000
40 TO 100,000
100 TO 500,000
OVER 500,000

LARGE FARMS BENEFIT FROM ECONOMIES OF SCALE.

HOW DO SMALL FARMS STAY IN BUSINESS?

IN REAL ESTATE, THERE ARE TWO COMPONENTS OF RETURN:
1. APPRECIATION
2. INCOME

900

*823
VALUE OF FIELD
*
*

737

*679
500
*

*548

*340

*
300
*

PRODUCTIVITY
FORCED
* * 196
INCREASE*LIQUIDATION

SALE, DROUGHT,

LOSS OF PRODUCTIVITY

0
1970
1975
1980
1985
AS PRODUCTIVITY INCREASED, LAND VALUE INCREASED. THE RESIDUAL VALUE OF
REAL ESTATE INCREASED TO INCREASE COLLATERAL ON LOANS.
AFTER
OVEREXTENSION, PRODUCTIVITY DECREASED, AS THEN DID LAND VALUES.

167

SEE FIGURE 2.15, THE SIGMOID CURVE OF POPULATION ECOLOGY

*

*
P
*
O
*
P
*
U
*
L
*
A
*
T * * *
I TIME
O
N
AS POPULATION UNDERGOES NATURAL INCREASE, THERE IS AN EXPONENTIAL GROWTH
OVER TIME, AS LONG AS THERE ARE ABUNDANT RESOURCES TO SUPPORT THE GROWTH,
AND THE AFTER THE RESOURCES ARE EXPENDED THE CURVE FLATTENS OUT.
A
SIMILAR OUTLOOK CAN BE APPLIED TO THE PREDICTIONS OF FUTURE GROWTH ON
LAND WHICH WILL EVENTUAL NO LONGER BE FEASIBLE FOR FARMING.
SCHEMATIC ANALYSIS OF PRE-DEVELOPMENT LAND VALUE CURVE

*
*
*

*
*
*

*
*
*
AGRICULTURAL.......PRE-DEVELOPMENT...............DEVELOPMENT

*
* M
S
*

* R
A
* A
A
*
+
+

* E
C
* N
L
*

* S
Q
* A
E +
*

* E
U
* G
S
*

* A
I
* E
*

* R
S
* M
+
*

* C
I
* E
*

* H
T
* N
*

*
I +* T
*

*
O
*
*

*
+ N
*
*

*
*
*

+
*
USER
*
+
+
* SPECULATIVE *
PRESSURE
*

* PRESSURE
*
*

*
*
*

*
*
*

\.........5 TO 7 YEARS...........\
EXPLANATION OF THE ABOVE

168

WHEN CONSIDERING THAT FARM FUNCTIONS AND THEIR PRACTICALITY ARE TIED IN
WITH PROXIMITY TO MARKET AND A PARTICULAR FARM'S DEPENDENCY ON VAST LAND
AMOUNTS, THE AREAS WITH THE LARGEST AMOUNTS OF LAND WOULD BE AWAY FROM
THE CITY CENTER. PLACES LIKE THIS WOULD BE MORE LIKELY TO GROW WHEAT,
SAY, THAN BE A DAIRY FARM, WHICH IS MORE DEPENDENT ON PROXIMITY TO THE
MARKET DUE TO THE EXPENSE OF TRANSPORTATION.
EVENTUALLY, THE COST OF
DOING BUSINESS CLOSE TO THE CITY CENTER WILL MAKE IT IMPOSSIBLE TO
CONTINUE WITH THE FARM USE PREVALENT IN PAST YEARS, SINCE ONLY VAST SCALE
OPERATIONS ARE ABLE TO CONTINUE MAKING PROFITS. THEREFORE, THE FARMLAND
COMES UNDER PRESSURE FOR DEVELOPMENT.
THE ABOVE GRAPH DEMONSTRATES LAND AS THE "RESOURCE" OF THE SIGMOID CURVE.
THE SPECULATOR WILL SEE INTEREST IN THE DIRECTION OF THE CITY'S GROWTH
AND MAKE A MOVE TO SECURE THE LAND. HE THEN WILL MANAGE THE RESOURCE BY
SECURING APPROVALS TO UTILIZE THE LAND FOR HOUSING OR ANOTHER USE OR
COMBINATION OF USES. THEN, ONCE THIS IS ACCOMPLISHED, HE WILL SELL THE
LAND ACCORDING TO ITS NEW VALUE AS SITES FOR BUILDING, RATHER THAN ITS
OLD VALUE AS OBSOLESCENT FARMLAND.
AT SOME POINT IN TIME A FARM PARCEL IN THE DIRECTION OF A CITY'S GROWTH
WILL BE RESEARCHED AND IDENTIFIED BEFORE GROWTH REACHES IT AND THE LAND
IS VALUED AT FARM PRODUCTION PRICES. DO NOT ACQUIRE IT, HOWEVER, UNTIL
OTHER PEOPLE NOTICE THE AREA.
BEFORE THE CITY GROWS, REZONE YOUR
AGRICULTURAL LAND TO SOMETHING ELSE, LIKE RESIDENTIAL OR OFFICE OR
INDUSTRIAL.
THIS IS THE MANAGEMENT STAGE. YOU THEN MAY ADD THE LEAST
AMOUNT OF INFRASTRUCTURE AS IN NECESSARY AND ADD A SALES PROGRAM, WHERE
YOU SELL TRACTS OF LAND OFF TO DEVELOPERS WHO ADD FURTHER CAPITAL TO
CREATE A PRODUCT. IT IS LIKE A SIGMOID CURVE BECAUSE IT IS A CURVE OF
VALUES OF LAND, AND FLATTENS OUT WHEN IT REACHES ITS HIGHEST USE.
FURTHER VALUE IS GAINED FROM IMPROVEMENTS ON THE LAND RATHER THAN FROM
THE LAND ITSELF.
REMEMBER THAT THE HIGHEST AND BEST USE OF LAND IS
DEFINED AS:
1. PHYSICALLY POSSIBLE
2. LEGALLY PERMISSIBLE
3. FINANCIALLY FEASIBLE
4. MAXIMUM PRODUCTION
END OF CLASS NINE
CLASS TEN WAS NOT ATTENDED DUE TO PASSOVER HOLIDAY
4/16/90
THIS CLASS WAS ON DALLAS.
DALLAS - DIVERSIFICATION
DALLAS/ATLANTA

COMPARISON

REGIONAL TRANSPORTATION CENTERS

169

RAIL TRAFFIC JUNCTION

CENTER OF SUPPLY/RESOURCES FOR THE REGIONS
CONVERGENCE OF REGIONS
DALLAS - MEXAMERICA - LABOR RESOURCE
BREAD BASKET INFLUENCE (COTTON)
EMPTY QUARTER (WEST AND NORTH)
OIL RESOURCES
BASIS FOR DIVERSIFICATION
ALL ABOVE LINKAGES ARE RESOURCE LINKAGES
RESOURCE BASE ECONOMIES NEED TO BECOME
GENERATORS OF GREATER NUMBER OF GOODS

IMPORT

BASE

ECONOMIES

AND

RESOURCE BASED ECONOMIES ARE BOOM AND BUST ECONOMIES

DEPENDENT ON AVAILABILITY AND DEMAND FOR RESOURCES
DALLAS - IMPORTANT DEFENSE COMPONENT IN AEROSPACE
GROWS THROUGH OTHER ECONOMIC RECESSIONS
GOVERNMENT SUPPLIES FUNDS SHIELDED FROM MANUFACTURING DOWN TURNS BECAUSE
GOVERNMENT IS BUYER OF ITS GOODS.
74-75 RECESSION CAUSED BY OIL AND GAS PRICES
81-82 RECESSION OIL EMBARGO GOOD FOR TEXAS
TEXAS BELIEVES THAT IT IS RECESSION PROOF
LOW ENERGY COST OF 84-86 BAD FOR TEXAS AND GOOD FOR THE NATIONAL ECONOMY
DIVERSE ECONOMIES HAVE A NUMBER OF ECONOMIC PROCESS WITH ITS OWN SET OF
LINKAGES WHICH ACT AUTONOMOUSLY.
DALLAS EXPORT INDUSTRIES
-----------------------OIL AND GAS
FABRICATED METALS
MACHINERY
PIPELINES
FINANCE
LEGAL
BUSINESS SERVICES
ALL ARE RELATED TO OIL: IT IS AN INVERTED PYRAMID ECONOMY
COMPLEX AND DIVERSIFIED ECONOMIES
MIX OF COMPONENTS AND ECONOMIC PROCESSES
1. TRADING ECONOMY

170

2. GOODS PROCESSING BASED ON LOCAL ECONOMY

3. IMPORT REPLACEMENT- DO NOT BE DEPENDENT ON GETTING FINISHED GOOD FROM
OUTSIDE, NEED TO EXPORT SOME FINISHED GOODS
LESS DIVERSIFIED ECONOMY
BOSTON- SHOE MAKING MILL ECONOMY
NON-DIVERSIFIED
70'S DIVERSIFY-DEFENSE, ELECTRONICS AND COMPUTERS
DIVERSIFIED ECONOMIC BASE MEANS DIFFERENT PROCESSES AND COMPONENTS
REFER TO SIGMOID CURVE:
IT ALSO APPLIES TO ECONOMIC DIVERSIFICATION
IN THE BEGINNING THERE IS A LOW LEVEL OF POPULATION WITH LITTLE
INTERACTION.
IT GROWS OVER TIME TO A POINT WHERE IT CAN SUSTAIN A
POPULATION.
EVENTUALLY IT GETS TO A POINT WHERE IT CAN NOT SUSTAIN A
LARGER POPULATION.

WHAT WERE THE DALLAS DANGER SIGNALS?

1. UNSUSTAINABLE GROWTH (NYC, 3%; DALLAS,10%)
2. DETACHMENT OF VALUES FROM COSTS
3. CIRCULAR LINKAGES IN ECONOMIC BASE
OIL AND GAS......MANUFACTURING.....REFINING....BUILDING...OIL & GAS
4. COMPARATIVE ECONOMIC DISADVANTAGE (IE. DETROIT, HIGH LABOR COST)
5. EXHAUSTION OF RESOURCES (ARE THERE POINTS WHERE THE RESOURCE IS NOT
ECONOMICAL TO EXPLOIT)
6. LINK TO OBSOLETE TECHNOLOGY (IE. BOSTON)
WHAT TO LOOK FOR:
WHERE ARE CITIES GOING IN TERMS OF DIVERSIFICATION, UP OR DOWN ON THE
SCALE.
BOSTON GETTING MORE DIVERSE, NYC GETTING LESS DIVERSE, LA IS MOST DIVERSE
COMPONENTS OF RESOURCE BASED ECONOMY (DIVERSIFIED)
1. RESOURCE
2. IMPORT REPLACEMENT GENERATED LOCALLY TO MEET THE NEEDS OF THE
LOCAL ECONOMY

171

3. CONNECTIONS TO NATIONAL MARKETS

4. CONNECTIONS TO WORLD MARKETS
TRADE, HOTELS, LOCAL SERVICES, CONSTRUCTION BUILT UPON BASE
LOOK FOR LINKAGE CLUSTERS
END OF CLASS TEN
CLASS ELEVEN
4/23/90
1.
2.
3.
4.

HOUSEKEEPING
PRESENTATIONS
L.A. / OFFICE - INDUSTRIAL SUBMARKETS
REVIEW: PART I

LOS ANGELES PRESENTATIONS:

FORBES MAGAZINE: "60 DIVERSE INDUSTRIES IN L.A. = 50% OF CALIFORNIA
EMPLOYMENT.
STRAIGHT UPWARD TREND IN L.A. TOTAL EMPLOYMENT EVEN AS HOUSTON AND NEW
YORK, FOR EXAMPLE, HAD UPS AND DOWNS.
DIVERSITY OF L.A. IS KEY TO STRENGTH, KEEPING IT HEALTHY IN DIFFICULT
TIMES. MOST FIRMS ARE SMALL WITH LESS THAN 50 WORKERS, KEEPING FLUIDITY
OF RESPONSE TO ECONOMIC CONDITIONS, GOOD RELATIVE TO EAST COAST BUSINESS.
MANUFACTURING RISING AS "GOESINTO" ITEMS PRODUCED. THEY ARE INCREASING
EVEN AS N.Y. AND HOUSTON TREND DOWNWARD. McDONNEL DOUGLAS AND NORTHROP
AND OTHER AEROSPACE INDUSTRY ACCOUNT FOR 37% OF MANUFACTURING.
CITY OF INDUSTRY IS 60% MANUFACTURING, WITH 60,000 EMPLOYEES PRODUCING
VERY DIVERSE PRODUCTS.
AIR, RAIL, WATER, HIGHWAY GIVES GOOD CAPACITY FOR TRADE WITH THE WORLD.
UNIVERSITIES (150) GIVE GOOD RESEARCH FUTURE.
HOME BANKS TIED TO LA MANUFACTURING AND ASIAN TRADE.
LA SURPASSED N.Y. METRO AREA IN SERVICE EMPLOYMENT RECENTLY, AND IS THE
FINANCIAL CENTER OF THE WEST.
IT IS THE U.S. CAPITAL OF THE PACIFIC RIM'S TRADE AND FINANCE INDUSTRIES,
BELIEVED THAT DOWNTOWN LA WILL BY 21ST CENTURY BE PREMIER FINANCE CENTER,
ABOVE N.Y.
IMMIGRANT POPULATION, CHANGED THE RACIAL MIX OF LA IN FAVOR OF ORIENTALS

172

AND HISPANICS.
215,000= MEDIAN LA HOME PRICE DUE TO DEMAND AND IMMIGRATION.
OFFICE INTENSIVE JOBS WERE AFFECTED MOST BY PACIFIC RIM TRADE, INCREASING
TO 16.9 PERCENT OF ECONOMY.
OFFICE: 5TH LARGEST MARKET.
400 TO 500 DOLLARS PER S.F. PURCHASE RATE IN 1989.
DOWNTOWN HAS 28 PERCENT OF THE LA OFFICE MARKET S.F., AT 16.4 PERCENT
VACANCY RATE.
100 FOREIGN BANKING FIRMS IN LA.
36 USA
OPERATIONS ALL HAVE PROXIMITY TO CUSTOMERS.
INTERNATIONAL
RECEIVING.

TRADE CARRIED

LA TO

BANKS

BE SECOND

WITH

INTERNATIONAL

BEHIND N.Y.

IN CUSTOMS

LA OCCUPIES PRIMARY FREIGHT GATEWAY TO THE PACIFIC RIM.

LA MAJOR OPERATIONS AND HEADQUARTERS CENTER FOR THE COUNTRY.
254,000 INVOLVED DIRECTLY IN INTERNATIONAL TRADE.
LATE 80'S BOOM IN OFFICE MARKET EXPECTED TO CONTINUE.
LA MAY LOSE MARKET SHARE IN CUSTOMS AS PACIFIC RIM TRADE SHIFTS TO
ATLANTIC AND EASTERN BLOCK.

PROPOSITION U
ANTI-GROWTH OR CONTROLLED GROWTH?
REDUCED BY 50% FAR OF DISTRICT 1 COMMERCIAL, AFFECTING 80% OF ACREAGE IN
THE CITY.
THE 20% EXCEPTION WERE CENTERS WHERE HIGH INTENSITIES WERE PERMITTED.
********************************************
THE PACIFIC RIM ECONOMY IS NOT SYNONYMOUS
RELATIONSHIP INCLUDES MANY OTHER PLAYERS.

WITH

JAPAN,

AND

TRADE PRODUCTION AND FINANCIAL SUPPORT RELATIONSHIPS FOR LOS ANGELES.

LA TRADING PARTNERS:

173

LA'S

EAST ASIA:

JAPAN
CHINA
SOUTH KOREA
TAIWAN
HONG KONG
SINGAPORE

THESE COUNTRIES ARE AT DIFFERENT LEVELS OF MATURITY, AND MAY COOPERATE

AMONGST THEM BY SUBCONTRACT TO PRODUCE GOODS AS THEIR OWN ECONOMY EVOLVES
AND THEIR OWN LABOR COSTS INCREASE.
THEY ARE THE INDUSTRIAL CENTERS OF THE PACIFIC RIM.
ASEAN (S.E. ASIA)
PHILIPPEANS
THAILAND
INDONESIA
MALAYSIA
THEY ARE LESS INDUSTRIALIZED, MORE RESOURCE BASED THAN EAST ASIA.
ARE LDC'S (LESS DEVELOPED COUNTRIES).

THEY

THEY RELATE TO LA AS A MARKET, SINCE THEY ARE THE TRADING CENTER OF THE
PACIFIC RIM.
THESE ARE CAPITAL SOURCES FOR LOS ANGELES....THEY ARE MARKETS FOR LOS
ANGELES PRODUCTS.
OCEANIA

NEW ZEALAND
AUSTRALIA

MANY RESOURCES, FEW PEOPLE, EXCESS OF ENERGY, RESOURCES AND THEREFORE

EXCESS OF CAPITAL LOOKING FOR INVESTMENT. THEY NEED MARKETS TO PUT ITS
EXCESS CAPITAL TO WORK.
IE. L.J. HOOKER, WESTPAC BANKING CORP.
THEY
INVEST IN LOS ANGELES AS A SOURCE FOR CAPITAL INVESTMENT
THEY ARE THE CAPITAL SOURCE OF THE PACIFIC RIM.
STILL A WAY TO RUN ON THE GROWTH CURB DUE TO FALLOW RESOURCES IN THE
PACIFIC RIM AWAITING MANUFACTURERS.

INDUSTRIAL MARKETS
LOS ANGELES = 9 DES MOINES LAID END TO END.

174

INDUSTRIAL SPACE
WHAT IS THE TRANSFERABILITY OF TECHNOLOGY?
HOW QUICKLY
PITFALLS?

CAN

THEY

TRANSFER

THEIR

TECHNOLOGY

TO

AVOID

ECONOMIC

THE INDUSTRIAL AND MANUFACTURING REGIONS OF LOS ANGELES

LOS ANGELES EAST:
ON CHEAPER LAND NEAR CHEAP HOUSING LOWER WAGE AND
LOWER SKILLED LABOR, THEREFORE NEAR L.A. EAST INDUSTRIAL ZONE.
DOWNTOWN LA INDUSTRIAL ZONE:
15 MINUTES WALK FROM DOWNTOWN EASTWARD....600,000,000 S.F. OF INDUSTRIAL
SPACE IN CENTRAL LOS ANGELES.
ORANGE COUNTY: R&D RELATED WAREHOUSING. AS R&D AROUND THE COUNTRY GOES
DOWN HILL, R&D ABSORPTION IS REDUCED.
CITY OF INDUSTRY:

MIX OF INDUSTRIAL USES.

SOUTH BAY AREA/LONG BEACH:

NON-DEFENSE ORIENTED.

DRIVEN BY THE TRADE OF IMPORTS AND EXPORTS.

OFFICES: FUNCTION AS SPECIALIZED MULTI-NODAL MARKET; ALL WITH THEIR OWN

SERVICE ECONOMIES.
CENTRAL L.A. - PETROLEUM BASED INDUSTRY.
BEVERLY HILLS - CENTURY CITY: ENTERTAINMENT
FINANCIERS, ACCOUNTANTS, AND OTHER SERVICES.

HAS

ITS

OWN

SET

OF

WESTWOOD/SANTA MONICA: A NODAL MARKET, CROSS PURPOSE.

THE AIRPORT: HIGH TECHNOLOGY, AEROSPACE, SERVICE FIRMS, MANUFACTURING,
FINANCIAL SERVICES.
****************
REVIEW
****************
KEY IDEA:
REAL ESTATE IS A RESIDUAL ECONOMIC PRODUCT WHICH TRANSLATES ECONOMIC
ACTIVITY INTO LOCATIONAL SPECIFIC ECONOMIC TERMS, AND IT RECEIVES ITS
VALUE FROM ECONOMIC ACTIVITY.

175

REAL ESTATE IS A SPATIALLY DEFINED ASSET CLASS, AND IS BY ITS NATURE

SUBJECT TO ECONOMIC GEOGRAPHY.
R.E. DIFFERS FROM FUNGIBLE ASSETS OF
STOCKS AND BONDS BECAUSE IT IS SPATIALLY DEFINED. IN COMMON THEY HOLD THE
QUALITY OF BEING RESIDUAL ECONOMIC PRODUCTS.
INSTITUTIONS THOUGHT THEY WERE BUYING INFLATION HEDGES IN REAL ESTATE,
THOUGH TIME HAS NOT BORN THIS OUT ALWAYS. IT HAS, HOWEVER, ALLOWED GOOD
INVESTMENT TO CAPTURE THE LOCALE'S BENEFIT.
NATIONAL ECONOMY HAS A PROFOUND EFFECT ON REAL ESTATE; TRADE DEFICIT,
INTEREST RATE, MONEY SUPPLY POLICY, FEDERAL TAXES, MORTGAGE RATES.
REGIONAL VARIATIONS MAKE A DIFFERENCE. I.E. DALLAS WHICH SUFFERED WHILE
THE ECONOMY GREW NATIONWIDE. THE TRANSLATION OF NATIONAL TRENDS MUST
FILTER THROUGH THE LOCAL ECONOMY'S SCREEN BEFORE LANDING ON REAL ESTATE.
IF IT IS SPATIALLY DEFINED, IT IS ALSO TRUE ON A LOCAL LEVEL, AND THIS IS
DISCERNED BY ANALYSIS OF LOCAL LINKAGES.
CYCLES DOMINATE THE REAL ESTATE MARKET. THE BIGGEST DANGER IS A MARKET
THAT THINKS IT WILL GO UP FOREVER BECAUSE THIS BREEDS EXCESS.
PROPERTY TYPES INTER-RELATE IN COMPLEX WAYS, WHICH MAKES IT IMPOSSIBLE TO
CONSIDER ONE PROPERTY MARKET WITHOUT THE OTHERS. IT PAYS TO GAUGE THE
HEALTH OF OTHER PROPERTY TYPES LIKED TO THE ONE YOU ARE STUDYING.
THE BAD NEWS.
THERE IS AN ENORMOUS AMOUNT OF ECONOMIC DATA WHICH IS
AVAILABLE THOUGH NOT MUCH IS DIRECTLY USEABLE IN REAL ESTATE ANALYSIS.
MEANS MUST BE DERIVED TO ACT AS TOOLS TO TRANSLATE COMMONLY AVAILABLE
DATA. AS A MINIMUM WE NEED TO BE GOOD TOOL USERS. AT BEST WE SHOULD BE
TOOL MAKERS.
SOURCES FOR INFORMATION ARE MORE ABUNDANT THAN GENERALLY REALIZED.
CRAFT OF ANALYSIS IS IN ITS INFANCY. TECHNICAL AND FUNDAMENTAL ANALYSIS
HAS IMPROVED. MOST OF OUR WORK IN CLASS HAS BEEN FUNDAMENTAL. TECHNICAL
ANALYSIS USES INTERNAL INDICATORS TO PREDICT PERFORMANCE.
END OF CLASS ELEVEN
CLASS TWELVE
4/30/90
SAN FRANCISCO
1. PRESENTATIONS
2. COMPARATIVE COMMENTS

176

3. EVALUATIONS
BREAK
4. REVIEW PART II
5. EXAM (SAMPLES FROM PAST SEMESTERS WILL BE ON FILE IN LIBRARY)
PURPOSE:
"THE EXAM IS PART OF THE COURSE"
IT IS NOT A REGURGITATION OF WHAT YOU LEARNED BUT IT IS AN APPLICATION OF
WHAT YOU LEARNED.
"WHAT DID HEILBRUN MEAN BY "SO & SO", AND HOW DID IT APPLY TO CHICAGO?"
WOULD BE A TYPICAL QUESTION.
WHAT YOU SHOULD REVIEW:
* REREAD PP. 328 TO 361 OF GARREAU: THE BREADBASKET.
ONE QUESTION WILL UTILIZE IT.
* HEILBRUN: PP 81 TO 106: URBAN HIERARCHIES
*STERNLIEB AND HUGHES: PP 161 TO 178: REGIONAL CHANGE
*FROM NOTES: REREAD NEW YORK CITY OFFICE EMPLOYMENT ESTIMATION
NO ARITHMETIC WILL BE NECESSARY, JUST UNDERSTAND THE CONCEPTS INVOLVED.
THE FORMAT
*8 QUESTIONS: CHOOSE 4 OUT OF THE 8 TO ANSWER
*7 QUESTIONS WILL BE IN ESSAY FORM AND WILL REQUIRE NARRATIVE ANSWERS.
*THE 8TH QUESTION WILL BE OBJECTIVE WITH TRUE AND FALSE, MULTIPLE CHOICE,
FILL IN THE BLANK, ETC. QUESTIONS IN IT.
BUDGET YOUR TIME.

ALLOW NO MORE THAN 25 TO 30 MINUTES PER QUESTION.

STUDY HARD, REVIEW NOTES, TAKE EMPHASIS FOR EXAMINATION FROM THE EMPHASIS
IN THE LECTURES. UNDERSTAND THE BROAD THEMES, NOT THE MINUTIAE.
*************************************************************************
*
WHAT IS THE 4 LEG METAPHOR? IT MUST HAVE BEEN DISCUSSED DURING THE DALLAS
LECTURE. ASK PROF. KELLY.
************************************************************************
SAN FRANCISCO
PROPOSITION M
CONSTRUCTION STARTED BY BEING LIMITED TO 950,000 S.F. IN SAN FRAN EXCEPT
FOR BUILDINGS BELOW 50,000 S.F. LATER CUT TO 475,000 WITH NO EXEMPTIONS.

177

ORLANDO, CONCORD, AND OTHER SUBURBAN AREAS ARE RECEIVING LARGE AMOUNTS OF
EMPLOYMENT SEEKING LARGE AMOUNTS OF S.F. WHICH IS NOT AVAILABLE IN THE
CITY.
WHAT MAKES UP THE HIGHEST AND BEST USE?
PHYSICALLY POSSIBLE (PHYSICAL ELEMENT)
LEGALLY PERMISSIBLE (POLITICAL ELEMENT)
ECONOMICALLY FEASIBLE (ECONOMIC ELEMENT)
MAXIMALLY PRODUCTIVE (SOCIAL ELEMENT)
THE DEFINITION OF MAXIMALLY PRODUCTIVE USUALLY HAS MEANT THE HIGHEST
PROFIT. OF LATE, IN ADDITION, IT HAS COME TO MEAN SOCIALLY PRODUCTIVE.

MACRO VARIABLES

MIXED

BENEFICIARY MSA
EFFECTS ON MSA
DAMAGED MSA

PROPERTY HELPED
PROPERTY HELPED
PROPERTY
PROPERTY
HURT
HURT
BENEFITS OR DETRACTIONS OF THE OVERALL ECONOMY TRICKLES DOWN AND FILTERS
THROUGH MSA'S TO HAVE IMPACTS ON PROPERTY TYPES. THE ENERGY CRISIS FOR
EXAMPLE HAD A BENEFICIAL IMPACT ON THE N.E., WHILE DALLAS WAS HURT,
ALLOWING ATLANTA TO BE A BENEFICIARY IN THE SOUTH WITH ONE LESS
COMPETITOR. THE FLIGHT OF PEOPLE FROM THE NORTH TO SOUTH WAS MITIGATED
SOMEWHAT BY THE FACT THAT IT WAS NO LONGER AS NECESSARY TO MOVE WHERE
HEATING FUEL WAS NOT NEEDED.

E X E R C I S E
THE AFFECTS OF THE FOLLOWING EVENTS WILL TRICKLE DOWN INTO THE ECONOMY

178

AND HAVE AN EFFECT ON WHICH AREAS AND WHAT PROPERTY TYPES?

THE IMPETUS:
JAPANESE INVESTORS ARE DEFUNDING THEIR INVESTMENTS IN US BONDS, WHICH
UNTIL NOW HAVE BEEN FLOATING THE MASSIVE US BUDGET DEFICIT. THE DEFUNDING
WILL TAKE PLACE OVER TEN YEARS AND BE COMPLETE BY THE YEAR 2000.
THE IMPETUS:
DROUGHT HITS EUROPE, FROM OSLO TO PALERMO, AND MOSCOW TO IRELAND.
DOES IT AFFECT THE US ECONOMY?

HOW

THE IMPETUS:
A FOUR NATION CONSORTIUM CONSISTING OF THE USA, USSR, JAPAN AND THE
UNITED GERMANYS CONSPIRES TO LAUNCH A JOINTLY PLANNED AND BUILT SPACE
VEHICLE TO MARS BY 1991. WHAT WILL THE IMPACTS BE?
************************************************************************
DETERMINE THE BENEFICIARIES.
DETERMINE THE LOSERS.
DETERMINE THE RECEIVERS OF MIXED BENEFITS.
*************************************************************************

DROUGHT SCHEME:
BENEFICIARIES;
BREADBASKET STATES OF OHIO, MISSOURI, ETC. ARE BENEFICIARIES BECAUSE OF
AGRICULTURAL BASE.
KANSAS CITY AND CHICAGO ARE BENEFICIARIES.
NO SNOW IN EUROPE DUE TO
DROUGHT. VERMONT'S SNOW AREAS BENEFIT FROM TOURIST TRADE.
LOSERS;
NATIONWIDE, HIGHER COMMODITY PRICES, INFLATIONARY CYCLES, CENTERS FOR
TOURISM SUFFER UNDER DECREASED DISCRETIONARY INCOME.
MIXED;
BECAUSE OF NATIONWIDE EFFECTS, EVERYTHING IS MIXED.
********

MARS SCHEME

179

BENEFICIARIES;
LA, SAN JOSE, WILMINGTON, WASHINGTON DC DUE TO SHIPPING, WAREHOUSING,
DEFENSE INDUSTRY AND PROXIMITY TO PARTNERS IN VENTURE.
HURT;
SEATTLE, SAN DIEGO, NORFOLK
NAVAL BASES, DEFENSE CUTS, AEROSPACE LOSS OF MARKET SHARE
MIXED;
PITTSBURGH,BOSTON
OFFICE, R&D GOOD
INDUSTRIAL, BAD
***************
BOND DIVESTMENT SCHEME
WINNERS;
AGRICULTURAL LAND GAINS VALUE WITH INFLATION AS THE COST OF FOOD RISES
AND THEREFORE MONETARY YIELD PER ACRE.
BREADBASKET
OIL INDUSTRY BOUNDS BACK AS INCREASING PETROLEUM PRICES MAKE IT
WORTHWHILE TO PRODUCE AMERICAN PETROLEUM PRODUCTS. SEE OFFICE AND TO A
LESSER DEGREE RETAIL MARKETS REBOUND, WITH STRENGTH IN RESIDENTIAL
BUILDING AT LOW AND HIGH ENDS OF THE MARKET.
OVERALL, THE ECONOMY WILL HAVE TO BE MORE SELF SUFFICIENT, BEING LESS
DEPENDENT ON IMPORTS.
THIS WILL HAVE A POSITIVE EFFECT ON AMERICAN
MANUFACTURING. MANUFACTURING AREAS WITH LOW LABOR COSTS WILL FARE WELL
IN THE BEGINNING OF THE PERIOD. HOWEVER, THERE WILL BE AN UPWARD TREND
IN LABOR COSTS TOWARD THE END OF THE PERIOD AS COSTS OF LIVING ARE MET BY
WAGE INCREASES.
EVENTUALLY, THE LESS DEBT DEPENDENT DOLLAR WILL
STRENGTHEN AMERICAN CURRENCY ABROAD, CAUSING A RELATIVE CHEAPENING OF
FOREIGN IMPORTS, THUS ENCOURAGING A FLUSH OF IMPORTS TOWARD THE LATER
PERIODS. THEREFORE, WHILE PORT CITIES MAY BE HURT IN THE BEGINNING OF
THE PERIOD THEY MAY GAIN IN THE LATER.
LOOK
FOR
INCREASES
MANUFACTURING AREAS.

IN

OFFICE

AND

WAREHOUSING

CONSTRUCTION

IN

WEST COAST PORT CITIES MAY SEE AN INCREASE IN ASSEMBLY ORIENTED

WAREHOUSING FACILITIES AS FOREIGN PARTS ARE SHIPPED TO US FOR ASSEMBLY.
LOOK FOR AN INCREASE IN ASSEMBLY FACTORIES.

180

NEW YORK CITY WILL SEE A MINOR RESURGENCE IN ITS FINANCE INDUSTRY AS US
INDUSTRY SEEKS NEW SOURCES OF MONEY TO FUND LIMITED AREAS OF GROWTH
AROUND THE COUNTRY. OVERALL N.Y.C. WILL BE MIXED.
INNER CITIES WILL BE SEVERELY HURT AS SOCIAL UNREST IS FUELED BY CUTBACKS
AT THE FEDERAL AND STATE LEVELS. TAXES WILL INCREASE SOMEWHAT TO MAKE UP
DEFICIT SPENDING OF THE PAST, SOMEWHAT DAMPENING RETAIL SPENDING AND
DEPRESSING RESIDENTIAL REAL ESTATE VALUES AROUND THE COUNTRY.
LENDING
WILL GET TIGHT AND INTEREST RATES WILL SOAR.
OTHER RECIPIENTS OF FEDERAL SPENDING SUCH AS SOUTHERN FLORIDA AND PHOENIX
AND OTHER RETIREMENT COMMUNITIES WILL SEE IMPACTS DUE TO SOCIAL SECURITY
CUTBACKS. THEREFORE EXPECT TO SEE RETAIL AND SERVICE SECTORS DO POORLY.
MIXED REACTIONS TOWARD WASHINGTON DC AND OTHER FEDERAL OR STATE
GOVERNMENT CENTERS.
SEVERE CUTBACKS WILL MAKE MONEY SPENDING
UNFASHIONABLE, THOUGH THERE IS NOT LIKELY TO BE SUBSTANTIAL AUSTERITY.
EXPECT TO SEE OFFICE SPACE SUFFER AS "EFFICIENCY" BECOMES KEY, AND RETAIL
WILL EITHER STAY LEVEL OR DROP SLIGHTLY.
IN ORDER TO BEAT THE DEFICIT, THE ENTIRE ECONOMY MUST BECOME MORE
EFFICIENT.
THEIR MAY BE A DESIRE TO ENLIST TECHNOLOGY TO INCREASE
PRODUCTION PER EMPLOYEE, AND THEREFORE A RESURGENCE OF R&D USES IN AREAS
LIKE BOSTON, NYC, LOS ANGELES, WASHINGTON DC, ST. LOUIS AND OTHER PLACES
WHERE IT IS STRONG. DO NOT EXPECT TO SEE A BROADENING OF THE R&D BASE
DUE TO INHERENT INEFFICIENCIES IN DOING SO.
CLASS THIRTEEN
5/7/90
1. PAPERWORK
2. PRESENTATIONS
3. COMMENTS ON GOVERNMENT
4. REVIEW III
BREAK
5. EVALUATIONS
WASHINGTON D.C.
1980'S "GET THE GOVERNMENT OFF OF THE AMERICAN PEOPLE"; RONALD REAGAN
PRIVATIZATION OF FEDERAL GOVERNMENT CAUSED AN INCREASE IN WASHINGTON DC
OFFICE SPACE WHEN IT WOULD HAVE APPEARED THAT DECREASING GOVERNMENT
SPENDING WOULD HAVE HAD A LIMITING EFFECT ON IT.
DEFENSE WAS MORE THAN HALF OF FEDERAL PROCUREMENTS IN BETWEEN 1983 AND
1988.

181

THE PEACE DIVIDEND; THE ECONOMIC VARIABLE

1.
2.
3.
4.

CUTTING TAXES
REDUCING BUDGET
REALLOCATING FUNDS
REDUCTION OF MILITARY SPENDING

U.S. HAS A "MIXED ECONOMY". WHAT IS IN THE MIXTURE? WE DO NOT HAVE AN

IDEOLOGICALLY PURE ECONOMY, IT IS ECLECTIC.
IT IS NEITHER A CENTRALLY
PLANNED ECONOMY, NOR A MARKET ECONOMY. IT IS A LOT OF BOTH.
THERE IS
CENTRAL GUIDANCE, ESPECIALLY DURING THE LAST 50 YEARS.
IT IS NOT
LAISSEZ-FAIRE THOUGH ELEMENTS OF IT ARE. WHEN GOVERNMENT ACTIONS IMPACT
US WE REALIZE THAT WE ARE NOT PART OF A TOTALLY MARKET BASED ECONOMY. AS
REAL ESTATE PROFESSIONALS WE MUST LEARN TO SUPERSEDE THE DICHOTOMOUS "ALL
OR NOTHING" STANCE OF THE LAYMAN TO REALIZE THE MIXTURE AND BENEFITS OF A
DIVERSIFIED AND MIXED ECONOMY.
WHERE AT ANY GIVEN MOMENT ALONG THE
CONTINUUM OF THE MIXED ECONOMY ARE YOU AT ANY POINT IN TIME?
THE CONTINUUM
SOCIAL DISTRIBUTION
FREE MARKET
GOVERNMENTAL PATERNALISM
SOCIAL DARWINISM

1. WHERE IS THE CURRENT CONSENSUS?

2. WHERE IS THE CONSENSUS TENDING?
3. WHERE IS THE TEMPER OF THE TIMES TAKING US?
NATURALISTIC FALLACY- "YOU CAN TAKE AN ANALYSIS OF WHAT YOU FIND OR
DERIVE "OUGHT TO BE" FROM "IS".
JUST BECAUSE SOMETHING "IS" THE CONSENSUS, THAT MAY NOT BE WHAT "OUGHT"
TO BE. YOU HAVE TO LEARN TO DISTINGUISH THE EMPIRICAL JUDGEMENT OF "IS"
FROM THE "OUGHT".
WHEN THERE IS A HERD INSTINCT IN REAL ESTATE, YOU HAVE CAPITAL RATHER
THAN DEMAND DRIVING THE INVESTMENT IN REAL ESTATE, CREATING A SPECULATIVE
BUBBLE WHICH BURSTS. FOLLOWING HERD INSTINCT CAUSES A RISK TO FALL IN
DEMISE OF THE SPECULATIVE BUBBLE.
THE CONVERSE OF THE NATURALISTIC FALLACY IS SAYING WHAT "OUGHT" TO BE
"IS".
OUR HOPES AND WISHES CAN NOT PERSUADE US THAT THE DATA SAYS
SOMETHING OTHER THAN WHAT IS SAYS. APPROACH DATA WITH A WILLINGNESS TO
BE SURPRISED, BECAUSE AS A PROFESSIONAL IT WILL BE ADVANTAGEOUS TO DO SO.
THIS DOES NOT MEAN, HOWEVER, THAT YOU NEED TO GIVE UP YOUR "OUGHTS", OR
YOUR IDEALS. THE BEST PEOPLE IN REAL ESTATE KEEP A SPOT IN THEIR BEING

182

WHICH ALLOWS THEM TO MAKE UP THEIR OWN MINDS. THEY DO NOT CONFINE
THEMSELVES TO BUILDING EMPIRES BUT TRY TO TRANSLATE IT INTO THEIR LIFE AS
CITIZENS.
REAL ESTATE MARKET FORECAST 1990
A "SUBSIDENCE" ECONOMY
FACTORS SUCH AS MODERATE INFLATION, LOWER REAL INTEREST RATES, A GRADUAL
SOFTENING
OF
THE
DOLLAR
LEADING
TO
IMPROVEMENT
IN
EXPORT
ACTIVITY....UNDERLIE LANDAUER'S ASSESSMENT OF NEAR TERM PROSPECTS.
SUBSIDENCE, AS IN WHEN THE WAVES OF AN OCEAN SUBSIDE TO GENTLE ACTION.
HOW, YOU MAY ASK, DO WE NAVIGATE IN LIGHT WINDS?
AMOUNT OF NEW EMPLOYMENT AND LITTLE DEMOGRAPHIC TRANSMIGRATION ARE LIMITS
THAT ARE STILL IN A SUBSIDENCE ECONOMY.
WILL SEE LESS PRESSURE ON
INCREASED EMPLOYMENT ENTRY POSITIONS AND LESS DEMAND FOR THEM IN THE
1990'S.
THE PEAKS OF UNEMPLOYMENT IN RECESSION OF THE 1990'S WILL BE
LESSENED WHEN COMPARED TO THE 60'S AND 70'S AND 80'S DUE TO LACK OF LARGE
AMOUNTS OF NEW ENTRY LEVEL POSITIONS PRESSURING THE ECONOMY.
INTEREST RATES WILL BE LESS VOLATILE IN THE 90'S.
THE INSTITUTIONAL
MEMORY OF INFLATION IS DECREASING, AND WILL CONTINUE TO DECREASE INTO THE
90'S.
AS THE INFLATION RATE GOES DOWN AND THE INTEREST RATE TO CPI
MARGIN GOES DOWN, SO WILL INTEREST RATES GO DOWN.
R&D...WHITE COLLAR LABOR ETC.
REVIEW NOTES ON LIGHT INDUSTRY
WHAT IS EACH TYPE OF INDUSTRIAL REAL ESTATE RUN ON?

BE SURE YOU KNOW.

LOW PRODUCTIVITY OF 1980'S DUE TO TRAINING PERIOD FOR ENTRY LEVEL

EMPLOYEES.
THERE WILL BE GREATER PRODUCTIVITY IN THE COMING YEARS AS
BABY BOOMERS ADVANCE THROUGH THE POPULATION.
"LESSEN THE LOAD, KEEP A STEADY HAND ON THE RUDDER, DIVERSIFY HOLDINGS
FOR DIFFICULT ECONOMIES".
REAL ESTATE IS A PEOPLE BUSINESS
RECIPE:
UNEQUAL PARTS OF

1. EXPERIENCE
2. INSTINCT
3. EXIGENCY
4. AMBITION

END OF CLASS THIRTEEN

183

FINAL EXAM NEXT WEEK

184

REAL ESTATE FINANCE

PROFESSOR STEVE PEARLMAN
AUTUMN 1990
NEW YORK UNIVERSITY

REAL ESTATE FINANCE

STEVE PEARLMAN
836-9411
RM.507
TEXT: BRUEGGEMAN, FISHER, AND STONE: REAL ESTATE FINANCE, 8TH EDITION ,
IRWIN (1989)
CLASS ONE: 9/11/90
PROFESSOR START WITH MANUFACTURERS HANOVER TRUST, IN CORPORATE FINANCE.
HE IS NOW WITH JONES LANG WOOTTON.
IN ADDITION TO THE HARDBOUND TEXT, YOU WILL BE REQUIRED TO PURCHASE THE
FOLLOWING FIVE MONOGRAPHS FROM THE BOOKSTORE.
1.
2.
3.
4.
5.
AND

REAL ESTATE GLOSSARY

SOURCES OF REAL ESTATE INFORMATION
FINANCIAL ANALYSIS OF REAL PROPERTY
ANGES CARTWRIGHT
FINANCIAL ANALYSIS - INTRODUCTION TO PRESENT VALUE, FUTURE VALUE
THE INTERNAL RATE OF RETURN.

THE GOAL OF THE COURSE IS "TO GIVE US AS MUCH INFORMATION AS WE NEED TO

UNDERSTAND HOW A PROJECT IS FINANCED BOTH FROM A DEBT AS WELL AS AN
EQUITY BASIS. WE WILL BE TAUGHT HOW TO QUANTIFY THE DECISION ON WHETHER
WE SHOULD BUY A PROPERTY."
THERE WILL BE A FINAL EXAMINATION, AND PROBABLY THERE WILL BE A MIDTERM.
THERE WILL BE THREE MAJOR CASES FOR ANALYSIS AND GRADE. CASES SHOULD BE
TYPEWRITTEN AND HANDED IN BY THE DUE DATE.
SOMETIMES, THERE MAY BE
HOMEWORK.
GRADES WILL BE DETERMINED ON THE QUALITY OF THE PRODUCT WE
TURN IN, AS WELL AS THE FINAL, MIDTERM, AND PARTICIPATION.
ATTENDANCE
WILL BE TAKEN.
THERE
1.
2.
3.
NEEDS

ARE THREE CASES. THEY ARE:

ROCKEFELLER CENTER
ANGES CARTWRIGHT
FINANCE CASE: A CONSTRUCTION LOAN ON AN EXISTING PROPERTY THAT
A CONSTRUCTION LOAN THAT CAN NOT BE SECURED WITHOUT A "TAKE-OUT".

**************************************
IMPORTANT ISSUES OF FINANCE IN REAL ESTATE
**************************************
WHAT LEGAL ISSUES IMPACT REAL ESTATE?
1. ZONING
2. RENT CONTROL
3. ENVIRONMENTAL
4. REGULATION (BUILDING CODES)

186

5. TAX
WHAT VALUATION ISSUES IMPACT REAL ESTATE?
1. WHAT IS THE PROPERTY WORTH BEFORE AND AFTER CONSTRUCTION?
2. HOW MUCH AM I PUTTING INTO THE PROJECT?
3. WHAT ARE THE RISKS?
IMPLEMENTATION, ENGINEERING AND ARCHITECTURAL ISSUES?
1. ARE YOU ABLE TO BUILD WHAT YOU WANT?
2. IS WHAT YOU ARE BUILDING A MARKETABLE AND APPROPRIATE PRODUCT?
3. IS YOUR PRODUCT GOING TO REQUIRE MORE EQUITY THAT YOU LIKE?

LEGAL

ISSUES

>

FINANCIAL

VALUATION
>>AND

ISSUES

INVESTMENT

ANALYSIS

>

IMPLEMENTATION

ISSUES

DIAGRAM OF THE PROCESS OF INVESTMENT ANALYSIS

FINANCIAL ANALYSIS:
DATA COLLECTION AND ANALYSIS
DEFINE THE PARAMETERS OF THE FOLLOWING FORCES ON THE PROJECT:
1.
2.
3.
4.

SOCIAL
ECONOMIC
GOVERNMENT
ENVIRONMENTAL FORCES

DEFINE THESE FORCES BY GATHERING PRIMARY AND SECONDARY DATA.

PRIMARY DATA: COLLECTED THROUGH A DIRECT SURVEY OR INTERVIEW PROCESS.
IE. REAL ESTATE BROKERS AND AGENTS, PLANNING AGENCIES, CHAMBERS OF
COMMERCE, OTHER GOVERNMENT AGENCIES, DEVELOPERS/BUILDERS, USERS, TENANTS,

187

APPRAISAL FIRMS, CONVENTION BUREAUS, ASSOCIATIONS SUCH AS THE BUILDING

OWNERS AND MANAGERS ASSOCIATION (BOMA).
SECONDARY DATA: NEWSPAPER ARTICLES, RESEARCH REPORTS, CENSUS DATA, BUREAU
OF LABOR STATISTICS.
DETERMINE WHETHER YOU ARE LOOKING AT A FREEHOLD ESTATE OR A LEASEHOLD
ESTATE.
IN A FREEHOLD ESTATE, YOU OWN THE LAND AND THE IMPROVEMENTS THEREON.
IN A LEASEHOLD ESTATE, YOU LEASE THE LAND FROM THE OWNER, AND IMPROVE
UPON IT SUBJECT TO THE TERMS OF THE LEASE.
POSSESSORY RIGHTS ARE THOSE SUCH AS IN A DEED, WHICH GIVE YOU THE RIGHT
TO DO WITH THE PROPERTY AS YOU WISH WITHIN THE CONFINES OF LAW.
NON-POSSESSORY RIGHTS ARE THOSE SUCH AS IN A LICENSE OR EASEMENT, WHICH
GRANT LIMITED RIGHTS UPON THE POSSESSION OF ANOTHER PERSON OR ENTITY.
THE MOST COMPLETE FORM OF OWNERSHIP IS THE FEE-SIMPLE ABSOLUTE ESTATE.
A DEED IS A LEGAL INSTRUMENT THAT CONVEYS LAND OR PROPERTY, AND CONTROLS
THE USE OF IT.
IT CONVEYS TITLE FROM ONE TO ANOTHER BY MEANS OF A
WRITTEN INSTRUMENT (A CONTRACT), REQUIRED UNDER THE STATUTE OF FRAUDS.
TO BE A VALID CONVEYANCE OF GOOD AND MARKETABLE TITLE, THE DEED MUST BE
IN ACCORDANCE WITH LOCAL AND STATE LAWS.
DEEDS COME IN SEVERAL FORMS, FROM THE MOST PROTECTIVE TO THE LEAST.
GENERAL WARRANTEE DEED - TITLE CONVEYED FREE AND CLEAR EXCEPT FOR LISTED
ENCUMBRANCES. THE WARRANTEE DEED CONVEYS:
1. GOOD TITLE
2. THE RIGHT TO CONVEY PROPERTY
3. COMPENSATES GRANTEE FOR LOSS OF PROPERTY OR EVICTION AS A RESULT OF
SUPERIOR CLAIMS TO THE PROPERTY
4. COVENANTS AGAINST OTHER ENCUMBRANCES THAN THOSE STATED.
SPECIAL WARRANTEE DEED - LIMITS TO ENCUMBRANCES PLACED WHILE THE GRANTOR
OF TITLE OWNED PROPERTY.
QUITCLAIM DEED - CLAIMS ONLY TO CONVEY WHATEVER THE GRANTOR OWNS.
HE
MAKES NO GUARANTEES, HOWEVER, THAT HE OWNS ANYTHING AT ALL.
GRANTOR = SELLER
GRANTEE = BUYER
A TITLE SEARCH IS COMPLETED TO DETERMINE THE OWNERSHIP HISTORY OF THE
PROPERTY.
ABSTRACTS WERE COMPLETED YEARS AGO, AND AT TIMES TODAY.
THEY RESEARCH
THE LAND BACK TO ITS LEGAL ESTABLISHMENT, AND AN ATTORNEY RENDERS AN

188

OPINION AS TO THE PROPERTY'S STATUS AND ITS CLAIM OF TITLE.

TITLE INSURANCE SHIFTS THE RISK OF TITLE IMPAIRMENT THAT CAN NOT BE
DISCOVERED THROUGH THE PUBLIC RECORD TO THE TITLE COMPANY.
OWNERSHIP MUST BE RECORDED TO GIVE NOTICE TO THE WORLD OF YOUR STATUS.
MECHANICS LIENS - RELATES BACK TO THE TIME THAT THE PROVIDER OF A SERVICE
TO THE LANDOWNER IS PERFORMED. IF THEY DO NOT GET PAID FOR IT, THEY CAN
ENCUMBER THE PROPERTY WITH A LIEN, AND TAKE PRECEDENCE BEFORE OTHER
ENCUMBRANCES FILED AFTERWARD. THIS IS ONE REASON THAT CONSTRUCTION AND
MORTGAGE LOANS ARE SEPARATED.
TAX LIENS TAKE PRECEDENCE OVER

EVERYBODY.

LIEN - LEGAL RIGHT OF CREDITOR TO HAVE BE PAID BACK FROM THE TAKER OF THE
CREDIT.
LIEN WAIVERS - FOR CONSTRUCTION LENDERS TO RETAIN THEIR PRIORITY
POSITIONS, THEY GET AFFIDAVITS FROM SUBCONTRACTORS STATING THAT THEY ARE
PAID TO DATE.
STATUTE OF FRAUDS- REQUIRES CONTRACTS TO BE IN WRITING WHEN CONVEYING
REAL ESTATE, AND REQUIRES THAT THE CONTRACT DEMONSTRATE INTENT TO CONVEY
A SECURITY INTEREST IN REAL PROPERTY.
**************************************
KEY COVENANTS OF CONCERN IN A MORTGAGE
**************************************
PRINCIPAL AND INTEREST CLAUSE - DUE DATES NEGOTIATED; TERM; RATE; ETC.
TAXES & INSURANCE CLAUSE - ESCROW AMOUNTS- WILL THE BANK PAY THROUGH
ESCROW OR WILL YOU DO IT YOURSELF AND GIVE THE BANK PROOF OF YOUR TIMELY
PAYMENT?
HAZARD INSURANCE / CONDEMNATION CLAUSE - CONSTRUCTION LOAN > INSURANCE TO
COVER PROBLEMS AND ACCIDENTS. IN A CONDEMNATION PROCEEDING ON A PIECE OF
THE LAND, WHAT HAPPENS TO THE PROCEEDS? THE LENDER WILL WANT IT TO PAY
DOWN THE LOAN. YOU WANT IT TO HOLD ON TO, OR GIVE IT TO THE BANK AND LET
THEM DOLE IT BACK TO YOU FOR PROPERTY IMPROVEMENTS ON THE PORTION OF
PROPERTY THAT REMAINS.
AFFIRMATIVE COVENANTS - FINANCIAL STATEMENTS MUST BE SUPPLIED, PROPERTY
MUST BE MAINTAINED, BANK RETAINS RIGHT OF INSPECTION, ETC.
NEGATIVE COVENANTS - CAN NOT HAVE MORE LIENS THAN ALREADY EXIST. CAN NOT
HAVE SUBORDINATED DEBT.
THE SUBORDINATOR CAN CREATE A DEFAULT FORCING
YOU AS THE SENIOR LENDER TO DO SOMETHING YOU DO NOT WANT TO DO.

189

ACCELERATION - HOW DO YOU ACCELERATE THE DEBT? THROUGH DEFAULT.

IF ANY
OF THE ABOVE ARE VIOLATED, PAYMENTS ARE ACCELERATED AND DUE IMMEDIATELY.
PREPAYMENT - YIELD MAINTENANCE FORMULA IS A FACTOR. IT WILL BE INSISTED
ON BY INSURANCE COMPANIES ON THE FIRST FIVE EARS OF A TEN YEAR LOAN.
NEXT, IF
THEIR YIELD IS CUT BY YOUR PREPAYMENT, YOU WILL MAKE UP THE
DIFFERENCE FROM THEIR
ACTUAL AND POTENTIAL YIELD.
THIS IS THE YIELD
MAINTENANCE FORMULA.
WHEN YOU PAY THIS PENALTY, YOU WILL WANT IT
DISCOUNTED BACK TO PRESENT VALUE.
DEFEASANCE - THE PAYMENT OF THE OBLIGATION OF THE MORTGAGE THROUGH
TRANSFERRING EQUITY TO THE PURCHASE OF NOTES THAT PAY OFF THE MORTGAGE
WHEN A PREPAYMENT PENALTY WOULD OTHERWISE PREVENT PREPAYMENT. A WAY OF
GETTING PAST PREPAYMENT PENALTIES.
DEFAULT - FAILURE TO MEET REQUIREMENTS AS PER A CONTRACT. IE. FAILURE TO
PAY PRINCIPAL, INTEREST, TAXES OR INSURANCE.
FORECLOSURE - LENDER MAY SUE FOR DEBT, AND EXECUTE JUDGEMENT ON THE
PROPERTY.
NEW YORK IS AN ELECTION STATE.
YOU MUST ELECT WHETHER YOU
WILL SUE ON THE NOTE, DEBT OR PROPERTY. IF YOU HAVE A GUARANTEE, YOU CAN
SUE ON THE PROPERTY AND GO AGAINST THE GUARANTOR. MOST PROPERTY IS OWNED
BY SINGLE PURPOSE CORPORATIONS. WHEN YOU SUE THEM, YOU ARE IN ESSENCE
SUING AGAINST THE PROPERTY SINCE THE PROPERTY IS THE CORPORATIONS SOLE
ASSET.
EQUITY OF REDEMPTION - BUYER MAY RECOVER THE PROPERTY AFTER FORECLOSURE
AFTER PAYING ALL COSTS AND OUTSTANDING DEBTS ON THE PROPERTY TO THE
FORECLOSING PARTY.
THERE ARE THREE PARTIES IN A DEED OF TRUST: THE BORROWER, TRUSTEE, &
LENDER.
DEED OF TRUST > BORROWER > TRUSTEE > LENDER

HOLDS DEED FOR LENDER

CREATES TRUST, TRANSFERS DEED TO TRUSTEE

DOCUMENT
WHEN BRINGING A FORECLOSURE AGAINST A DEED OF TRUST, YOU MUST SUE ALL
PARTIES; THE BORROWER, TRUSTEE, ALL OTHER MORTGAGE HOLDERS, LIMITED
PARTNERS, AND ALL INDIVIDUALS INDEPENDENTLY.
A JUNIOR HOLDER MAY BRING A SUIT AND
SUE SUBJECT TO THE SENIOR LENDER. AS A
VALUE IN THE PROPERTY IN ADDITION TO
WANT TO CONTROL THE PROPERTY TO GET MY
CHAPTER 7 - LIQUIDATION OF ASSETS

190

MAY NOT JOIN A SENIOR LENDER, BUT

JUNIOR LENDER I KNOW THAT THERE IS
THE SENIOR LENDER'S PRINCIPAL, I
MONEY BACK.

CHAPTER 11 - PRESERVE PROPERTY WITH REORGANIZATION PLAN.

HURTS THE
LENDER THE MOST.
JUDGES CAN DISAVOW CERTAIN EXECUTORY LEASES BY
EXTENDING THE TIME FORWARD FOR PAYMENT OF THE OBLIGATION.
CHAPTER 13 - ALTERNATIVE TO LIQUIDATION THROUGH A REPAYMENT PLAN.
WITHIN 90 DAYS OF BANKRUPTCY, THERE CAN NOT BE ANY DISTRIBUTION OF
PROPERTY THROUGH SALES. THIS IS 12 MONTHS IF AN INSIDER.

OWNERSHIP OF REAL ESTATE:

1. CORPORATE - NO PERSONAL LIABILITY
2. PARTNERSHIP - GENERAL: INDIVIDUAL UNLIMITED LIABILITY.
LIMITED: LIMITED LIABILITY, NO PERSONAL INVOLVEMENT.
3. S CORPORATION - COMBINES CORPORATION AND LIMITED PARTNERSHIP. TAXED
AS PARTNERSHIP, THOUGH ACTS AS A CORPORATION WITH LIMITED LIABILITY.
END OF CLASS ONE.
CLASS TWO
9/18/90
**********************************************************************
TONIGHT'S CLASS:
PRESENT VALUE ANALYSIS
REAL ESTATE MATH
DEBT SERVICE
COVERAGE RATIOS
MAXIMUM LOAN FORMULA
DEBT ANALYSIS
SEMI-ANNUAL BOND INTEREST CONVERSION TO ANNUAL MORTGAGE INTEREST
***********************************************************************
REAL ESTATE INVESTMENT AND EQUITY INVESTMENT PROJECTIONS ARE USED IN
DETERMINING WHICH INVESTMENTS TO INVEST IN.
PRESENT VALUE ANALYSIS
CONSIDERS THE TIME VALUE OF MONEY, AND INVOLVES THE DISCOUNT OF FUTURE
DOLLARS TO REFLECT PRESENT WORTH.
IF I HAVE THE CHOICE BETWEEN RECEIVING 100.00 DOLLARS TODAY AND 110.00
DOLLARS A YEAR FROM NOW, AND I TAKE THE LATER CHOICE, WHAT DO I LOSE? I
LOSE THE OPPORTUNITY COST OF INVESTING THE 100.00 DOLLARS AND PERHAPS
ENDING UP WITH 115.00 DOLLARS IN A PERIOD OF ONE YEAR. INSTEAD OF MAKING
10 PERCENT, I COULD HAVE MADE 15 PERCENT; THE OPPORTUNITY COST WAS 5
PERCENT.

INTEREST

PRINCIPAL

RATE

FUTURE VALUE:
IF I INVEST 100.00 DOLLARS TODAY, AT 8%, IT IS WORTH
108.00 DOLLARS AT THE END OF YEAR ONE. AT THE END OF YEAR TWO, IT IS

191

(108.00 X 8 PERCENT) + 108.00 = 116.64 DOLLARS.

FUTURE VALUE IS THE
ANALYSIS OF WHAT MONEY TODAY WILL BE WORTH TOMORROW.
IF I HAVE 100 DOLLARS AT 10 PERCENT OVER 5 YEARS, WHAT WILL THE FUTURE
VALUE BE? $161.05.
BY HP12C; 100, PV; 10, i; 5, n; FV; ANSWER IS 161.05
BY TABLE, YOU FIND FACTOR OF 1.61510
1.61510 X 100 = 161.05
IF I HAVE 161.05 AT YEAR 5, AT 10 PERCENT, WHAT WOULD I NEED TO INVEST IN
YEAR ONE.
100 DOLLARS IS THE ANSWER, WHICH IS THE PRESENT VALUE OF
161.05 IN THE 5TH YEAR INVESTED AT 10 PERCENT. IN THE TABLE THE FACTOR
WOULD BE 0.619, WHICH IS THE INVERSE OF 1.6151, THE FACTOR FOR FUTURE
VALUE.
161.05 X 0.619 = 100.00
WOULD YOU RATHER HAVE 75.00 DOLLARS TODAY, 85 DOLLARS IN ONE YEAR, OR 94
DOLLARS IN 2 YEARS FROM TODAY? YOU CAN INVEST AT 12 PERCENT. THE ANSWER
IS YOU WOULD TAKE THE 85 DOLLARS IN ONE YEAR.
METHOD: FIGURE OUT THE PV OF 85 IN ONE YEAR AT 12 PERCENT AND THE PV OF
94 IN TWO YEARS AT 12 PERCENT (COMPOUNDED ANNUALLY).
THE PV OF 85 IS
75.89 AND THE PV OF 94 IS 74.94. THE PV OF 85 IS 89 CENTS MORE THAN THE
75 DOLLARS YOU COULD RECEIVE TODAY, SO YOU TAKE THE 85 DOLLARS TO BE
RECEIVED IN ONE YEAR, INVESTED AT 12 PERCENT.
WHAT HAPPENS AS INTEREST RATES INCREASE?
PRESENT VALUES DECREASE.
AS
INTEREST RATES DECREASE, PRESENT VALUES INCREASE.
WHEN WE DISCUSS
PRESENT VALUE, WE ARE DISCOUNTING MONEY. WHEN WE DISCUSS FUTURE VALUE,
WE ARE COMPOUNDING MONEY.

TIME (10%)

YR.
12
3
4 5
6
7
8
$
110.00
121.00
133.10
146.41 161.05 177.16 194.87 214.36
AS COMPOUNDING BECOMES MORE FREQUENT, VALUES GO UP.
AT 10 PERCENT, $100 = $110 IN ONE YEAR COMPOUNDED ANNUALLY.
AT 10 PERCENT, $100 = $110.47 IN ONE YEAR COMPOUNDED MONTHLY.
AT 10 PERCENT, $100 = $110.52 IN ONE YEAR COMPOUNDED DAILY.
EXAMPLE: I HAVE 1000.00 DOLLARS AT 8 PERCENT PER ANNUM, AND I WANT THE
PV AT ANNUAL, SEMI-ANNUAL, MONTHLY AND DAILY TIME INTERVALS.
FORMULA:

PRINCIPAL / (1 + (INT.RATE / # OF PERIODS)#

PVannual = 1000 / (1 + .08) = 925.93

PVsemi-annual = 1000 / (1 + (.08 / 2)2) = 924.56

192

OF PERIODS

PVmonthly = 1000 / ( 1 + (.08 / 12)12) = 923.36

PVdaily = 1000 / (1 + (.08 / 360)360) = 923.13
INCOME STREAMS AND ANNUITIES - AN ANNUITY IS AN INCOME STREAM WITH AN
EQUAL PAYMENT PAID OVER EQUAL PERIODS OF TIME. ANNUITIES CONSIST OF A
DEPOSIT, TIME, AND AN INTEREST FACTOR (IF).
TIME
1
2
3
4
5

AMOUNT
1000
1000
1000
1000
1000

IF

FUTURE VALUE
1.21551215.51
1.15767
1157.63
1.10251102.50
1.050
1050.00
1.000
1000.00
5525.63
YOU COULD GO TO THE 5% TABLE AMOUNT OF 1.00 DOLLAR AT COMPOUND INTEREST (
COLUMN ONE ) AND FINE THE FACTOR OF 5.525631. 1000 X 5.525631 = 5525.63
AT 10 PERCENT IT WOULD BE 1000 X 6.105100 = 6105.10
AT 15 PERCENT IT WOULD BE 1000 X 6.742381 = 6742.38
REVERSING THE ABOVE TO FIND THE PRESENT VALUE OF A SERIES OF ANNUAL
RECEIPTS (MEANS TO BE RECEIVED IN THE FUTURE) AS FOLLOWS:
(500 X (PVIF,6%,1 YR.)
TIME
1
2
3
4
5
6

AMOUNT
500
500
500
500
500
500

IF

PRESENT VALUE
0.9434471.70
0.8900445.00
0.8396419.81
0.7921396.05
0.7473373.03
0.7050352.48

500

4.917324 = 2458.66

IF YOU TAKE 5000 TODAY DEPOSITED INTO AN ANNUALLY COMPOUNDING 10 PERCENT

ACCOUNT, WHAT DO YOU HAVE IN FIVE YEARS?
ANSWER IS 8,052.55 DOLLARS.
1.610510 IS THE INTEREST FACTOR. 5000 X 1.610510 = 8,052.55
====================
MR. DOE HAS A CHOICE OF 800 DOLLARS TODAY OR 1000 DOLLARS IN FIVE YEARS.
BANKS PAY 5 PERCENT INTEREST. SHOULD DOE TAKE THE 800?
1000 (PVIF,5%,5 YEARS) = 783.53
DOE SHOULD NOT DO IT. HE SHOULD TAKE THE 800 NOW SINCE 800 > 783.53.
======================
YOU HAVE TEN ANNUAL DEPOSITS OF 1000 EACH, AT 9 PERCENT.
FROM NOW, WHAT DO YOU HAVE?

193

AT ONE YEAR

ANSWER IS 15,192.93
10, n; 9, i; 1000, PMT; FV; READ ANSWER
=====================
TO ACCUMULATE 25,000 10 YEARS FROM NOW, WITH 10 DEPOSITS AT 9 PERCENT AND
THE FIRST DEPOSIT MADE IMMEDIATELY, WHAT ARE YOUR PAYMENTS?
g 7(BEGIN); 25000, FV; 9, i; 10, n; PMT; READ ANSWER (1,509.64)
THIS PROBLEM IS TRICKY BECAUSE YOU HAVE TO NOTICE THAT THE PAYMENTS ARE
MADE AT THE BEGINNING OF THE PERIOD AS OPPOSED TO THE END.
INTERNAL RATE OF RETURN: THE SINGLE RATE THAT EQUATES THE NET PRESENT
VALUE (NPV) OF A SET OF CASH FLOWS TO ZERO.
IT IS THE PERCENTAGE AT
WHICH THE INVESTMENT STREAM MUST BE DISCOUNTED TO EQUAL ZERO.
INTERNAL RATE OF RETURN (CONTINUED)
THE LIMITATIONS:

NEGATIVE
OFF DUE
RATE OF

1. ASSUMES ALL CASH FLOWS ARE REINVESTED EACH

YEAR AT THE SAME RATE AS THE INTERNAL RATE OF
RETURN.
2. ANYTHING OVER 20 PERCENT WOULD BE AN
UNREALISTIC ANSWER.
3.
INCOME STREAMS COULD INCLUDE CERTAIN
CASH FLOWS, WHICH COULD THROW THE ANSWER
TO AN INHERENT WEAKNESS IN THE INTERNAL
RETURN FORMULA.
4.
THE INTERNAL RATE OF RETURN IS CALCULATED
BASED ON PRETAX MONEY.

INTEREST CONVERSIONS
GIVEN AN INTEREST RATE OF 12 PERCENT (ANNUAL) WHAT WOULD IT BE ON A SEMIANNUAL, MONTHLY OR DAILY BASIS IN THE SAME TERMS?
FORMULA FOR
MONTHLY)

LESS

FREQUENT

RATE

(IE.

ANNUAL)

TO

MORE

FREQUENT

(((RATE + 1)1/X) - 1) X # OF COMPOUNDING PERIODS

(X = NUMBER OF COMPOUNDING PERIODS)
IE.

(((12+1)1/4) - 1) X 4 = 11.49 PERCENT (QUARTERLY BASIS)

= 10.78 PERCENT (MONTHLY BASIS)

THE FORMULA FOR MORE FREQUENT RATE TO LESS FREQUENT IS AS FOLLOWS:

(( RATE / # OF PERIODS) + 1)#

OF COMPOUNDING PERIODS

194

(IE.

*********************
REAL ESTATE MATH
*********************
IE. 5 YEAR OLD COMPLEX WITH 84 APARTMENTS
64 1 BEDROOM UNITS; AVG.SIZE 600 S.F.
20 2 BEDROOM UNITS; AVG.SIZE 850 S.F.
ASKING PRICE; 1,000,000 DOLLARS
FINANCE 800,000 DOLLARS AT 9.25 PERCENT FOR 28 YEARS
EQUITY 200,000 DOLLARS
STEP ONE - CREATE A PRO FORMA CASH FLOW
PRO FORMA MEANS HYPOTHETICAL.

WHAT IS THE GROSS POTENTIAL RENTAL INCOME?

$163,800.
WHAT OTHER INCOME IS THERE?
VENDING MACHINES, PARKING AND WASHER/DRYERS...$3,180
GROSS POTENTIAL INCOME?
163,800 + 3,180 = 166,980
LESS VACANCY AND COLLECTION (5%)
(USUALLY 3 TO 5 PERCENT)

- $8349.00

GROSS EFFECTIVE INCOME?

166,980 - 8349 = 158,631.00
LESS OPERATING EXPENSES AND REAL ESTATE TAXES
(40 PERCENT OF GROSS POTENTIAL INCOME)
LESS DEBT SERVICE OF 80,000 ANNUALLY
(800,000 X 10 % (THE MORTGAGE CONSTANT)

- $66,792.00
EQUALS 91,839.00
- $80,000.00

CASH FLOW..........................................$11,839.00
THIS PRO FORMA DOES NOT CONSIDER EQUITY BUILD UP THROUGH DEPRECIATION OR
APPRECIATION, NOR DOES IT CONSIDER INCOME TAXES.

195

MORTGAGE CONSTANT - THE AMOUNT OF ANNUAL DEBT SERVICE NECESSARY TO PAY

PRINCIPAL AND INTEREST OVER THE PAYMENT PERIOD, AS A PERCENT.
ANNUAL DEBT SERVICE = LOAN AMOUNT X MORTGAGE CONSTANT.
THIS IS CALCULATED BY DOING THE FOLLOWING OPERATION:
RATIONALE (MONTHLY PAYMENTS)
KEYSTROKES
DISPLAY
*************************************************************************
CLEAR EVERYTHING
GOLD
FIN
MONTHLY PAYMENTS FOR 30 YRS.
30
BLUE 12X
360: AMORT PERIODS
10% ANNUAL INTEREST RATE
10
BLUE 12 / .83: MONTHLY INT.
RATE $100 MORTGAGE AMOUNT
100
CHS
PV
-100.00
DETERMINE P&I PYMT./MONTH
PMT
.88 OR $0.87757 PER
MONTH PER $100.00
ANNUAL MORTGAGE CONSTANT
12
X
10.53% MORTGAGE
CONSTANT
DEBT SERVICE RATIO = NET INCOME / DEBT SERVICE
IN THE ABOVE EXAMPLE, DEBT SERVICE = 91,839 / 80,000 = 1.15
THE 1.15 REPRESENTS AN ADDITIONAL 15 PERCENT INCOME TO COVER THE DEBT OF
THE BORROWER.
1.2 OR A 20 PERCENT SURPLUS IS USUALLY THE MINIMUM
ACCEPTABLE DSR. DSR IS A FACTOR THAT REPRESENTS AND MEASURES RISK.
TABLE OF MINIMUM ACCEPTABLE DSR RATES (INDUSTRY STANDARDS)
OFFICE..................................1.1 TO 1.2
HOTELS..................................1.25 TO 1.3
RESIDENTIAL.............................1.2 TO 1.3
RETAIL..................................1.1 TO 1.2
MAXIMUM LOAN FORMULA = (NET INCOME / DESIRED DSR) / MORTGAGE CONSTANT
AS PER THE ABOVE EXAMPLE,

(91,839 / 1.3) / 10% = 706,454

IF THE DSR WERE 1.15, THE MLF WOULD BE 798,600.

AS YOU LOWER THE DSR, THE MAXIMUM LOAN INCREASES.
(91,839/1.15) / 12% = 665,500
AS YOU RAISE THE MORTGAGE CONSTANT, THE MAXIMUM LOAN DECREASES.
THIS TOOL GIVES YOU AN UNDERSTANDING OF WHAT AMOUNT OF A LOAN YOU COULD
EXPECT TO GET GIVEN A PRO FORMA'S PROJECTION OF INCOME FLOW.
RETURN ON TOTAL CAPITAL (OR RETURN ON ASSETS (ROA) )

196

FORMULA:

NET INCOME / CAPITAL

AS PER THE ABOVE EXAMPLE,

91,839 / 1,000,000 = 9.18 PERCENT

RETURN ON EQUITY (ROE)

NET CASH FLOW AFTER DEBT SERVICE / EQUITY INVESTMENT = ROE
AS PER THE ABOVE EXAMPLE,

11,839 / 200,000 = 5.92 PERCENT

OFTENTIMES, INCOME TAX FACTORS ARE IGNORED BECAUSE DEVELOPERS PRESUME

THAT THE GENERATED LOSS FROM DEPRECIATION WILL NEGATE TAXABLE INCOME.
***********
FOR NEXT WEEK, THE ROCKEFELLER CENTER CASE. READ ARTICLES ON REITS, DO
IRR, VALUE OF MONEY (PRESENT VALUE ANALYSIS), ETC. EVALUATE WHETHER YOU
SHOULD INVEST, YES OR NO, AND WHY.
GET COMFORTABLE WITH THEIR
PRESENTATION OF THEIR ANALYSIS.
END OF CLASS TWO.

CLASS THREE
9/25/90
THERE WILL BE NO MIDTERM.
ANGUS CARTWRIGHT WILL BE DUE ON OCTOBER 23RD (IN LIEU OF MIDTERM)
FINANCING CASE WILL BE DUE EITHER ON NOV. 6 OR NOV. 13TH.
BE HANDED OUT WITHIN THE NEXT TWO WEEKS.

THE CASE WILL

************
MORTGAGE CONSTANTS ASSUME MONTHLY PAYMENTS, MADE AT THE BEGINNING OF THE
MONTH.
REWORK THE ROCKEFELLER CENTER PROPERTIES PROJECT BASED ON CHALLENGED
ASSUMPTIONS MADE BY THE PROSPECTUS.
FINANCIAL PROJECTIONS - NOT SIMPLY MECHANICAL CALCULATIONS, BUT THE ART
OF CONSTRUCTING ASSUMPTIONS TO FORMULATE A PROJECTION OF FINANCIAL GROWTH
IN AN INVESTMENT.
WHEN FINANCIALLY ANALYZING PERFORMANCE, LOOK AT:
1.

CAPITAL BUDGET
A. INCOME PROJECTIONS (ON A STABILIZED CASH BASIS)
B. THE CONSEQUENCES OF THE INVESTMENT

197

YOU

C. CASH FLOW MODEL - A MANAGEMENT TOOL DETERMINING WHETHER A

PROPERTY WILL MEET YOUR PROJECTIONS.
D. WHAT IS THE TIME HORIZON? ANYTHING BEYOND THREE YEARS IS
"GUESS WORK", AND CAN NOT BE COUNTED ON FOR PRECISION.
TEN YEARS IS AN ACCEPTABLE TIME LIMIT.
IT IS VERY
UNUSUAL FOR APPRAISALS TO USE THE INCOME PROJECTION
METHOD USING CASH FLOWS BEYOND TEN YEARS. THE FURTHER
YOU CAST OUT PROJECTIONS, THE LESS CERTAIN YOU ARE OF
PRESENT VALUE. GOING FAR OUT ALSO HAS AN EFFECT ON
LIQUIDITY.
DEPENDING ON THE 15TH YEAR REVERSION TO
BRING PRESENT VALUES INTO THE BLACK WON'T CUT IT IF
ARE USING A TIME HORIZON THAT IS TEN YEARS LONG, AT
WHICH POINT THE PROPERTY WILL BE SOLD OR REFINANCED.

IN LOOKING AT PROJECTS, BE RESPONSIVE TO ISSUES OF MARKET IN ANALYZING

WHETHER GROWTH RATES ARE ACCEPTABLE. YOU TEND TO USE INFLATION AS A RULE
OF THUMB TO PREDICT ANNUAL GROWTH RATES, UNLESS THE MARKET IS SOFT.
DETAILED STUDY OF RENT UP PERIODS ARE
OPERATING BUDGET (IE. TAXES, ETC.).

NECESSARY AND

UNDERSTAND THE

EXAMINE THE LEASE STRUCTURE.

INFLATION COULD BE COVERED BASED ON CPI
INDEX, STEPPED RENT, PORTER'S WAGE, PERCENTAGE RENT (IN RETAIL USES),
ESCALATIONS OVER A BASE OR EXPENSE STOPS (TAX STOPS, OPERATING STOPS,
ETC.). SEE LEASES IN LEGAL ISSUES NOTES FOR MORE INFORMATION.
LOOK AT RESIDUAL VALUE - YOU HAVE GOT TO CONSIDER THE FUTURE SALE OR
REFINANCING OF THE PROPERTY.
WHAT KIND OF CAP RATE AND INTEREST WILL
APPLY? THE BENEFIT OF REFINANCING A PROPERTY RATHER THAN SELLING IT AT
THE END OF THE PERIOD IS THAT THE FUNDS GO INTO YOUR POCKET TAX FREE.
WHAT WILL THE RESIDUAL VALUE BE TEN YEARS INTO THE FUTURE?
2.

THE CONSTRUCTION BUDGET

TO BE SUCCESSFUL, THE DEVELOPER MUST CONTROL COST OVER-RUNS.

YOU HAVE
GOT TO BE ABLE TO ESTIMATE TOTAL PROJECT COST AND INVESTMENT BEFORE
INVOLVING YOURSELF IN THE INVESTMENT.
1. LAND AND ACQUISITION COSTS
LOOK AT THE INVESTMENT VALUE OF THE LAND ALONE, IE. FARMING, MOBILE HOME
PARK, PARKING LOT, ETC.
IN AN URBAN SETTING, THE VALUE OF LAND DEPENDS ON THE COST OF DEVELOPING
AND THE TYPE OF USE. OFTEN, OLD BUILDINGS WILL BE REMOVED TO BE REPLACED
BY MORE PROFITABLE USES.
LAND CAN BE CARRIED ON THE BUDGET AT EITHER MARKET VALUE OR COST VALUE.
IF YOU CAN SELL YOUR LAND AT MARKET, AND YOU USE IT TO DEVELOP, SHOULD
YOU FOREGO THE PROFIT ON THE LAND? THE BANK WILL WANT YOU TO CARRY IT AT

198

COST WITH THE INHERENT PROFIT OF THE SALE REMAINING AS SAFETY BUFFER FOR
THE BANK'S INVESTMENT IN THE EVENT OF FORECLOSURE.
IMPROVEMENTS ON THE LAND THAT INCREASE THE VALUE AND COST OF THE LAND ARE
ADDED BACK INTO THE COST FACTORS.
2. BUILDING COSTS ( HARD COSTS )
DEVELOP A PRELIMINARY COST ESTIMATE. COSTS NEED TO BE MONITORED AND ARE
CHANGED FROM TIME TO TIME. ONCE YOU HAVE A PRELIMINARY BUDGET BASED ON
COSTS PER SQUARE FOOT, YOU WILL GO TO AN ESTIMATOR TO CONFIRM THE COSTS.
ESTIMATE METHODS VARY WIDELY, BUT BASICALLY THEY ARE FROM THE STANDARD
SYSTEMS SUCH AS MEANS COST ESTIMATES TO DERIVE COSTS. YOU LOOK AT BOTH
QUANTITY AND UNIT COST BASIS.
THE OTHER VARIABLE IN DEVELOPMENT IS
"QUALITY". IF YOU BUILD, YOU WILL WANT TO BUILD WITH QUALITY TO AVOID
EXPENSIVE "FIXES" LATER ON.
CORE & SHELL MEANS THE WALL, CEILINGS, FLOORS, UTILITIES, AND NOTHING
ELSE. THE REST IS DONE AS TENANT IMPROVEMENTS. IN EACH BUDGET, YOU WILL
ALLOCATE 20 TO 50 DOLLARS PER S.F. TO TENANT IMPROVEMENT WORK.
THE
TENANT WILL NEGOTIATE BASED ON HIS WORK LETTER WHAT YOU MUST PROVIDE HIM,
AS WELL AS THE QUALITY.
ITEMS COULD INCLUDE, FOR EXAMPLE, LIGHT
FIXTURES, WALL COVERINGS, ELECTRICAL DISTRIBUTIONS, HVAC, ETC.
TENANT
IMPROVEMENTS ARE PAID FOR BY THE LANDLORD AS DESCRIBED IN THE WORK
LETTER. YOU MAY WANT TO EXAMINE THE WORK LETTER. THE WORK IN IT MAY
APPRAISE FOR AN AMOUNT GREATER OR LESSER THAN THAT STATED AS A FACE
VALUE. FOR EXAMPLE, A 30 DOLLAR WORK LETTER MAY IN FACT BE A 90 DOLLAR
WORK LETTER WHEN THE ESTIMATE IS ACTUALLY PERFORMED.
THE WORK LETTER
DOES NOT NECESSARILY STATE THE COST OF THE WORK, BUT WHICH WORK MUST BE
PERFORMED, AND ITS QUALITY.
INDIRECT COSTS ( SOFT COSTS ) - THOSE COSTS THAT ARE DISTINGUISHED FROM
HARD COSTS OR LAND COSTS. THEY INCLUDE PROFESSIONAL SERVICES, INTEREST,
FEES, CLOSINGS COSTS, APPRAISALS, AND OTHER FINANCING COSTS, DEVELOPMENT
FEES, LEASE UP COSTS, CARRYING COSTS AND CONSTRUCTION INSURANCE.
IF YOU ARE LOOKING AT THE CONSTRUCTION INTEREST, AS A RULE OF THUMB:
IF YOU HAVE THE LAND COMPONENT, AND A ONE MILLION DOLLAR PROJECT, TAKE...
************************************************************************
THE LAND COMPONENT PLUS THE CLOSING DRAW*
200,000 DOLLARS + 100,000 DOLLARS = 300,000 DOLLARS (DRAWN ON DAY ONE)
CLOSING DRAW X INTEREST RATE X CONSTRUCTION PERIOD = INT. PAYMENT
$300,000 X 12% X 2 YEARS = 72,000 DOLLARS
(PROJECT PRICE - CLOSING DRAW) X INT. RATE X CONST. PERIOD X PERIOD LOAN
IS OUTSTANDING = INT. PAYMENT

199

700,000 X 12% X 2 YEARS X 50% = $84,000

*THE CLOSING DRAW IS THE AMOUNT THAT THE DEVELOPER TAKES FROM THE
CONSTRUCTION LOAN TO PAY START HIS CONSTRUCTION AND PAY HIS EXPENSES FOR
THE PROJECT.
*************************************************************************
YOU GUESS "50%" FOR THE PERIOD THE LOAN IS OUTSTANDING BECAUSE YOU ARE
ASSUMING THAT AFTER THE FIRST YEAR, 50% OF THE LOAN WILL HAVE BEEN
CONSUMED BY THE CONSTRUCTION ACTIVITY. SOME USE 60% BECAUSE THE EARLIER
CONSTRUCTION PERIODS OFTEN ARE MORE EXPENSIVE THAN THE LATER ONES.
THE 700,000 DOLLAR FIGURE INCLUDES THE INTEREST RESERVE.
*************************************************************************
INT. PAYMENT X CONST. PERIOD = TOTAL CARRYING COSTS FOR THE CONST. PERIOD
84,000 DOLLARS X 2 YEARS = 156,000 DOLLARS
*************************************************************************
RENT UP DEFICIT / CARRYING LOAN UP COSTS - DETERMINE, BASED ON THE FIRST
MONTH OR YEAR OF INCOME, THE FACTORING IN OF INTEREST TO FIND YOUR
"LEASE-UP RESERVE".
INCOME
INTEREST

YEAR 1 YEAR 2
100,000
120,000
(20,000)

YEAR 3

YEAR 4

THE 20,000 DEFICIT IS THE REQUIRED LEASE UP RESERVE.

GENERAL AND ADMINISTRATIVE COSTS - THE DEVELOPER'S OVERHEAD, OR THE
DEVELOPER'S FEE, SUCH AS THAT WITH A MERCHANT BUILDER.
MERCHANT BUILDER - A BUILDER WHO MAKES HIS PROFIT ON THE MARGIN BETWEEN
HIS COST OF BUILDING THE PROJECT, AND THE AGREED UPON DELIVERY PRICE.
COST OVERRUNS CUT INTO HIS PROFIT. EXCEPT FOR HIS EXPOSURE TO OVERRUNS,
HE RARELY HAS AN EQUITY POSITION IN THE PROJECT, OPERATING COMPLETELY ON
OTHER PEOPLE'S MONEY.
*************************************************
PROJECTING RISK THROUGH THE ANALYSIS OF CASH FLOW
*************************************************
SETUP - PROJECTED CASH FLOW BASED ON A STABILIZED PERIOD, IE. 3 TO 5
YEARS AFTER THE COMPLETION OF CONSTRUCTION. USE IT AS A TOOL TO ANALYZE
CASH FLOWS.
AN EXAMPLE OF A SETUP WAS HANDED OUT.
PAGE).

200

SEE "ONE COMMERCE SQUARE" (1

FREE & CLEAR EVALUATION - AN ANALYSIS OF CASH FLOWS BEFORE DEBT SERVICE.
HOW DO YOU DETERMINE THE DISCOUNT RATE TO USE ON A PROJECT?
1. ASSESSMENT OF RISK FOR INVESTMENT
2. OPPORTUNITY COSTS
3. "BAND OF INVESTMENT METHOD" - THE PROPERTY IS BROKEN DOWN INTO 75%
DEBT, AND 25% EQUITY. WHAT IS THE COST OF DEBT; WHAT RATE COULD I BORROW
FOR?
EXAMPLE OF THE BAND OF INVESTMENT METHOD:
*****************************************
I COULD COMPARE A TREASURY YIELD FOR AN EQUIVALENT PERIOD, ADD A SPREAD,
AND ARRIVE AT A RATE.
ASSUME A 10 YEAR T-BILL AT 9 PERCENT
ASSUME A 150 BASIS POINT SPREAD.
SPREADS ARE THE RISK PREMIUM PAID ON THE PROJECT, PLUS THE DESIRED YIELD
ON THE MONEY.
9 PERCENT + 1.5 PERCENT = 10.5 PERCENT
DISCOUNT RATE:
75% RELATES TO THE 10.5 PERCENT RATE
25% RELATES TO A TYPICAL LOAN RATE, SAY 10 PERCENT
75% X 10.5 =
7.875
25% X 10.0 = + 2.5
10.375% = 10 3/8%

CAP RATES - YOU HAVE UP-FRONT CAPS AND TERMINAL CAPS.

NOI / CAP RATE = RESIDUAL VALUE
CAP RATES ARE INDUSTRY STANDARDS SET BY DEMONSTRATED DEMAND FOR THE TYPE
OF REAL ESTATE USE, AS A REFLECTION OF INVESTOR'S EXPECTATIONS FOR INCOME
GROWTH RELATIVE TO EQUITY INVESTMENT, DEBT SERVICE, AND OPERATING
EXPENSES.
EXAMPLE OF NPV AND IRR USE.
SEE "ONE COMMERCE SQUARE" SETUP
REALIZE THAT INCOMES PREDICTED BEYOND 10 YEARS ARE USELESS.
1990

YR 1

NCF
2374

X
IF
X 0.909041

= PV
=2158

201

2 3688
3 4223
4 4411
5 4169
6 4286
7 3536
8 2342
9 4027
10 4840
+50632
$55472

0.826446
0.751315
0.0683013
0.620921
0.564474
0.513158
0.466507
0.424080
0.385543

=3048
=3173
=3013
=2589
=2419
=1815
=1093
=1708
=21387
42198

ASSUME SALE IS ON THE FIRST OF THE YEAR FOLLOWING YEAR TEN.

ADD THE
PROCEEDS OF THE ELEVENTH YEAR SALE AFTER DEDUCTING REAL ESTATE
COMMISSIONS, LEASING COMMISSIONS, TENANT IMPROVEMENTS AND MORTGAGE.
THE SALE OF THE PROPERTY FOR CAP RATE PURPOSES IS PREDICATED ON THE
ELEVENTH YEAR NOI, NOT THE TENTH YEAR'S.
TAKE CASH FLOW / CAP RATE = SALE PRICE
5242 / 10% =
52,420,000
LESS 3% COMMISSIONS=
(1573000)
LESS LEASING COMMISSION=
(93000)
LESS TI (TENANT IMPROVEMENTS)= (122000)
LESS MORTGAGE =
(0)
NET PROCEEDS
50,632,000
THE INCOME STREAM OF ONE COMMERCE SQUARE GIVES THE PROPERTY A VALUE OF
42,200,000 DOLLARS BASED ON A CONSERVATIVE CAP RATE FOR INCOME PROPERTIES
THAT ARE OFFICE USES, BASED ON THE NET PRESENT VALUE OF THE INCOME
STREAM.
END OF CLASS THREE
CLASS FOUR
10/2/90
LEVERAGE - RELATES TO HOW EFFICIENTLY YOU CAN BORROW MONEY BASED ON THE
INTEREST YOU PAY, OR BASED ON THE MORTGAGE CONSTANT ( INCLUDES INTEREST +
PRINCIPAL REPAYMENT). IF THE CONSTANT IS LESS THAN THE RETURN ON THE
PROPERTY, YOU HAVE POSITIVE LEVERAGE. IF THE RETURN OF THE ASSET (ROA)
IS LESS THAN THE INTEREST RATE, IT IS CONSIDERED TO BE NEGATIVE LEVERAGE.
THINK OF LEVERAGE AS A FULCRUM WITH
PROJECT'S RETURN ON COSTS AS WEIGHTS.
******************
FINANCIAL LEVERAGE

202

THE

MORTGAGE

CONSTANT

AND

THE

******************
FOR A PROPERTY COSTING 1,000,000 DOLLARS
PROJECTED NOI = 12%, OR 120,000 DOLLARS PER ANNUM

MORTGAGE CONSTANT (10%)

EQUITY RETURN (30%)
\\\\\--------------------------------------\\\\\\\\
^
^^^
RETURN = 12 PERCENT
(THE FULCRUM)

90 % LEVERAGE (900,000 DOLLAR LOAN AMOUNT)

900,000*/10%** = 90,000 (THE DEBT SERVICE)
* = PRICE OF PROPERTY LESS DOWNPAYMENT (10% MORT. CONSTANT)
** = MORTGAGE CONSTANT
120,000* - 90,000 DOLLARS** = 30,000 DOLLARS
* = THE NOI
** = THE DEBT SERVICE
30,000 DOLLARS / 100,000 DOLLARS* = 30 PERCENT EQUITY RETURN
* = 1,000,000 (THE PROPERTY PRICE) - 900,000 (LOAN AMT.) = 100,000
DOLLARS
WITH A MORTGAGE CONSTANT OF 10 PERCENT, AND A RETURN OF 12 PERCENT, YOU
HAVE A RETURN ON EQUITY OF 30 PERCENT.
WITH A 13 PERCENT MORTGAGE CONSTANT AND THE 900,000 DOLLAR DEBT YOU ARE
PAYING 117,000 INSTEAD OF 90,000.
YOUR RETURN ON EQUITY WILL BE 3
PERCENT, THE FREE AND CLEAR RETURN.
(120,000 - 117,000) / 100,000 = 3 PERCENT

DEMONSTRATION
LEVERAGE RATIO
0%
25%
50%
75%
90%

LOAN AMT.
0
250,000
500,000
750,000
900,000

ROI (12%)
12%
12%
12%
12%
12%

MORT.CONST.
10%
10%
10%
10%
10%

CASH ON CASH
12%
12.7%
14%
18%
30%

SWITCHING THE RATE FOR ROI AND MORTGAGE CONSTANT, WE HAVE THE FOLLOWING
RESULTS:

203

LEVERAGE RATIO
0%
25%
50%
75%
90%

LOAN AMT.
0
250,000
500,000
750,000
900,000

ROI (10%)
10%
10%
10%
10%
10%

MORT.CONST.
12%
12%
12%
12%
12%

CASH ON CASH
10%
9.3%
8%
4%
NEGATIVE

AS LONG AS THE LEVERAGE IS POSITIVE, INCREASING THE LOAN AMOUNT WILL

INCREASE THE RATE OF RETURN.
LEVERAGE PLAYS AN IMPORTANT ROLE IN EVERY INVESTMENT.
WITH PROPER
LEVERAGE, YOU CAN CONTROL THE RATE OF RETURN FOR ANY TYPE OF INVESTMENT.
"MORTGAGE CONSTANT" IS THE SAME AS THE RATE OF INTEREST.
OPERATING LEVERAGE IS MORE FUNDAMENTAL TO AN INVESTMENT BECAUSE IT
RESULTS FROM THE MOVEMENT OF INCOME AND EXPENSES. IT AFFECTS OPERATING
EXPENSES, WHICH CONSIST OF TWO ASPECTS. THESE ARE: VARIABLE AND FIXED.
VARIABLE OPERATING EXPENSES ARE THE COSTS THAT YOU CAN ALLOCATE PER
SQUARE FOOT, SUCH AS LABOR, CLEANING AND UTILITIES.
FIXED OPERATING EXPENSES ARE INSURANCE, HEATING AND FUEL, WATER, SEWER,
AND MAINTENANCE. THEY'RE FIXED BECAUSE THE NUMBERS ARE PREDICTABLE, AND
CAN NOT BE BROKEN DOWN INTO FURTHER UNITS OF WORK. THESE COSTS ARE NOT
BASED ON OCCUPANCY, BUT ARE PAID WHETHER OR NOT YOU HAVE OCCUPANTS. FOR
EXAMPLE, YOU ARE CHARGED THE SAME SEWER CONNECTION CHARGE REGARDLESS OF
HOW MANY TENANTS YOU HAVE.
EXAMPLES:
100% VARIABLE EXPENSES
1. IF YOU HAD NO FIXED EXPENSES WITH A NET RENTAL REVENUE OF 250,000,
WITH OPERATING EXPENSES VARIABLE OF 150,000, THEN YOUR NET OPERATING
INCOME IS 100,000.

2/3 VARIABLE EXPENSES

2. WITH THE SAME NET RENTAL OF 250,000 AND VARIABLE OF 2/3 OR 100,000,AND
FIXED EXPENSES OF 50,000, YOU HAVE THE SAME NET OPERATING INCOME OF
100,000.
50% VARIABLE EXPENSES
3. IF YOU HAVE NET REVENUE OF 250,000 AND FIXED EXPENSES AND VARIABLE
EXPENSES EVENLY SPLIT (75,000 EACH), THE NET OPERATING INCOME IS 100,000.

204

FOR THE NEXT YEAR, IF YOU WANT A 10 PERCENT INCREASE IN REVENUES TO

275,000 AND VARIABLES WENT UP TEN PERCENT IN THE SAME YEAR, NOI WOULD GO
UP TO 110,000 DOLLARS IN CASE ONE, WHICH IS A 10 PERCENT INCREASE.
IN THE SECOND CASE, THE FIXED FEES OF 50,000 AND VARIABLES UP TO 110,000,
YOU INCREASE THE NOI TO 15%.
IN THE THIRD CASE, WITH 75,000 AT FIXED AND 75,000 AT VARIABLE, A 10
PERCENT INCREASE IN VARIABLE EXPENSES WOULD BRING TOTAL EXPENSES TO
157,000, GIVING A 17.5% INCREASE IN NOI.
CASE 1
RETURN

YEAR ONE

YEAR TWO(10% INCREASE)

NET REVENUE
OPERATING EXP.
RETURN
VARIABLE
PERCENT
FIXED

250,000

275,000

150,000

165,000

RATE

OF

RATE

OF

IS

10

LEVERAGE
1.0
NOI

100,000

110,000

CASE 2
RETURN

YEAR ONE

YEAR TWO(10% INCREASE)

NET REVENUE
OPERATING EXP.
RETURN
VARIABLE
PERCENT
FIXED

250,000

275,000

100,000

110,000

50,000
150,000

50,000
160,000

RATE

OF

RATE

OF

IS

15

LEVERAGE
1.5
NOI

100,000

115,000

CASE 3
RETURN

YEAR ONE

YEAR TWO(10% INCREASE)

NET REVENUE
OPERATING EXP.
RETURN
VARIABLE
FIXED

250,000

275,000

75,000
75,000
150,000

75,000
75,000
157,500

205

RATE

OF

RATE

OF

IS 17.5%
LEVERAGE

=1.75
NOI

100,000

117,500

FIXED COSTS SHOULD BE KEPT DOWN TO A LIMIT BECAUSE AT A POINT, THEY MAY
BE SO LARGE AS TO SINK AN INVESTMENT BECAUSE OF THEIR WEIGHT. INCREASING
THE FIXED COSTS PORTION OF OPERATING EXPENSES AS OPPOSED TO THE PORTION
OF VARIABLE COSTS DOES NOT ALWAYS MAKE SENSE.
*************************************
ROCKEFELLER CENTER - CLASS DISCUSSION
*************************************
PRO-INVESTMENT OPINIONS
1. PREMIERE LANDMARK INVESTMENT
2. GOOD RATE OF RETURN (13.25%)
3. IN VIEW OF THE CURRENT STOCK AND REAL ESTATE MARKET, CURRENT PRICES OF
STOCK ARE LOW AND IT WOULD BE A GOOD TIME TO BUY IT. HOWEVER, THE
PROJECT REQUIRED LOOKING AT THE CONDITIONS AS OF 1985.
4. LARGE SPACE ROLLOVER IN 1994, GOOD OPPORTUNITY.
5. PORTFOLIO BALANCING
6. HIGHLY MARKETABLE STOCK - GOOD LIQUIDITY
7. LIC - SECURITY
8. 95% PAYOUT OF INCOME
9. CONVERSION OPTION
ANTI-INVESTMENT OPINIONS
1. CASH FLOW INSUFFICIENT TO PAY DEBT SERVICE
2. OPTIMISTIC PROJECTIONS
3. CASH FLOW ANALYSIS EXTENDS TOO FAR OUT.
4. RENTAL PROJECTIONS. HOW COULD THEY EXPECT 75.00 DOLLARS PER S.F. WHEN
THEY ARE RELEASING 2/3 OF THE SPACE IN 1994?
************************************
REIT - REAL ESTATE INVESTMENT TRUSTS
* THEY PAY NO FEDERAL TAX ON INCOME AND GAINS, THEY ARE PASSED THROUGH TO
THE SHAREHOLDER WHO PAYS TAX AT HIS APPLICABLE RATE.
* 95% OF INCOME MUST BE PASSED THROUGH.
* 75% OF ASSETS MUST BE REAL ESTATE OR GOVERNMENT SECURITIES.
* PUBLICLY TRADED
* 75% OF INCOME MUST BE FROM QUALIFYING REAL ESTATE INCOME.
* THEY APPEAL TO LARGE AND SMALL INVESTORS ALIKE.
IN 1974, REITS POSSESSED ENORMOUS ASSETS. BUT THEY COULD NOT FIND ENOUGH
DEALS TO DO. THE MORE INCOME THE REIT CREATED, THE MORE THE STOCK WENT
UP.
REITS TOOK ON RISKY INVESTMENTS, BECAUSE CARELESS IN THEIR
UNDERWRITING OF CONSTRUCTION AND MORTGAGE LOANS.
IN THE 1974 RECESSION,
MANY REITS TOOK A DIVE IN VALUE.
TODAY REITS ARE MORE CONSERVATIVE AND LESS LEVERAGED.

206

THEY ARE LONG TERM

IN PERSPECTIVE, AND
PROPERTY, ETC.

LOOK FOR

PREFERRED RATES

WITH INTERESTS

EACH LOAN GOES TO A PROPERTY WHICH CONSISTS OF DEBT AND EQUITY.

ROCKEFELLER CENTER AS AN EXAMPLE;

IN THE

USING

ROCKEFELLER CENTER REIT

1.3 BILLION DOLLARS

PARTICIPATING

MORTGAGE

\/

CONVERTIBLE EQUITY

TO 71.5 PERCENT

BORROWER: ROCKEFELLER CENTER

CAPITALIZED WITH 37,500,000 SHARES (750,000,000 DOLLARS)

CURRENT COUPON CONVERTIBLE DEBENTURES, 8 TO 13% RATE (335,000,000)
ZERO COUPON CONVERTIBLE DEBENTURES;
PRINCIPLE, 952,250,000
YIELD TO MATURITY = 10.25% (215,000,000)
----------------------------------TOTAL
1,300,000,000 DOLLARS
CURRENT COUPON MEANS THAT IT PAYS INTEREST ANNUALLY.
ZERO COUPON MEANS THAT IT PAYS NO INTEREST. A DEEP DISCOUNT BOND.
IF
YOU HAVE A RESTRICTED CASH FLOW AND DO NOT WANT TO PAY INTEREST YOU FLOAT
ONE OF THESE BONDS. THE INVESTOR PAYS TAX ON THE IMPUTED INTEREST OF THE
BOND ANNUALLY UNLESS THE INVESTOR IS TAX EXEMPT, LIKE AN IRA.
DEBENTURE IS AN UNSECURED BOND.
SERIAL ZERO COUPON BOND IS "SERIAL" BECAUSE EACH YEAR FOR THE LIFE OF THE
BOND A CERTAIN AMOUNT OF THE DEBT MATURES.
PROFESSOR'S EVALUATION OF ROCKEFELLER CENTER
FACTS: APPRAISAL AS OF 1/1/86 IS 1.6 BILLION DOLLARS
ASSUMPTIONS: 7 PERCENT AVERAGE ANNUAL RENTAL GROWTH.

207

6% AVERAGE ANNUAL OTHER INCOME GROWTH.

6% INCREASE IN EXPENSES ANNUALLY
3% REAL ESTATE TAXES GROWTH
8 PERCENT CAPITALIZATION RATE
13% DISCOUNT RATE

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

'96
IN MILLIONS
229.
4
NOI
89.8 95.1 98.6 103.4 109.2 113.5 117.1 121.0 122.8 220.1
CAP IMPR.
29.8 26.2 20.0
T.I.
3.0
2.3
2.0
SEE ROCKEFELLER CENTER DATA
LEAS.COMM. 2.8
2.1
1.8
------------------------------------------------------------------------NCF
54.2 64.5 74.7 80.2 81.0 80.6 93.7 105.0 10.4 197.0
FREE &
CLEAR
NCF
DISCOUNT FACTOR
DISCOUNTED CASH FLOW
YEAR ONE
54
.884
48
YEAR TWO
64
.783
50
YEAR THREE 74
.693
51
YEAR FOUR
80
.613
49
YEAR FIVE
81
.542
44
YEAR SIX
81
.480
43
YEAR SEVEN 94
.425
40
YEAR EIGHT 105
.376
39
YEAR NINE
10
.302
3
YEAR TEN
197
.294
58
847
425 + 729 = 1,154,000,000
TAKING THE 1996 INCOME STREAM CAPPED AT 9 PERCENT = 2,549,000,000, LESS
COMMISSIONS, ETC. = 2,479,000,000.
THE PRESENT VALUE OF THIS AT A 13
PERCENT DISCOUNT IS 729,000,000.
THE NET PRESENT VALUE OF THE CASH
STREAMS IS 425,000,000, WHICH WHEN ADDED TO 729,000,000 GIVES A VALUE OF
THE PROPERTY OF 1.154 BILLION DOLLARS AT A 9 PERCENT CAP RATE, WHICH IS
450 MILLION DOLLARS BELOW THAT OF THE APPRAISAL OF 1/1/86.
END OF CLASS FOUR
CLASS FIVE
10/9/90
TOPICS: MORTGAGES, INVESTMENT ANALYSIS (AS OPPOSED TO FINANCIAL ANALYSIS)
CARTWRIGHT DUE IN 2 WEEKS ON OCTOBER 23RD.
INSTRUCTIONS AND GLOSSARY TO BE HANDED OUT NEXT WEEK.

208

FINISH THE ANALYSIS ON THE OTHER THREE PROPERTIES BASED ON THE FORMAT OF
NEXT WEEK'S INSTRUCTIONS.
*************************
RESIDENTIAL MORTGAGES
FROM AN UNDERWRITER'S PERSPECTIVE:
THE EVALUATION OF A BORROWER'S
DEFAULT RISK AND THE LOAN'S TERMS IS THE CONCERN OF THE UNDERWRITER.
UNDER THE FAIR PRACTICES ACT FULL DISCLOSURE MUST BE MADE OF BORROWER
CREDENTIALS, YET CERTAIN FACTORS SUCH AS RACE AND RELIGION CAN NOT BE
CONSIDERED.
ONCE THE APPLICATION IS COMPLETE, THE BANK TAKES OUT AN
APPRAISAL. USUALLY, FOR INDIVIDUAL HOUSING, THIS COSTS APPROXIMATELY 200
TO 250 DOLLARS.
FOR RELOCATIONS, THE APPRAISAL IS MORE INVOLVED AND
COSTS ROUGHLY 500 DOLLARS.
FOR COMMERCIAL OR CONDO RESIDENCES, THIS
FIGURE IS USUALLY 10 TO 25 THOUSAND DOLLARS, YET CAN BE AS LOW AS 3,000
DOLLARS.
AN APPRAISER GOES THROUGH THE SAME ANALYSIS AS YOU DO OF MAINTENANCE,
UPKEEP, INCOME FLOWS, CAPITAL IMPROVEMENTS, OPERATING EXPENSES, MARKET
RENTS, LEASES, ETC. HE IS HIRED TO GIVE AN INDEPENDENT OPINION OF VALUE.
SALES COMPARABLE METHOD, COST REPLACEMENT, AND OTHER METHODS ARE USED TO
DETERMINE VALUE.
IN EACH LENDING INSTITUTION, ESPECIALLY THOSE WHO SELL OFF THEIR LOANS ON
THE SECONDARY MORTGAGE MARKET TO FNMA (FANNIE MAE) AND FHLMC (FREDDIE
MAC) BUNDLE THE PROPERTIES AND SELL THEM AT A DISCOUNT, OR PREMIUM, TO
THE MARKET DEPENDING ON THE MARKET CONDITIONS.
LEGAL OPINIONS,
APPRAISALS, ETC.TAKE A SIMILAR FORMAT BECAUSE THE SECONDARY MORTGAGE
MARKET REQUIRES THE FORMAT TO QUALIFY FOR PURCHASE WITHIN THE BUNDLE.
THE LIMIT OF MORTGAGES THAT THE SECONDARY MORTGAGE MARKETS WILL BUY IS
187,500 DOLLARS AS OF 9/90.
ABOVE THAT, MORTGAGE ARE CALLED JUMBO
MORTGAGES, OR JUMBO LOANS, AND WILL GENERALLY BE KEPT WITHIN THE
INSTITUTION'S PORTFOLIO RATHER THAN BEING SOLD, AT A HIGHER RATE THAN
THAT TYPICAL OF FNMA AND FHLMC BACKED LOANS. EXPECTED PAYMENT TO INCOME
RATIO AND LOAN TO VALUE RATIOS ARE USED TO ANALYZE RISK. THE INCOME RATIO
STATES THAT MORTGAGE + INSURANCE + TAXES SHOULD NOT EXCEED 1/3 OF THE
PURCHASER'S MONTHLY GROSS INCOME.
THIS 1/3 FIGURE IS THE PAYMENT TO
INCOME RATIO. LOAN TO VALUE IS GENERALLY 75 TO 80 PERCENT, DEPENDING ON
THE TYPE OF MORTGAGE USED. FHA MORTGAGES ALLOW UP TO 90 PERCENT BECAUSE
OF THE INSURANCE PROVIDED AGAINST DEFAULT. VA MORTGAGES PROVIDE AN LTV
OF 95%.
THE TYPES OF MORTGAGES ARE:
1. CONVENTIONAL
- FIXED RATE
- ADJUSTABLE RATE
2. FHA (FEDERAL HOUSING ADMINISTRATION)
- INSURED BY FED. GOV'T. TO LENDERS AGAINST DEFAULT. CREATED IN

209

1934

TO STABILIZE HOUSING INDUSTRY.

- TOUGH TO GET FOR INCOME PROPERTY DUE TO GUIDELINES.
3. VA GUARANTEED
- NOT INSURED, YET GUARANTEED UP TO A SPECIFIC AMOUNT
- HAS THE ADVANTAGE OF NO DOWNPAYMENT REQUIREMENT.
- THE MAX. GUARANTEE IS FOR 135,000 DOLLARS BASED ON THE REGIONAL
ELIGIBLE AMOUNT.
FEDERAL RESERVE REGULATION Q REGULATED SAVINGS INSTITUTIONS ABILITY TO
PAY INTEREST ON DEPOSITS OF 5.5 PERCENT. AFTER ABORTING REGULATION Q
(DEREGULATION UNDER THE REAGAN ADMINISTRATION), SAVINGS INSTITUTIONS BID
UP RATES TO COMPETE WITH OTHER INVESTMENTS. WITH THE FIXED PORTFOLIO IN
THE AREA OF 6 TO 7 PERCENT, THE BANKS WERE FUNDING DEPOSITS AT 12 TO 15
PERCENT, RESULTING IN A MISMATCH OF INSTITUTIONAL CASH FLOW. THE RESPONSE
TO THIS WAS THE VARIABLE, ADJUSTABLE AND EQUITY MORTGAGES.
80/20 FINANCING WAS ONE OF THE ONLY KINDS OF RENTAL HOUSING THAT THE FHA
WOULD PROVIDE A GUARANTEE FOR DUE TO ITS PUBLIC BENEFIT OF PROVIDING
HOUSING TO FAMILIES EARNING LESS THAN 80 PERCENT OF THE AREA'S MEDIAN
FAMILY INCOME.
IN A DEVELOPMENT, IF 80 PERCENT OF THE PROPERTY WAS AT
MARKET RATES AND 20 PERCENT AT A RATE THESE FAMILIES COULD AFFORD, THE
FHA WOULD GUARANTEE IT. BONDS WERE CREATED AND SOLD TO INVESTORS WITH AN
FHA GUARANTEE, TAX EXEMPT WITH INTEREST RATES IN THE 6 TO 7 PERCENT
RANGE.
1986 SAW THE END OF THIS AT THE HAND OF THE INTERNAL REVENUE
SERVICE.
THE BANK REVIEWS THE BORROWER'S INCOME WITH A POINT SYSTEM RATING
PROCESS.
FOR EVERY ITEM ON THE APPLICATION, SUCH AS PERIOD OF
EMPLOYMENT, INCOME, ETC. AND THE LIKELIHOOD OF IT CONTINUING. THE ASSET
VALUE WILL BE VERIFIED. ON THE BALANCE SHEET YOU SUBMIT THEY WILL LOOK
FOR THE SOURCE OF YOUR DOWNPAYMENT, SUCH AS CASH, I.O.U.'S, ETC. THEY
WILL LOOK AT YOUR CREDIT HISTORY. THEY WILL WANT AN ESTIMATE OF HOUSING
EXPENSES, CONSISTING OF PRINCIPAL, INTEREST, PROPERTY TAX, INSURANCE,
UTILITIES, ETC.
THEY WILL WANT TO KNOW WHAT YOUR FINANCIAL OBLIGATIONS
ARE.
FEDERAL RESERVE REGULATION THREE PROHIBITS DISCRIMINATION. REDLINING IS
ILLEGAL, AND IS THE EVIDENCE OF DISCRIMINATING AGAINST A NEIGHBORHOOD
(DIFFERENT THAN THAT OF REGULATION THREE). PROOF OF REDLINING IS THAT,
FOR EXAMPLE, A BANK HAS MORTGAGES IN ALL OF BROOKLYN EXCEPT BROWNSVILLE.
IF THE BANK THINKS BROWNSVILLE IS GOOD ENOUGH TO HAVE BRANCH THERE TO
TAKE THE RESIDENT'S MONEY, THEN THEY SHOULD FEEL THAT THE COMMUNITY IS
WORTH RISKING MAKING MORTGAGES IN.
AFTER REVIEW AND APPROVAL, A COMMITMENT IS GIVEN TELLING THE TERMS OF THE
LOAN, SUCH AS TERM, POINTS, RATE, ETC. IN CLOSING THE LOAN, THERE ARE
FINANCING COSTS AND OTHER COSTS THAT INCLUDE:
1.

THE LOAN APPLICATION FEE

210

2.
3.
4.
5.
6.
7.
8.
9.
10.

CREDIT REPORT FEE

LOAN ORIGINATION FEE (POINTS)
ATTORNEY'S FEES
SURVEY FEE
LOAN DISCOUNT FEE
PREPAID INTEREST
APPRAISAL FEE
ESCROW ACCT. FOR INSURANCE AND TAXES
TITLE INSURANCE

REAL ESTATE SETTLEMENT AND PROCEDURES ACT (RESPA) FORMS NEED TO BE

FILLED
OUT
AND
DISTRIBUTED
TRUTH IN LENDING ACT
**********

ARM'S- ADJUSTABLE RATE MORTGAGE - INDEXED OF 6, 12, AND 36 MONTH TREASURY

BONDS, OR OFF THE FEDERAL HOME LOAN BANK BOND INDEX.
YOU HAVE AN INITIAL INTEREST RATE THAT IS LOWER THAN THE PREVAILING RATE.
THEN A SPREAD OVER THE INDEX, CALLED A MARGIN, IS APPLIED AFTER THE
INITIAL PERIOD, SUCH AS 750 BASIS POINTS ABOVE THE 3 YEAR T-BILL. CAPS
WILL LIMIT THE PERIODIC JUMP.
INVESTMENT ANALYSIS
PROPERTY TYPES:
INCOME PROPERTIES - PROPERTY PURCHASED FOR THE PURPOSE OF RECEIVING AN
INCOME STREAM.
RESIDENTIAL PROPERTY
SINGLE FAMILY (ATTACHED AND DETACHED)
MULTI-FAMILY (APARTMENT HOUSES)
HIGH RISE APARTMENTS
LOW RISE APARTMENTS
GARDEN APARTMENTS
COMMERCIAL PROPERTY
OFFICE BUILDINGS
MULTI-TENANT
CENTRAL BUSINESS DISTRICT (CBD), DISTINCT & SUBURBAN
SINGLE USER BUILDINGS
IN CBD AND IN SUBURBIA
BUILD TO SUIT
OFFICE AND SHOWROOM

211

RETAIL USES
REGIONAL MALLS (600 TO 800K S.F.)
SUPER REGIONAL MALLS (1000K S.F.)
NEIGHBORHOOD CENTER (200 TO 300K S.F.)
STRIP CENTER
SPECIALTY CENTER
DISCOUNT CENTER
INDUSTRIAL
HEAVY MANUFACTURING
LIGHT MANUFACTURING
FLEX SPACE (OFFICE/WAREHOUSE)
RESEARCH AND DEVELOPMENT
WAREHOUSE SPACE
HOTEL/MOTEL
CONVENTION/BUSINESS CENTERS
TOURIST/RESORT CENTERS
RECREATIONAL
GOLF CLUBS
MARINAS
SPORTS COMPLEXES
AMUSEMENT PARKS
INSTITUTIONAL
HOSPITAL
UNIVERSITY
GOVERNMENT
IN LOOKING AT THE PRODUCTS YOU EVALUATE IN YOUR ANALYSIS, DETERMINE WHAT
YOUR MOTIVATION IS TO INVEST, SUCH AS: RETURN, CASH FLOW, SALE, TAX
CONSIDERATIONS, ETC.
IN PROJECTING INCOME AND OPERATING EXPENSES, LOOK AT MARKET RENTS AND THE
LIKELIHOOD FOR INCREASES BY EVALUATING SUPPLY, DEMAND (ABSORPTION), AND
COMPARABLE VALUES. ASSUME 95% MAXIMUM OCCUPANCY TO CONSIDER FOR VACANCY
AND NON-PAYMENT OF RENT IN A GOOD MARKET. USE LESS THAN 95% IN A POOR
MARKET.
**************
LEASING
**************
LEASING STARTS WITH:
* A BASE RENT, SAY 10.00 DOLLARS PER S.F., FOR EXAMPLE.
* A TERM, SUCH AS FIVE YEARS.
FIVE YEAR LEASES ARE TOUGH TO FINANCE
BECAUSE OF THE REFINANCING RISK. AT THE END OF 5 YEARS IF THE LESSEE
DOESN'T RENEW THE LEASE THE LENDER IS SUBJECT TO WHO WILL TAKE OUT THE
LEASE AT THE END OF THE TERM WHEN THEY HAVE TAKEN OUT A TEN YEAR NOTE TO
COVER THE FINANCING, MAKING THEIR PROFIT ON THE MARGIN.
IF THE LEASE
DOES NOT RENEW, THERE IS A RISK THAT THE LENDER WILL BE "HUNG OUT TO
DRY".

212

* YOU HAVE ANNUAL INCREASES. YOU HAVE A PERCENTAGE RENT, SUCH AS THAT
USED IN A RETAIL LEASE ( OVERAGE ).
OPTIONS ON A LEASE OFFER RENEWAL. AT THE OPTION OF THE TENANT THEY CAN
RENEW THE LEASE BASED ON A PRE-AGREED FORMULA SUCH AS "95% OF MARKET
RENT" PER SQUARE FOOT.
***********************************
EXAMPLE OF THE USE OF EXPENSE STOPS
***********************************
TENANTS.F. RENT/S.F.
EXPIRY OF LEASE
TAX BASE
OP.EXP.BASE
PH
6000 25.00
1/1/91
40,0003.50/S.F.
WH
4000 35.00
1/1/90
80,0004.50/S.F.
-----------------------------------------------------------------------TOTAL
RENTABLE
S.F.
10,000
ASSUMPTIONS:
* 6 MONTH VACANCY BETWEEN EACH LEASE
* EACH TENANT PAYS PROPORTIONATE SHARE OF INCREASES
OPERATING EXPENSES AND TAX EXPENSES.
* 1989 OPERATING EXPENSES ARE 40,000 DOLLARS
* 1989 TAX EXPENSES ARE 90,000 FOR CALENDAR YEAR
* 1989 MARKET RENT IS 50 DOLLARS PER S.F.
* LEASING COMMISSION IS 25% OF FIRST YEAR'S RENT

OVER

BASE

FOR

ASSUMPTIONS (CONT)
* ASSUME 5 YEAR LEASES
* 5 DOLLARS PER S.F. TENANT IMPROVEMENTS
* 5% INFLATION FACTOR FOR ALL RENTS, OPERATING EXPENSES, TAXES, AND T.I.
TASK: PREPARE A 4 YEAR INCOME AND EXPENSE PROJECTION FOR THE PROPERTY.
YEAR

1989

1990

MKT.RENT
TI

50.00
5.00

52.50
5.25

PH'S BASE RENT

330,750
OPERATING ESCALATION
1,323****
TAX ESCALATION
2,977

150,000*

1991

55.13
57.88
5.51
5.79
RENEWAL YEAR
150,000
330,750***

3,000**

4,200

30,000

32,700

* 6000 S.F. X 25.00/S.F. = 150,000

** 40,000 TAX / 10,000 TOTAL S.F. = 4.00
4.00 ACTUAL COST - 3.50 BASE COST = 50 CENT PER S.F. ESCALATION
50 CENTS X 6000 S.F. = 3000 DOLLARS

213

1992

*** 55.13 X 6000 = 330,750

**** 4.41 = NEW BASE
46305/10000 = 4.63
4.63 - 4.41= 22 CENTS
22 CENTS X 6000 = 1323.00
YEAR

1989

1990

MKT.RENT
TI

50.00
5.00

52.50
5.25
RENEWAL YEAR
140,000
210,000

1991

1992

55.13
5.51

57.88
5.79

WH'S BASE RENT

210,000
210,000
OPERATING ESCALATION
0
0
840
1,722
TAX ESCALATION
4,000
0*
1,890
3,875
* 94,500 =NEW BASE
-------------------------------------------------------------------------LESS VACANCY
0
(105,000)
(165,375)
0
EFFECTIVE GROSS INCOME
327,000
291,900
378,105
550,646
LESS OPERATING EXPENSES
(40,000)
(42,000)
(44,000)
(46,305)
LESS TAXES
(90,000)
(94,500)
(99,225)
(104,185)

NOI
197,000
155,400
234,780
400,155
LESS T.I.
0
(21,000)*
(33,075)
0
LESS COMMISSION
0
(52,500)
(82,688)**
0

NET CASH AVAILABLE

FOR DEBT SERVICE
197,000
81,900119,018
400,155
(A.K.A. NET CASH FLOW)
* 5.25 X 4,000 = 21,000
** 330,750 MARKET X 25% = 82,688
END OF CLASS FIVE
CLASS SIX - 10/16/90
GUEST SPEAKER - BILL HAYNES: PRESIDENT OF THE BROMLEY COMPANIES
STARTED IN 1972, MANAGEMENT AND CONSULTATION FOR REAL ESTATE INVESTMENT.
WHAT DOES A DEVELOPER DO, AND HOW DOES HE DO IT? WHAT IS A DEVELOPER? A
DEVELOPER IS TWO THINGS: HE IS A CONCEPTUALIZER, AND HE IS A DOER. HE
TURNS HIS CONCEPT INTO REALITY.
THERE ARE A LOT OF GREAT THINKERS BUT DEVELOPERS ARE MEN OF

214

ACTION, NOT

REFLECTIVE THINKERS.
THERE ARE SOME WHO ARE"DEAL JUNKIES" AND WISH TO
MAKE A DEAL A DAY RATHER THAN SIT AROUND AND CONCEPTUALIZE.
CONCEPTUALIZATION:
"PICK PEOPLES MINDS". NETWORKING, PICKING UP IDEAS, BOUNCING IDEAS OFF
GOVERNMENT AGENCIES.
AN IDEA HAS
ITS TIME AND OLD IDEAS MAY BE WELL
RECEIVED IF THE CONDITIONS ARE CORRECT.
AFTER YOU SELECT WHAT YOU WANT TO BUILD, EVEN CONCEPTUALLY, YOU NEED TO
LOOK AT THE MARKET. ONCE YOU START A DEVELOPMENT PROCESS, IT WILL BE
THREE TO FIVE YEARS BEFORE THE PROJECT COMES ON LINE. MARKET STUDIES ARE
THEREFORE OF LITTLE USE, ACCORDING TO BILL HAYNES.
THE CYCLICALITY OF
REAL ESTATE, APPARENTLY EVERY SEVEN YEARS, CAUSES THE HISTORICITY OF
MARKET STUDIES TO FALL SHORT. "PLAYING THE CYCLES", RATHER THAN STUDYING
THE MARKET IS A BETTER INDICATOR OF WHETHER ONE SHOULD PROCEED WITH A
DEAL. TO PROCEED, YOU NEED MONEY.
YOU GO TO PENSION FUNDS, INVESTORS, INSURANCE COMPANIES, BANKS, ETC. DO
NOT USE YOUR OWN MONEY.
STARTING IN 1991-92 FOR ON-LINE PROJECTS IN
1995-96 IS GOOD. FINDING MONEY IS TOUGH BECAUSE PEOPLE WITH MONEY HAVE
TAKEN HITS OVER THE PAST FEW YEARS AND DO NOT WANT TO PART WITH WHAT THEY
HAVE LEFT UNLESS A DEAL IS EXTREMELY CHOICE.
AT THAT POINT THERE IS
LITTLE LEFT FOR THE DEVELOPER. DEVELOPERS GO INTO DEALS TO MAKE 30 TO
50 PERCENT, NOT 10 PERCENT. WHEN WE HIT IT WE HAVE TO MAKE A LOT BECAUSE
IT IS EASY TO LOSE A LOT OF MONEY DUE TO THE INHERENT RISK. A PROJECT
PRO FORMA LISTING 15 PERCENT RETURNS WILL LIKELY "BREAK EVEN" WHEREAS A
40 PERCENT IRR WILL LIKELY END UP A 15 PERCENT RETURN.
EXAMINE ALL ASSUMPTIONS TO DETERMINE ACTUAL RISK.
THE DEVELOPMENT TEAM
SMALL OR LARGE DEVELOPERS HAVE THE SAME TEAM. IN HOUSE VS. OUTSIDE IS
THE KEY FACTOR. MOST DEVELOPERS DO NOT HAVE LARGE IN-HOUSE STAFFS. WHAT
THEY DO HAVE IS CONSTRUCTION SUPERVISORY CAPABILITY. YOU NEED KEY PEOPLE
TO REPRESENT YOUR INTERESTS.
YO NEED A STRONG IN HOUSE FINANCIAL
DEPARTMENT, NOT JUST A STRONG ACCOUNTING DEPARTMENT.
THE FINANCIAL
DEPARTMENT IS THE LIAISON WITH THE FINANCIAL INSTITUTIONS. THEY HANDLE
THE INSURANCE PREMIUMS ALSO. CHANGE ORDERS ARE HANDLED BETWEEN FINANCE
AND CONSTRUCTION DEPARTMENTS.
YOU ALSO NEED A PURCHASE MANAGER.
YOU
NEED A PERSONNEL MANAGER. THEY DEAL WITH UNION PROBLEMS. HE ALSO DEALS
WITH THE MARKETING DEPARTMENT THAT DOES LEASING AND SELLING. MARKETING
IS VERY HEAVY IN PERSONNEL.
OUTSIDE, YOU HIRE YOUR ARCHITECT AND ENGINEERS AND LANDSCAPE ARCHITECTS.
ALSO, YOU NEED DIFFERENT LEGAL FIRMS TO HANDLE DIFFERENT LEGAL ASPECTS
SUCH AS REAL ESTATE, FINANCING, AND ACQUISITION. YOU ALSO NEED A ZONING
LAWYER WHO ACTS AS A LOBBYIST MORE THAN THEY ACT AS ATTORNEYS. YOU ALSO
NEED OUTSIDE AUDITING, ACCOUNTING, AND TAX ADVICE (BOTH LEGAL AND
ACCOUNTING). YOU ALSO NEED TO HIRE CONSTRUCTION MANAGERS.

215

NEGOTIATING CONTRACTS WITH CONSTRUCTION MANAGERS IS TOUGH. YOU NEED TO

HIRE AN ATTORNEY WHO SPECIALIZES IN CONSTRUCTION AGREEMENTS.
YOU CAN
HIRE ON A FEE BASIS TO UPSET PRICE WITH SHARED SAVINGS, ETC. BUT SINCE
THE MANAGER HAS MORE EXPERIENCE IN NEGOTIATION CONTRACTS THAN YOU DUE TO
THE VOLUME OF WORK HE HAS DONE, YOU NEED EXPERT ADVICE FROM A SPECIALIZED
ATTORNEY.
GENERAL CONTRACTORS DIFFER FROM MANAGERS BECAUSE THEY WORK SOLELY ON A
FIXED FEE.
IN BONDING, YOU BOND ANY SUBCONTRACTOR YOU ARE WORRIED ABOUT, AS WELL AS
THE KEY TRADES AFFECTING THE INITIAL BUILDING OF THE STRUCTURE, INCLUDING
ELECTRICAL, MECHANICAL AND CONCRETE. ELEVATORS WOULD NOT BE BONDED. YOU
DO NOT BOND THE ENTIRE JOB SINCE THIS IS NOT FISCALLY PRACTICAL.
SMALLER JOBS WILL BE REQUIRED TO HAVE A FULL BOND, THOUGH BIGGER
FINANCING SOURCES NO LONGER REQUIRE FULL BONDS SINCE THEY DEPEND ON THE
DEVELOPER'S TRACK RECORD, AND SINCE THE COSTS ARE SO HIGH. THE BOND ONLY
GIVES YOU THE RIGHT TO SUE THE INSURANCE COMPANY, AND DOES NOT GUARANTEE
RECOVERY OF THE BOND MONEY.
LENDERS ALMOST
UNIVERSALLY REQUIRE
DEVELOPERS TO GUARANTEE THE COMPLETION OF THE JOB.
FINANCIAL INSTRUMENTS: ILLUSTRATED BY AN EXAMPLE.
THE BROMLEY - 83RD AND BROADWAY
AFTER NETWORKING WITH LOEWS REAL ESTATE DIRECTOR, HAYNES PURCHASED LAND
FROM THE LOEWS CORPORATION. NEEDED TO ACQUIRE LAND ON LONG-TERM CONTRACT
WITHOUT PUTTING UP A LOT OF CASH. IDEALLY YOU DO NOT WANT TO PUT UP MONEY
UNTIL SPADE HITS GROUND. BROMLEY PUT UP A LETTER OF CREDIT FOR 3/4 TO 1
PERCENT RATHER THAN PUT UP HIS OWN MONEY AT 9 TO 10 PERCENT FOR THE TWO
YEARS HE TOOK TO ACQUIRE PERMITS.
THIS SAVED 345,000 DOLLARS.
THE
LETTER OF CREDIT WAS FOR TWO YEARS.
IT CAN BE BORROWED AGAINST AS
COLLATERAL FOR THE SELLER.
THE ZONING VARIANCE WAS GOTTEN FOR ADDITIONAL BULK AND TO ALLOW TWO
PARCELS TO BE JOINED TO MAKE ONE BUILDING. THE PARCEL WAS ALSO CAUGHT IN
THE MIDDLE OF A ZONING CHANGE (CONTEXTUAL ZONING). ALL THE WHILE, THE
OUTSIDE
OF THE DESIGN WAS CHANGED TO SATISFY ZONING CRITERIA YET THE
INSIDES WERE BEING REDESIGNED TO SATISFY CUSTOMERS.
CHASE BANK COMMITS TO FINANCE THE WHOLE JOB. A JAPANESE BANK JOINS AS A
PARTNER IN EXCHANGE FOR TEACHING ITS PEOPLE HOW TO DEVELOP REAL ESTATE IN
NEW YORK. THEY IN TURN BROUGHT IN MORE BANKS AND ALL WORKED WELL.
CONSTRUCTION TOOK PLACE DIRECTLY ONTO THE LOEWS THEATER.
A LOT OF
BLASTING TOOK PLACE TO INSTALL FOUNDATIONS INTO THE GRANITE HARDPAN.

REMEMBER

"YOU
216

DON'T

MAKE

THE

MARKET, THE MARKET MAKES YOU."

HARRY HELMSLEY
START MARKETING THE BUILDING THE DAY YOU SECURE THE LAND.
WITH BROKERS AND OTHERS.

NETWORK IT

THE BROMLEY SAVED 750,000 DOLLARS BY SELLING 1/2 THE BUILDING UP FRONT.
TEMPORARY OCCUPANCY CERTIFICATES WERE GIVEN BEFORE THE PROJECT WAS TOPPED
OFF. IT WAS IMPORTANT TO WATCH THE PROJECT'S REPUTATION AND DEAL WITH
THE INEVITABLE COMPLAINTS WHILE CONSTRUCTION WENT ON.

PEOPLE LIVE ON PERCEPTIONS. MARKET SUCCESS AND

STRIVE FORE SUCCESS. NOTHING BREEDS FAILURE LIKE
FAILURE.
FINANCING IS BASED IN PERMANENT FINANCING, WHICH IS SECURED ON RENTAL
INCOME OR ABSORPTION FROM SALES.
THE LAST QUARTER OF THE YEAR IS EITHER GOOD OR BAD FOR GETTING FINANCING.
THE FINANCIER EITHER HAS MONEY HE NEEDS TO UNLOAD BEFORE YEAR END, OR IF
HE IS CLOSE TO EXCEEDING HIS BUDGET HE WILL WISH TO PUSH IT OVER TO THE
NEXT YEAR.

SUCCESSFUL DEVELOPERS DO NOT TAKE RISKS.

ASSESS RISKS.

THEY

YOU CAN HEDGE MOST EVERYTHING. IF YOU SEE CONSTRUCTION AS RISKY, GET A
FIXED PRICE.
HEDGE ZONING BY GETTING A CONTINGENCY CLAUSE.
YOU CAN
HEDGE MARKETING BY PRELEASING OR PRESELLING.
WHEN YOUR CFO SAYS YOU WILL MAKE 50 MILLION, YOU CAN STILL GO BROKE IF
YOUR CASH FLOW PROJECTIONS SHOW THAT YOU CANNOT SUSTAIN THE PROJECT UNTIL
THE PROJECT COMES ON LINE.
IF YOUR CONSTRUCTION GOES LONGER AND SETS BACK
LEASING, THE EXTENDED
PERIOD IS CARRYING A BUILDING WHICH IS 90 PERCENT FUNDED.
YOU PAY
INTEREST ON INTEREST, COST, AND MISCELLANEOUS FEES.
END OF GUEST LECTURE
TAXES
TAX REFORM ACT OF 1986 -THE LAW THAT WE HAVE BEEN WORKING WITH. THESE
LAWS DO CHANGE, HOWEVER, AND POTENTIAL CHANGES MUST BE CONSIDERED IN
PLANNING.
PRIOR TO 1986, REAL ESTATE INVESTMENT AND FINANCING WAS CONSIDERED TO BE

217

AN EXCELLENT TAX SHELTER. THIS TAX BENEFIT CAUSED A LOT OF BUSINESS.

ACCELERATED DEPRECIATION ON BUILDINGS ALLOWED A PROPERTY TO "WRITE DOWN"
ITS INCOME, THEREBY CREATING A LOSS WHICH WHEN ADDED TO DEBT INTEREST
COULD OFFSET INCOME.
LOSSES PASSED THROUGH TO INVESTORS COULD REDUCE
PERSONAL INCOME TAXES SUBSTANTIALLY.
1986'S ACT CHANGED THIS THROUGH
CHANGES IN DEPRECIATION AND THE CONCEPT OF PASSIVE VS. ACTIVE PORTFOLIO
INCOME. ADDITIONALLY, 1988 SAW A GRADUATED INCOME TAX WITH A 15 AND 28
PERCENT BRACKET APPLIED AS MARGINAL TAX RATES.
INVESTMENT TAX CREDITS
WERE RESTRICTED AND THE HANDLING OF CAPITAL GAINS WAS REVAMPED.
**************************
FORMULA FOR TAXABLE INCOME
**************************
TAXABLE INCOME = NET INCOME - DEPRECIATION - INTEREST ON DEBT
DEPRECIATION - THE 1986 ACT LENGTHENED THE DEPRECIABLE LIFE OF REAL
ESTATE BY ELIMINATING ACCELERATED DEPRECIATION AND LENGTHENING THE TERM
TO:
27.5 YEARS FOR RESIDENTIAL PROPERTIES
31.5 YEARS FOR NON-RESIDENTIAL PROPERTIES
DEPRECIATION = COST OF IMPROVEMENT / DEPRECIATION PERIOD
IMPROVEMENT COST = ACQUISITION PRICE + ANY INSTALLATION COST, TRANSACTION
COSTS AND LOAN POINTS AMORTIZED OVER THE LOAN TERM
LAND IS NOT A DEPRECIABLE ASSET.
GROSS SALES PRICE IS NOT ONLY MEASURED IN CASH EXCHANGED AT SALE, BUT IN
TRANSFERRED DEBT, SERVICES, ETC.
GROSS SALES PRICE LESS SELLING EXPENSES = NET SALES PROCEEDS.
TAXABLE GAIN - THE ORIGINAL COST LESS ADJUSTED BASIS LESS CAPITAL
IMPROVEMENTS LESS ACCUMULATED DEBTS.
SEE LAST WEEK'S EXAMPLE FOR MORE ON THE FOLLOWING PROBLEM
NET CASH

1989
197,000

1990
1991
81,900119,018

1992
400,155

DEPRECIATION PERIOD = 31.5 YEARS

TAX RATE OF INVESTOR = 28 PERCENT
15% OF VALUE ALLOCABLE TO LAND, 85% TO BUILDING
PURCHASE PRICE = 2,500,000
1989

1990

1991

218

1992

PRETAX NOI
197,000
155,400
234,780
DEPRECIATION (67,460)
(67,460)
(67,460)
TI
-------(4200)*
(10,815)
LEASING EXPENSE
-------(10,500)** (27,038)
TOTAL
129,540
73,240129,467
*20% OF EXPENSES
**LEASING EXPENSE AND TENANT IMPROVEMENTS AMORTIZED OVER THE TERM OF THE
LEASE, IN THIS CASE FIVE YEARS.
SALE BASED ON 1992'S NET INCOME
NOI
400,155 / 9% CAP RATE = 4,446,167
LESS COMMISSIONS =
88,923
TOTAL =
4,357,243 = NET PRICE
85% X 2.5 MILLION / 31.5 YEARS = 67,460 ANNUAL DEPRECIATION
1989

1990

1991

TOTAL
28% TAX

129,540
36,271

73,240129,467
20,507 36,231

NET CASH FLOW

LESS TAXES
AFTER TAX CASH

197,000
(36,271)
160,729

81,900119,018
(20,507)
36,251
61,39382,767

DEDUCTING TAXES FROM CASH FLOW GIVES YOU AFTER TAX CASH FLOW.
TAX ON SALE
NET SALE PRICE =
LESS PURCHASE PRICE =
PLUS DEPRECIATION = 67,460 X 3 =
PLUS ALLOCATION OF CAPITAL EXPENSES =

4,357,243
(2,500,000)
202,380
52,553

TAXABLE GAIN =
FEDERAL TAX RATE =

2,112,177
X

28%

TAXES

591,410

IF YOU LOOK AT THE INCOME FLOW, WE HAVE THE NET AFTER TAX CASH FLOW OF:
1989
1990
1991
CASH FLOW
160,729
61,39382,767
PLUS RESIDUAL VALUE
-------------4,357,243
LESS TAXES ON SALE -------------(591,410)
AFTER TAX CASH FLOW

160,729

61,3933,848,601

219

THE FORMAT IS AS FOLLOWS:

EFFECTIVE GROSS
LESS OPERATING EXPENSES
LESS REAL ESTATE TAX
EQUALS
NET OPERATING INCOME
LESS TENANT WORK
LESS COMMISSION
EQUALS
NET AVAILABLE FOR DEBT SERVICE (NET CASH FLOW)
END OF CLASS SIX
CLASS SEVEN
GUEST SPEAKER: MR. FRANK TROISI
CHIEF APPRAISER FOR MANUFACTURERS HANOVER TRUST
"REAL ESTATE IS A COMMODITY THAT HAS CYCLES.
HELLS - THIS (OF 1990) IS THE THIRD."

I HAVE BEEN THROUGH TWO

THE BULLSEYE OUTLOOK TO APPRAISAL ANALYSIS:

MOVE FROM THE OUTSIDE IN, THIS IS, FROM THE

THE MARKET
MARKET STUDY OF DEMOGRAPHICS AND LOCAL
SUPPLY

AND DEMAND TO THE VALUATION PROCESS OF

THOSE

MARKET CONDITIONS.

THE

VALUATION

PROCESS

THE
MARKET

EVERY MARKET IS INDEPENDENT WITH ITS OWN CHARACTERISTICS AND ITS OWN WAY
OF RESPONDING TO ACTIONS OF THE ECONOMY.
"IF YOU DO YOUR MARKET ANALYSIS WELL, THE APPRAISAL IS A SNAP".
"ALL PROJECTS HAVE MINUSES....KNOW THEM".

220

KNOW GEOGRAPHY: IE. SEATTLE.

A HEALTHY ECONOMY BECAUSE BOEING IS A
HEALTHY FIRM.
ATLANTA. CLAIMED TO BE RECESSION PROOF BECAUSE OF A
DIVERSITY OF INDUSTRY.
KNOW LAW: IE. LOCAL LAW
KNOW SOCIOLOGY: IE. PEOPLE. TEN YEARS AGO YOU COULD NOT SELL 3 TO 4
BEDROOM UNITS IN MANHATTAN. TODAY YOU CAN'T SELL STUDIOS. THIS IS A 180
DEGREE REVERSAL OF THE SITUATION TEN YEARS AGO SINCE TODAY THE EXACT
OPPOSITE IS TRUE.
KNOW ECONOMICS: BUILD WHERE COST EQUALS VALUE; THIS IS RARELY THE CASE
HOWEVER. WHEN YOU BUILD THE PROPERTY SHOULD BE WORTH AT LEAST WHAT YOU
PUT INTO IT.
REAL ESTATE IS A LONG TERM INVESTMENT/COMMODITY.
IT COMPETES AGAINST
OTHER COMMODITIES IN THE MARKET PLACE, AND HAS UNIQUE CHARACTERISTICS
THAT NEED TO BE UNDERSTOOD.
VALUATION - THE PROCESS OF ESTIMATING MARKET VALUE, WHICH CONSISTS OF
MANY THINGS.
IT IS THE MOST PROBABLE CASH PRICE, IN A COMPETITIVE
MARKET, WITH THE BUYER AND SELLER ACTING PRUDENTLY, WITH KNOWLEDGE, IN
SELF-INTEREST, AND WITHOUT DURESS.
THE BUYER AND THE SELLER MUST BE MOTIVATED AND WELL-INFORMED. SPECIAL
FINANCING CAN CLOUD THE VALUE OF THE PROPERTY. WHEN SOMEONE PUTS DOWN
25% HE MEANS BUSINESS. IF IT IS SOLD AT 0% DOWN, THEN THE PROPERTY IS
BEING SOLD AT AN ACCOMMODATION PRICE, AND THE VALUE SHOULD BE ADJUSTED
ACCORDINGLY TO A DISCOUNT.
EVALUATION - ADDRESSES SUPPLY AND DEMAND IN A MARKET PLACE. WHEN YOU DO A
MARKET STUDY, YOU MUST TRY TO UNDERSTAND HOW THE MARKET WORKS....WHEN
THINGS HAPPEN. IE. AFTER OCTOBER 87 AND THE STOCK MARKET CRASH, IT COULD
HAVE BEEN SAID THAT THE MARKET FOLLOWING IS AN ENTIRELY DIFFERENT MARKET
THAN THAT WHICH HAD PRECEDED IT.
AN IMPETUS THAT
CAN CHANGE MARKETS
POSITIVELY WOULD BE A CHANGE IN THE DEPRECIATION RATE OF REAL ESTATE THAT
ALLOWS ACCELERATION.
"PEOPLE CREATE AND DESTROY VALUE".
MARKET.

OUTLOOK HAS A DEFINITE

IMPACT ON THE

KNOW THE CHARACTERISTICS OF MARKET STRUCTURE.

IE. CLASS A, CLASS B, AND CLASS C ARE ALL OFFICE SPACE, YET THEY ARE NOT
INTER-RELATED IN EVALUATION. THEY ARE DIFFERENT CLASSES OF REAL ESTATE.
FOR EXAMPLE, IN NOTICING THAT CLASS B SPACE IN NEW JERSEY IS SIMILAR IN
PRICE TO THAT OF CLASS B SPACE IN NEW YORK CITY, YOU CAN POSIT THAT NEW
JERSEY CLASS B SPACE WILL LIKELY SUFFER ABSORPTION PROBLEMS. THIS WOULD
NOT BE A GOOD EXTRAPOLATION TO MAKE ABOUT CLASS A OR C SPACE WITHOUT
FIGURES TO SUPPORT IT, HOWEVER.

221

REAL ESTATE - THE PHYSICAL COMPONENTS OF LAND AND BUILDING.

REAL PROPERTY - THE THINGS YOU DO NOT SEE- VIOLATIONS, TAXATION, BUILDING
CODES. THEY ARE THINGS YOU DON'T SEE BUT THAT YOU ARE RESPONSIBLE FOR.
PERSONAL PROPERTY - WHEN YOU REMOVE IT FROM THE REAL ESTATE DO YOU CREATE
INJURY. IF NOT, IT IS PERSONAL PROPERTY RATHER THAN REAL PROPERTY.
COST DOES NOT DETERMINE VALUE.
PRICE IS WHAT A PARTICULAR PURCHASER
AGREES TO PAY AND WHAT THE PURCHASER AGREES TO ACCEPT.
IT IS WHOLLY
SUBJECTIVE RATHER THAN OBJECTIVE.
INVESTMENT VALUE- THE VALUE OF AN INVESTMENT TO A PARTICULAR INVESTOR.
LIQUIDATION VALUE - THE PRICE THAT OWNERS ARE COMPELLED TO SELL FOR IN A
DOWN MARKET. IT IS A VALUE NOT BASED ON PRUDENCE. IT IS BASED ON PANIC.
PEOPLE BUY REAL ESTATE BASED ON ANTICIPATION OF GAIN RATHER THAN ON
ANNUAL RETURN.
"PRESENT WORTH" FOR FUTURE ANTICIPATION IS WHAT YOU MUST ANALYZE.
YOU
MUST UNDERSTAND WHAT THE MARKET WILL BE LIKE WHEN THE PRODUCT COMES ON
LINE AFTER THE CONSTRUCTION PERIOD.
THE VALUATION PROCESS:
DATE OF VALUE ESTIMATE - THE DAY YOU INSPECT THE REAL ESTATE, NOT THE
DATE YOU ISSUE THE APPRAISAL REPORT.
"VALUE IS AN ART, NOT A SCIENCE. CALCULATORS DO NOT REALLY SOLVE THE
QUESTION OF VALUE COMPLETELY".
COST METHOD OF EVALUATION IS RARELY USED, EXCEPT FOR PRODUCTS THAT ARE
NOT DESIGNED TO GENERATE INCOME, SUCH AS A LIBRARY.
FROM SALES, YOU CAN EXTRACT UNITS OF COMPARISON. I.E. FINDING OUT GROSS
AREA OF BUILDINGS AND NUMBERS OF UNITS CAN HELP YOU TO FIND A COMPARATIVE
PRICE PER S.F. OR PER UNIT.
INCOME CAPITALIZATION - PEOPLE WHO BUY REAL ESTATE ARE INTERESTED
IN
REVENUE FLOW.
RATES DEPEND ON WHETHER LEASES ARE ROLLING OVER INTO A
WEAK OR A STRONG MARKET, MAINTENANCE PROGRAMS, ETC.
"A" RATED
UTILITY BONDS ARE USED AS A BASE MEASURE WHEN RISK IS AN
ISSUE. WHEN RISK IS NOT AN ISSUE, U.S. TREASURY BONDS ARE CONSIDERED A
GOOD RATE, SUCH AS WHEN THE LEASE IS ISSUED TO A GOVERNMENT AGENCY.
DISCOUNT RATES DEPEND ON THE QUALITY OF THE TENANTS AMONGST OTHER THINGS.
IE. 13% DISCOUNTS WITH A 9 3/4% REVERSION RATE.
250,000

S.F.

OF

OFFICE

SPACE

IS

"MANAGEABLE".

222

MORE

THAN

THAT

IS

DIFFICULT TO MANAGE, AND IS THEREFORE A BIGGER RISK.

END OF GUEST SPEAKER'S LECTURE

LOOK TO PREVIOUS LESSONS FOR MORE ON THE FOLLOWING EXAMPLES

NET AVAILABLE

1989
197,000

AFTER TAX

160,729

1990
1991
1992
81,900119,018*
400155
4,357,243
61,3933,848,601

USING A 10 PERCENT DISCOUNT RATE, WHAT IS THE NPV?

PURCHASE = 2.5 MILLION DOLLARS
NPV = 1,109,858 DOLLARS
AFTER TAX NPV = 588,366
IRR AFTER TAX = 18.37%
IRR BEFORE TAX = 25.03%
INITIAL CAP RATE = NOI / PURCHASE PRICE
TERMINAL CAP RATE = NOI / SALE PRICE
* 4,357,243 IS THE SALE PRICE, WHICH WHEN ADDED TO THE 119,018 CASH FLOW
GIVES A TOTAL CASH FLOW OF 4,476,261 DOLLARS.
PRICE PER S.F. IS A MEASURE OF VALUE IN THAT YOU CAN LOOK AT THE
REASONABLENESS OF THE PROPOSED PURCHASE PRICE.
IE. 36,000,000 / 175,000 S.F. = 205 DOLLARS PER S.F.
I WOULD HAVE TO EARN 20.50 DOLLARS PER S.F. TO GET FINANCING.
IF
OPERATING EXPENSES ARE 8.00 DOLLARS PER S.F., AND THE RESULTING 28.50
DOLLARS PER S.F. IS OVER THE MARKET LEVEL OF RENT, THE PROPERTY IS OVERPRICED.
IF MARKET RENT IS 21 DOLLARS PER S.F., THEN SUBTRACT 8.00
DOLLARS PER S.F. OPERATING EXPENSES TO ARRIVE AT 13 DOLLARS PER S.F.
13.00 X 175,000 S.F. = 2,275,000 / 10 PERCENT = 22,750,000 SALES PRICE.
CAP CONTRACT - A CAP OF INTEREST AT LIBOR, PRIME, COMMERCIAL PAPER OR
OTHER INDEX FOR PRICING OF SHORT-TERM PAPER PLUS A BASIS POINT FACTOR.
YOU ARE BUYING A FINANCIAL INSTRUMENT THAT AMOUNTS TO AN INSURANCE POLICY
TO INSURE THE LARGEST INTEREST INCREASE POSSIBLE BEFORE INTEREST IS
EFFECTIVELY FIXED.

223

COLLAR CONTRACT - A CAP CONTRACT SETS THE CEILING.

GOVERN THE FLOOR.

COLLAR CONTACTS

CAP CONTRACTS AND COLLAR CONTRACTS ARE FINANCIAL INSTRUMENTS. THE BANK
WANTS TO KNOW, THESE DAYS, THAT YOU HAVE A CEILING ON THE INTEREST RATE
YOU ARE PAYING BECAUSE THEY WANT TO BE CERTAIN YOU CAN CONTINUE TO MAKE
THE PAYMENTS.
AN 8.5 PERCENT COLLAR WITH A TEN PERCENT CAP IS TYPICAL. THE DEVELOPER
BUYS THE CAP AND SELLS THE COLLAR. IF I AM PAYING 7.5 PERCENT, I PAY
SOMEONE ELSE THE 1 PERCENT DIFFERENCE BETWEEN 8.5 AND 7.5 PERCENT. IF I
AM PAYING 11 PERCENT, I AM PAID THE ONE PERCENT MARGIN BETWEEN THE TEN
PERCENT CAP AND THE 11 PERCENT RATE BUY THE PERSON I BOUGHT THE 10
PERCENT CAP FROM.
INTEREST RATE SWAPS ARE WHEN YOU TAKE A FLOATING RATE AND EXCHANGE IT
FOR A FIXED RATE WITH AN INTERMEDIARY BANK, WHO BUYS THE FIXED RATE FROM
THE ISSUER OF THE FIXED RATE. IF YOU ARE PAYING A LIBOR + ONE FLOATING
RATE AT 9.25 PERCENT, YOU TAKE THE SWAP COST OF 55 BASIS POINTS, ADD IT
TO THE TREASURY BOND RATE AND ADD THE + ONE MARGIN FROM YOUR FLOATING
RATE LOAN TO ARRIVE AT THE NEW FIXED RATE.
TREASURY BOND = 8.25 PERCENT (AS PER APPLICABLE 5,7 OR 10 YR. T-BILL
RATE)
SWAP COST =
0.55 PERCENT
CREDIT SPREAD = 1.00 PERCENT
9.80 PERCENT FIXED RATE
IF THE LIBOR + ONE FACTOR GOES UP TO 13 PERCENT, THEN YOU PAY YOUR
FLOATING RATE AT THIRTEEN PERCENT AND ARE IMMEDIATELY REIMBURSED FOR THE
SPREAD OF 3.2 PERCENT BY THE INTERMEDIARY BANK GIVING YOU AN EFFECTIVE
FIXED RATE OF 9.8 PERCENT. THE INTERMEDIARY BANK IS BETTING THAT RATES
WONT GO UP. IF THEY GO DOWN, YOU OWE THEM.
END OF CLASS SEVEN
CLASS EIGHT
10/30/90
CLASS DISCUSSION - ANGUS CARTWRIGHT
STEP ONE - DEFINE OBJECTIVES
MARTHA DeRIGHT
1. DIVERSIFICATION
2. DOES NOT NEED THE INCOME, SO SHE IS LOOKING FOR CAPITAL APPRECIATION.
3. NEEDS PROFESSIONAL MANAGEMENT
4. MINIMUM RETURN OF 12 PERCENT.
5. CAN DO A RISKIER INVESTMENT BECAUSE SHE DOES NOT HAVE TO WORRY ABOUT
CASH FLOW.

224

6. HAS 2.5 MILLION DOLLARS TO INVEST.

JAMES DeRIGHT
1.
2.
3.
4.

DIVERSIFICATION
NEEDS CASH FLOW - SHELTERED
LESS RISKY
1.6 MILLION AVAILABLE FOR INVESTMENT.

ALISON GREEN
100 UNITS, GARDEN APARTMENTS, BUILT IN 1984, 97 PERCENT LEASED, IN AN
AREA WHERE EXISTS A SEWER MORATORIUM, THEREBY LIMITING FUTURE
COMPETITION. ADDITIONAL EQUITY MIGHT BE REQUIRED DUE TO POTENTIAL NEED
FOR IMPROVEMENTS. ALISON GREEN HAS FAVORABLE MORTGAGE TERMS.
STONY WALK
46,000 RENTABLE
MORTGAGE.

S.F.,

BUILT

IN

1978,

97

PERCENT

OCCUPIED,

20

YEAR

IVY TERRACE
80 UNIT GARDEN APARTMENTS, UNDER CONSTRUCTION.
BUILT ON A 99 YEAR
LEASEHOLD WITH PAYMENTS OF 20,000 DOLLARS ANNUALLY. 3 YEAR GUARANTEE ON
95 PERCENT OCCUPANCY.
FOWLER BUILDING
50,000 NET RENTABLE S.F., UNDER CONSTRUCTION, 80 PERCENT PRELEASED, 3
YEAR GUARANTEE, 99 YEAR LEASEHOLD AT 55,000 DOLLARS ANNUALLY.
STEP TWO - LOOK AT THE INCOME STATEMENT

ALISON GREEN

STONY WALK

GROSS RENT
600,000 470,000
VACANCY 18,000
14,100
582,000 455,900

IVY TERRACE

560,000

FOWLER BUILDING

550,000
28,000

532,000

27,100
522,500

OP. EXP.
TAXES

158,000 80,100
84,000
65,800

142,800

76,500

NOI

340,000 310,000

322,000

380,000

FINANCING
LEASE PMT.

268,125 282,550
0
0

264,560

299,060
20,000

55,000

PRETAX CF

71,880

37,440

23,936

67,200

27,450

225

66,000

EQUITY
DEBT RATIO

800,000 400,000
75%
85%

CAP AT PRCH.
CAP AT SALE
CASH ON CASH
INCR. IN VAL

10.63%
9.69%
8.98%
46.9%

NPV
IRR
PROF. INDEX

494,500 381,025
22.01
25.5
61.81
95.26

500,000

11.7%
12.22%
6.86%
28.3%
359,469

1,000,000
82%

72%

11.5%
11.66%
7.49%
32.14%

10.56%
8.49%
2.59%
66.67%

571,620
23.51
71.89

20.42
57.16

FINANCING OF REAL ESTATE

SEE BOOK ON PAGE 598: FLOW OF FUNDS CONCEPT, AND SOURCES OF DEBT AND
EQUITY IN THE ECONOMY.
SOURCES
USES

HOUSEHOLDS (SAVINGS)

HOUSEHOLDS

BUSINESS (EARNINGS)
> CONSUMER DURABLES

NET FOREIGN INVESTMENT

RESIDENCES

OTHER USES

BUSINESS

PLANTS & EQUIP.

PRIMARY FINANCIAL INTERMEDIARIES
INVENTORY LEVELS
\/
OTHER USES

DEMAND DEPOSITS
COMMERCIAL BANKS

NOW ACCOUNTS
SAVINGS & LOANS

> SAVINGS ACCOUNTS MUTUAL SAVINGS

/\
TIME DEPOSITS
BANKS

RESERVES: LIFE INSURANCE COMPANIES

RESERVES: PENSION FUNDS AND TRUSTS

SHARES: CREDIT UNIONS

GOVERNMENT

SHARES: INVESTMENT COMPANIES

REAL ESTATE INVESTMENT TRUSTS
/\

MORTGAGE COMPANIES

OTHERS

FEDERAL

RESERVE

/\

226

\/\/

CONSUMER LOANS

HOUSEHOLDS: MORTGAGE LOANS

OTHER ASSETS

\/

FINANCIAL>
BUSINESS:
MORTGAGE LOANS

ASSETS

COMMERCIAL PAPER

BANK LOANS

CORPORATE STOCKS AND BONDS

GOVERNMENT: US GOVERNMENT OBLIGATIONS

STATE AND LOCAL OBLIGATIONS

ISSUES OF FEDERAL AGENCIES

/\

MULTIPLIER EFFECT
THE FEDERAL GOVERNMENT, THROUGH THE FEDERAL RESERVE MARKET COMMITTEE,
REGULATES THE SUPPLY OF FUNDS TO THE ECONOMY.
THE FEDERAL RESERVE
REGULATES AVAILABLE CASH BY:
1. REGULATING BANK'S RESERVE REQUIREMENTS
2. DISCOUNT RATE CHARGED TO BANKS
3. OPEN MARKET OPERATION
OPEN MARKET OPERATION - WHEN THE FED GOES TO THE MARKET AND FORCES BANKS
TO SELL GOVERNMENT SECURITIES IN THE OPEN MARKET.
WHEN THE SALE IS
FORCED, IT MAKES THE BANK LIQUIDATE ITS RESOURCES BY BUYING SECURITIES,
THEREBY REACHING LOWERING ITS RESERVES AND THE AMOUNT AVAILABLE FOR
LENDING. THIS IN TURN REDUCES THE LIQUIDITY OF THE SYSTEM. BECAUSE LESS
IS AVAILABLE TO LEND, CASH IS DRAWN OUT OF THOSE WHO WOULD OTHERWISE
BORROW AND PLACE THERE CAPITAL IN A BANK ACCOUNT. THEY PAY CASH, WHICH
IN TURN PUTS LESS IN THE RESERVES. THE OPPOSITE CAN ALSO TAKE PLACE AS A
METHOD OF DECREASING RATES. THROUGH THIS REGULATION OF FLOWS, THE FEDS
GOVERN THE AVAILABILITY AND COST OF FUNDS, AS WELL AS THE LIQUIDITY OF
THE BANKING SYSTEM.
WHEN THE FED LOWERS THE FEDERAL FUNDS RATE (ALSO CALLED THE "FED FUNDS
RATE", THIS IS THE RATE THAT BANKS USE WHEN BORROWING FROM EACH OTHER) BY
ADDING MONEY TO THE SYSTEM, SHORT TERM RATES HEAD DOWNWARD.
LONDON INTERBANK OFFERING RATE (LIBOR) - A MARKET RATE FOR CASH, OFTEN
USED IN FINANCING AS A BASIS FOR APPLYING A SPREAD TO ARRIVE AT AN
INTEREST RATE.

227

LIBOR OPTION - PRICED AT A HIGHER SPREAD OVER LIBOR THAN WOULD BE TYPICAL
OF A PRIME RATE SPREAD IN A PRIME OPTION. IE. LIBOR + (RANGE OF 100 TO
200 BASIS POINTS) = 9 TO 10 PERCENT WHEN LIBOR IS AT 8 PERCENT.
PRIME OPTION - PRICED AT 0 TO 1 PERCENT SPREAD.
WHEN PRIME IS AT TEN PERCENT.

IE. 10 TO 11 PERCENT

FINANCIAL INTERMEDIARIES
COMMERCIAL BANKS
SAVINGS AND LOANS
MUTUAL SAVINGS BANKS
INSURANCE COMPANIES
PENSION FUNDS
FINANCE COMPANIES
CREDIT UNIONS
MORTGAGE BANKERS
REITS
ALL OF THESE LENDERS CAN LEND OR INVEST MONEY
INVESTMENT COULD BE THROUGH EQUITY OR THROUGH DEBT.

FOR

REAL

ESTATE.

IN LOOKING AT THE RAISING OF EQUITY CAPITAL, THE MOST OBVIOUS SOURCE IS A

JOINT VENTURE. ANY OF THE ABOVE CAN BE INVOLVED IN A JOINT VENTURE. IN
THE GUISE OF A SUBORDINATE, CONVERTIBLE OR OTHER MORTGAGE, COMMERCIAL
BANKS MAY BE, IN ESSENCE, JOINT VENTURERS.
INSURANCE COMPANIES WILL
EITHER OWN OUTRIGHT OR JOINT VENTURE.
GUARANTEED INVESTMENT CONTRACT (GIC) - OFTEN REFERRED TO BY ACRONYM,
RHYMES WITH "STICK".
MUCH OF THE INSURANCE COMPANY INVESTMENTS IN THE
1980'S WERE THROUGH GICS. IT IS A TYPE OF GUARANTEED RETURN. GICS ARE A
PRODUCT THAT ONLY INSURANCE COMPANIES ISSUE. IT IS AN INSURED RETURN.
PENSION FUNDS - INVEST PRIMARILY IN EQUITY
FINANCE COMPANIES - NOT BIG EQUITY PLAYERS, EXCEPT FOR
FINANCE COMPANIES; MAY GIVE PARTICIPATING MORTGAGES.

THE BIGGEST

IN THE EARLY 1970'S, THERE WERE SIGNIFICANT EQUITY DEVELOPMENT FINANCING

THROUGH REITS. IT WAS ONE OF THE BEST WAYS OF INVESTING IN REAL ESTATE.
IN
THE
1980'S,
WE
HAD
SPECULATIVE
SYNDICATIONS
USING
LIMITED
PARTNERSHIPS.
IN THE 1990'S, HOPEFULLY, THERE WILL BE THE
INVESTOR (DUTCH, ENGLISH, JAPANESE, SWEDISH).

GROWTH

OF

THE

FOREIGN

AS A DEVELOPER, IF I AM GOING TO ATTRACT EQUITY WITHOUT PUTTING MY OWN

MONEY INTO IT, WHAT DO I HAVE TO OFFER THE EQUITY SOURCE?

228

1. A PREFERRED RETURN, IE. 8 TO 10 PERCENT.

ON A 100,000,000 INVESTMENT, WITH 60 PERCENT PRELEASED, I CAN GET A
70,000,000 DOLLAR LOAN. EQUITY WILL BE 30,000,000 DOLLARS, TO BE FOOTED
BY THE EQUITY PARTNER. IN TURN, WE ARE OFFERING A 50 PERCENT INTEREST IN
THE PROPERTY.
A CUMULATIVE PREFERENTIAL RETURN IS WHEN THE CASH FLOW IS NOT THERE TO
MAKE DEBT PAYMENTS, SO IT ACCUMULATES WITH INTEREST UNTIL THE CASH FLOW
OR SALE CAN PROVIDE THE RETURN.
2. 50 PERCENT OF THE CASH FLOW
3. 50 PERCENT OF THE RESIDUAL
A LOOK BACK INTERNAL RATE OF RETURN IS A
EXAMPLE, I WILL GUARANTEE YOU, AN EQUITY
INTERNAL RATE OF RETURN, AND YOU WERE AT
RETURN WITH 50 PERCENT OF THE CASH FLOW AND

GUARANTEE OF A RETURN.
FOR
PARTNER, A 12 PERCENT TARGET
A 8 TO 10 PERCENT PREFERRED
RESIDUAL.

BY YOU TAKING THE CASH FLOW ON THE RESIDUAL OF MY RETURN BASED ON THE 12
PERCENT RETURN UNTIL THE RETURN TO YOU IS EQUAL TO 12 PERCENT (WHEN
CONSIDERING THE RESIDUAL RATE OF THE CASH FLOWS AND SALE), YOU ARE
GETTING A 12 PERCENT LOOK BACK INTERNAL RATE OF RETURN. IF THE VALUE OF
THE IRR COMES TO 11 PERCENT, THEN THE PARTNER TAKES OUT FROM MY RESIDUAL
UNTIL A RATE OF 12 PERCENT IS ARRIVED AT.
THE PARTNER WANTS THE MANAGER TO WORK FOR THE RESIDUAL. IF THE EQUITY
PARTNER MAKES THE TERMS TOO ONEROUS, HE WOULD NOT BE GIVING THE
MANAGER/DEVELOPER THE STAKE NEEDED TO PROVIDE HIM THE INCENTIVE TO MANAGE
THE PROPERTY PROFITABLY.
END OF CLASS EIGHT
CLASS NINE
11/6/90
FINANCING CASE HANDED OUT TODAY.
IT IS DUE ON TUESDAY THE 27TH OF
NOVEMBER. THE QUESTION TO ANSWER IS, "WOULD YOU APPROVE THE LOAN, ITS
TERMS AND CONDITIONS?
IF YOU REJECT OR SUPPORT THE LOAN, GIVE THE
REASONS WHY. IF YOU WANT TO UPDATE THE MARKETING INFORMATION YOU MAY,
BUT IT IS NOT NECESSARY. YOU HAVE AN EMPTY BUILDING THAT HAS JUST BEEN
PURCHASED.
THE DEVELOPER WANTS TO RENOVATE IT AND MAKE IT A CLASS A
SPACE".
TONIGHT, WE WILL GO THROUGH "CREDIT ANALYSIS", AND THE INSTITUTIONS AND
THEIR METHODS OF LENDING MONEY. ALSO, WE WILL TALK ABOUT THE DIFFERENT
FORMS OF LOANS.
DISINTERMEDIATION AS INTEREST RATES WENT UP IN THE MID 1970'S, THE
SAVINGS AND LOANS WHO INVEST IN HOME MORTGAGES COULD ONLY RECEIVE UP TO

229

5.5 PERCENT INTEREST FROM DEPOSITORS, YET CERTIFICATES OF DEPOSIT WERE

PAYING AS MUCH AS 17 TO 18 PERCENT. REGULATION D WAS ANNULLED TO ALLOW
S&L'S TO OFFER HIGHER RATES IN SAVINGS ACCOUNTS TO SAVERS. TO PAY THE
HIGHER RATES, THE S&L'S TOOK GREATER RISKS.
DISINTERMEDIATION IS WHEN
BANKS PAID OUT MORE IN THESE INTEREST PAYMENTS THAN THEY WERE RECEIVING
IN RETURN FROM THEIR ASSET PORTFOLIOS.
INSURANCE COMPANIES HAVE TWO WAYS OF SUPPLYING FUNDS TO REAL ESTATE
INVESTORS:
1. GENERAL ACCOUNT MONEY - FROM INSURANCE PREMIUMS
2. OTHER MONEY - FROM GICS, OR FROM FEES FOR MANAGING AND ADVISING
PENSION FUNDS.
WHEN YOU GO TO AN INSURANCE COMPANY AND THEY APPROVE YOUR LOAN, THEY HAVE
TO PUT THE FUNDING IN PLACE. IF YOU HAVE A TEN YEAR LOAN, THEY NEED TEN
YEAR MONEY.
SOME MAY ONLY HAVE 5 YEAR MONEY, WHILE OTHERS ONLY TEN
MONEY. IF COMPANIES FEEL INTEREST RATES WILL BE GOING HIGHER, THEY WILL
INVEST SHORT. IF THEY BELIEVE THE OPPOSITE THEY WILL INVEST LONG TERM
( IE., IN TEN YEAR INVESTMENTS AS OPPOSED TO 5 YEAR INVESTMENTS).
INSURANCE
MOST LEND
OFF OF A
CLOSES AT
POINTS TO

COMPANIES TEND TO BE MULTI-TERM LENDERS, FROM 5 TO 30 YEARS.

BETWEEN 5 TO 15 YEARS. THEY ARE A FIXED RATE LENDER, PRICING
SPREAD OVER THE TERM TREASURY BILLS.
IF A 10 YEAR TREASURY
8.5 PERCENT, ADD A SPREAD FOR AN A RATED DEAL OF 150 BASIS
EQUAL A 10 PERCENT RATE (AS AN EXAMPLE).

SPREADS HAVE INCREASED FROM 90 TO 110 BASIS POINTS LAST YEAR ON TRIPLE A
INVESTMENTS TO 140 BASIS POINTS TODAY.
THIS INCREASE IN SPREAD IS A
RESULT OF FEAR, AND AN ATTEMPT TO MAKE UP FOR LOST PROFITS.
INSURANCE COMPANIES DO NOT LIKE PREPAYMENT. IF YOU PREPAY, THEY WILL USE
A YIELD MAINTENANCE FORMULA TO PENALIZE YOU FOR THAT PREPAYMENT.
IF THE RATE ON A 10 YEAR LOAN IS 10 PERCENT AND YOU PREPAY WHEN THE 10
YEAR TREASURY RATE IS 8 PERCENT, YOU WOULD BE OBLIGATED TO PAY THE 2
PERCENT DIFFERENCE FOR THE NUMBER OF YEARS REMAINING ON THE LOAN X THE
LOAN AMOUNT. IT IS A MATTER OF NEGOTIATION IF THIS IS TO BE PAID AT THE
PRESENT VALUE OF THE ANNUITY OR AT FACE VALUE.
INSURANCE COMPANIES WILL LEND ON ANY TYPE OF REAL ESTATE.
LOAN TO VALUE RATIOS OF 75 PERCENT.

THEY REQUIRE

INSURANCE COMPANIES LIKE AMORTIZATION. THEY MAY, HOWEVER, ALLOW INTEREST

ONLY PAYMENTS FOR THE FIRST 2 OR 3 YEARS OF A LONG TERM LOAN IF CASH
FLOWS ARE NOT ADEQUATE TO MAKE THE PAYMENT.

COMMERCIAL BANKS HISTORICALLY HAVE BEEN SHORT TERM INTERIM LENDERS.

230

FOR

EXAMPLE, THEY LEND ON CONSTRUCTION LOANS,

FINANCING FROM 7 TO 10 YEARS IN DURATION.

MINI-PERMS,

AND

BRIDGE

A MINI-PERM FINANCING TAKES THE PROJECT THROUGH THE 2 TO 3 YEAR LEASE-UP

PERIOD.
BRIDGE FINANCING COULD BE AN ACQUISITION LOAN WHERE MONEY IS ADVANCED TO
THE PROJECT. LASTS 1 TO 7 YEARS.
COMMERCIAL BANKS OFFER FLOATING RATES (VARIABLE RATES) BASED ON A SPREAD
OVER PRIME, LIBOR, FED FUNDS, CD INDEX OR OTHER OBJECTIVE STANDARD.
FLOATING RATES CAN BE FIXED WITH SWAPS, COLLARS, AND CAPS, WHICH ARE ALL
TYPES OF HEDGES. A HEDGE IS A TERM THAT DESCRIBES A FINANCIAL INSTRUMENT
THAT IS PUT INTO PLACE TO BUFFER THE EFFECTS OF AN UNEXPECTED CHANGE IN A
VARIABLE RATE.
COMMERCIAL BANKS WILL ALLOW PREPAYMENT IN MOST CASES. USUALLY COMMERCIAL
BANKS DO NOT REQUIRE AMORTIZATION, AS NO ASSET IS LIKELY BUILT YET THAT
CAN EARN A CASH FLOW. THEY REQUIRE 75% LOAN TO VALUE RATIO OR LOWER.

SAVINGS AND LOANS ARE SIMILAR TO COMMERCIAL BANKS. THEY BOTH BUY THEIR
MONEY. THEIR LIABILITIES ARE IN CERTIFICATES OF DEPOSIT OR FLOATING RATE
OBLIGATIONS, WHICH IS WHY THEY NEED FLOATING RATES ON THEIR DEBT TO
COMBAT DISINTERMEDIATION TENDENCIES. 70 PERCENT OF S&L ASSETS HAVE TO BE
IN RESIDENTIAL MORTGAGES.
PENSION FUNDS CAN DO EQUITY PARTICIPATIONS AS WELL AS DEBT LENDING. THEY
LIKE PARTICIPATION AND CONVERTIBLE LENDING. THEY ARE NOT USUALLY DIRECT
LENDERS. THEY LOOK FOR A 9 TO 12 PERCENT INTERNAL RATE OF RETURN AT 5 TO
10 YEAR TERMS.
REITS- REAL ESTATE INVESTMENT TRUSTS - THEY LOOK FOR HIGH RETURNS.
TO PREVIOUS NOTES.

REFER

MASTER LIMITED PARTNERSHIPS - MLP'S CAN BE FORMED AS SUCH IN THE

BEGINNING, OR BY A PROCESS CALLED ROLL-UP. ROLL-UPS ARE THE AGREEMENT OF
THE PARTNERS OF SEPARATE LIMITED PARTNERSHIPS TO CONVERT THEIR ASSETS
INTO SHARES OF A LARGER MASTER LIMITED PARTNERSHIP. SOME ROLL-UPS GIVE
EQUIVALENT, LESSER, OR GREATER VALUE IN SHARES TO VALUE. THE NEW SHARES
ARE PLACED ON THE MARKET AND CAN BE SOLD, THEREBY GRANTING THE BENEFIT OF
LIQUIDITY. THE ASSET NEED NOT BE SOLD TO PULL EQUITY BACK OUT. A TOTAL
OF 51 PERCENT OR MORE OF THE PARTNERS MUST AGREE TO JOIN A MLP.
THE
REASON FOR JOINING AN MLP, OTHER THAN LIQUIDITY, IS THAT THE SUM OF
PARTNERSHIP ASSETS IS GREATER THAN THE PARTS DUE TO SUPERIOR DIVERSITY OF
INVESTMENT.

231

MLP'S ARE BASICALLY THE SAME AS REITS, EXCEPT THAT THEY ARE NOT REGULATED
BY THE TAX CODE AND DO NOT HAVE SPECIAL TAX BENEFITS.
************************************************************************
UNDERWRITING - ANOTHER WORD FOR CREDIT ANALYSIS.
THE CREDIT ANALYST (OR LENDER, LOAN OFFICER, CREDIT LENDER, ETC.) DRAWS
HIS DECISION FROM THE FOLLOWING DATA:
CASH FLOW ANALYSIS
LOAN ANALYSIS
EVALUATION
ARCHITECT'S OR ENGINEER'S STUDY
LEGAL ISSUES OF THE PROPERTY
FINANCIAL ANALYSIS
THESE RESULT IN THE CREDIT ANALYSIS. A GENERIC CREDIT ANALYSIS CONSISTS
OF AT LEAST FIVE ITEMS, CALLED THE FIVE P'S OF CREDIT ANALYSIS.
THEY
ARE:
1.
2.
3.
4.
5.

PEOPLE
PURPOSE
PAYMENT
PROTECTION
PERSPECTIVE

PEOPLE - VERY IMPORTANT TO ANY LENDER TRANSACTION.

"PEOPLE" PAY BACK
LOANS, NOT PROPERTIES. NO MATTER HOW GOOD AN INVESTMENT, BAD PEOPLE DO
NOT PAY. NO MATTER HOW BAD AND INVESTMENT, GOOD PEOPLE ALWAYS PAY.
THINGS TO EXAMINE:
THE LEGAL STRUCTURE OF THE BORROWER; GUARANTEES; CONTRACTORS AND
SUBCONTRACTORS; TENANTS AND TENANT MIXES (RELATION TO THE MARKET), ARE
THERE ANY TAKE OUTS ON THE CONSTRUCTION LOAN; WHAT ARE THE MOTIVES OF THE
INVESTOR; IS HE RELIABLE; WHAT IS THE DEVELOPER'S BACKGROUND.
PURPOSE - WHAT IS THE PURPOSE OF THE PRODUCT WITHIN THE MARKET PLACE?
REGARDLESS OF USE, HOW DOES THE PRODUCT FIT INTO THE MARKET PLACE? WHAT
IS THE DESIGN OF THE BUILDING, AND HOW DOES IF FIT INTO THE MARKET?
PAYMENT- THE ABILITY OF THE PROJECT TO REPAY THE DEBT.

232

LOOK AT EFFECTIVE

RENTS, CONSIDERING ALL FREE RENTS AND SPECIAL TENANT WORK. LOOK AT THE
MARKET, MARKET RENTS, MARKET AREAS, TENANT MIXES, 3 TO 4 YEAR BREAK EVEN
ANALYSIS ON HOTEL DEVELOPMENTS, ETC.
ONCE CASH FLOW ANALYSIS IS DONE, YOU CAN DETERMINE THE REFINANCE RISK.
WHAT HAPPENS IF THE TENANT DOES NOT RELEASE? YOU WOULD RATHER HAVE, FOR
EXAMPLE, A FIVE YEAR LOAN AGAINST A 10 YEAR LEASE THAN A 5 YEAR LOAN
AGAINST A 5 YEAR LEASE.
YOU HAVE TO BE COMFORTABLE THAT YOU CAN
REFINANCE THE BUILDING IF, FOR EXAMPLE, LEASES ROLL OVER INTO LOWER RENT
THAN THAT AVAILABLE ON THE MARKET TODAY.
PROTECTION- SECURITY OF THE LOAN BASED UPON THE CERTAINTY OF FUTURE
INCOME AND EXPENSES.
AFTER 1990, ALL INVESTMENTS TOUCHED BY FEDERAL
MONEY, BE IT A FHA LOAN, OR EVEN FEDERAL INSURANCE FOR A BANK, MUST BE
APPRAISED BY A CERTIFIED APPRAISER HIRED BY THE BANK, NOT THE LOAN
APPLICANT.
YOU WILL WANT AT LEAST A 75 PERCENT LOAN TO VALUE RATIO, ALTHOUGH UP TO
95 PERCENT IS OCCASIONALLY JUSTIFIABLE WITH THE APPROPRIATE GUARANTEES
AND INTEREST RATES.
POSSIBLE GUARANTEES ARE COMPLETION GUARANTEES,
PAYMENT GUARANTEES, DEBT SERVICE GUARANTEES, AND TAXES & INSURANCE
GUARANTEES. IF A LETTER OF CREDIT IS PURCHASED BY THE APPLICANT, WHAT IS
THE QUALITY OF THE INSTITUTION GRANTING THE CREDIT?
A LENDER MAY REQUIRE A TAKE-OUT LOAN, ALSO CALLED A BUY AND SELL
AGREEMENT OR A TRI-PARTY BUY AND SELL AGREEMENT. THIS IS WHEN THE LENDER
ENTERS AN AGREEMENT WITH THE BORROWER AND THE TAKE-UP LENDER THAT SPELLS
OUT THE ROLES OF EACH, AND GUARANTEES THAT THE INITIAL LENDER WILL AGREE
TO SELL THE MORTGAGE TO THE TAKE OUT LENDER WHO IN TURN GUARANTEES THAT
THEY WILL BUY IT. THE BORROWER AGREES TO THIS HAPPENING.
TAKE OUT LENDERS USE TO PROVIDE STAND-BY COMMITMENTS WHEREBY FOR A FEE
THEY WOULD SAY THEY WOULD TAKE THE TAKE OUT LOAN WHEN IN PRACTICE THEY
NEVER WOULD. THIS IS WHY STAND-BY COMMITMENTS ARE NOT ACCEPTABLE.
YOU GO TO THE TAKE-OUT LENDER FIRST, GETTING A FIRM COMMITMENT WITHOUT
ONEROUS CONDITIONS (IE. 80% LEASED PROPERTY). UPON COMPLETION, WITH NO
LEASING CONTINGENCY, A CONSTRUCTION LENDER WILL BE MORE COMFORTABLE ABOUT
GIVING YOU A CONSTRUCTION LOAN.
YOU APPROACH THE CONSTRUCTION LENDER
AFTER SECURING THE TAKE-OUT LOAN.
PERSPECTIVE - LOOKING AT THE OVERALL PROJECT AND EVALUATING THE RISKINESS
OF THE PROJECT. ONCE YOU EVALUATE RISK, YOU EVALUATE REWARD ALSO WITH A
RISK/REWARD ANALYSIS. YOU HAVE TO DETERMINE WHAT PRICING OF THE PROJECT
OVERCOMES THE BASIC HURDLES OF RISK OF GETTING INVOLVED. REWARDS CAN BE
MEASURED IN FEES (IE., 1/2 TO 1 PERCENT) OR IN RETURN OVER PRIME, LIBOR,
OR OTHER STANDARD.

233

END OF CLASS NINE

CLASS TEN
11/13/90
INFORMATION NEEDED BY THE LENDER FOR PRESENTATION TO THE CREDIT COMMITTEE
LOAN REVIEW PACKAGE:
o INFORMATION ABOUT THE BORROWER
o WHAT, WHERE, WHEN OF THE PROJECT
o MARKET INFORMATION, AREA ECONOMICS, COMPARABLES, OPERATING EXPENSES,
TYPE OF LOAN
o CASH FLOW ANALYSIS, ABILITY TO GET FINANCED OUT AT 5 TO 10 YEAR HORIZON
DEBT SERVICE COVERAGE (IE. 1.1 TO 1.3)
DEBT CAPACITY = (NOI/DSC)/INT. RATE CONSTANT
(INT. RATE CONSTANT MEASUREMENT OF ABILITY TO REFINANCE AT 5
TO 10 YR. HORIZON NEEDS TO BE PREDICTED AT THE HORIZON TIME).

TO

IN STUDYING PROJECTED CASH FLOWS, BE CAREFUL TO EXAMINE THE GROWTH

ASSUMPTIONS, PARTICULARLY WHEN THE CASH FLOWS ARE NOTED WITH
"PROJECTIONS SUPPLIED BY BORROWER". DEVELOPERS CAN BE OPTIMISTIC
A FAULT. IT IS YOUR JOB TO DETERMINE CREDIBLE ASSUMPTIONS.

BULLET LOAN - A LOAN THAT IS INTEREST ONLY.

BALLOON LOAN - A PARTIALLY AMORTIZING LOAN, WITH THE MAJORITY OF EACH
PERIODIC PAYMENT CONSISTING OF INTEREST.
WHEN LEASES COME DUE DURING THE LOAN PERIOD, EXAMINE WHETHER OR NOT THE
MARKET IS GROWING, STAYING LEVEL OR SLIDING WITH RESPECT TO RENTS. THIS
HAS A BEARING ON THE FUTURE REFINANCING OF THE SITE.
COLLATERAL SECURITY - EXAMINE THE GUARANTEES, LETTERS OF CREDIT, LOAN TO
VALUE RATIO, APPRAISALS, TAKEOUTS AND TRI-PARTY AGREEMENTS, INSURANCE,
AND SWAPS REQUIRED BY THE LENDER OR NEGOTIATED BY THE BORROWER.
AFTER EXAMINING THE DATA, YOU WILL DECLINE, RECOMMEND, OR MODIFY THE
TERMS AND AMOUNTS OF THE LOAN.
ASSUME FOR THE SAKE OF THE FINANCING
ASSIGNMENT THAT THE BORROWER IS THE BANK PRESIDENT'S BEST FRIEND AND THAT
HE NEEDS GOOD REASONS NOT TO MAKE THE LOAN.
PUT / CALL - AN OBLIGATION UPON THE SELLER TO SELL HIS PROPERTY WHEN THE
PURCHASER ISSUES HIS OPTION TO BUY.
THIS OPTION TO BUY IS A "CALL".
WHEN THE OBLIGATION OF THE BUYER TO BUY IS ENFORCED BY THE SELLER HOLDING
THIS OPTION, THIS OPTION IS CALLED A "PUT".
CALLS ARE HELD BY THE PURCHASERS AND PUTS ARE HELD BY SELLERS. A PUT /
CALL AGREEMENT MEANS THAT THE POTENTIAL PURCHASER AND THE POTENTIAL
SELLER HAVE AGREED TO SELL OR PURCHASE (AS APPLICABLE) THE PROPERTY UPON

234

THE REQUEST OF THE OTHER PARTY TO THE AGREEMENT.

REQUIREMENT TO EXERCISE THIS OPTION.

THERE IS NOT A

GIVEN A CASE AS FOLLOWS:

* THE BUYER AGREES TO PAY 4.9 MILLION DOLLARS PER YEAR FOR A 4 YEAR
PERIOD, OR UNTIL A 70 PERCENT OCCUPANCY IS REACHED, WHICHEVER IS LONGER.
* THE BUILDING IS 350,000 S.F.
* THE MARKET RENTS ARE 34 DOLLARS PER S.F.
* THE COST TO BUILD IS 150 DOLLARS PER S.F.
* THE BORROWER WISHES TO BORROW 52,500,000 DOLLARS.
* OPERATING EXPENSES ARE PREDICTED TO BE 10 DOLLARS PER S.F.
* THERE IS A 10 YEAR PUT / CALL FOR THE PROPERTY FOR 63 MILLION DOLLARS.
14 DOLLARS PER S.F. WILL BE SPENT ON THE LAND LEASE PER ANNUM
(4.9 M / 350 K = 14.00 ) FOR THE FIRST FOUR YEARS.
THERE IS A 15 DOLLARS PER S.F. DEBT SERVICE ON THE 52.5 MILLION THAT WAS
BORROWED FOR THE BUILDING'S CONSTRUCTION ( 52.5M X .10 INT. CONSTANT /
350K = 15.00 )
14 + 15 = 29 DOLLARS + 10 DOLLARS FOR OPERATING EXPENSES = 39 DOLLARS PER
S.F. PER YEAR. THIS IS FIVE DOLLARS OVER MARKET RENT, PRESENTING A LOSS.
THE BENEFIT OF THIS AGREEMENT IS THAT THE MONEY FOR THE LAND SALE IS ALL
AT THE END OF THE REFINANCE PERIOD (YEAR TEN) AND THAT A GREATER AMOUNT
OF MONEY COULD BE BORROWED TO FUND CONSTRUCTION OF THE 52.5 MILLION
DOLLAR BUILDING.

*******************
LOANS
*******************
FIXED RATE MORTGAGE - (CONVENTIONAL) 15 TO 25 YEARS.
THESE LOANS ARE AT 10 YEARS.

TODAY, MOST OF

THE LOANS WERE MEANT TO APPROXIMATE THE ECONOMIC LIFE OF THE PROPERTY.
IN RECENT YEARS, DUE TO UNPREDICTABLE ECONOMIC CONDITIONS, FIXED RATE

235

MORTGAGES HAVE BEEN REDEFINED TO BE SHORTER AS OPPOSED TO LONGER TERM,

THE STANDARD NO LONGER BEING APPLIED TO THE PROPERTIES ECONOMIC LIFE.
BECAUSE TERMS ARE SHORTER, THE LOANS CANNOT BE FULLY AMORTIZED OVER THE
LOAN TERM. THERE WILL BE A BALLOON PAYMENT AT THE END OF THE LOAN TERM,
AS AMORTIZATION TERMS ARE FIGURED OVER A LONGER PERIOD, SUCH AS 25 TO 40
YEARS.
INSURANCE COMPANIES, PENSION FUNDS, THRIFTS, ETC. TEND TO BE SOURCES OF
FIXED RATE MORTGAGES. FIXED RATE MORTGAGES HAVE A PREPAYMENT PENALTY, AS
WELL AS DUE ON SALE CLAUSES. IF YOU SELL THE PROPERTY THE LOAN BECOMES
DUE. SOMETIMES, THE LENDER CONSIDERS WHO THE SALE IS TO IN DETERMINING
WHETHER TO EXERCISE THE DUE ON SALE CLAUSE.
IT IS POSSIBLE NOT TO
EXERCISE THE CLAUSE SIMPLY BY TRANSFERRING THE MORTGAGE TO THE NEW BUYER,
WHO IN TURN WOULD BECOME THE NEW BORROWER BY ASSIGNMENT.
DUE ON SALE
CLAUSES DO NOT NORMALLY ALLOW ASSIGNMENT UNLESS THIS IS NEGOTIATED INTO
THE LOAN COMMITMENT.
IF YOU EXPECT RATES TO GO UP OR IF RATES ARE LOW, YOU WILL SEEK A FIXED
RATE MORTGAGE. OTHERWISE YOU WILL SEEK A VARIABLE RATE MORTGAGE.
RATES ARE OFTEN SET ON A TERM TREASURY PLUS A SPREAD, SUCH AS IN THE
FOLLOWING EXAMPLE:
5 YR MONEY
IF TERM TREASURY IS
PLUS 150 BASIS POINT SPREAD
(160 FOR 10 YR.)

10 YR MONEY

8.00
1.50

8.35
1.60

----9.5%

----9.95%

VARIABLE RATE MORTGAGE (ALSO CALLED FLOATING RATE MORTGAGE) - A PERMANENT

LOAN THAT FEATURES AN INTEREST RATE THAT VARIES OVER TIME, BASED UPON A
FORMULA PEGGED TO FED FUNDS, LIBOR, PRIME RATE OR OTHER INDEX.

VARIABLE RATE LOANS TEND TO BE PREPAYABLE. IF YOU HAVE A SWAP TO FIX THE
VARIABLE RATE, YOU WILL HAVE TO PAY SWAP UNWIND COSTS IN THE EVENT THE
LOAN IS PREPAID. VARIABLES HAVE LITTLE IF ANY AMORTIZATION. THEY HAVE
THE SAME LOAN TO VALUE RATIOS AS FIXED MORTGAGES ( 1.1 TO 1.3 ). THEY
ARE GENERALLY FUNDED AT TERMS FROM ONE TO SEVEN YEARS.
THE INDEX IS ADJUSTED BY A CREDIT SPREAD, AS IN THE FOLLOWING EXAMPLE:
LOAN RATING

CREDIT SPREAD

AAA
AA

60 TO 75 BASIS POINTS
100 BASIS POINTS

236

ZZZ

250 BASIS POINTS

IF 90 DAY LIBOR INDEX IS 8 PERCENT, AND THE ZZZ SPREAD IS 2.5 PERCENT,
THEN THE INTEREST RATE WILL BE 10.5 PERCENT.
A TYPICAL CASE OF DETERMINING A RATE IS AS FOLLOWS:
A PROJECT OF SEVERAL MILLIONS OF DOLLARS COULD BE FINANCED AT A RATE
DETERMINED BY THE RETURN ON COMMERCIAL PAPER ADDED TO INSURANCE FEES,
LIQUIDITY AND OTHER FEES, AND A CAP FEE BOUGHT TO STEADY THE RATE.
7.8%
(commercial paper)
+0.5%
(insurance fee)
0.5%
(liquidity and other fees)
+8.8%
floating rate
0.7%
cap fee (bought to fix the interest rate)
9.5%
fixed rate
STANDBY COMMITMENTS
BANKS DRAW A 1 TO 3 PERCENT FEE ON THE LOAN AMOUNT FOR A STANDBY
COMMITMENT. THE BANKS HAVE NO INTENTION OF TAKING ON THE LOAN, AND MAKE
THIS AN UNLIKELY EVENT IN ANY CASE DUE TO VERY POOR TERMS. IN THE PAST
(AS OPPOSED TO CURRENTLY), STANDBY COMMITMENTS WERE ACCEPTABLE TO
CONSTRUCTION LENDERS AS ADEQUATE TO INSURE THAT HE WOULD BE FINANCED OUT
AT THE END OF CONSTRUCTION AS THE STANDBY LENDER BECOMES THE PERMANENT
LENDER.
THE AGREEMENTS WEE OFTEN WRITTEN TO MAKE IT PRACTICALLY IMPOSSIBLE FOR
DEVELOPERS TO GET THE BANK TO ACT ON ITS STANDBY COMMITMENT, INCLUDING
SUCH ONEROUS CLAUSES AS:
PRELEASE RATES
MIN. RENT PER S.F.
FINANCIAL CONDITIONS GUARANTEE
3.0% + PRIME RATE
2% FINANCING FEE
15% PARTICIPATION INTEREST
CHANGE IN MATERIAL CONDITIONS CLAUSE NEVER ACCEPT THIS
CONDITION.
IT IS GUARANTEED TO FIND YOU IN LITIGATION OVER THE
DEFINITION
OF "MATERIAL".
A BANKABLE COMMITMENT - IS ONE WHERE NOTHING IS REQUIRED EXCEPT FOR THE
COMPLETION OF CONSTRUCTION FOR THE TAKE-OUT LENDER TO ADVANCE PERMANENT
LENDING TO THE PROJECT.
THIS IS WHAT CONSTRUCTION LENDERS WILL ALWAYS
WANT, SINCE THEY DO NOT WANT TO BE SURPRISED AT THE END OF CONSTRUCTION
TO SEE THAT THE TAKE-OUT LENDER REFUSES TO FINANCE BASED ON A
TECHNICALITY OF THE COMMITMENT AGREEMENT. CONSTRUCTION LENDERS WILL ONLY
LEND THE AMOUNT OF MONEY THAT THE TAKE OUT LENDER OR STANDBY COMMITMENT

237

AGREES TO COVER. NOTE THAT STANDBY SALE COMMITMENTS ALSO EXIST, WHICH IS
IN ESSENCE A FULL EQUITY FINANCING RATHER THAN A DEBT FINANCING.
TRI-PARTY BUY AND SELL AGREEMENTS.
A CONSTRUCTION LENDER MAY REQUIRE
THIS TYPE OF TAKE-OUT LOAN. THIS IS WHEN THE LENDER ENTERS AN AGREEMENT
WITH THE BORROWER AND THE TAKE-UP LENDER THAT SPELLS OUT THE ROLES OF
EACH, AND GUARANTEES THAT THE INITIAL LENDER WILL AGREE TO SELL THE
MORTGAGE TO THE TAKE OUT LENDER WHO IN TURN GUARANTEES THAT THEY WILL BUY
IT. THE BORROWER AGREES TO THIS HAPPENING.
IN ISSUING A CONSTRUCTION LOAN, THE LENDER WILL LOOK AT COMPLETION RISK.
WILL THE PROJECT BE COMPLETED AS DESIGNED AND ON TIME, IF AT ALL? WILL
THERE BE SUFFICIENT FUNDS TO BUILD THE BUILDING? IS THE DEVELOPMENT WELL
CAPITALIZED?
WHAT HAPPENS IF ANTICIPATED PRELEASES DO NOT TAKE PLACE?
ARE THE MAJOR PLAYERS DISHONEST?
WHAT IS THE LIKELIHOOD OF COST
INCREASES? ARE THE MAJOR TRADES UNDER CONTRACT IN ORDER TO AVOID COST
OVERRUNS?
THE CONSTRUCTION LENDER WILL ALSO LOOK AT THE BUSINESS FAILURE RISK OF
THE DEVELOPER. HOW STRONG IS THE DEVELOPER? WHAT IS THE MAKE-UP OF THE
DIFFERENT TRADES AND THEIR RELATIONSHIP WITH THE DEVELOPER?
WHAT
PLANNING HAS OCCURRED TO HANDLE FORCE MAJEURE (ACTS OF G-D, TRADE
STRIKES, ETC.)?
THE CONSTRUCTION LENDER WILL ALSO LOOK AT THE ECONOMIC FEASIBILITY OF THE
PROJECT. WILL THE MARKET BE THERE FOR THE PRODUCT WHEN IT IS COMPLETED?
WHAT IS THE RISK OF LOSING ONE OR MORE TENANTS?
WHAT IS THE RISK OF
EXTERNAL EVENTS, SUCH AS LEGAL OR COMMUNITY ACTIONS, OF DERAILING THE
PROJECT? ARE THE ESTIMATES OF CAP RATE AND CASH FLOW GROWTH REASONABLE?

COMPLETION RISK IS OFFSET BY:

1. EQUITY
2. GUARANTEES OF COMPLETION
CONSTRUCTION DRAWS ARE PARTIALLY WITHHELD ( CALLED RETAINAGE ) TO ASSURE
THAT SUBCONTRACTORS WILL COMPLETE WORK ( 5 TO 15% WITHHOLDING ).
CONSTRUCTION LOAN AGREEMENTS DESCRIBE THE CONDITIONS FOR DISPENSING
PAYMENTS ON CONSTRUCTION PROJECTS. IN NEW YORK STATE, THE LOAN MUST BE
SPLIT INTO TWO DISTINCT PARTS.
1. THE BUILDING LOAN AGREEMENT
2. THE PROJECT LOAN AGREEMENT
THE BUILDING LOAN AGREEMENT COVERS ALL COSTS ATTRIBUTABLE TO THE
BUILDING, SUCH AS BRICKS, MORTAR, ARCHITECT'S FEES, ETC. BOTH AGREEMENTS
ARE FILED UNDER THE NEW YORK STATE LIEN LAW. IT LIST THE FINANCING AND
THE TERMS SO THAT CONTRACTORS AND DEVELOPERS CAN GIVE NOTICE TO EACH

238

OTHER AS TO PRIORITY OF LIEN.

FOR EXAMPLE:
THE JOB BEGINS IN MONTH ZERO AND 500,000 DOLLARS IS DISTRIBUTED PER MONTH
AS THE DRAW DOWN. IN MONTH THREE A DISPUTE BETWEEN THE CONTRACTOR AND THE
DEVELOPER OCCURS. THE CONTRACTOR HAS THE RIGHT TO FILE HIS LIEN WITH THE
STATE.
IF HE FILES IN MONTH THREE, HIS LIEN GAINS PRIORITY OVER THE
500,000 DOLLAR DRAW DOWNS IN THE FOLLOWING MONTHS. IF HE DOES NOT FILE
HIS LIEN UNTIL MONTH SEVEN, HIS LIEN TAKES PRIORITY OVER PAYMENTS IN THE
FOLLOWING PERIODS, EVEN THOUGH THE DISPUTE GOES BACK TO MONTH THREE,
UNLESS THE DRAW DOWN IN MONTHS FOUR THROUGH SEVEN WERE NOT RECORDED WITH
THE STATE BY THE CONSTRUCTION LENDER. IN THAT EVENT, THE LIEN WOULD GAIN
PRIORITY ALL THE WAY BACK TO MONTH THREE.
FOR THIS REASON, ALL DRAW DOWNS ARE RECORDED BY THE CONSTRUCTION LENDER
WITH THE STATE UNDER THE LIEN LAW.
ADDITIONALLY, CONSTRUCTION LENDERS
WILL NOT AGREE TO DISTRIBUTE THE DRAW DOWN UNTIL THE DISPUTE WITH THE
CONTRACTOR IS RESOLVED, EITHER BY BOND, ARBITRATION OR DIRECT PAYOFF.
END OF CLASS TEN
CLASS ELEVEN
11/20/90
MIKE DeJACAMO
YALE - ATTORNEY
GRAD FORDHAM LAW
WORKED FOR DEWEY VALENTINE
MOVED FROM D.V. TO KIDDER PEABODY AS A PRINCIPAL IN FINANCING DEALING
WITH ASSET BASED LENDING WITH AN EMPHASIS IN REAL ESTATE.
NOW WORKS FOR JONES LANG WOOTTON.
************************************************************************
THE USE OF CAPITAL MARKETS TO FINANCE REAL ESTATE FOR COMMERCIAL
MORTGAGES AND OTHER MORTGAGES
*************************************************************************
*
CHRONOLOGICAL OVERVIEW OF ASSET FINANCE
ASSET SECURITIZATION - THE PROCESS BY WHICH LIQUID FINANCIAL ASSETS ARE
TURNED INTO CAPITAL MARKET ASSETS.
THE CREATION OF DEBT SECURITIES,
BACKED BY SPECIFIED POOLS OF ASSETS AND SOLD IN THE MARKET. THE ASSET
CAN BE ANY INSTRUMENT THAT PRODUCES AN INCOME STREAM.
HISTORY

239

FIRST ASSET SECURITY CREATED 15 YEARS AGO.

THEY WERE PASS THROUGH
SECURITIES CREATED BY FREDDIE MAC, GINNIE MAE AND FANNIE MAE. THE FIRST
ASSET SECURITIES WERE POOLS OF SINGLE FAMILY LOANS.
AS INSTRUMENTS OF
FEDERAL AGENCIES, THEY WERE CONSIDERED AAA INSTRUMENTS.
PASS THROUGH SECURITIES ARE AN UNDIVIDED
INTEREST OF THE PASS THROUGH SECURITY POOL.

INTEREST

OF

PRINCIPAL

AND

X X X
X X

X X XXXX
XX THROUGH GUARANTEES, THE RISK TO THE HOLDER OF THE
X XXX X
X
SECURITY IS MEANINGLESS. THE RETURNS ARE
X
XX
X X X X GUARANTEED BY THE GOVERNMENT, REGARDLESS OF WHETHER
XXX
XXX X XX A GIVEN MORTGAGE (X) PAYS OR IS FORECLOSED ON.
X X X XX X X X <

XX
X XX X

POOL OF MORTGAGES WORTH MILLIONS

X = INDIVIDUAL MORTGAGE WORTH THOUSANDS
THE PREPAYMENT ASPECT OF THE SECURITY IS INTEREST RATE SENSITIVE.
AS
INTEREST RATES GO DOWN, LOWER PAYMENT INCENTIVES CAUSE MORTGAGE HOLDER
"X" TO PREPAY AND GET A LOWER LOAN RATE.
THE HOLDER OF THE SECURITY
TAKES A SHARE OF PREPAYMENTS.
UNPREDICTABILITY OF PREPAYMENT MADE THE
SECURITY LESS ATTRACTIVE TO INVESTORS.
APPROXIMATELY 100 MILLION IS THE TYPICAL POOL SIZE.
WEIGHTED AVERAGE MATURITY (WAM)
WEIGHTED AVERAGE COUPON (WAC)

CALCULATED RATES PASSED THROUGH TO INVESTORS.

IT IS DETERMINED BY
AVERAGING ALL OF THE INDIVIDUAL MORTGAGE RATES. GINNIE MAE TAKES A SMALL
CUT TO PROVIDE THE GUARANTEE.
THE CMO, OR COLLATERALIZED MORTGAGE OBLIGATION WAS A REORIENTING OF CASH
FLOW FROM THE PASS THROUGH SECURITY TO OVERCOME THE UNCERTAINTIES OF
PREPAYMENT OF INDIVIDUAL MORTGAGES IN THE POOL.
THERE ARE FOUR CLASSES OF CMO. ALL THE PREPAYMENTS IN THE POOL ARE FIRST
ASSIGNED TO PAY OFF THE CLASS I CMO. AFTER PAY OFF OF CLASS ONE, THE
COMES CLASS II AND SO FORTH.
IF YOU WANT A LONGER PERIOD BEFORE YOUR
SECURITY "MATURES", YOU BUY A CLASS III OR IV CMO.
YOU CAN GENERALLY
CALCULATE LIFE SPANS, IE., CLASS I = 3 YEARS, CLASS II = 7 YEARS, CLASS
III = 10 TO 12 YEARS, AND CLASS IV = 15 TO 17 YEARS.
INSTEAD OF THE MONTHLY PAYMENTS RECEIVED WITH PASS THROUGHS, CMO'S HAVE
QUARTERLY PAYMENTS. INSTITUTIONAL INVESTORS PREFER THIS FOR ACCOUNTING
SIMPLICITY REASONS.

240

SECURITIZATION OF COMMERCIAL MORTGAGES

THE MOTIVATION FOR COMMERCIAL MORTGAGE SECURITIZATION:
WE WILL SEE MORE SECURITIZATION OF COMMERCIAL MORTGAGES BECAUSE
TRADITIONAL LENDING SOURCES ARE DISAPPEARING AS A SOURCE FOR LENDING.
FURTHERMORE, SECURITIZATION IS A MORE EFFICIENT MEANS OF SECURING SHORT
TERM FUNDING BY CUTTING OUT THE MIDDLEMEN AND GOING TO THE SOURCE OF THE
MONEY.
THERE ARE TWO KINDS OF SECURITIZED GENERIC COMMERCIAL MORTGAGE.
1. ON A SINGLE PROPERTY ( "PROPERTY SPECIFIC SECURITY" )
2. POOLED FINANCINGS - POOLS OF COMMERCIAL MORTGAGES ON MANY COMMERCIAL
PROPERTIES ( "ACTUARIAL MORTGAGE SECURITY")
SECURITIZATION IS A TWO STEP PROCESS:
1. OBTAIN A CREDIT RATING FROM FITCHES DUFF & PHELPS, MOODY'S, OR FROM
STANDARD & POOR'S. YOU NEED A CREDIT RATING TO GIVE THE INVESTOR
WITH NO UNDERSTANDING OF THE INVESTMENT A SENSE OF SECURITY ABOUT
HIS INVESTMENT. THE RATING MAKES THE LARGER MARKET MORE CERTAIN OF
THE INVESTMENTS QUALITY.
2. EXECUTE THE TRADE.
HOW DO YOU GET THE RATING?
o METHOD ONE
1. FROM A RATING AGENCY, PARTICULARLY STANDARD & POOR AND MOODY HAVE COME
UP WITH TECHNIQUES OF RATING THE BOND.
A. GETTING ONE FOR A PROPERTY SPECIFIC SECURITY CANT TAKE A LONG TIME (AS
MUCH AS SIX MONTHS TO A YEAR).
B. THEY ARE VERY CONSERVATIVE - ALMOST DRACONIAN.
C. THERE IS A SKEPTICISM ABOUT RATINGS APPLIED TO SPECIFIC PROPERTIES.
THE MARKET WILL PRICE THE PAPER CHEAPLY (AT A HIGHER INTEREST
RATE) REGARDLESS OF THE RATING GIVEN BY THE RATING AGENCY.
RATING AGENCIES GET PAID A PERCENTAGE FEE ON THE DEAL AT CLOSING. THEY
WILL REQUIRE EXPENSES AND A BREAK-UP FEE IF THE DEAL DOES NOT CLOSE.
o

THE SECOND TECHNIQUE FOR GETTING A RATING:

STRUCTURE THE TRANSACTION TO GAIN THE DESIRED RATING.

IE. A GIVEN OFFICE BUILDING:

SENIOR

SECURITY

65 %

241


75% LOAN TO VALUE RATIO

JUNIOR
10 %

SECURITY

WITH REFERENCE TO THE DIAGRAM ABOVE, SPLIT THE CASH FLOWS COMING OFF THE
MORTGAGE INTO AN "A" PIECE (THE SENIOR PIECE) AND THE "B" PIECE (THE
JUNIOR PIECE). THE JUNIOR PIECE IS IN THE LOSS POSITION. CASH FLOWS GO
FIRST TO PAY THE SENIOR ASPECT OF THE LOAN.
THE SENIOR PIECE HAS A
CREDIT ENHANCEMENT RELATIVE TO THE JUNIOR PIECE. THE A PIECE MIGHT BE
RATED AA WHEREAS THE B PIECE WOULD BE OFFERED TO A DIFFERENT SOURCE OF
LENDING THAT IS WILLING TO FINANCE AT GREATER RISK.
o

THE THIRD TECHNIQUE FOR GETTING A RATING:

GIVE THE CREDIT WORTHINESS OF THE TENANT A ROLE IN THE SECURITIZATION.

IE. AAA RATING PROVIDED TO A TRIPLE NET LEASE TO THE FEDERAL GOVERNMENT.
PRESENT VALUE THE LEASE AMOUNTS TO PRESENT DAY AND RAISE FUNDS TO EQUAL
THE AMOUNT.
o

THE FOURTH TECHNIQUE FOR GETTING A RATING:

BUY A GUARANTEE ON THE CASH FLOWS FROM A COMMERCIAL BANK IN RETURN FOR A
FEE.
CERTAIN INSURANCE COMPANIES CALLED SURETY BOND PROVIDERS OR
FINANCIAL
GUARANTORS
MAKE IT THEIR SOLE BUSINESS TO PROVIDE THESE GUARANTEES.
THEY GUARANTEE THE PERFORMANCE OF YOUR PRINCIPAL AND INTEREST PAYMENTS.
THERE ARE THREE MAJOR SURETY BOND PROVIDERS.

THEY ARE:

FSA - FINANCIAL SECURITY ASSURANCE

THEY ARE AAA RATED, A NEW YORK INSURANCE COMPANY OWNED BY US WEST.
FGIC - FINANCIAL GUARANTEE INSURANCE CORPORATION
THEY ARE AAA RATED, WHOLLY OWNED BY GENERAL ELECTRIC CAPITAL
CAPMAC - CAPITAL MARKETS ASSURANCE CORPORATION
THEY ARE AAA RATED, OWNED BY CITIBANK
THEY ALL PROVIDE INSURANCE FOR A 45 TO 50 BASIS POINTS PER YEAR FEE.
VERY LARGE DEALS HAVE THE APPEARANCE OF LIQUIDITY.
A TRANSACTION BELOW
SECURITIZATION.
NOTE THAT

50

MILLION

DOLLARS

WOULD

NOT

BE

FINANCED

BY

CREDIT ENHANCING INSTITUTIONS ARE NOT THE SAME AS RATING

242

AGENCIES!
A BOND UNDERWRITER, CREDIT ENHANCER AND RATING AGENCY ALL CHARGE FEES
THAT MAY BE LARGER THAN A SINGLE COMMERCIAL LENDER WOULD CHARGE, YET THE
INTEREST RATE THAT RESULTS WILL STILL BE LESS THAN THAT PAID TO A SINGLE
LENDER.
END OF GUEST LECTURE.
TRANCHE - A FACTION OF DEBT. SAY, A 140,000,000 DEBT DIVIDED INTO TEN
TRANCHES WOULD HAVE 14 MILLION DOLLARS PER TRANCHE.
NEXT WEEK - CASE III IS DUE. FINAL IS ON THE 11TH OF DECEMBER.
WILL BE SPENT IN REVIEW AND DISCUSSING CAPS AND SWAPS.

THE 4TH

THE FINAL WILL BE ALL PROBLEMS. IE. CASH FLOW ANALYSIS OF INCOME STREAM,
READING A LEASE AND TAKING APART THE FINANCIAL REQUIREMENTS, TAKING A
RENT ROLL AND SHOWING HOW TO COME UP WITH AN OPERATING BUDGET, CASH FLOW
AND EVALUATION OF PRESENT VALUE AND FINANCING STRUCTURES. THE TEST WILL
BE 1 TO 1 AND A HALF HOURS LONG.
MORTGAGES
THE JUNIOR MORTGAGE IS OFTEN USED BECAUSE THERE IS NOT ENOUGH MONEY TO
PAY FIRST MORTGAGE.
IT IS A SUBORDINATE MORTGAGE DEFINED AS A LIEN
JUNIOR TO ANOTHER SENIOR LIEN (MORTGAGE). A PROPERTY WITH MULTIPLE LIENS
ON IT WOULD GO TO PAY OFF THE FIRST MORTGAGES FIRST AND SO ON. AS SECOND
AND THIRD MORTGAGES ARE TAKEN, THE RISK OF NON-PAYMENT INCREASES AND
THEREFORE THE INTEREST RATE INCREASES.
FIRST MORTGAGES MAY NOT ALLOW JUNIOR MORTGAGES TO TAKE PLACE BECAUSE THEY
ARE A NUISANCE. THEY COULD FORCE A FORECLOSURE. THE FIRST MORTGAGEE MAY
ONLY ALLOW A SECOND MORTGAGE THAT IS A CASH FLOW MORTGAGE, OR THAT WHICH
IS BASED ON A CASH FLOW AFTER PAYMENT OF THE FIRST MORTGAGE. A SECOND
CONDITION POSSIBLY PLACED ON SECOND MORTGAGES IS THAT IT BE A NONFORECLOSURE LOAN, OR IN OTHER WORDS, DEFAULT PROOF. THIS MEANS THAT WHEN
THE CASH FLOW IS NOT THERE TO PAY THE SECOND MORTGAGE, THE PRINCIPAL AND
INTEREST ACCRUES. LACK OF CASH FLOW IS NOT A PERMISSIBLE REASON FOR A
FORECLOSURE UNDER THE TERMS OF THE FIRST MORTGAGE.
END OF CLASS ELEVEN
CLASS TWELVE
11/27/90
PARTICIPATIONS (EQUITY KICKER LOAN)
A FORM OF REAL ESTATE FINANCING THAT HAS BEEN COMMONLY USED. TODAY, THEY
ARE NOT BEING USED AS MUCH AS IN THE PAST 4 TO 5 YEARS BECAUSE BORROWERS

243

ONLY GIVE UP EQUITY IN TURN FOR LARGER LOANS (THAT IS, HIGHER LTV'S) OR
LOWER INTEREST RATES. WHEN THIS IS NOT FORTHCOMING, BORROWERS WILL NOT
ACCEPT THE EQUITY KICKER.
EQUITY KICKERS CAN TAKE THE FORM OF A PERCENTAGE OF NET CASH FLOW OR NOI
PLUS A PERCENTAGE OF RESIDUAL VALUE (IE., ON SALE OR REFINANCING).
CONVERTIBLE LOANS NEED TO BE CONSTRUCTED SO AS NOT TO CREATE A TAXABLE
EVENT ON CONVERSION.
ASSUMPTIONS:
NOI, YR 1 = 100,000
INCREASE IN ANNUAL NOI = 3 PERCENT
PURCHASE PRICE = 1 MILLION
900,000 ALLOCATED TO BUILDING
100,000 ALLOCATED TO LAND
DEPRECIATION = 27.5 YEARS
ANNUAL VALUE INCREASE = 3 PERCENT
LOAN AMOUNT = 700,000
TERM = 15 YEARS
PARTICIPATION = 50% OF NOI IN EXCESS OF 100,000 PLUS 45% PARTICIPATION IN
GAIN.
ASSUME A FIVE YEAR TIME HORIZON.
***************
NOI
DEBT SERV.
CASH FLOW
PARTICPTN

YEAR ONE
YEAR TWO
YEAR THREE
100,000 103,000 106,090 109,273 112,551
80,275
80,275
80,275

YEAR FOUR

YEAR FIVE

80,275

80,275

19,275

28,998
4,636

32,276
6,275

22,275
1,500

25,815
3,045

PRETAX CF
19,275
21,225
22,270
24,362
********************************************************************

26,001

LENDER'
RETURN*
80,275
80,275
80,275
80,275
80,275
PARTICPTN
0
1500
3,045
4,636
6,275
LOAN BACK
----------------- -----551,364
PARTICPTN
------ ------------ -----71,673
----------------------------------------------------------------------700,000**
80,275
81,775
83,320
84,911
709,587
IRR = 10.07%
SALES PRICE IN YEAR FIVE AFTER COMMISSIONS = 1,159,274
MTG BALANCE = 551,364
NET = 607,910

244

PARTICIPATION = 45% = 71,673 = (1,159,274 - 1,000,000) X 45%

CONVERTIBLE LOANS
CONVERTIBLE LOANS ARE A HYBRID OF DEBT AND EQUITY.
IT ALLOWS THE
BORROWER TO GET A LOWER INTEREST RATE AND/OR A HIGHER LTV WITH AN OPTION
TO CONVERT ALL OR A PORTION OF THE MORTGAGE TO EQUITY.

TO COMPARE A CONVENTIONAL LOAN AND SALE TO GAIN CASH WITH A CONVERTIBLE

MORTGAGE LOAN TO GAIN CASH, OBSERVE THE FOLLOWING:
SALE

VS.

PROCEEDS = 100,000,000
TAXES = 32,000,000
CASH GAIN = 68,000,000

CONVERTIBLE
FINANCE FOR 75,000,000 AT
BELOW MARKET RATE
TAXES = 0
CASH GAIN = 75,000,000
THIS IS A 7,000,000 ADVANTAGE

CONSIDER FURTHER THE TOTAL PRESENT VALUE:

75,000,000 PRINCIPAL
(10,000,000) TAX
13,000,000 CASH FLOW FROM BUILDING
24,000,000 ADDITIONAL SALE VALUE
102,000,000 TOTAL PRESENT VALUE VS. 68,000,000 VALUE OF CASH IF SOLD
TODAY.
THIS DEMONSTRATES THE VALUE OF CONVERTIBLE LOANS.
DURING THE OPTION PERIOD, WHICH ON A TEN YEAR LOAN COULD BE IN THE YEARS
FIVE TO TEN, THE BORROWER OR LENDER HAVE THE OPTION TO CONVERT THE DEBT
TO EQUITY.
END OF CLASS TWELVE
CLASS TWELVE
12/4/90
TODAY THE CLASS WAS DEVOTED TO SWAPS AND REVIEW.
COULD NOT ATTEND DUE TO ILLNESS.
END OF COURSE

245

LEGAL ISSUES IN REAL ESTATE NOTES

PROFESSOR DANIEL ZANINI
SUMMER 1990

CLASS ONE

5/21/90

DAN ZANINI
11 YEARS PRACTICE IN REAL ESTATE
SPECIALIZES IN

CONTRACTS
CLOSINGS
MORTGAGES
EXEMPTIONS

ATTORNEY AT PARKER-DURRIER
529 5TH AVENUE
STARTED OUT WITH CITY
***************************
COURSE WILL BE RUN AS IF WE WERE SELLING A SMALL OFFICE BUILDING.
WHEN HAS THE BROKER EARNED HIS FEE AND WHEN IS THE DEVELOPER OBLIGATED TO
PAY A FEE?
WHEN IS THERE IS A MEETING OF THE MINDS AS THE PARTIES AGREE TO THE
MATERIAL CONTENT OF THE CONTRACT?
THE CONTRACT PERIOD
THE BROKER PUTS THE BUYER AND THE SELLER TOGETHER. THE MEETING OF THE
MINDS IS REPRESENTED BY THE CONTRACT, ACCORDING TO THE STATUTE OF FRAUDS,
WHICH DOES NOT PERMIT REAL ESTATE TO BE SOLD WITHOUT A WRITTEN CONTRACT
OF SOME FORM.
THE CONTRACT PERIOD
THE PERIOD BETWEEN THE CLOSING AND THE CONTRACT PERIODS. THIS IS WHERE
THE SELLER'S ATTORNEY IS DOING LESS THAN THE BUYERS. HE IS GETTING THE
PROPERTY READY FOR SALE. HE GETS THE PAYOFF LETTER FROM THE MORTGAGEE
(THE BANKER). THE SELLER IS GETTING THE TITLE INSURANCE, ALTHOUGH IT IS
NOT MANDATORY BY LAW.
ONCE THE REPORT IS PRODUCED IT IS SENT TO THE
BUYER AND THE SELLER. THE BUYER'S ATTORNEY EXAMINES THE TITLE FOR LIENS
OR MORTGAGES AND DETERMINES THE NEED FOR "CLEARING THE TITLE". THE BUYER
IS ALSO WORKING TO SECURE FINANCING FOR THE PROPERTY.
A WELL WRITTEN
CONTRACT WILL HAVE A WINDOW OF TIME FOR WHEN THIS FINANCING MUST BE
SECURED BEFORE THE BUYER CAN BACK OUT OF THE DEAL. THE SECURED FINANCING
IS GUARANTEED BY A LETTER OF COMMITMENT FROM THE BANK.
THE CLOSING
THE CLOSING IS ATTENDED BY THE BROKER, BUYER, SELLER AND COUNCIL FOR BOTH

240

SIDES WITH THE TITLE COMPANY AND THE BUYER'S AND SELLER'S BANKER.
WARRANTEE DEED - "I WARRANT THAT I FULLY OWN THE PROPERTY THAT I AM
SELLING".
QUIT-CLAIM DEED - WHATEVER I HAVE I AM SELLING TO YOU, AND I MAKE NO
CLAIMS ABOUT WHAT I OWN OR THE EXTENT OF IT.
DEEDS AND MORTGAGES ARE THE RECORDS STORED AT THE COUNTY WHICH TITLE
COMPANIES EXAMINE.
A PROSPECTUS IS AN OFFERING STATEMENT
VEHICLES FOR FORMING SYNDICATES.

AND

PRIVATE

PLACEMENT

ARE

IN A COOPERATIVE OR CONDOMINIUM SALE OF AN EXISTING BUILDING IN NEW YORK

STATE, THE FOLLOWING APPLY:
15% OR MORE OF THE UNITS MUST BE SOLD UNDER A NON-EVICTION PLAN
51% OR MORE OF THE UNITS MUST BE SOLD UNDER AN EVICTION PLAN
CONTRACTS (CONT)
EXCULPATORY PROVISIONS - PROVISION WHICH STATES THAT THERE IS NO
GUARANTEE OF PAYMENT ON THE LOAN PRINCIPAL AND INTEREST WITH RECOURSE TO
THE ASSETS OF THE PERSON OR CORPORATION TAKING OUT THE LOAN.
**************
THE PAPER
IT IS A "BRIEF" OF NO LIMIT OF PAGES, BUT BE REASONABLE. YOU MAY PICK
YOUR OWN TOPIC WITH THE APPROVAL OF THE PROFESSOR, BUT BE AS SPECIFIC AS
POSSIBLE. IT SHOULD BE A LEGAL ISSUE OR RELATED TO LEGAL ISSUES.
ADDRESS THE ISSUE TAKING A POSITION OF "PRO" OR "CON", HAVING RECOGNIZED
THE OPPOSING POINT OF VIEW AND REBUTTING IT.
"WHAT IS THE BASIS FOR RENT REGULATION" WOULD BE A TOPIC, FOR EXAMPLE.
****************
ASSIGNMENT LEASE - HAVING DEPARTED FROM A LEASED SPACE, YOU RENT IT OUT,
BUT YOU ARE STILL RESPONSIBLE TO PAY THE LANDLORD.
SUBLET LEASE - YOU LEASE ALL OR PART OF A SPACE TO A SUBLETTER FOR A
LIMITED PERIOD OF TIME.
NOVATION - A TRUE SUBSTITUTION OF A NEW TENANT FOR A PRIME TENANT.
IS A RARE PHENOMENON.

241

THIS

PRACTICAL VS.THEORETICAL
PRACTICAL.

LAW

THIS

CLASS

WILL

BE

PREDOMINANTLY

A SITUATION:
2 PARCELS, ADJOINING, EACH 5 ACRES IN SIZE.
T
H
E * A
T
L
A
N
T
I
C *
O
C
E
A
**

A "GORE" ( A DISCONTINUITY IN

*
THE SURVEY)

5 ACRES

5 ACRES

THE CLIENT APPROACHES YOU TO PREPARE A CONTRACT (THE GORE WAS AN UNKNOWN
FACTOR AT THIS TIME). HE THOUGHT HE BOUGHT TWO TRACTS WITH A CONTINUOUS
AND UNBROKEN COMMON BORDER. HE DISCOVERS LATER THAT THE SPOT HE WANTS TO
BUILD HIS HOUSE ON IS OWNED BY SOMEONE ELSE. WHAT DID YOU NEED TO AVOID
THIS ERROR?
YOU NEED A CERTIFIED SURVEY, OR A SURVEY UPDATE.
YOU COULD HAVE ALSO GOTTEN AFFIRMATIVE INSURANCE OF CONTIGUITY - WHICH
GUARANTEES THAT ALL POINTS BETWEEN TWO PROPERTIES ARE CONTIGUOUS. BOUGHT
FROM THE TITLE AND GUARANTEE COMPANY.
THIS COULD GUARANTEE THAT IN THE
EVENT IT IS NOT TRUE, THE TITLE COMPANY WILL BUY THE DEAL OR BUY THE GORE
TO MAKE THE PIECE CONTIGUOUS.
*********************
LEGAL ISSUES IN REAL ESTATE
2 TYPES OF LAW:
STATUTORY LAW; A CREATURE OF STATUTE, COMING FROM THE 3 LEVELS OF
GOVERNMENT.
FEDERAL: CONDO & COOP ABUSE ACT
ENVIRONMENTAL LAWS
INTERCOASTAL WATERWAYS
BANKING
STATE:
REAL PROPERTY LAW
REAL PROPERTY ACTIONS AND PROCEEDINGS LAW
MULTIPLE DWELLING LAW

242

LOCAL:

ZONING
BUILDING CODE

"STATUTES ARE CODIFIED AND PUT TOGETHER"

COMMON LAW: (LEADING TO CASE LAW)
DISPUTES THAT ARISE THAT ARE
STATUTORY LAW. IT IS NON-STATUTORY.

NOT

COVERED

EXPLICITLY

BY

AT EACH LEVEL OF COURT SYSTEMS THERE ARE "REPORTS".

THE HIGHEST IN THE HIERARCHY IN NEW YORK IS THE COURT OF APPEALS. NEXT
COMES THE APPELLATE DIVISION, AND LASTLY THE NEW YORK SUPREME COURT.
THE "NEW YORK REPORTS" ARE CATEGORIZED AS FOLLOWS:
TYSON V. DOUGLAS (THE CASE NAME)
54 NY 2d 100, 400 NYS 2d 302
DATE(1989)
OF CASE

PAGE NUMBER

2ND SERIES

NEW YORK SUPPLEMENT

(UNOFFICIAL CITE)

VOLUME NUMBER

PAGE NUMBER

2ND SERIES

COURT OF APPEALS

VOLUME NUMBER
AD = APPELLATE DIVISION
NY = COURT OF APPEALS
IN A REFERENCE CALLED McKINNEY'S, CONSOLIDATED LAW EDITION YOU CAN FIND
INFORMATION CLASSIFIED BY LEGAL TOPIC AND HISTORY.
IE.

MDL SEC.701

FIRST SECTION OF ARTICLE 7C

MULTIPLE DWELLING LAW

NEW YORK CITY HAS LAWS THAT ARE BASED ON THE NEW YORK CITY ADMINISTRATIVE
CODE.

243

THE AMERICAN JURIST REVIEW (AMJUR) GIVES A NARRATIVE DISCUSSION

WHICH OVERVIEWS PERTINENT CASES - A GOOD START WHEN RESEARCHING.
SHEPHERDING - THE SHEPHERD PUBLICATIONS RECORD EVERY CASE AND THROUGH A
LEGEND, TELLS YOU WHAT HAPPENS THROUGHOUT THE CASE'S HISTORY, AND EVERY
CASE IN WHICH THIS CASE IS CITED.
REAL ESTATE- EVERYTHING ABOVE AND BELOW THE LAND AND ATTACHED TO IT.
BLACK ACRES - THE GENERIC TERM FOR "A PARCEL TAKEN AS A "FOR INSTANCE"".
BUNDLE OF RIGHTS- THE KEY ASPECTS OF OWNERSHIP.
WHEN YOU OWN REAL ESTATE, YOU OWN FEE TITLE.
HAVE THE BROADEST RIGHTS POSSIBLE. YOU CAN:

IF YOU OWN FEE TITLE, YOU

SELL IT
MORTGAGE IT
AND PLEDGE IT
WITHIN THE CONFINES OF THE LAW.
LEASEHOLD INTEREST - A PARTIAL INTEREST IN THE PROPERTY.
MORTGAGE INTEREST - THE BANK'S INTEREST IN YOUR PROPERTY.
SECURITY OR COLLATERAL INTEREST AS A GUARANTEE FOR THE LOAN.

IT IS A

EASEMENT- THE RIGHT TO USE SOMEONE ELSE'S LAND FOR A SPECIFIC PURPOSE.
EASEMENT OF NECESSITY - A LANDLOCKED PIECE OF LAND FOR EXAMPLE, HAS A
RIGHT TO ACCESS A ROAD OVER SOMEONE ELSE'S LAND.
LICENSE - THE CRITERIA:
AUTHORIZES YOU TO SPEND A TIME ON A PROPERTY AND AFFECT IT WHILE
PERFORMING A SPECIFIED PURPOSE. THEY ARE SHORT-TERM, WHICH DISTINGUISHES
THEM FROM AN EASEMENT.
EASEMENT BY PRESCRIPTION - A COURSE OF CONDUCT DISCLOSED TO ALL WHICH
TURNS INTO AN EASEMENT.
ADVERSE POSSESSION - YOU HAVE TREATED A PROPERTY AS YOUR OWN FOR 10
YEARS, PAID TAXES ON IT, ARE NOT A RELATIVE OF THE OWNER, YOU CAN
ESTABLISH OWNERSHIP OF THE PROPERTY BY BRINGING A QUIET TITLE ACTION.
FIXTURES- PART OF THE PROPERTY, TRAVELS WITH THE PROPERTY AND IS UTILIZED
IN THE USE OF THE PROPERTY. THEY ARE PART OF THE REAL ESTATE IF THEY
WERE INTENDED TO BE PERMANENTLY ATTACHED.
TEST:

244

1. HOW ATTACHED?
A. PERMANENT
B. TEMPORARY
2. CHARACTERISTIC OF THE ITEM (IE. PIPING VS. VENETIAN BLINDS)
3. WHAT IS INTENDED BY THE CONTRACT?
END OF CLASS ONE

CLASS TWO
6/4/90
A DESCRIPTION IN A DEED MUST BE CORRECT.
IN A CONTRACT IT IS NOT
ABSOLUTELY MANDATORY. ASK FOR A COPY OF THE TITLE REPORT AND DEED THE
SELLER RECEIVED WHEN HE BOUGHT IT.
LOOK AT THE TITLE REPORT FOR
EASEMENTS OR ENCUMBRANCES WHICH SHOULD BE REFLECTED IN THE CONTRACT,
BECAUSE THE PROPERTY IS BEING SOLD SUBJECT TO THEM.
SHOULD NOT SAY IN CONVEYANCE OF A DEED, "I AM SELLING TO YOU THE LOWER
SOUTHWEST OF THE PROPERTY" SINCE THIS IS NOT ANYWHERE NEAR SPECIFIC
ENOUGH TO DELINEATE WHICH PROPERTY OR PORTION OF IT IS BEING SOLD.
METE = MEASURE OF DISTANCE
BOUND = BOUNDARY
**********
FIRST PAGE OF A DEED AND A SURVEY PASSED OUT FOR CLASS DISCUSSION.
*********
HOW TO READ A SURVEY
1. FIND A NORTH ARROW
2. COMPARE THE METES AND BOUNDS TO THE SURVEY, COURSE BY COURSE.
RULES OF THUMB:
IF A SURVEY IS LESS THAN 8 YEARS OLD IT CAN BE UPDATED.
IF YOU WANT TO MORTGAGE THE PROPERTY, YOU MAY HAVE TO GET A SURVEY
INSPECTION, WHICH IS COMPRISED OF A SITE INSPECTION AND REPORT COMPARISON
BETWEEN THE TWO. AT A MINIMUM, THE BANK WILL REQUIRE AT LEAST THIS.
THE SECOND WAY TO DESCRIBE A PROPERTY IS WITH REFERENCE TO A FILED MAP OR
PLOT PLAN. TITLE COMPANIES OFTEN PREFER THIS TO METES AND BOUNDS.
A CORRECTION DEED -- IF A MINOR PROBLEM SHOWS
YOU CAN FILE A CORRECTION DEED.

UP IN A DEED AS

AN ERROR,

STREET ADDRESSES IN A CONTRACT MAY BE USEABLE, BUT THEY ARE NOT ADEQUATE

245

FOR THE CONVEYANCE OF A DEED.

THE SAME IS TRUE WHEN DESCRIBING THE
PROPERTY BY NAME IE., "THE SMITH FARM".
THESE ARE TECHNICALLY OK FOR A CONTRACT, YET FROWNED UPON.
EVERY RECORDED DOCUMENT IN NEW YORK STATE MUST BE NOTED BY BLOCK AND LOT
NUMBER.
***********
CONDOMINIUM DESCRIPTION FOR A DEED
***********
1. BLOCK AND LOT NUMBER
2. DESCRIPTION OF THE COMMON ELEMENTS AND THE PERCENTAGE THEREOF.
**************
BROKERAGE
**************
SELLING BROKER- ACTS TO FIND SELLERS AND BUYERS.
LEASING BROKER- ACTS TO FIND LESSEES.
THE ROLE OF THE BROKER IS ESSENTIAL TO THE REAL ESTATE TRANSACTION.
BRING THE PARTIES TOGETHER.

THEY

IN NEW YORK A BROKER MUST BE LICENSED THROUGH A WRITTEN EXAMINATION. IF

THEY ARE NOT LICENSED THEY ARE NOT ENTITLED TO BE PAID, EXCEPT FOR
LAWYERS WHICH ARE AUTOMATICALLY ACCORDED BROKER'S STANDING.
FEES ARE CALLED COMMISSIONS, WHICH ARE TYPICALLY PAID BY THE SELLERS
(USUALLY 6 PERCENT OF THE CONSIDERATION, WHICH IS TO SAY, THE PURCHASE
PRICE).
LEASING BROKER COMMISSIONS ARE ON A SLIDING SCALE BASED UPON THE RENT.
IE.

5
4
3
2

PERCENT
PERCENT
PERCENT
PERCENT

OF
OF
OF
OF

YEAR
YEAR
YEAR
YEAR

ONE'S RENT
TWO'S AND THREE'S RENT
FOUR AND FIVE'S RENT
SIX THROUGH TEN'S RENT

IN A RESIDENTIAL DEAL YOU PAY AT THE CLOSING, AND PAYMENTS ARE USUALLY
CUT AND DRY, AND NOT SUBJECT TO NEGOTIATION.
A BROKER MAY SPLIT A COMMISSION WITH A BUYER, AS A FUNCTION OF THE SALE.
HE MAY NOT SPLIT IT WITH A NON-BROKER BECAUSE THE STATE NEEDS TO PROTECT
THE WELFARE OF THE PUBLIC AND NEEDS TO POINT TO A RESPONSIBLE
PROFESSIONAL FOR RECOMPENSE SHOULD SOMETHING GO WRONG.
WHEN A BUYER HIRES A BROKER, THE SELLER IS NOT RESPONSIBLE FOR FEES TO
THE BROKER, UNLESS HE AGREED TO THIS BY CONTRACT.

246

WHEN A BROKER APPROACHES A SELLER WITH A BUYER, AND THE SELLER ACCEPTS
THE BUYER, HE IS OBLIGATED TO PAY THE BROKER EVEN THOUGH HE HAS NO
CONTRACT WITH THE BROKER.
******************
BROKER CONTRACTS
******************
1.
2.
3.
4.
5.

NAMES OF THE PARTIES

DESCRIPTION OF THE PROPERTY
TERMS
LENGTH OF CONTRACT
SPECIAL OR UNIQUE PROVISIONS.

MOST
OPEN
THAN
SELL

BROKERS INSIST ON A TYPE OF ARRANGEMENT WITH THE SELLER.

LISTING - LEAST COMMON - WHERE BROKER UNDERSTANDS THAT MORE BROKERS
HE MAY HAVE THE LISTING, AND THAT THE OWNER RESERVES THE RIGHT TO
ALSO. IF ANY OTHER THAN HE SELL, HE GETS NO COMMISSION.

EXCLUSIVE AGENCY LISTING - HIRE ONLY ONE BROKER AND YOU MAY TRY TO SELL
IT ON YOUR OWN ALSO. YOU MAY NOT HIRE ANOTHER BROKER, SINCE IF YOU DO
YOU WILL OWE TWO COMMISSIONS; TO THE BROKER YOU HIRED AND THE ONE WHO
SOLD THE PROPERTY.
EXCLUSIVE RIGHT TO SELL - THE ARRANGEMENT MOST BROKERS INSIST ON.
NEITHER YOU OR ANYONE ELSE MAY SELL THE UNIT.
THE BROKER GETS PAID
REGARDLESS OF WHO FINDS THE BUYER.
EXCEPTIONS - I HAVE HAD FOR SALE AND SHOWN TO THESE PEOPLE, X,Y, AND Z.
THEY, IF THEY BUY, WILL NOT BE A REASON TO GIVE A COMMISSION.
MULTIPLE LISTING SERVICES- A GROUP OF LISTINGS PUT TOGETHER BY AN
INDEPENDENT AGENCY FOR A PARTICULAR AREA.
IT IS A POOL WHERE MEMBERS
THROW THEIR LISTINGS INTO THE POOL AND THE INFORMATION IS AVAILABLE TO
ALL WHO ARE MEMBERS.
IN THIS INSTANCE YOU WILL ARRIVE AT THE "SPLIT
COMMISSION"
SITUATION.
THE VARIOUS BROKERS INVOLVED IN A DEAL WILL
SPLIT THE COMMISSION BASED ON TRADITIONAL PRACTICES.
FROM A LEGAL
STANDPOINT, THE PARTY WHO CAN BRING ACTION IS THE LISTING BROKER. THE
SELLING AGENT CAN NOT SUE THE OWNER, BUT MUST SUE THE LISTING BROKER TO
COLLECT HIS COMMISSION IF IT IS NOT PAID.
"READY, WILLING, AND ABLE" - A BUYER WHO WILL PURCHASE ON THE SELLER'S
TERMS. WHEN A BROKER PROCURES THIS BUYER, THE COMMISSION IS EARNED. TO
CHANGE THIS ASSUMPTION, YOU MUST CHANGE THE CONTRACT TO READ "EARNED AT
CLOSING". YOU DO NOT WANT TO PAY A COMMISSION UNLESS THE DEAL CLOSES.
***************
THE BINDER
***************
IF YOU ARE A SELLER, STEER CLEAR OF A BINDER.

247

IF YOU ARE A BUYER, YOU

PROBABLY CAN NOT EXPLAIN IN TERMS OF LAW WHAT YOU HAVE DONE. THE PROBLEM
IS THAT THEY OUGHT TO BE CONTRACTS, YET BY DEFINITION, THEY FALL SHORT OF
THE MARK BECAUSE IT INCORPORATES A "SUBJECT TO" CLAUSE.
YOU DO NOT HAVE A BINDING CONTRACT. THE ONLY PEOPLE WHO LIKE BINDERS ARE
BROKERS, WHO SEE IT AS "THE MEETING OF THE MINDS" AND PROOF OF BRINGING A
BUYER "READY, WILLING AND ABLE".
IF YOU ARE A BUYER, BINDERS SHOULD BE SUBJECT TO TERMS TO BE NEGOTIATED.
IF YOU ARE A SELLER, LIMIT THE TIME OF THE BINDER'S EFFECT.
THE FACT THAT THERE IS A "SUBJECT TO" CLAUSE MEANS THAT THE BINDER IS NOT
A CONTRACT.
"WILLING" - WILLING TO SIGN AN UNCONDITIONAL CONTRACT ENFORCEABLE AGAINST
THE BUYER AND PURSUANT TO WHICH THE BUYER WILL PAY ALL CASH.
"ABLE" - FINANCIALLY ABLE - FUNDS ARE "IN HAND" OR HAVE BEEN ARRANGED.
PURCHASE IS NOT CONDITIONED ON A MORTGAGE. IF THE DEAL IS CONTINGENT ON
THE BUYER SECURING THE MORTGAGE, THEN IF THE CONTINGENCY IS NOT
SATISFIED, THEN THE BROKER IS NOT ENTITLED TO A COMMISSION.
THE CONTINGENCY CLAUSE MUST BE CLEAR AS TO WHAT THE OBLIGATION OF THE
BUYER AND SELLER TO EACH OTHER IS, WITH LIMITATIONS AS TO TIME, THE
AMOUNT OF THE MORTGAGE, AND THE INTEREST RATE THE PURCHASER MUST ACCEPT,
ETC.
AFFIDAVIT OF ENTITLEMENT - A STATUTORY LAW, SECTION 440 OF THE REAL
PROPERTY LAW;294B CREATES A MECHANISM WHEREBY A BROKER CAN ENCUMBER THE
PROPERTY, STAKING A CLAIM TO MONEY FOR A COMMISSION FROM THE SALE OF A
BUILDING. IT IS NOT A LIEN AGAINST THE PROPERTY, BUT AN ENCUMBRANCE.
LEASING BROKERS HAVE AN ADDITIONAL LIEN RIGHT AS OF 1982 UNDER SECTION ??
WHICH REGARDS THE COMMISSION AS AN IMPROVEMENT ON THE PROPERTY.
YOU NEED:
1. WRITTEN BROKERAGE CONTRACT (IN THIS CASE, IT IS NECESSARY)
2. APPLIES ONLY TO A COMMERCIAL PROPERTY.
3. LEASE IN QUESTION MUST BE FOR MORE THAN 3 YEARS.
4. LEASE MUST BE SIGNED AND EXCHANGED.
LIEN - A TYPE OF ENCUMBRANCE
THE DIFFERENCE BETWEEN A LIEN AND A SIMPLE ENCUMBRANCE IS THAT A LIEN IS
ENFORCEABLE. IN A LIEN, SUCH AS A MORTGAGE, FORECLOSURE MAY TAKE PLACE
TO ENFORCE THE AGREEMENT.
BUYER DOES NOT SIGN THE CONTRACT BUT IS INTRODUCED DURING THE LISTING
AGREEMENT WITH THE BROKER.
DOES THE BROKER EARN A COMMISSION?
PUT A
CLAUSE CALLED A SUNSET AGREEMENT IN THE CONTRACT OF BROKERAGE WHICH FOR A

248

PERIOD OF TIME, SAY 30 TO 60 DAYS, COVERS "WHAT HAPPENS" DURING THIS TIME
IN SUCH INSTANCES.
THE BASIC DUTIES OF THE BROKER CAN BE SUMMARIZED AS FOLLOWS:
1. MAKE A GOOD FAITH EFFORT AT SELLING PROPERTY.
2. REPRESENT INFORMATION ACCURATELY AND COMPLETELY.
IF
REPRESENTATION IS FALSE, THE BROKER MAY BE LIABLE FOR DAMAGES TO
THE
BUYER, AND WILL NOT GET A COMMISSION.
NYBTU FORM 8041 HANDED OUT (CONTRACT OF SALE)
MEETING OF THE MINDS ACHIEVED.....WE WANT TO FORMALIZE THE AGREEMENT.
FOR A CONTRACT OF SALE OF PROPERTY TO BE VALID, IT MUST BE IN WRITING.
THE SELLER CALLS THE ATTORNEY AND SAYS " I HAVE A BUYER". ATTORNEY FOR
THE SELLER USUALLY PREPARES THE CONTRACT. HE REQUIRES THE TITLE AND THE
DEED.

5 ELEMENTS TO A VALID CONTRACT FOR REAL ESTATE

1. IT NEEDS TO BE IN WRITING
2. STATE THE NAMES OF THE BUYER AND THE SELLER. THE DEED WILL SHOW WHAT
THE SELLER OWNS OR THAT THEY OWN IT WITH SOMEONE ELSE. AS A BUYER, YOU
NEED TO GIVE THOUGHT AS TO WHOM YOU WANT THE PROPERTY TO BE SOLD TO. IE.
A CORPORATION, IN YOUR WIFE'S NAME, ETC. A GOOD PRACTICE IS TO PUT THE
ADDRESS OF THE PARTIES IN THE CONTRACT. IN A DEED, THIS IS REQUIRED.
3. AN ADEQUATE AND SATISFACTORY DESCRIPTION OF THE PROPERTY.
4. CONSIDERATION (PAYMENT)
5. SIGNATURES BY THE PARTIES AGAINST WHOM EITHER WOULD SEEK TO HAVE THE
CONTRACT ENFORCED AGAINST.
STATE SALE TAX IS 0.004 (4 TENTHS OF ONE PERCENT) OF THE PURCHASE PRICE.
END OF CLASS TWO
CLASS THREE
6/11/90
5 ELEMENTS OF A CONTRACT
1.
2.
3.
4.

MUST BE IN WRITING
MUST HAVE BUYER AND SELLER'S SIGNATURES
DESCRIPTION OF WHAT IS BEING SOLD
CONSIDERATION

249

5. THE NAMES OF THE PARTIES IN THE SALE

TO MISS ANY OF THESE PROVISIONS IS A FATAL ERROR.
ELEMENTS WHEN MISSED DO NOT INVALIDATE THE CONTRACT.

ANY OF THE OTHER

THE PARAGRAPH CONTENTS OF THE REAL ESTATE CONTRACT

10 PERCENT IS A TYPICAL DOWNPAYMENT WITH THE REMAINING 90 PERCENT THROUGH
A GOOD OR CERTIFIED CHECK DUE AT CLOSING.
I.E. ON 100,000, THE
DOWNPAYMENT IS 10,000. THE GOOD OR CERTIFIED CHECK IS FOR 20,000, AND
THE TAKING OVER OF THE EXISTING MORTGAGE OF 30,000 AND 40,000 PURCHASE
MONEY MORTGAGE FROM THE SELLER.
THIS ARRIVES AT THE TOTAL PRICE OF
100,000 DOLLARS.
PURCHASE MONEY MORTGAGE ANY FUNDS USED TO BUY PROPERTY, TECHNICALLY
SPEAKING. USUALLY CONVEYS THE IDEA THAT THE SELLER IS TAKING A NOTE IN
LIEU OF THE MONIES OWED.
THE TYPE OF FORM TO BE USED FOR THE PURCHASE MONEY MORTGAGE IS THE LAST
ENTRY IN THE CONTRACT.
A COPY OF THE CONTRACT MAY BE APPENDED TO THE
CONTRACT AS AN EXHIBIT.
THE FOURTH PARAGRAPH - ALSO ABOUT A PURCHASE MONEY MORTGAGE, AND IS A
COMPLICATED TOPIC WHICH REQUIRES KNOWLEDGE OF HOW MORTGAGES WORK.
THE PERSON BORROWING IS THE MORTGAGOR.
THE PERSON LOANING IS THE MORTGAGEE.
YOU CAN FORECLOSE ON A MORTGAGE AND ON A LIEN.
POINT OF FACT!!!!!!!!!!!!!!!!!

THIS IS AN IMPORTANT

I.E. GIVEN A 100,000 PROPERTY

1ST MORTGAGE = 50,000 TO CITIBANK MORTGAGE SERVICES
2ND MORTGAGE = 10,000 TO JOE'S, THE SELLER
THE EQUITY IS THEREFORE 40,000.
IF THE PURCHASE MONEY MORTGAGE IS TO BE SUBORDINATE TO A SUPERIOR
MORTGAGE, THE AMOUNT AND INTEREST RATE OF THE SUPERIOR MORTGAGE MUST BE
WRITTEN INTO THE CONTRACT SO THAT THE BUYER DOES NOT REFINANCE, SAY, FROM
50,000 UP TO 90,000 SEVERELY LESSENING THE ABILITY OF JOE TO COLLECT IF
HE HAS TO FORECLOSE.
IN OTHER WORDS JOE IS ONLY WILLING TO TAKE A 2ND MORTGAGE BEHIND A 50,000
SUPERIOR MORTGAGE AT 10%.
****************
NOTHING SUBSTITUTES FOR PREPARATION - COVER THE ISSUES, KNOW THE
DOCUMENTS, READ THE CONTRACTS. IT IS CRITICAL THAT YOU KNOW WHAT YOU ARE

250

DOING.
PREPARE A CHECKLIST.
DETAILS.
****************

YOU MUST HAVE YOUR BASES COVERED AND HAVE FULL

WHEN YOU ASSUME AN EXISTING MORTGAGE YOU WILL WANT A "CERTIFICATE OF

REDUCTION" FROM THE FIRST MORTGAGEE.
THIS IS SOMETIMES CALLED AN
ESTOPPEL CERTIFICATE.
ESTOPPEL - A CONFIRMATORY INSTRUMENT WHICH CONFIRMS A SITUATION AS A
MATTER OF FACT.
ONE OF THE THINGS THE CERTIFICATE OF REDUCTION, WHICH IS SIGNED BY A 1ST
MORTGAGEE WILL SAY, IS THAT THE TRANSFER OF PROPERTY WILL NOT CAUSE THE
MORTGAGE TO BE "DUE ON SALE".
THE GENERAL RULE WHEN YOU ARE A BUYER IS THAT YOU ARE ACQUIRING TITLE
"FREE AND CLEAR".
PARAGRAPH SIX MODIFIES THIS GENERAL RULE.
PARAGRAPH.

IT IS CALLED THE "SUBJECT TO"

"UNMARKETABLE" VS. "UNINSURABLE"

UNMARKETABLE IS THE PREFERRED WORD BY THE BUYER.
UNINSURABLE IS THE PREFERRED WORD BY THE SELLER.
UNMARKETABLE BECAUSE A REASONABLE PERSON WOULD NOT BUY THE PROPERTY DUE
TO THE "PROBLEM" WHICH AROSE OR CAME TO LIGHT DURING THE CONTRACT PERIOD.
UNINSURABLE BECAUSE INSURANCE TO RECTIFY A PROBLEM IS EASIER TO SECURE
THAN AN NEW BUYER.
AFTER A, B, AND C IN THE "SUBJECT TO" PARAGRAPH, YOU WILL NEED TO ADD
SEVERAL MORE STIPULATIONS.
IF THE TAX INFORMATION IS FOR THIS*

PROPERTY A

BUT YOU BOUGHT THIS *

PROP'TY

THEN STATE YOU HAVE BOUGHT THE

PROPERTY SUBJECT TO THE TAXES BEING

FOR THIS

AND NOT THAT **

DO NOT GUARANTEE THAT A SALE IS SUBJECT TO A TAX BEING SO AND SO LAST

YEAR. IF THE INFORMATION IS KNOWN THROUGH AN INDEPENDENT 3RD PARTY, LET

251

THEM FIND OUT ON THEIR OWN.

VIOLATIONS CLAUSE - TYPICALLY THE SELLERS OBLIGATION IS TO CLEAR
VIOLATIONS THAT HAVE BEEN POSTED AS OF THE DAY OF THE CONTRACT, NOT
CLOSING.
THIS IS GENERALLY SUBJECT TO NEGOTIATIONS. IT IS AS OF
CONTRACT DATE BECAUSE THE SELLER ASSUMES THAT THE BUYER WILL CALL
BUILDING INSPECTOR AND TELL THEM TO EXAMINE IT FOR VIOLATIONS.

ALL
THE
THE
THE

THE NEXT TWO PROVISIONS APPLY ONLY TO N.Y.C. PROPERTY.

1. A SITUATION THAT HAS BECOME SO HAZARDOUS THAT THE CITY FIXED IT AND
ADDED AN EMERGENCY REPAIR LIEN. IF YOU HAVE AN ERL, YOU THE SELLER MUST
PAY IT AT OR BEFORE THE CLOSING.
2. A SPECIAL ASSESSMENT, SAY 5000 DOLLARS FOR A SIDEWALK, IS ASSESSED AS
A ONE TIME REAL ESTATE TAX WHICH MUST BE PAID BY THE CLOSING BY THE
SELLER.
THE NEXT PARAGRAPH, AN EXAMPLE OF EACH ITEM.
WE NEED TO DEAL WITH A SITUATION WHERE CERTAIN EXPENSES HAVE BEEN PREPAID
BY THE SELLER AND SHOULD BE CONTRIBUTED TO BY THE BUYER SINCE THE EXPENSE
HAS BEEN PAID - I.E. 12,000 REAL ESTATE TAXES PAID TWICE A YEAR, JANUARY
1 OR JULY 1. BUYER PURCHASES THE PROPERTY. 6000 DUE JAN 1, 6000 DUE ON
JULY 1.
CLOSING TAKES PLACE ON APRIL 1ST.
THE BUYER REIMBURSES THE
SELLER 3000.
THIS IS CALLED AN APPORTIONMENT, BASED UPON THE DAY OF
CLOSING, REIMBURSING THE SELLER FOR PREPAID EXPENSES.
RENTS - IF MONTHLY RENT IS 30,000 AND ITS THE 15TH, AND THE BUYER IS
REIMBURSED 15,000.
INTEREST - 30,000 MORTGAGE PAYMENT, AND ITS THE 15TH. THE SELLER PAYS
THE BUYER 15,000 (WHERE SELLER TAKES OVER THE MORTGAGE).
PREMIUM ON INSURANCE - SAME CONCEPT. AN ENDORSEMENT MUST BE GOTTEN FROM
THE INSURANCE COMPANY TO TRANSFER THE INSURANCE. MOST PEOPLE GET THEIR
OWN INSURANCE ANYWAY.
UNCOLLECTED RENTS - TO WHOM ARE THEY OWED? USUALLY COVERED SEPARATELY,
AND ADJUSTED BASED ON THE OVERALL RENT ROLE. PROVISIONS FOR A PERIOD OF
TIME, SAY A MONTH, WILL BE COLLECTED BY THE BUYER FOR THE SELLER.
WATER CHARGES - SELF EXPLANATORY
FUEL - 1000 GALLONS IN THE TANK - BUYER PAYS FOR ITS VALUE.
DUES - FOR CONDOS OR HOA'S
MAINTENANCE - FOR COOPS
*****

252

TOP OF THE THIRD PAGE, PARAGRAPH ELEVEN

NOT VERY IMPORTANT PARAGRAPH - SPEAKS FOR ITSELF.
OF TAX RATES.

SPEAKS TO THE MATTERS

PARAGRAPH TWELVE - IF BASED ON FRONTAGE, BILLED LIKE A TAX.

IF BASED ON A METER, NOTES THAT A READING WILL BE
TAKEN
SOON BEFORE CLOSING.
PARAGRAPH THIRTEEN - IMPORTANT
THE DEED SHOULD BE THE USUAL ................... THE TYPE OF DEED TO BE
USED AT THE CLOSING IS TO BE LISTED HERE.
THE CHOICES ARE:
1. QUITCLAIM DEED - SEE LECTURE ONE
2. BARGAIN AND SALE DEED WITH COVENANTS AGAINST GUARANTORS ACTS
COVENANT = REPRESENTATIONS OR PROMISES
STATES THAT GOOD AND CLEAR TITLE WITH THE LISTED EXCEPTIONS ARE THE
CASE, IN AN ARMS LENGTH TRANSACTION.
3. BARGAIN AND SALE DEED WITHOUT COVENANTS.
4. EXECUTORS DEED
5. WARRANTY DEED
SECTION 909 OF THE BUSINESS CORPORATION LAW
STATES THAT TO THE EXTENT THAT THERE ARE LIENS ON THE PROPERTY, THE
MONEYS RECEIVED INT HE TRANSACTION WILL BE USED TO REPAIR THE LIENS.
2ND PART OF PARAGRAPH 13
THE CORPORATE SELLER. IF THE SELLER IS AN INDIVIDUAL OR A PARTNERSHIP,
CROSS THIS OUT.
2ND PART OF PARAGRAPH 13 CONTINUED
CERTAIN BASICS MUST BE SATISFIED IN ORDER FOR A CORPORATION TO BE SOLD IN
N.Y.
THE CORPORATION MUST BE INT HE REAL ESTATE BUSINESS OR THE SALE
MUST BE CONSENTED TO BY THE REQUIRED NUMBER OF SHAREHOLDERS. THERE MUST
BE A RECITATION THAT THE BYLAWS HAVE BEEN COMPLIED WITH. THE RECITATION
COULD SAY THAT THE SALE IS PURSUANT TO A VOTE OF THE BOARD, AND DOES NOT
REPRESENT A MATERIAL PORTION OF CORPORATE ASSETS.
PARAGRAPH 14
THE REQUIREMENT THAT THE SELLER DELIVER A CHECK AT CLOSING TO PAY THE
STATE TRANSFER TAX. IT IS THE OBLIGATION OF THE SELLER.
ADDED TO THIS SOMETIMES IS ANOTHER TAX CALLED THE CUOMO TAX, WHICH IS THE
NYS TRANSFERS GAINS TAX. IF THE PURCHASE PRICE IS MORE THAN ONE MILLION,
THE SELLER MUST PAY A TAX EQUIVALENT TO TEN PERCENT OF THE GAIN. IF THE
SALE PRICE IS BETWEEN 500,000 AND 1,000,000, YOU REPORT IT AND THE STATE
SENDS YOU A NOTE SAYING "NO TAX DUE". IF MORE, YOU REPORT THE SALE PRICE
AND THE STATE SENDS BACK A TENTATIVE TAX DUE NOTE.

253

PARAGRAPH 15 - OMITTED IF NOT A N.Y.C. PROPERTY.

AT THE CLOSING BOTH
SIDES WILL SIGN A NYC TRANSFER TAX RETURN OR THE RPT (REAL PROPERTY
TRANSFER).
1.425% BELOW 500,000
2.5% ABOVE 500,000
PARAGRAPH 16 - FILL IN THE BLANK. WHICH TITLE COMPANY DO YOU WANT TO PUT
IN? YOU SHOULD AVOID LEAVING IT UP IN THE AIR AS TO WHAT KIND OF TITLE
IS BEING CREATED, AND BUYERS WILL PREFER TO DEAL WITH TITLE COMPANIES
THEY ARE USED TO WORKING WITH. THE SELLER DOES NOT LIKE THIS SINCE HE IS
AFRAID THAT THE BUYER WILL MANIPULATE HIS TITLE COMPANY SO AS NOT TO PASS
ON THE TITLE WHEN AND IF THE BUYER WOULD LIKE TO BACK OUT OF THE DEAL.
YOU HAVE TO DISTINGUISH BETWEEN ABSTRACT COMPANIES WHICH ARE ONLY AGENTS
AND DO NOT UNDERWRITE TITLES.
YOU NEED TO KNOW OF THE FINANCIAL
WHEREWITHAL OF THE TITLE COMPANY TO INSURE THE TRANSACTION.
PARAGRAPH 17 - THE BUYER THAT SIGNS A CONTRACT IS CALLED THE CONTRACT
VENDEE.
THE SELLER THAT SIGNS THE CONTRACT IS CALLED THE CONTRACT VENDOR.
THE CONTRACT IN AND OF ITSELF CREATES A LIEN FOR THE BUYER, BUT DOES NOT
MEAN MUCH IF THE MEMORANDUM OF THE CONTRACT (A BRIEF SUMMARY OF THE
PENDING DEAL, IN WRITING AND SIGNED BY BOTH PARTIES, IDENTIFYING THE
PARTY, DESCRIBING THE PROPERTY, AND SETTING FORTH THE APPROXIMATE CLOSING
DATE.
DOES NOT MENTION CONSIDERATION) IS NOT ALLOWED TO BE RECORDED
ACCORDING TO THE CONTRACT. IT IS THE EXCEPTION TO RECORD IT, AND USUALLY
ONLY HAPPENS WHEN THE CONTRACT PERIOD IS EXTENDED OVER A LONG TIME, SAY A
YEAR OR MORE. THE SELLER DOES NOT LIKE IT BECAUSE IT IS AN ENCUMBRANCE
WHICH ATTACHES ITSELF TO A LIEN. IF THE DEAL BREAKS UP, THE SELLER HAS
TO TROUBLE HIMSELF WITH REMOVING THE LIEN ON THE PROPERTY.
PARAGRAPH 18 - FIXTURES
THE PERSONAL PROPERTY PROVISION
SELF EXPLANATORY; WHATEVER IS BEING SOLD, IT IS INCLUDED HERE. IF IT IS
LISTED BUT NOT TO BE SOLD, STRIKE IT OUT. THE BLANK AFTER THE PARAGRAPH
IS TO EXPRESSLY STATE WHAT SHOULD NOT BE INCLUDED IN THE PROPERTY SALE.
PARAGRAPH 19 - NOT A MAJOR PARAGRAPH. AN ACCOMMODATION PROVISION. ANY
UNPAID TAXES ARE TO BE PAID FOR FROM THE MONIES PAID AT CLOSING. SAY OF
THE 100,000 PAID, THE BUYER COULD BE ASKED TO "CUT CHECKS" TO PAY THE
TAXES OUT OF THIS FEE, PAY THE COMMISSION TO THE BROKERS, ETC.
PARAGRAPH 20 - SAME AS ABOVE WITH RESPECT TO ALL BUT TAXES. CHECKS CUT
FOR CLEARING OF TITLE, FOR EXAMPLE.

254

PARAGRAPH 21 - A TITLE ISSUE OF MODERATE IMPORTANCE - ESTABLISHES AT

CLOSING THE RIGHTS AND RESPONSIBILITIES.
IF A SEARCH LOCATES A LIEN
AGAINST SOMEONE WITH THE SAME NAME AS THE SELLER, THE PURCHASER CAN
ACCEPT AN AFFIDAVIT FROM THE SELLER THAT THE LIEN IS AGAINST HIM IF THE
TITLE COMPANY IS WILLING TO ACCEPT THIS.
PARAGRAPH 22 - IF FOR SOME REASON THE SELLER CAN NOT CONVEY TITLE, AS IN
A DEFECT IN THE TITLE NOT DISCUSSED IN THE CONTRACT THAT CAN NOT BE
CLEANED UP, THE SOLE RESPONSIBILITY OF THE SELLER IS TO RETURN THE
DOWNPAYMENT PLUS TITLE SEARCH AND SURVEY COSTS TO THE BUYER.
GET A
LIQUIDATED DAMAGE AGREEMENT IN.
TEN PERCENT OF THE PRICE IS TYPICAL.
DEFINE WHAT DAMAGES ARE. IF YOU DO NOT HAVE IT AND THE BUYER BACKS OUT,
HE COULD BE LIABLE NOT ONLY FOR THE DOWNPAYMENT BUT FOR THE ENTIRE
PURCHASE PRICE.
THE SELLER AS HIS SOLE AND EXCLUSIVE REMEDY MAY IN THE EVENT OF DEFAULT
OR BREACH BY THE BUYER RETAIN THE ENTIRE DOWNPAYMENT.
PARAGRAPH 23 - WHERE PAYMENTS SHOULD BE RECEIVED - SELF EXPLANATORY
THIS IS THE WHEN AND THE WHERE.
YOU TYPICALLY PROVIDE ENOUGH TIME TO FINISH OFF BY CLOSING - IE. 45, 60,
OR 90 DAYS. BOTH PARTIES HAVE A RIGHT TO A REASONABLE ADJOURNMENT (30
DAYS). TO AVOID THE POSSIBILITY OF ONGOING ADJOURNMENTS, THE SELLER
INSISTS THAT IT BE A "TIME IS OF THE ESSENCE" CLOSING DATE.
THIS PHRASE ALLOWS DAMAGES EITHER WAY, FOR THE BUYER OR THE SELLER,
UNLESS STATED DIFFERENTLY, IF A LOSS IS EXPERIENCED, THE OPPOSING PARTY
CAN BE SUED FOR THOSE DAMAGES. EVEN IF THE CLOSING DATE IS NOT "TIME IS
OF THE ESSENCE", EXTENSIONS CAN BE "TIME IS OF THE ESSENCE".
PARAGRAPH 24 - AGREEMENT AS TO WHO IS THE BROKER, AND ALSO CAN EXPECT A
CLAIM FOR COMMISSION.
A RIDER SHOULD BE ADDED TO COVER CROSSINDEMNITIES, ETC. TO BE COVERED IN THE LECTURE ON CLOSING DOCUMENTS.
PARAGRAPH 25 - MERGER PROVISION.
INTENDED TO CLEAR UP ANY "MINI
CONTRACTS" SUCH AS BINDERS. "IF IT IS NOT IN THE CONTRACT, IT DOES NOT
EXIST" STATEMENT. THE PROVISION STATES THE PROPERTY IS "AS IS", SUBJECT
TO DAMAGE BEYOND NORMAL WEAR AND TEAR.
PARAGRAPH 26 - MODIFICATIONS - ORAL AGREEMENTS CAN NOT MODIFY
AGREEMENT. THE ESTATE IS OBLIGATED IF THE BUYER OR THE SELLER DIES.

THE

PARAGRAPH 27 - MEANINGLESS
LAST PAGE
SIGNATURE MUST BE ACKNOWLEDGED IF RECORDED. IF THE DOCUMENT IS NOT TO BE
RECORDED, THIS IS NOT NECESSARY. GENERALLY, RECORDING IS NOT DONE IN
PRACTICE.

255

END OF CLASS THREE

CLASS FOUR
6/18/90
RIDERS TO THE CONTRACT; CONTINUED
TYPICALLY DOWNPAYMENTS ARE 10 PERCENT. ON VERY LARGE CONTRACTS THIS CAN
BE REDUCED BY NEGOTIATION. THE CHECK, NOT CERTIFIED, IS MADE OUT TO THE
SELLER'S ATTORNEY, WHO ACTS AS ESCROWEE.
THIS MUST BE COVERED ON AN
ESCROW PROVISION RIDER WHICH SPELLS OUT WHERE THE DEPOSIT WILL BE HELD,
IF THE ACCOUNT IS INTEREST BEARING, AND WHAT THE INTEREST IS.
IN NEW
YORK, THE ATTORNEY DOES NOT CHARGE FOR THIS.
IN CALIFORNIA THIS IS
DIFFERENT.
ON A 100,000 ESCROW THE FEE WOULD BE 2000.
THE PROVISION
PROVIDES NOT ONLY FOR THE STORAGE OF THE MONEY, BUT THE WAY THE ESCROW
WILL BE DISTRIBUTED AND UNDER WHAT TERMS.
WHEN THE PARTIES TO THE CONTRACT HAVE A FALLING-OUT, THE CLAIMANT GOES TO
THE ESCROWEE TO COLLECT HIS MONEY. THE ESCROWEE WILL SEND A LETTER TO
THE NON-CLAIMEE TO TELL HIM WHAT THE CLAIMANT PLANS. IF THE TWO CAN NOT
AGREE, THE ESCROWEE CAN DEPOSIT THE ESCROW WITH THE COURT, OR IN ANOTHER
ESCROW ACCOUNT.
AN INTERPLEADER IS WHEN THE ESCROWEE REDEPOSITS THE
MONEY TO BRING THE TWO TO COURT TO SOLVE THE DISPUTE. THE AGREEMENT WILL
OFTEN SAY THAT THE ATTORNEY/ESCROWEE CAN BE THE NON-CLAIMANT'S ATTORNEY.
THE ATTORNEY, DUE TO CONFLICT OF INTEREST ISSUES INHERENT IN ACTING AS
ESCROWEE OFTEN DEPOSITS THE ESCROW WITH A THIRD PARTY TO BEGIN WITH.
THE NOTICE PROVISION - THE METHOD BY WHICH ONE PARTY GIVES NOTICE TO THE
OTHER.
I.E. CERTIFIED, REGISTERED MAIL; HAND DELIVERY; FAX.
IN A
FALLING-OUT, AN ARGUMENT CAN ENSUE OVER WHETHER OR NOT NOTICE HAS BEEN
PROPERLY GIVEN.
ADDITIONAL COMMENTS ON THE VIOLATIONS CLAUSE;
THE SELLER IS LIABLE TO CURE VIOLATIONS AS OF THE DATE OF THE CONTRACT.
IF FOR EXAMPLE THE VIOLATIONS COST 25% OF THE PURCHASE PRICE, THE SELLER
MAY PROTECT HIMSELF IN THE RIDER BY SAYING THAT THE VIOLATIONS ABOVE, SAY
THE USUAL 2 PERCENT OF THE SALES PRICE, WILL NOT HAVE TO BE CORRECTED BY
THE SELLER. HE WILL THEN BE RESPONSIBLE FOR MAKING A CHOICE. EITHER FIX
THE PROBLEM, OR TERMINATE THE CONTRACT. IF THE SELLER REFUSES TO FIX THE
VIOLATIONS ABOVE THE SPECIFIED AMOUNT, THE BUYER MAY OFFER TO TAKE THE
PROPERTY WITH THE AMOUNT DEBITED AGAINST THE PURCHASE PRICE. THE COST OF
REPAIRS SHOULD BE DETERMINED BY EXPERTS.
TRANSFER TAX CLAUSE: "THE SELLER WILL PAY FOR ALL TRANSFER TAXES, AND THE
BUYER WILL COOPERATE WITH THE SELLER TO DETERMINE THE TAXES REQUIRED".
THE CONTRACT PERIOD: THE 30 TO 90 DAYS AFTER A CONTRACT IS SIGNED.

256

WHAT ARE THE PARTIES TO THE CONTRACT DOING?

BUYER:
ORDERS THE TITLE SEARCH
OBTAINS FINANCING COMMITMENTS
SENDS INSPECTOR TO EXAMINE PROPERTY
environmental
structural
radon
termites
IF A PROBLEM IS FOUND DURING THE INSPECTION,THEN AT THE OUTSET THE
SELLERS OPTION IS TO CURE THE PROBLEM OR NOT TO. IF THE SELLER
CURES THE PROBLEM THE BUYER MUST CLOSE.
IF NOT, THE BUYER MAY
CHOOSE TO EITHER BUY THE PROPERTY OR BACK OUT OF THE DEAL.
A
"PROBLEM" SHOULD BE DEFINED BY A DOLLAR AMOUNT. THE SELLER WILL
USUALLY REQUEST THAT THIS BE DONE BEFORE CONTRACT IF THE BUYER'S
CLAUSES FOR INSPECTION ARE TOO ONEROUS.
INSPECTION CLAUSES ARE
RELATIVELY RARE.
OBTAIN A SURVEY OR A SURVEY INSPECTION
SELLER:
CONTACTS THE MORTGAGEE TO ADDRESS PREPAYMENT OR TRANSFER OF MORTGAGE
ISSUES. THE SELLER IS OBLIGATED TO GET THE PAYOFF LETTER.
CLOSING DOCUMENTS PREPARED (MOST BY THE SELLERS' ATTORNEY, SOME BY THE
BUYER'S ATTORNEY).
PROPERTY TRANSFER TAXES (TENTATIVE ASSESSMENT) USUALLY TAKES 20 TO 30
DAYS TO GET FROM ALBANY. FROM THE POINT OF VIEW OF THE BUYER, THE BUYER
CAN NOT CLOSE WITHOUT IT SINCE HE CAN NOT RECORD THE DEED.
ARTICLE 31B - THE NEW YORK TAX LAW - THE NEW YORK STATE TRANSFER GAINS
TAX (CUOMO TAX):
IT APPLIES TO SALES OF OVER ONE MILLION DOLLARS. THE TAX IS EQUAL TO 10
PERCENT OF THE GAIN BEING REALIZED FROM THE SALE.
THE GAIN IS THE
SELLERS ORIGINAL PURCHASE PRICE PLUS THE COST OF CERTAIN SPECIFIED
CAPITAL IMPROVEMENTS, PLUS THE COST OF SELLING THE PROPERTY; THIS IS
SUBTRACTED FROM THE CONSIDERATION AND DIVIDED BY 10 TO EQUAL THE TAX.
APPLIES BOTH TO RESIDENTIAL AND COMMERCIAL.
A TRANSFEROR AND A TRANSFEREE QUESTIONNAIRE IS USED TOGETHER WITH A COPY
OF THE CONTRACT, THE SELLER'S CLOSING STATEMENT, AND ANY BROKERAGE
AGREEMENT AS A PACKAGE SENT TO ALBANY. 20 TO 30 DAYS LATER YOU GET A
TENTATIVE ASSESSMENT OF TAXES DUE.
IT IS TENTATIVE BECAUSE N.Y.S.
RESERVES THE RIGHT TO AUDIT LATER. IF THE SELLER DOES NOT PAY THE TAXES,

257

THE STATE MAY GO AFTER THE BUYER.

*********
THE NEW YORK STATE TRANSFER TAX
*********
DOES NOT HAVE A THRESHOLD AMOUNT - APPLIES TO EVERY SALE. 4 DOLLARS FOR
EVERY ONE THOUSAND DOLLARS OF CONSIDERATION.
ONE FORM COMBINES THE
TRANSFER TAXES WITH A CREDIT-LINE MORTGAGE CERTIFICATE AND OTHER FORMS.
THE CREDIT LINE MORTGAGE CERTIFICATE IS SIGNED BY THE SELLER SWEARING TO
THE AMOUNT OR LACK OF A HOME EQUITY LOAN SECURED BY THE REAL ESTATE.
*********
THE NEW YORK CITY TRANSFER TAX
*********
RATE DEPENDS ON IT BEING 500,000 OR MORE
RESIDENTIAL LESS THAN 500K = 1 PERCENT
RESIDENTIAL MORE THAN 500K = 2 PERCENT
COMMERCIAL LESS THAN 500K = 1.425 PERCENT
COMMERCIAL MORE THAN 500K = 2.625 PERCENT
THIS TAX IS NOT STEPPED, IT IS INCREMENTAL. 499K PROPERTY IS TAXED FULLY
AT 1 PERCENT. IF RESIDENTIAL 501K PROPERTY IS TAXED FULLY AT 2 PERCENT.
***********
THE MANSION TAX
***********
PASSED LAST SUMMER.
HAS A THRESHOLD AMOUNT OF ONE MILLION DOLLARS.
PAYABLE BY THE BUYER - 1 PERCENT OF THE PURCHASE PRICE PAID.
NO PREFILING; THIS TAX IS PAID AT CLOSING. PAID TO NEW YORK STATE. ONLY FOR
RESIDENCES. DOES NOT APPLY TO RESIDENTIAL LAND THAT IS UNIMPROVED.

DOCUMENTS PREPARED DURING THE CONTRACT PERIOD:

THE TITLE REPORT - ORDERED BY THE ATTORNEY FOR THE BUYER FROM THE TITLE
COMPANY ( THE UNDERWRITER ) OR AN AGENT OF ONE OR MORE TITLE COMPANIES
(AN ABSTRACT COMPANY).
MOST REAL ESTATE ATTORNEYS HAVE DEVELOPED A
RELATIONSHIP WITH ONE OR TWO TITLE OR ABSTRACT COMPANIES. THERE IS NOT A
WHOLE LOT TO WORRY ABOUT WHERE SELECTING ONE OF A HALF DOZEN TO TEN
COMPANIES THAT ARE MAJOR UNDERWRITERS.
WHY? BECAUSE MOST HAVE ASSETS
THAT ARE MORE THAN SUFFICIENT TO COVER POTENTIAL CLAIMS.
NOT A
COMPETITIVE BUSINESS.
THE TITLE FEE IS SET BY STATE LAW.
IT IS A
PERCENTAGE OF THE INSURANCE, WHICH IN TURN IS A PERCENTAGE OF THE
PROPERTY VALUE.
I.E. A DEAL OF 1.5 MILLION DOLLARS WILL HAVE A TITLE

258

PREMIUM OF APPROXIMATELY 7,500 TO 8,000 DOLLARS. YOU ARE PAYING FOR THE
PREMIUM FOR INSURANCE IF THE DEAL CLOSES, AND IF NOT, FOR A TITLE REPORT
THAT THE COMPANY WENT THROUGH AND EXAMINED.
THE TITLE REPORT WILL STATE AND CERTIFY THE TITLE IN A PARTICULAR PERSON
OR ENTITY. IF THIS IS NOT THE PERSON YOU SIGNED A CONTRACT WITH, BELLS
AND WHISTLES SHOULD GO OFF. IT ALSO SAYS "WHAT THE STATUS OF THE TITLE
IS" IN SCHEDULE B OF THE REPORT, WHICH LISTS EVERY RECORDED ENCUMBRANCE
SUCH AS MORTGAGES AND LIENS, JUDGEMENTS, TAX LIENS, MECHANICS' LIENS,
TRAFFIC SUMMONSES, COMMON WALL AGREEMENTS, EASEMENTS, RIGHTS OF WAY, ETC.
THE NEXT PAGE IS THE MORTGAGE SCHEDULE. THEY WILL IDENTIFY THE MORTGAGE
BY BANK, THE NAME OF THE BORROWER, AND THE AMOUNT OF THE MORTGAGE AND
POSSIBLE THE TAX PAID. IF WILL SAY IF THE MORTGAGE WAS CONSOLIDATED OR
TAKEN OVER BY ANOTHER BANK.
IT WILL MAKE REFERENCE TO A SURVEY OR SURVEY READING.
A VIOLATIONS
SEARCH MAY BE PART OF THE TITLE SEARCH. A SEPARATE COMPANY WILL DO THIS.
IT TELLS YOU WHO OWNS THE PROPERTY AND WHAT THE STATUS OF THE TITLE IS.
SCHEDULE "B" ISSUES AS TO THE SELLER:
YOU HAVE TO DETERMINE WHICH ELEMENTS NEED TO BE CLEANED UP, IE. THOSE
ELEMENTS NOT IN THE "SUBJECT TO" CATEGORY OF THE CONTRACT. MORTGAGES ARE
PAID OFF AT THE CLOSING (GET PAYOFF LETTERS).
EVERYTHING IN SCHEDULE B IS AN EXCEPTION TO THE TITLE. THE TITLE COMPANY
IS ENSURING THE TITLE UNENCUMBERED EXCEPT FOR THE ITEMS IN SCHEDULE B.
AS SELLER YOU MUST HAVE THE TITLE SEARCH "OMIT" THESE EXCEPTIONS AS THEY
ARE ADDRESSED. THE CLOSER (THE TITLE COMPANY) WRITES "OMIT" OR "EXCEPT"
ON EACH ITEM AS HE IS SATISFIED WITH THE HANDLING OF THE EXCEPTIONS.
MARKET VALUE RIDER AS VALUE OF THE PROPERTY INCREASES, FOR A 10
PERCENT PREMIUM WILL INSURE THE INCREASING VALUE.
NEW YORK IS A TORRENS STATE.
THE RECORDER EXAMINES THE DEED FOR
VALIDITY.. ARTICLE 12 OF THE REAL PROPERTY LAW. REGISTRATION OF TITLE
AS OPPOSED TO RECORDING.
CLOSING DOCUMENTS ON CHECKLIST:
IN ADDITION TO THE:
TITLE REPORT
DEED
THERE ARE THE TRANSFER TAX FORMS:
THE NYCRPT: THE NEW YORK CITY REAL PROPERTY TRANSFER TAX.
THE COMBINED N.Y.S. TRANSFER TAX AFFIDAVIT

259

THE MANSION TAX, TRANSFER TAX, AND CREDIT FORM

THE N.Y.S. TRANSFER GAINS TENTATIVE ASSESSMENT
THE MULTIPLE DWELLING TRANSFER CARD
IF THE TRANSACTION REQUIRES A LOAN, THERE IS A:
RESPA - A HUD FORM WHICH IS PREPARED BY THE BANK WHICH DEMONSTRATES THE
BUYER AND SELLER'S CLOSING DETAILS IN A SUMMARY FORM.
FIRPTA - FOREIGN INVESTORS REAL PROPERTY TAX ACT.
THE BUYER SHOULD GET FROM THE SELLER A FIRPTA AFFIDAVIT STATING
THAT THE SELLER IS FOR TAX PURPOSES NOT A FOREIGN PERSON AS DEFINED BY
THE IRC. IF THE SELLER IS A FOREIGN INVESTOR, THEN YOU AS THE SELLER ARE
OBLIGATED TO WITHHOLD TEN PERCENT OF THE PRICE.
THERE ARE DIFFERENT
FIRPTA FORMS FOR PARTNERSHIPS, INDIVIDUALS AND CORPORATIONS.
REAL ESTATE TAX BILL FOR PURPOSES OF VERIFYING THAT THE TAXES HAVE BEEN
PAID.
THE ADJUSTMENT (APPORTIONMENT) SCHEDULE; SHOULD BE AGREED ON AND PREPARED
BEFORE THE CLOSING.
INSPECTION REPORTS.
SMOKE DETECTOR AFFIDAVIT (ATTACHED TO NYCRPT).
WINDOWS GUARD NOTICE (IN NEW YORK CITY)
MULTIPLE DWELLING REGISTRATION CARD (3 APARTMENTS OR MORE )
FILED WITH THE HOUSING DEPARTMENT. MUST BE PRESENTED TO REGISTRAR
WITH THE RECORDING OF THE DEED. INCLUDES A 24 HOUR PHONE NUMBER
WHERE A SUPERINTENDENT MAY BE REACHED, AND THE INSURANCE CARRIER.
SURVIVAL AGREEMENT - "SURVIVES" THE CLOSING; AGREEMENT AS TO WHAT NEEDS
TO BE DONE "POST CLOSING" IE. PRODUCING A CERTIFICATE OF OCCUPANCY FOR
THE DECK WHICH WAS NOT PRODUCED AT THE CLOSING.
THE DEAL MAY NOT BE
RESCINDED IF THE AGREEMENT IS NOT CARRIED THROUGH, AND THE SELLER MAY SUE
FOR ESCROW AND DAMAGES.
POWER OF ATTORNEY - MUST BE IN WRITING, SIGNED BY THE PARTY GIVING THE
POWER, SIGNATURE MUST BE ACKNOWLEDGED, MUST BE RECORDED ( ALL TRUE IN A
REAL ESTATE DEAL). YOU ALSO HAVE A CERTIFICATE BY THE ATTORNEY-IN-FACT
STATING THAT THE POWER OF ATTORNEY HAS NOT BEEN REVOKED AND REMAINS IN
EFFECT. THE POWER OF ATTORNEY TAKES PLACE WHEN THE APPROPRIATE PARTY CAN
NOT ATTEND THE CLOSING. THE ATTORNEY-IN-FACT IS A TERM REPRESENTING A
ROLE, AND NEED NOT ACTUALLY BE AN ATTORNEY.
EVIDENCE
OMITTED.

THAT

EXCEPTIONS

ON

THE

TITLE

260

ARE

NOT

VALID

AND

SHOULD

BE

A BILL AT CLOSING FOR BROKER OR BANK'S ATTORNEY FEE AS A RECEIPT SHOULD

BE ATTACHED AS A CLOSING DOCUMENT.
COPIES OF ANY CHECKS THAT ARE WRITTEN.
IN FACT, GET A COPY OF EVERYTHING AT THE CLOSING.
AFTER THE CLOSING, EACH ATTORNEY PREPARES A CLOSING STATEMENT OF
APPROXIMATELY SIX PAGES LONG SUMMARIZING THE TRANSACTION AND ATTACHING AS
EXHIBITS ALL OF THE DOCUMENTS PERTINENT TO THE CLOSING; I.E.
THE DEED
LOAN DOCUMENTS
CLOSING DOCUMENTS
EVERYTHING ELSE GERMANE TO THE CLOSING
BILL FOR LEGAL FEES.
****************
TOPIC FOR TERM PAPERS HANDED OUT
****************
10 SINGLE SPACED PAGES, THOUGH NO LIMIT
REPRESENT QUALITY AS WILL AS QUANTITY OF SOURCES USED.
STATUTES
CASE LAW
TREATISES (LAW REVIEW ARTICLES)
NEWSPAPERS AND MAGAZINES
PROFESSIONALS IN FIELD WITH RELATION TO THE TOPIC.
END OF CLASS FOUR
CLASS FIVE 6/25/90
TOPICS OF TODAY'S LECTURE
LEGAL RESEARCH
CLOSINGS AND DEEDS
REAL ESTATE FINANCE (MORTGAGES)
MIDTERM EXAMINATION

LEGAL RESEARCH
***************
3 BASIC SOURCES
1. CASE LAW

261

A. UNOFFICIAL REPORTS
B. OFFICIAL REPORTS
2. STATUTES
A. McKINNEY'S
3. TREATISES
A. LAW REVIEW
B. AMERICAN LAW REVIEW
A PRIVATE COMPANY COMPILING ARTICLES ON DIFFERENT TYPES OF
LAW
C. MATTHEW BENDER
REAL ACTION PROPERTY AND PROCEEDINGS LAW
SUBSTANTIVE TEXTS IN REAL ESTATE LAW
THE WARRENS, WEED TREATISE ON REAL PROPERTY LAW
D. CORPUS JURIS SECUNDUM (CJS) ENCYCLOPEDIA OF LAW
STATUTES - THE CODIFICATION OF LAWS PASSED BY THE FEDERAL, STATE, AND
CITY GOVERNMENTS.
ONCE LEGISLATED, THEY ARE CODIFIED BY CATEGORY IN
McKINNEY'S, BUT IN ADDITION THEY HAVE AN AUTHOR TO COMMENT ON IT. ALSO
CASES THAT CITE THE LAW ARE LISTED AFTER THE SECTION COMMENTARY.
THROUGH ANALYSIS OF THE CASE LAW AND THE STATUTE YOU CAN GET A GOOD IDEA
AS TO HOW THE LAW APPLIES.
NEW YORK STATE CODES FOUND IN McKINNEY'S
NEW YORK CITY CODES FOUND IN ADMINISTRATIVE CODE, WHICH INCLUDE THE REAL
ESTATE TAX LAWS AND THE BUILDING CODES.
FEDERAL LAW CODES ARE FOUND IN THE U.S. CODE ANNOTATED
YOU DO CITE SECTIONS, YOU DO NOT CITE ARTICLES.
A CITE MIGHT BE, FOR
EXAMPLE, REAL PROPERTY LAW OF THE STATE OF NEW YORK (STATUTE), ARTICLE 12
(TORRENS LAW), SECTION 12.04 (QUIET TITLE CLAIMS). THE PARENTHETICALLY
MENTIONED PARTS OF THE ABOVE EXAMPLE WOULD BE EXCLUDED FROM THE CITE, AND
ARE SHOWN FOR INSTRUCTIONAL PURPOSES ONLY.
REFER TO QUIET TITLE CLAIMS AS SECTION 12.04 OF THE REAL PROPERTY LAW OF
THE STATE OF NEW YORK, FOR EXAMPLE.
EVERY YEAR A "POCKET PART" INCLUDING AMENDMENTS, IF ANY, ARE PRODUCED AND
PLACED IN A POCKET BOUND INTO THE BINDER OF THE VOLUME OF LAW. IF YOU
KNOW THE SECTION YOU ARE LOOKING FOR, SEEK THE POCKET PART IMMEDIATELY,
SINCE THE OLD LAW IS OF NOW USE. ONCE YOU HAVE REFERRED TO THE POCKET
PART, REFER TO THE TEXT FOR ANNOTATIONS, OR UNMODIFIED LAW IF NOT FOUND
IN THE POCKET PART.
SEE DISCUSSIONS ON SHEPHERDING IN LECTURE ONE NOTES.

CASE LAW
***********

262

BROKEN OUT INTO :

*FEDERAL REPORTS*
F. = FEDERAL REPORTS (OFFICIAL) INTERPRETS FEDERAL LAWS
F. SUPP = FEDERAL SUPPLEMENT (UNOFFICIAL)
IE. PLAINTIFF >>>>>>>>>>DOE VS. SMITH >>>>>>>>DEFENDANT
405 (THE VOLUME) F.201 (THE PAGE IN THE FEDERAL REPORTS)
320(THE VOLUME) F.SUPP.19(THE PAGE IN THE FEDERAL SUPPLEMENT)(1990)
(YEAR)
OR WRITTEN WITHOUT THE PARENTHETICALLY PLACED INSTRUCTIONS, IT WOULD
APPEAR AS :
DOE VS. SMITH
405 F.201
320 F.SUPP. 19 (1990)
*STATE REPORTS*
NY= NEW YORK REPORTS - THE COURT OF APPEALS CASES (OFFICIAL)
NY. SUPP. = THE NEW YORK SUPPLEMENT
THEN YOU HAVE REPORTS FOR GEOGRAPHIC REGIONS SUCH AS
ATLANTIC = THE REPORT FOR ATLANTIC STATES
AGAIN, YOU CITE BOTH OFFICIAL AND UNOFFICIAL REPORTS.
WHEN YOU ARE CORRECTLY CITING A CASE, YOU CITE BOTH THE SUPPLEMENT AND
THE REPORT.
USUALLY, BOTH TEXTS ARE EXACTLY THE SAME ALTHOUGH THE
SUPPLEMENT TAKES LIBERTIES IN EDITING THE PLACEMENT OF TOPICS.
EXPERT TESTIMONY IS SOMETIMES AVAILABLE AS A COURTESY BY ATTORNEYS
INVOLVED IN THE CASE, IF NOT AVAILABLE FROM THE RECORD OF THE COURT (THE
COURT CHARGES A FEE)
CASES ARE INDEXED A NUMBER OF WAYS:
BY PLAINTIFF
BY DEFENDANT
BY DESCRIPTIVE WORD INDEX BASED ONE TO
SUBORDINATION) DESCRIBING THE CASE TYPE.

FOUR

WORD

INDEX

(IE.

LEASE

LEXIS, NEXIS, WESTLAW

COMPUTERIZED LEGAL RESEARCH LIBRARY. TO USE IT YOU NEED TO KNOW THE AREA
OF RESEARCH AND THE TYPE OF SOURCE, SUCH AS FEDERAL CASES ON HOUSING
DISCRIMINATION.
*************************************************************************
CLOSINGS AND DEEDS CONTINUED FROM LAST LECTURE

263

THE CROWN JEWEL OF CLOSING DOCUMENTS IS THE DEED (OF SALE). IT IS THE
WRITTEN DOCUMENT PURSUANT TO WHICH LAND IS TRANSFERRED.
THERE ARE
BASICALLY THREE TYPES. IN REVERSE ORDER OF QUALITY (LEAST TO MOST
RELIABLE) THEY ARE:
1. THE QUITCLAIM DEED
2. A BARGAIN AND SALE DEED WITH COVENANTS
AND A BARGAIN AND SALE DEED WITHOUT COVENANTS
3. THE WARRANTEE DEED
QUITCLAIM DEEDS CONVEY THE GRANTORS PRESENT INTEREST IN THE LAND, IF ANY.
IT IS USED WHERE THE SELLER EITHER DOES NOT KNOW IF THEY HAVE GOOD TITLE,
OR IF THEY KNOW THEY DO NOT HAVE GOOD TITLE. IN OTHER WORDS, REGARDLESS
OF KNOWLEDGE TO THE FAVOR OR AGAINST, THE OWNER IS CONVEYING WHATEVER
THEY OWN, LOCK, STOCK, AND BARREL. IT PURPORTS TO DEED PROPERTY NOT JUST
AN INTEREST IN PROPERTY.
WARRANTEE DEED - ASSURANCES BY THE GRANTOR THAT HE IS CONVEYING GOOD AND
UNENCUMBERED TITLE.
THE COVENANTS WOULD STIPULATE:
1. THE COVENANT OF SEIZIN IS PRESENTED STATING THAT LAND HAS NOT
BEEN SEIZED.
2. THE COVENANT OF NO ENCUMBRANCES, EXCEPT FOR WHAT IS RECITED IN
THE DEED ITSELF.
3. THE COVENANT OF QUIET ENJOYMENT - THE GRANTEE WILL NOT BE
DISTURBED IN THEIR INTEREST BY ANYBODY.
BARGAIN AND SALE DEED WITHOUT COVENANTS - CONVEYED FREE AND CLEAR.
THERE ARE SEVEN ELEMENTS TO A DEED.

THEY ARE:

1. A COMPETENT GRANTOR
LEGAL AGE
OF SOUND MIND
2. A GRANTEE
MUST BE IDENTIFIED SOMEHOW, GOOD ENOUGH TO PLACE TITLE.
3. CONSIDERATION
HOW MUCH MONEY WAS SPENT. THE PRACTICE, FOR THE SAKE OF PRIVACY,
IS TO SAY "FOR THE SUM OF TEN DOLLARS GOOD AND VALUABLE
CONSIDERATION".
IT IS NOT IMPORTANT FOR THIS TO BE EXACT, EXCEPT WHEN YOU HAVE AN
EXECUTOR TRANSFERRING TO A BENEFICIARY.
4. WORDS OF CONVEYANCE
IE. I HEREBY SELL SO AND SO TO YOU.
5. A DESCRIPTION OF THE PROPERTY.
6. SIGNED BY THE GRANTOR.
7. DELIVERY OF THE DEED FROM THE GRANTOR TO THE GRANTEE.

264

IF THERE IS A MISTAKE, FRAUD, OR COERCION, THE DEED CAN BE VOIDED BY

EITHER PARTY. WHEN YOU HAVE TWO PEOPLE ON THE DEED AS GRANTEES, THERE
SHOULD BE A STATEMENT AS TO HOW THEY ARE TAKING TITLE - AS TENANTS IN
COMMON, TENANTS BY THE ENTIRETIES, OR JUST TENANTS WITH THE RIGHT OF
SURVIVORSHIP (TWRS).
IF NOTHING IS SAID AS TO HOW THE PROPERTY IS CONVEYED, IT IS ASSUMED THAT
IT IS TRANSFERRED AS A TENANT IN COMMON TRANSFERENCE.
WHEN ONE DIES,
THEN THAT PERSON'S SHARE GOES TO THEIR ESTATE, NOT TO THE OTHER TENANT.
IF THE DEED SAYS "JOINT TENANT", OR "JOINT TENANT WITH THE RIGHT OF
SURVIVORSHIP", THEN WHEN ONE TENANT DIES, THE OTHER RETAINS THE FULL 100
PERCENT OF OWNERSHIP.
WHEN FOUR THINGS HAPPEN TOGETHER (THE FOUR
UNITIES)
YOU HAVE THIS JOINT TENANCY.
1.
2.
3.
4.

UNIT OF PROPERTY (ALL PARTIES OWN THE SAME PROPERTY).

UNITY OF TITLE (THE INTEREST ARISE FROM THE SAME DEED).
UNITY OF POSSESSION ( EACH IS ENTITLED TO USE THE PROPERTY).
UNITY OF TIME (OWNERSHIP BEGINS AT THE SAME TIME).

WHEN YOU HAVE "JOHN JONES AND MARY SMITH" WHO ARE MARRIED, THEY MAY TAKE
TENANCY BY THE ENTIRETY. IF THEY ARE MARRIED BUT DO NOT HAVE THE TENANCY
BY THE ENTIRETY STATEMENT IN THE DEED, MOST STATES HOLD THAT THEY ARE
TENANTS IN COMMON. NEW YORK IS DIFFERENT. HERE THEY ASSUME THAT THEY
TAKE POSSESSION AS JOINT TENANTS (WITH THE RIGHT OF SURVIVORSHIP), NOT
TENANTS IN COMMON.
A MORTGAGE IS THE CONVEYANCE OF LAND IN ORDER TO SECURE THE REPAYMENT OF
A DEBT. WHERE THIS IS TRUE, THE LAND IS SOLD SUBJECT TO THE REPAYMENT OF
THE DEBT. IN THESE STATES, FOR THIS REASON, YOU MORE ACCURATELY CONVEY A
DEED OF TRUST. "DEED" BECAUSE AN INTEREST IN THE PROPERTY IS CONVEYED,
AND "TRUST" BECAUSE THAT INTEREST IS HELD IN TRUST.
LIEN THEORY STATES - A STATE THAT HOLDS THAT A MORTGAGE IS A LIEN TO
INSURE REPAYMENT OF A DEBT.
TITLE THEORY STATES - A STATE THAT HOLDS THAT A MORTGAGE IS A TITLE
ACTUALLY CONVEYING A TITLE INTEREST IN THE PROPERTY TO THE MORTGAGEE.
NEW YORK IS A LIEN THEORY STATE.
WITH A MORTGAGE, YOU STOP JUST SHORT OF GIVING THE PROPERTY AWAY TO THE
BANK.
IN A LIEN THEORY STATE, YOU GIVE THEM HUGE RIGHTS TO THE PROPERTY AS
OPPOSED TO THE TITLE.

265

A DEED IN TRUST IS EXCHANGED FOR A MORTGAGE IN A TITLE THEORY STATE.

LOAN APPLICATIONS
ON PAGE 284 OF THE TEXT THERE IS A COPY OF A LOAN APPLICATION
THE REASON MOST APPLICATIONS ARE IDENTICAL IS THAT USUALLY THEY ARE
TRANSFERRED TO THE SECONDARY MORTGAGE MARKET.
THE SECONDARY MORTGAGE
MARKET IS A MARKET OF QUASI-GOVERNMENTAL AGENCIES THAT BUY MORTGAGES FROM
BANKS THAT WANT TO "UNLOAD" THEIR MORTGAGE PORTFOLIOS. THEY DO THIS BY
SELLING THE "PAPER" TO THE SECONDARY MARKET, MAKE THEIR MONEY IN POINTS,
ETC, AND GETTING MONEY TO RELEND FOR OTHER LOANS. THE STANDARDIZED FORMS
ARE USED TO EASE THE SALE OF THE MORTGAGES ON THE SECONDARY MARKET.
THE APPLICATION IS THE OFFER.
THE COMMITMENT IS THE ACCEPTANCE.
THIS MEANS THAT THE COMMITMENT IS ENFORCEABLE,A ND THE BANK CAN BE SUED
IF THEY BALK AT THE LOAN AFTER GIVING IT. THE COMMITMENT IS VIRTUALLY AS
IMPORTANT AS ANY OTHER CLOSING DOCUMENTS. THE COMMITMENT WILL COVER THE
BASICS OF THE LOAN, I.E. INTEREST RATE, AND TERM, BUT ALSO SUBSTANTIVE
POINTS SUCH AS WHETHER THE LOAN WILL BE EXCULPATORY, WHICH MEANS THAT THE
MORTGAGEE MAY LOOK ONLY TO THE PROPERTY FOR REPAYMENT IN THE EVENT OF
FORECLOSURE, AND NOT TO THE BORROWER'S OTHER ASSETS. THIS IS ALSO CALL A
NON-RECOURSE LOAN PROVISION.
WHEN THE BORROWER GETS A MORTGAGE HE SIGNS A MORTGAGE AND A NOTE. THE
NOTE IS A SPERATE DOCUMENT CREATING A SEPARATE AND PERSONAL LIABILITY FOR
THE REPAYMENT OF THE LOAN.
THIS MEANS THAT SUBJECT TO AN EXCULPATION
CLAUSE, THE BANK CAN SAY "WE DO NOT WANT THE HASSLE OF SELLING THE
PROPERTY TO REGAIN OUR INTEREST, WE ARE SUING YOU THE MORTGAGEE DIRECTLY
FOR THE MORTGAGE MONEY YOU BORROWED FROM US". IF YOU HAVE AN EXCULPATION
CLAUSE, YOU ARE DISALLOWING THE BANK THIS OPTION. IT IS A COMPLICATED
PROVISION BECAUSE THE QUESTION IS NOT WHETHER THE LOAN IS EXCULPATORY,
BUT WHEN IT IS EXCULPATORY. ONCE YOU GET BEYOND THE THRESHOLD OF WHEN IT
IS EXCULPATORY, YOU MUST DECIDE WHEN IT IS NOT.
TYPICAL "SUBJECT TO" PROVISIONS IN AN EXCULPATION CLAUSE ARE :
1. WILLFUL MISREPRESENTATIONS OF THE BORROWER
2. IF THERE IS AN ENVIRONMENTAL PROBLEM
EXCULPATION WILL NOT EXTEND TO COVER THE
LIABILITIES IN
CLEANING UP THE MESS.

266

WITH THE PROPERTY, THE

BORROWER FOR THE BANKS

THE NOTE CREATES THE LIABILITY, AND EVEN WHEN AN EXCULPATION CLAUSE WITH
ADDITIONAL "SUBJECT TO" CLAUSES EXISTS, IS HELPFUL IN PROVING THAT THERE
IS A LIABILITY EVEN THOUGH THE NOTE WOULD NOT HELP TO CREATE PERSONAL
LIABILITY IN THIS CASE.
IN OTHER WORDS, THE MORTGAGE CREATES THE
SECURITY IN THE PROPERTY, AND THE NOTE CREATES THE LIABILITY FOR
REPAYMENT OF THE MORTGAGE.
PREPAYMENT CLAUSE
TWO CLAUSES THAT DOVETAIL : THE PREPAYMENT CLAUSE AND THE DUE ON SALE
CLAUSE.
ASSUME THE FOLLOWING CASE:
1. THAT THERE IS NO ASSIGNABILITY ( THAT THE LOAN IS NOT ASSUMABLE AND
THEREFORE IS DUE ON SALE ).
2. THAT PREPAYMENT IS NOT PERMITTED.
IN THE ABOVE CASE, YOU HAVE BEEN PAINTED INTO A CORNER. THE BANK SAYS YOU
CAN NOT SELL THE PROPERTY BECAUSE YOU CAN NOT PREPAY. YET SELLING THE
PROPERTY WILL BRING THE MORTGAGE DUE, CAUSING YOU TO PREPAY. THIS "BOX"
USUALLY PLAYS OUT BY RENEGOTIATING THE LOAN AND PAYING STIFF PENALTIES BY
PROVIDING STEEP DISCOUNTS TO THE BANK.
OFTENTIMES, THE YIELD MAINTENANCE FORMULA WILL BE PART OF THE COMMITMENT,
ALLOWING PREPAYMENT IF THE YIELD IS REIMBURSED, BASED UPON THE
DIFFERENTIAL BETWEEN PRESALE AND FULL TERM.

MORTGAGES MUST BE RECORDED IN ORDER TO ESTABLISH THE SUBORDINATION OF

LIENS (LIEN PRIORITY).
THE AMOUNT OF EACH MORTGAGE MUST BE NOTED IN
ORDER TO PRECLUDE ADJUSTMENT BY THE BORROWER AND THE LENDER OVER TIME,
THEREBY MAKING IT IMPOSSIBLE TO INDEPENDENTLY ASSESS THE LIABILITIES
AGAINST THE PROPERTY.
IT MUST LIST THE AMOUNT, LENGTH OF PERIOD, AND
INTEREST RATE. CO-OPS HAVE A NOTE AND A SECURITY AGREEMENT. SECURITY
INTERESTS (ABBREVIATED FORM OF SECURITY AGREEMENT) CAN BE RECORDED, BUT
SECURITY AGREEMENTS ARE NOT.
UNIFORM COMMERCIAL CODE FORM ONE (UCC1)
LISTS THE LENDER, BORROWER, COLLATERAL, AND PROPERTY AND IS RECORDED. IT
IS ALSO CALLED THE FINANCING STATEMENT.
THE MIDTERM IS PASSED OUT.
END OF CLASS FIVE
CLASS SIX 7/2/90
LOAN TO VALUE (LTV) - MEASUREMENT OF EXPOSURE TO DEFAULT. ONCE THERE IS
A DEFAULT, THE LTV GIVES THE MORTGAGEE AN IDEA OF WHAT THEY CAN RECOUP IN
A FORECLOSURE, BEING THAT THEIR FEES, INTEREST,A ND COURT COSTS ARE ALL

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NEEDED IN ADDITION TO THE MORTGAGE DUE.

IN A COMMERCIAL TRANSACTION, LTV CONTROLS THE LIKELIHOOD OF GRANTING
EXCULPATION, SINCE THE BANK LENDING ON A HIGH LTV WILL NOT GRANT
EXCULPATION, BEING THAT IT MAY HAVE TO GO AFTER THE MORTGAGOR TO BE MADE
WHOLE AFTER THE FORECLOSURE.
MORTGAGES
**********
THE STANDARD MORTGAGE FORM IS FAR LESS THAN ADEQUATE. IT EXCLUDES MORE
THAN IT INCLUDES.
OFTENTIMES, CONTRACTS WILL BE REDRAFTED ON WORD
PROCESSORS BASED UPON THE BASIC FORM, BUT IN MUCH MORE DETAIL.
THE DOCUMENTS IN A LOAN CLOSING INCLUDE THE NOTE AND THE MORTGAGE.
TONIGHT THE MORTGAGE WILL BE DISCUSSED IN DETAIL. SOME OF THE FORMS USED
BY THE BANK AND EXCHANGED AT THE LOAN CLOSING, ATTENDED BY COUNSEL FOR
THE BANK, A TITLE COMPANY REPRESENTATIVE, THE BUYER AND THE SELLER. MAY
OR MAY NOT BE ATTENDED BY AN OFFICER OF THE BANK.
THERE IS A REVIEW OF TITLE. IF ACCEPTABLE TO THE BANK'S COUNSEL, THERE
IS A SLEW OF DOCUMENTS, REVIEWED AHEAD OF TIME AND REVIEWED BY THE BANK,
WHICH IS EXCHANGED.
WHEN YOU GET THE PACKAGE OF DOCUMENTS FROM THE BANK, CHECK THE TERMS
AGAINST THE LETTER OF COMMITMENT, SUCH AS INTEREST RATE, ESCROW, DUE ON
SALE, TERM, ENVIRONMENTAL LIABILITY, ETC.
THE COMMITMENT IS TO THE
CONTRACT WHAT THE DEED IS TO THE MORTGAGE. IF YOU ARE GEARING UP FOR A
TITLE CLOSING, YOU REVIEW THE CONTRACT.
IF YOU ARE PICKING UP THE
MORTGAGE DOCUMENTS YOU EXAMINE THE COMMITMENT.
NEXT YOU
THE SAME
THE BANK
THE SAME

LOOK AT THE TITLE REPORT. TAXES DUE, JUDGEMENTS, ETC.; EXACTLY

REPORT FROM THE TITLE COMPANY THAT YOU GOT BUT IS CERTIFIED TO
FOR LENDING PURPOSES. IN A REFINANCE SITUATION THIS REPORT IS
FOR THE BUYER AND THE LENDER.

SATISFACTION - A LETTER FROM THE BANK SAYING THAT THE LOAN HAS BEEN PAID
AND IS "HISTORY". IF YOU ARE A MORTGAGOR, SOMETIMES YOU WILL PREFER AN
"ASSIGNMENT". IN OTHER WORDS, INSTEAD OF TERMINATING THE MORTGAGE, THE
MORTGAGOR PAYS OFF THE MORTGAGE AND ASKS THE MORTGAGEE TO ASSIGN THE
MORTGAGE TO A NEW MORTGAGEE, WHICH COULD EVEN BE ANOTHER SUBSIDIARY OF
THE MORTGAGOR'S COMPANY.
THIS IS DONE TO SAVE THE MORTGAGE RECORDING
TAX. WHEN MORTGAGES EXCEED 500,000 DOLLARS, THE MORTGAGE RECORDING TAX
IS 2.5 PERCENT OF THE MORTGAGE AMOUNT. YOU MAY SAVE THE MORTGAGE TAX ON
THE PORTION OF THE MORTGAGE THAT IS ASSIGNED, ACCORDING TO SECTION 255 OF
THE NEW YORK STATE TAX LAW.
IE. 500,000 1ST MORTGAGE TODAY

1,000,000 1ST MORTGAGE TOMORROW

THE TAX PAID WILL BE BASED ON (1,000,000 - 500,000) = 500,000 X .025

=12,500 DOLLARS.

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THERE IS A CONSOLIDATION AGREEMENT WHEREBY THE SECOND 1ST MORTGAGE (THE

ONE FOR 1,000,000 DOLLARS) TAKES A NOTE FOR A NEW 500,000 DOLLAR MORTGAGE
WHILE CONSOLIDATING THE OLD 1ST MORTGAGE INTO IT. IN ORDER TO DUE THIS,
THE MORTGAGE CANNOT BE EXTINGUISHED.
THIS OLD MORTGAGE IS SOMETIMES
CALLED A DORMANT MORTGAGE. A DORMANT MORTGAGE USED TO BE USEABLE IN A
VARIETY OF WAYS. UNDER THE REVISED SECTION 255 OF THE NEW YORK STATE TAX
CODE, THE USE OF DORMANT MORTGAGES WAS RESTRICTED. THIS IS WHAT USED TO
BE POSSIBLE:
JOE TAKES A MORTGAGE WITH A BANK.
JOE IS SELLING A "DUE ON SALE"
PROPERTY. JOE WISHES TO BUY ANOTHER PROPERTY FOR WHICH HE WILL PAY THE
MORTGAGE TAX. JOE CAN CHOOSE TO TAKE A SATISFACTION AND LET THE MORTGAGE
DIE UPON SALE, OR HE CAN ASSIGN THE MORTGAGE TO HIS COMPANY.
HE WILL
THEN PUT IT ON THE OTHER PROPERTY THAT HE NOW OWNS, IN CASE HE LATER
NEEDS TO SHIFT THE MORTGAGE BACK. WHEN HE NEEDS TO MAKE A REAL MORTGAGE,
HE WILL ASSIGN THE MORTGAGE BACK TO JACK'S BANK, AND JACK'S WILL PAY JOE
THE VALUE OF THE MORTGAGE, AND THE TAX CREDIT FOR THAT ASSIGNED MORTGAGE
WILL BE JOE'S SINCE JOE ASSIGNED IT TO HIMSELF BEFORE HE REASSIGNED IT TO
JACK'S BANK.
ANYTIME A MORTGAGE IS RECORDED IN NEW YORK STATE, AND THE MORTGAGE IS
GREATER THAN 500,000 DOLLARS, A MORTGAGE TAX IS REQUIRED. A CHECK IS CUT
TO THE TITLE COMPANY AT THE CLOSING. THE RECORDING CHARGE IS ABOVE THIS.
IT IS AT THIS TIME TEN DOLLARS PER DOCUMENT PLUS 2 DOLLARS PER PAGE. A
TYPICAL FEE WOULD BE APPROXIMATELY 100.00 DOLLARS.
WRAPAROUND MORTGAGE - THE UNDERLYING FIRST MORTGAGE STAYS THE SAME. THE
OWNER, WHEN SELLING HIS PROPERTY, GAVE PERSONALLY A MORTGAGE TO THE
BUYER.
THE BUYER PAYS THE SELLER, AND THE SELLER PAYS THE FIRST
MORTGAGE. THE SELLER USUALLY MAKES PROFIT ON THE INTEREST RATE OVER WHAT
HE IS PAYING ON THE UNDERLYING LOAN, AS WELL AS ON THE DIFFERENCE IN
PAYMENTS.
MORTGAGES AND THE DIFFERENT DOCUMENTS OF THE MORTGAGE LOAN (CONT.)
A CONSOLIDATION LOAN RESTATES THE MATERIAL TERMS OF, BY AND LARGE,
COMMERCIAL DEALS, BINDING TWO MORTGAGES TOGETHER INTO A NEW SINGLE
MORTGAGE.
A COLLATERAL ASSIGNMENT OF RENTS (OVERKILL BY THE BANK) - THE OWNER OF
THE PROPERTY AGREES TO ASSIGN ALL RENT PAID BY THE TENANTS IN THE
BUILDING. THE BANK AGREES THAT IT WILL NOT EXERCISE THIS RIGHT UNTIL THE
MORTGAGOR STOPS MAKING PAYMENTS ON THE MORTGAGE. THIS HAS ALREADY BEEN
COVERED IN THE MORTGAGE, SO IT IS NOT REALLY AN ESSENTIAL CLAUSE.
THE SECURITY INTEREST AND THE
STATEMENT - IN ADDITION TO THE
THE FIXTURES THAT ARE PART AND
SEPARATELY WITH THE RECORDER.

UCC1 FORM, ALSO KNOWN AS A FINANCING

MORTGAGE, THE BANK TAKES AN INTEREST IN
PARCEL OF THE BUILDING, AND GETS FILED
(THE UNIFORM COMMERCIAL CODE, UCC, IS A

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NATIONWIDE STATUTE COVERING COMMERCIAL TRANSACTIONS). THIS IS THE SAME AS

A CHATTEL MORTGAGE.
PLEDGE AGREEMENT AND NEGATIVE PLEDGE AGREEMENT - A PROMISE OF AN INTEREST
IN ADDITIONAL COLLATERAL ABOVE WHAT HAS BEEN PLEDGED AS SECURITY, SUCH
AS:
SECURITY INTEREST IN REAL ESTATE
NOTE
ASSIGNMENT OF RENTS
SECURITY INTEREST IN FIXTURES AND PERSONALTY
PLEDGE AGREEMENTS ARE USED IN HIGH LTV LOANS.
IT IS COLLATERAL NOT
ASSOCIATED DIRECTLY WITH THE PROPERTY, SUCH AS SHARES OF STOCK IN THE
MORTGAGOR'S CORPORATION.
OOPS AFFIDAVIT - WHEN CITIBANK WAS DOING A LOT OF VOLUME IN HOME
MORTGAGES, NO ONE COULD ADEQUATELY MONITOR IT. THE SENSE THAT SOMETHING
WOULD SLIP BETWEEN THE CRACKS CAUSED THE BANK TO HAVE AN OOPS AFFIDAVIT
INSERTED INTO THE CONTRACT, WHICH WHEN SIGNED CAUSES THE BUYER TO PERFORM
A CORRECTION DEED OR FILL IN THE MISSING BLANK SHOULD SOMETHING BE
OVERLOOKED.
CERTIFIED RENT ROLE - A COPY OF THE RENT ROLL FOR A GIVEN BUILDING THAT
IS BEING ENCUMBERED, AND CERTIFIED BY THE OWNER AS CORRECT.
ESTOPPEL CERTIFICATE - STATEMENTS FROM THE TENANTS TO THE BANK SAYING, "I
HAVE A LEASE, VALID AND IN EFFECT, WITHOUT OFFSETS AND DEFENSES, AND NOT
PREPAID AT A GIVEN RATE OVER A CERTAIN TERM". PART OF THE CERTIFIED RENT
ROLE.
FLOOD CERTIFICATION - A CERTIFICATION (COSTS 17 DOLLARS) FROM A COMPANY
IN NEW JERSEY THAT FOR ANY PLACE IN THE COUNTRY WILL CERTIFY ITS STATUS
AS IN OR OUT OF A FLOOD PRONE AREA.
RESPA - REAL ESTATE SETTLEMENT PROCEDURES ACT. TELLS THE BUYER WHAT THE
TOTAL COST OF THE LOAN IS, WHERE THE MONIES WENT, AND WHAT COSTS WERE
INCURRED. PREPARED BY THE BANK, AND USED BY ATTORNEYS AS PART OF THEIR
CLOSING STATEMENT. IT TELLS THE SELLER THE CONTRACT DEPOSIT AND DEPOSITS
DUE.
TRUTH IN LENDING STATEMENT - SUMMARIZES THE AFFECT OF AN ADJUSTABLE RATE
LOAN, ITS TERMS, AND TELLS YOU WHAT YOU WILL PAY THE BANK IF YOU PAY OFF
AT ANY TIME DURING THE TERM.
CERCLA - COMPREHENSIVE ENVIRONMENTAL COMPENSATION LIABILITY ACT - ALMOST
ALL COMMERCIAL LENDERS REQUIRE A PHASE I ENVIRONMENTAL AUDIT DUE TO
SUPERFUND LAWS MAKING THE LENDER LIABLE IN SOME INSTANCES. THE MORTGAGEE
WILL STILL INSIST THAT THE MORTGAGOR BE LIABLE FOR THE COST OF
ENVIRONMENTAL CLEAN-UP.

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UNDER CERCLA, THERE IS A LIABILITY BASED ON BOTH CONDUCT AND STATUS. BY

THIS, WE MEAN THAT IF YOU ENJOY STATUS AS AN OWNER, OPERATOR, PERSON
RESPONSIBLE FOR COLLECTION AND CLEANUP, OR CARTING AT THE PLACE, YOU ARE
FULLY RESPONSIBLE FOR CLEANUP UNDER CERCLA. IF AS A LENDER YOU HAVE AN
INFLUENCE ON THE DAY TO DAY AFFAIRS OF THE PROPERTY, YOU ARE ALSO
RESPONSIBLE. THIS IS TRUE ESPECIALLY AFTER FORECLOSURE, BUT MAY BE TRUE
BEFORE A FORECLOSURE WHEN THE MORTGAGE IS CURRENT.
THE MORTGAGE FORM
PARAGRAPH ONE - LISTS THE PRINCIPAL AMOUNT (THE AMOUNT OF THE LOAN), THE
TERMS, ANNUAL RATE, THE DATE, AND THE BORROWER'S AND LENDER'S NAMES.
YOU PAY THE MORTGAGE IN ARREARS. YOUR PAYMENT IS FOR THE MONTH THAT HAS
JUST PASSED, NOT THE ONE COMING.
WHEN CLOSING IS JUNE 1ST, THE DATE
PLACED HERE IS AUGUST 1ST.
YOU SKIP A MONTH AFTER CLOSING, AND START
PAYING A MONTH LATER.
SHORT INTEREST COVERS THE PERIOD OF INTEREST FROM THE DATE OF THE CLOSING
TO THE END OF THE MONTH. MONTHS FOR THIS PURPOSE ARE ALL 30 DAYS.
FIXTURES, PERSONAL PROPERTY, AWARDS OF EMINENT DOMAIN ARE COVERED.
A COVENANT IS AN AGREEMENT TO DO SOMETHING. THE BORROWER AGREES TO PAY
THE DEBT. HE AGREES TO INSURE THE PROPERTY. HE AGREES THAT IT SHOULD BE
ADEQUATELY INSURED IN THE EYES OF THE MORTGAGE. HE AGREES NOT TO ALTER
OR DEMOLISH THE BUILDING WITHOUT THE LENDER'S CONSENT. THE BANK DOES NOT
WANT TO INHERIT A PROPERTY IN MID-CONSTRUCTION.
DEFAULT PROVISION - A 15 DAY GRACE PERIOD, WITHOUT PENALTY.
A MONETARY DEFAULT.

ALSO CALLED

NON-MONETARY DEFAULTS MAY BE CURED IN 30 DAYS AFTER THE BANK NOTIFIES

YOU.
PARAGRAPH 5
THE BANK RESERVES THE RIGHT TO APPOINT A RECEIVER IN THE EVENT OF A
FORECLOSURE.
PARAGRAPH 6
THE MORTGAGOR AGREES TO PAY TAXES, WATER, AND INSURANCE PREMIUMS.
USUALLY, THE BANK IS THE ONE TO COLLECT THIS, AND THEY PAY THESE ITEMS
FROM AN ESCROW ACCOUNT.
THE BANKS MAKE MONEY ON THE SPREAD IN TIME
BETWEEN ESCROWAGE AND PAYMENT.
PARAGRAPH 7 - THE SAME PURPOSE AS AN ESTOPPEL CERTIFICATE.
MORTGAGOR
SAYS, "I HAVE NOT PAID OFF THE DEBT, AND AM NOT IN A BATTLE WITH THE
BANK, AND I AM WILLING TO SAY SO".

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PARAGRAPH 12 - IN THE EVENT OF A FORECLOSURE, ALL SUMS DUE BY WAY OF

COSTS GET THROWN INTO THE MORTGAGE DUE.
IF MONIES ARE DUE, SUCH AS
TAXES, THAT IS ADDED AS WELL AS INTEREST FOR THOSE SUMS.
PARAGRAPH 13 - REDUNDANT - STATES ESSENTIALLY THE SAME AS THE ASSIGNMENT
OF RENT DOCUMENT.
THE MORTGAGOR IS GIVING TO THE MORTGAGEE RIGHTS TO
INCOME STREAM, AND THE RIGHT TO STEP IN AND OPERATE THE PROPERTY AS OWNER
EVEN BEFORE THE PROPERTY IS FORECLOSED. THE RIGHT IS WAIVED AS LONG AS
PAYMENTS ARE MADE.
MORTGAGOR AGREES NOT TO COLLECT RENTS TOO FAR IN
ADVANCE, SINCE THE TENANT WILL NOT OTHERWISE PAY THE BANK IN THE EVENT OF
FORECLOSURE ON THE MONIES DUE IT.
PARAGRAPH 14
- WHEN THE LOAN MAY BE ACCELERATED - ANOTHER DEFAULT
PROVISION;
WHEN THE PROPERTY BECOMES UNINSURABLE
WHEN THE TAXES ARE NOT PAID
WHEN THE BUILDING IS ALTERED OR DEMOLISHED, OR FIXTURES REMOVED.
WHEN THE PROPERTY IS NOT KEPT IN REPAIR.
WHEN THERE ARE UNADDRESSED VIOLATIONS.
WHEN RENTS ARE ASSIGNED TO SOMEONE OTHER THAN THE MORTGAGEE
IT IS AN ELEMENT OF EQUITY AND NOT LAW. THEREFORE JUDGEMENTS IN DISPUTES
ON THESE MATTERS MUST BE FAIR. ACCELERATION MAY TAKE PLACE WHEN AN ACT
OF LAW REDUCES THE PROPERTY VALUE BELOW A CERTAIN GIVEN LTV RATIO.
PARAGRAPH 15 - REQUIRES THE MORTGAGOR TO TAKE THE MONEY FROM THE BANK AND
SETTLE ENCUMBERING LIENS ON THE PROPERTY.
PARAGRAPH 16 - DULY AUTHORIZED BY THE OFFICERS OF THE CORPORATION OR
RESOLUTION OF THE BOARD OF THE CORPORATION STATING THAT THE MORTGAGE IS
ACCEPTABLE.
BOTTOM
SIGNED BY THE
AGREEMENT)

MORTGAGOR, NOT

THE BANK

(EXCEPT WHEN

A CONSOLIDATION

SIGNATURE MUST BE NOTARIZED.

BECAUSE RECORDED, THE BLOCK AND LOT MUST BE LISTED, AND THE NAME TO WHOM
THE MORTGAGE WILL BE RETURNED (USUALLY THE BANK'S ATTORNEY)
END OF CLASS SIX
CLASS SEVEN - 7/9/90
LOCUS SIGILLI (SEE-JEE-LEE) - LOCATION OF THE SEAL; WHERE THE SEAL IS TO
BE AFFIXED ON A CONTRACT. INITIALS ARE L.S.
WITNESS - STATES; "I SAW A PERSON SIGN THIS DOCUMENT AND I MAKE NO
STATEMENT AS TO THE AUTHENTICITY OF THE SIGNATURE".

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NOTARIZATION- "I SWEAR TO THE FACT THAT A SIGNATURE IS AUTHENTIC, AND

THAT THE I THE NOTARY SAW THE PERSON SIGN IT."
MORTGAGES
EXCULPATION CLAUSES DETERMINE WHETHER OR NOT THE BANK CAN GO BEYOND THE
REAL ESTATE MORTGAGED TO REMEDY THE LOSS OF FUNDS EXPERIENCED BY THE
MORTGAGEE WHEN THE REAL ESTATE IS FORECLOSED. IF THE BANK FORECLOSES AND
THERE IS AN EXCULPATION CLAUSE, THE BANK MAY (1) COLLECT THE PRINCIPAL
DUE PLUS (2) RECOUP ACCRUED INTEREST TO THE DATE OF THE SALE, (3) LATE
FEES AND REPAYMENT FEES, (4) AND THE COST OF FORECLOSURE SUCH AS
ATTORNEY'S FEES, PREPAYMENT FEES, LATE FEES, ETC. THIS LAST ITEM CAN BE
A SUBSTANTIAL AMOUNT. IF AFTER RECOUPING THESE FOUR ITEMS THERE IS ANY
MONEY LEFT FROM THE SALE, IT GOES TO THE MORTGAGOR. IF IN SELLING THE
PROPERTY THE BANK DOES NOT RECOUP THESE ITEMS, A "DEFICIENCY JUDGEMENT"
CAN BE SOUGHT AGAINST THE MORTGAGOR TO SEEK REDRESS IF THE LOAN IS A
RECOURSE LOAN.
A NON-RECOURSE (EXCULPATORY) LOAN WILL NOT ALLOW THE
MORTGAGEE TO LOOK FURTHER THAN TO THE REAL ESTATE FOR REDRESS.
EXCULPATION, WHEN AVAILABLE SUCH AS WHEN THE LTV RATIO IS LOW, IS
NEGOTIATED AT THE COMMITMENT. EVEN WHEN EXCULPATION IS GRANTED,L IT HAS
BEEN "CHIPPED AWAY" OVER THE PAST SEVERAL YEARS. OFTEN THE RIGHT WILL BE
RESERVED TO GO AFTER THE MORTGAGOR IF:
1) THE MORTGAGOR COMMITTED A FRAUD WITH RESPECT TO A MATERIAL ASPECT OF
THE AGREEMENT BETWEEN THE BANK AND THE MORTGAGOR. SUCH AS:
MISSTATEMENT AS TO INCOME (FRAUD AND MISREPRESENTATION)
MISSTATEMENT AS TO BROKER RELATIONSHIP
ETC.
2) ENVIRONMENTAL LIABILITY - SEE LECTURE SIX
TO PROTECT THEMSELVES FROM ENVIRONMENTAL LIABILITY, BANKS TYPICALLY
EXPECT A SERIES OF REPRESENTATIONS FROM THE MORTGAGOR THAT IT HAS DONE
NOTHING:
1) IN THE PAST TO CAUSE ENVIRONMENTAL PROBLEMS ON THE PROPERTY;
2) WILL NOT DO ANYTHING TO THE PROPERTY TO CAUSE ENVIRONMENTAL
PROBLEMS IN THE FUTURE;
3) WILL INDEMNIFY THE BANK FROM LIABILITY FOR THE ENVIRONMENTAL
DAMAGE, IF ANY;
4) THEY WILL ALSO INSIST THAT AN ENVIRONMENTAL AUDIT BE TAKEN AS A
CONDITION OF MAKING THE LOAN.
REPRESENTATION - MADE IN THE CONTEXT OF A CONTRACT, GIVES RISE TO A
BREACH IF VIOLATED, WHICH CAN BE PURSUED IN COURT AS A BREACH OF
CONTRACT.
WARRANT - A "STAND ALONE" TYPE OF PROMISE, GIVING RISE TO A TORT CLAIM.
NOTE:
ALWAYS DEMAND TO SEE AN UNSIGNED AND UNDATED DRAFT OF THE
ENVIRONMENTAL AUDIT THAT YOU COMMISSIONED SO THAT PRIOR TO SUBMISSION TO
THE BANK YOU HAVE THE OPPORTUNITY TO ELIMINATE ALL UNWARRANTED

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CONCLUSIONS OR STATEMENTS MADE BY THE CONSULTANT IN HIS EFFORT TO PROTECT

HIMSELF FROM LIABILITIES.
A PHASE ONE REPORT - THE BANK ASKS THE MORTGAGOR TO CERTIFY THAT HE, WITH
DUE DILIGENCE, HAS PURSUED AN AUDIT OF THE PROPERTY AND HAS DETERMINED
THAT THERE IS NO ENVIRONMENTAL PROBLEM.
DUE ON SALE CLAUSE - SEE PAST LECTURES
PREPAYMENT PENALTY CLAUSE - SEE PAST LECTURES
RESIDENTIAL UNITS, OWNER OCCUPIED AND ONE TO SIX UNITS, ARE ALL
PREPAYABLE AFTER THE FIRST YEAR IN NEW YORK. COMMERCIAL TERMS DIFFER AND
ARE NEGOTIATED AT THE COMMITMENT PHASE.
THE BANK MAY CONSENT TO
PREPAYMENT PROVIDED THAT THE BANK IS PAID A PREMIUM TO DO SO. SEE YIELD
MAINTENANCE FORMULA, LECTURE FOUR.
YIELD MAINTENANCE FORMULAS WILL
GUARANTEE THE MORTGAGEE THE MARGIN BETWEEN THEIR INVESTMENT IN, SAY, TBILLS, AND THE RATE ON THE MORTGAGE.
MOST BANKS WILL NOT ACCEPT PARTIAL
PREPAYMENT. SOME MAY ALLOW PREPAYMENTS IN, SAY, 50,000 OR 100,000 DOLLAR
INCREMENTS. THE YMF IS NOT A PENALTY, AS PER STATEMENTS TO THAT POINT IN
THE CONTRACT FOR THE MORTGAGE. PENALTIES FOR PREPAYMENT ARE ILLEGAL.
EXCULPATION CLAUSE - RESIDENTIAL LOANS ARE NEVER EXCULPATORY AS A MATTER
OF PRACTICE.
LATE FEES CLAUSE - 2 TO 5 PERCENT OF THE PAYMENT IF NOT PAID WITHIN 15
DAYS OF DUE DATE.
SUBORDINATION CLAUSE - DEALS WITH PRIORITY OF LIEN ON THE MORTGAGE.
PROVIDES FOR WHETHER OTHER MORTGAGES MAY BE PLACED ON THE PROPERTY EVEN
WHEN THE OTHER MORTGAGES ARE SUBORDINATE IN LIEN. IF MORTGAGOR'S ABILITY
TO REPAY THE FIRST MORTGAGE IS IMPEDED BY THE SECOND MORTGAGE, THE FIRST
MORTGAGEE WILL INSIST THAT THE MORTGAGOR NOT TAKE THE LOAN, AND WOULD
HAVE A RIGHT TO INSIST ON THIS IN A SUBORDINATION CLAUSE.
IF THE
MORTGAGOR SEEKS TO GAIN A SECOND MORTGAGE TO IMPROVE THE PROPERTY, THE
FIRST MORTGAGOR WOULD BE HARD-PRESSED TO WIN IN COURT IF IN EFFECT THE
IMPROVEMENTS IMPROVE THE PROPERTY'S VALUE, IN TURN INCREASING OR
ANCHORING THE EQUITY IN THE PROPERTY THAT THE FIRST MORTGAGOR IS TRYING
TO PROTECT.
DIFFERENT TYPES OF MORTGAGES
FIXED RATE MORTGAGE - (RESIDENTIAL PROPERTY, ONE TO SIX FAMILY)
TYPICALLY PROVIDES THAT THE INTEREST RATE IS LOCKED IN BEFORE CLOSING AND
FOR THE LIFE OF THE LOAN. USUALLY 15, 30, OR 40 YEAR LOANS.
A.P.R. - ANNUAL PERCENTAGE RATE - THE REAL COST OF THE BORROWING.
FUNDING COMPANY - A FUNDING COMPANY IS A PRIVATE LENDER.
IT DOES NOT
NEED TO MEET THE STATUTORY REQUIREMENTS FOR BANKING. THEY OFTEN HAVE NO
MONEY OF THEIR OWN.
THEY ACT AS INTERMEDIARIES.
THEY FIND A LENDER,
MAKE A LOAN, AND SELL THE LOAN ON THE SECONDARY MARKET. USUALLY THEY ARE

274

MORE EXPENSIVE SINCE THERE ARE MORE MIDDLE-MEN TAKING A CUT, THEY HAVE
TO MEET TOUGHER SELLING REQUIREMENTS ON THE SECONDARY MARKET, OR THE
FUNDING COMPANY CAN NOT FIND THE MONEY. IN THE LAST CASE, YOU WILL NOT
BE ABLE TO CLOSE AS SCHEDULED. ALWAYS ASK WHETHER THE FUNDING COMPANY IS
LENDING THEIR OWN MONEY. IF NOT, DO NOT USE THEM.
ADJUSTABLE RATE MORTGAGE - ADJUSTED PERIODICALLY BASED ON A MARGIN ADDED
TO AN INDEX SUCH AS A 1 YEAR T-BILL. ADJUSTMENT LIMITED BY A CAP ON THE
ANNUAL INCREASE, SUCH AS 2%, AND A MAXIMUM CAP, SAY 5%, OVER THE LIFE OF
THE LOAN. ADJUSTABLE RATE LOANS USUALLY HAVE LOW INTRODUCTORY RATES, AND
IS USEFUL FOR SHORT TERM LOANS. DECISIONS TO TAKE AN ARM BASED UPON WHAT
YOU CAN AFFORD TO PAY, WHETHER RATES ARE GOING UPWARD OR DOWNWARD, AND
HOW LONG YOU WILL BE IN THE PROPERTY.
NEGATIVE AMORTIZATION MORTGAGE - THERE IS AN UPWARD TREND IN INTEREST
RATE COUPLED WITH A FIXED MONTHLY PAYMENT.
THE MARGIN IS ADDED TO THE
PRINCIPAL PORTION OF THE LOAN, AND IS PAID AT THE END.
BECAUSE THE
PRINCIPAL PORTION GETS LARGER RATHER THAN SMALLER, THE LOAN IS CONSIDERED
TO NEGATIVELY AMORTIZE.
VARIABLE RATE MORTGAGE - SIMILAR TO ADJUSTABLE RATE MORTGAGE. PRIMARILY
FOR COMMERCIAL LOANS. RATES ARE NOT LINKED TO AN INDEX SUCH AS THE TBILLS, BUT IS LINKED TO THE PRIME RATE. DOES NOT HAVE ANY CAPS. OFTEN
HAS A SLIDING SCALE PREPAYMENT PENALTY.
IE. GIVEN A TEN YEAR LOAN, WITH TYPICAL PREPAYMENT PENALTIES.
YEAR ONE, 4%; YEAR TWO, 3%; YEAR THREE, 2%; YEAR FOUR, 1%; YEAR FIVE, 0%;
YEAR SIX, 4%; YEAR SEVEN, 3%; YEAR EIGHT, 2%; YEAR NINE, 1%; YEAR TEN,
0%.
ROLLOVER MORTGAGE - FOR EXAMPLE, HAS A FAIRLY SHORT MATURITY ON THE SHORT
TERM, SUCH AS FIVE YEARS, WITH AMORTIZATION CALCULATED AT SAY, 30 YEARS.
WILL HAVE A BALLOON PAYMENT AT THE END OF THE TERM.
BALLOON PAYMENT - THE LAST PAYMENT ON A LOAN, SUCH AS IN A ROLLOVER
MORTGAGE, THAT IS THE PORTION OF THE PRINCIPAL REMAINING UNPAID AT THE
END OF THE TERM.
REVERSE MORTGAGE - NEW YORK DOES NOT ALLOW ADJUSTABLE REVERSE MORTGAGES.
THE BANK GIVES THE OWNER PAYMENTS THAT REDUCE THE PRINCIPAL EQUITY.
PARTNERSHIP - AN ENTITY TYPICALLY CONSISTING OF ONE OR MORE GENERAL
PARTNERS WHO MANAGE A PARTNERSHIP, AND SEVERAL LIMITED PARTNERS WHO DO
NOT MANAGE.
A PROSPECTUS IS A DISCLOSURE DOCUMENT FILED WITH THE ATTORNEY GENERAL
THAT DISCLOSES THE MATERIAL FACTS OF AN INVESTMENT THAT YOU WANT PEOPLE
TO MAKE IN A SYNDICATE.
IT IS LIKE AN OFFERING PLAN FOR A COOP.
IT
PERMITS YOU TO OFFER A PARTICIPATORY INTEREST N A PROPERTY TO STRANGERS.
WHERE YOU ARE LOOKING TO PUT PEOPLE TOGETHER TO RAISE MONEY FOR A

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SYNDICATE, A SMALL GROUP MAY NOT REQUIRE A PROSPECTUS. UNDER 35 PEOPLE,

YOU CAN USE A PRIVATE PLACEMENT MEMORANDUM OR DO WITHOUT IT OR THE
PROSPECTUS AS YOU FEEL COMFORTABLE DOING. A PRIVATE PLACEMENT MEMORANDUM
IS A SHORT FORM PROSPECTUS FILED WITH THE ATTORNEY GENERAL "AFTER THE
FACT".
THE ATTORNEY GENERAL DOES NOT EXAMINE IT BEFOREHAND AS WITH A
PROSPECTUS.
THE AMOUNT OF MONEY DOES NOT DISTINGUISH WHETHER YOU CAN
FILE A PRIVATE PLACEMENT MEMORANDUM. IT IS THE NUMBER OF ENTITIES (SUCH
AS PERSONS OR CORPORATIONS, EACH AS AN ENTITY).
UNITS (MONETARY BLOCKS OF VALUE, USUALLY 50,000 OR 100,000) ARE LISTED IN
THE PRIVATE PLACEMENT MEMORANDUM.
UNITS CAN BE CONVERTED TO A LIMITED
PARTNERSHIP SHARE OF THE PARTNERSHIP.
THE PERSON RAISING THE MONEY IS
OFTEN THE GENERAL PARTNER, AND HOLDS 40 TO 50 PERCENT OF THE UNITS. TO
MARKET THE SYNDICATION IN DIFFERENT STATES, YOU HAVE TO MEET THE
REQUIREMENTS OF EACH STATE.
END OF CLASS SEVEN
CLASS EIGHT
7/16/90
DRAGNET CLAUSE - IN MORTGAGES, WHEN A BUYS FROM B, WHO GIVES A 10,000
LOAN TO A, AND WHEN A GETS A 100,000 LOAN FROM BANK C, IF BANK C BUYS OR
IN ANOTHER WAY ACQUIRES THE 10,000 LOAN FROM B THAT 10,000 LOAN WILL JOIN
WITH THE 100,000 DOLLAR LOAN TO FORM A 110,000 LOAN WITH PRIORITY OF LIEN
IN THE EVENT OF A FORECLOSURE. THIS IS ALSO CALLED AN ANACONDA CLAUSE.
***********************
LEASING (WITH AN EMPHASIS ON OFFICE LEASING)
A LEASEHOLD INTEREST IS AN INTEREST IN REAL PROPERTY THAT ALLOWS THE
TENANT TO GAIN THE USE AND PROFITS OF THE REAL ESTATE IN TURN FOR RENT TO
THE LANDLORD. IT CREATES A TENANT INTEREST IN THE PROPERTY. A LEASE IS
DIFFERENT THAN A MORTGAGE IN THAT THE BANK DOES NOT HAVE THE RIGHT TO
POSSESS THE PROPERTY. IN LIEN THEORY STATES, A MORTGAGE SECURES REPAYMENT
WHEREAS A LOAN DOES NOT. A LEASE IS DIFFERENT FROM A LICENSE. A LICENSE
IS AN ARRANGEMENT THAT GRANTS RIGHTS, IS REVERSIBLE, AND INVOLVES
PAYMENTS DIFFERENT THAN THAT REQUIRED UNDER LEASEHOLD SITUATIONS. THEY
ARE ALSO TYPICALLY SHORT TERM AGREEMENTS.
REBNY FORM (REAL ESTATE BOARD OF NEW YORK) - PRO-LANDLORD DOCUMENT FOR
LEASING.
BLUMBERG FORM - PRO-LANDLORD, BUT NOT TO THE DEGREE THAT THIS IS TRUE
WITH THE REBNY FORM.
NEW YORK BAR ASSOCIATION FORM - FAIR TO BOTH TENANT AND THE LANDLORD,
THEREFORE IS LEAST USED.
THE DEGREE OF REVIEW IN NEGOTIATION RELATES DIRECTLY TO THE SIZE OF THE

276

DEAL.
FROM A LAWYER'S STANDPOINT, YOU FIRST DETERMINE WHO THE OTHER
ATTORNEY IS, WHAT THE BASIC DEAL IS, AND IF YOU CAN GET INVOLVED IN THE
TRANSACTION BEFORE THE AGREEMENTS HAVE BEEN SUBSTANTIVELY DECIDED UPON.
SOMETIMES THIS INVOLVES SITE VISITS TO NOTE WHETHER OR NOT SOMETHING IS
OBVIOUSLY AMISS WITH THE LEASING AGREEMENT WHEN COMPARED TO THE FACTS ON
THE GROUND. IN TERMS OF SETTING FEES, IT IS A BIG MISTAKE TO SET A FLAT
FEE FOR THIS SINCE THE ACTION IS NOT PREDICTABLE AND IS RARELY IDENTICAL.
WHO ARE THE LANDLORD AND THE TENANT? WHAT DOES THE LANDLORD OWN? DOES HE
OWN THE FEE OR DOES HE OWN THE LEASEHOLD (IE. A GROUND LEASE)? IT IS
CRITICAL TO KNOW THIS SINCE THE LANDLORD HAVING A GROUND LEASE MAY
INDIRECTLY TERMINATE YOUR LEASE WHEN HIS GROUND LEASE IS TERMINATED. THE
OWNER OF THE GROUND LEASE HAS A SUPERIOR POSITION TO YOUR LEASEHOLD.
VERY OFTEN WHEN YOU THINK YOU ARE DEALING WITH THE LANDLORD, YOU ARE
DEALING WITH A MANAGING AGENT. IT ALSO HELPS TO KNOW WHO THE OWNERS ARE,
AND WHO ARE THE PRINCIPALS IN THE OWNING CORPORATION.
SOME NAMES ARE
"KNOWN" BY REPUTATION TO ATTEMPT TRICKERY IN THEIR LEASING FOR THEIR
TENANTS, AND KNOWING WHO THEY ARE WILL CAUSE YOU TO BE EXTRA CAUTIOUS.
KNOW YOUR TENANT.
"McDONALDS" IS DIFFERENT FROM "McDONALDS OF NEW
JERSEY" FOR EXAMPLE. GET GUARANTEES OF CORPORATE APPROVAL FOR THE DEAL.
KNOW WHETHER IT IS A SUBSIDIARY OR PARENT COMPANY. KNOW IF THE COMPANY
IS PROPERLY INCORPORATED IN YOUR STATE. IF YOU HAVE A CORPORATE TENANT
YOU WANT A CORPORATE RESOLUTION AND A SIGNATURE OF THE CORPORATE HEAD. A
SIGNATURE OF A SUBSIDIARY DOES NOT BIND A PARENT COMPANY.
OFTENTIMES THE TENANT WILL FOR A "SHELL CORPORATION" WHOSE SOLE ASSET IS
THE LEASEHOLD.
THIS WAY, THE TENANT LIMITS HIS LIABILITY TO THE
LEASEHOLD ASSET AND AVOIDS ATTACHING LIABILITY TO HIS OTHER ASSETS.
SIMILAR TO EXCULPATORY PROVISION IN MORTGAGE CONTRACTS.
BANK BRANCHES NEED THE APPROVAL OF THE STATE BANKING AUTHORITY BEFORE A
LEASE CAN BE IN FULL FORCE. RESTAURANTS MUST GET APPROVAL FROM THE STATE
LIQUOR AUTHORITY BEFORE A LEASE CAN BE IN FULL FORCE. BE AWARE OF THE
USES OR PROFESSIONS THAT REQUIRE THESE SPECIAL PERMITS IN ORDER TO
OPERATE, AND KNOW THAT THE LEASE DOES NOT GO INTO FULL FORCE UNTIL THE
PERMITS ARE SECURED.
THE ENTITY TAKING THE LEASE MUST REPRESENT THAT IT KNOWS OF NO REASON WHY
IT WOULDN'T GET APPROVAL FROM THE PERMITTING AUTHORITY IN THE ABOVEMENTIONED CASES.
A CONVICTED FELON WOULD BE MIS-STATING THIS
AFFIRMATION, KNOWING FULL WELL, FOR EXAMPLE, THAT HE COULD NOT SECURE A
LIQUOR LICENSE.
IT IS DIFFICULT TO SECURE LEASES WITH GOVERNMENTS SINCE THEY ARE NOT
SUBJECT TO THE LAWS OF THIS COUNTRY DUE TO DIPLOMATIC IMMUNITY. THEY CAN
NOT BE EVICTED, OR SUED. YOU MUST REQUIRE THEM NOT TO RESORT TO THEIR
SOVEREIGN IMMUNITY. GOVERNMENT AGENCIES ALSO CAN BE PROBLEMATIC.

277

RENT IS OFTEN BASED ON A PER SQUARE FOOT BASIS WHEN CONCERNING OFFICE OR
RETAIL SPACE.
YOU DISTINGUISH BETWEEN RENTABLE SQUARE FOOTAGE AND
USEABLE SQUARE FOOTAGE.
LOSS FACTOR - 22 TO 27 PERCENT; THAT AMOUNT OF SQUARE FOOTAGE THAT IS
REPRESENTED BY WALLS, LOBBIES, ELEVATOR SHAFTS, ETC. THAT SQUARE FOOTAGE
NOT USEABLE FOR THE DAY TO DAY OPERATIONS OF THE TENANT. THE LANDLORD
DOES NOT PLACE SQUARE FOOTAGE AMOUNTS IN THE LEASE EVEN THOUGH HE MARKETS
A GIVEN SQUARE FOOTAGE BECAUSE BY DOING SO HE WOULD LIMIT HIS ABILITY TO
INCREASE THIS PORTION OF THE RENTABLE SQUARE FOOTAGE.
SINCE RENT IS
CHARGED FOR THIS SPACE, INCREASING THE AMOUNT IN TURN INCREASES THE
RETURN TO THE LANDLORD.
THE BASE RENT IS THE:
(USEABLE SQUARE FOOTAGE + THE NON-USEABLE SQUARE FOOTAGE) X THE ANNUAL
RATE PER SQUARE FOOT
THE ANNUAL RATE IS PAID IN MONTHLY INSTALLMENTS TO ALLOW THE LANDLORD TO
SUE FOR THE REST IN CASE OF DEFAULT.
ADDITIONAL RENT IS ALL RENTS IN ADDITION TO THE BASE RENT. IT INCLUDES:
PORTER'S WAGE ESCALATIONS
DIRECT OPERATING EXPENSE ESCALATIONS
REAL ESTATE TAX ESCALATIONS
RENT INCLUSION PROVISION FOR ELECTRICITY
LATE FEES
CONTRIBUTION TOWARD COSTS OF WATER USE
CONTRIBUTION TOWARD COSTS OF SPRINKLER MAINTENANCE CONTRACT
HVAC AFTER BUSINESS HOURS
ALL LANDLORD REMEDIES INCLUDING SUMMARY PROCEEDINGS APPLIES TO BASE RENT
AND ADDITIONAL RENT. THE ADDITIONAL RENT IS CALLED "RENT" TO INCLUDE IT
IN THE SUMMARY PROCEEDINGS, WHICH WOULD NOT BE THE CASE IF NOT CALLED
"RENT".
ALTERATIONS - WORK THAT THE TENANTS MAY WANT TO DO - GOVERNS WHETHER OR
NOT THEY HAVE PERMISSION. IN MOST LEASES, TENANT IMPROVEMENTS BECOME THE
LANDLORD'S PROPERTY. IT IS STATED TO BE REQUIRED THAT IT BE DONE UNDER
LAW. SOMETIMES IT IS REQUIRED THAT UNION LABOR BE USED.
RESTORATION PROVISION - THE LANDLORD WILL OFTEN LOOK TO THE TENANT TO
RESTORE THE PREMISES TO THE ORIGINAL CONDITION AT THE LANDLORD'S OPTION
WITHIN A CERTAIN PERIOD BEFORE THE LEASE ENDS. SOMETIMES THE RESTORATION
PROVISION MAY BE RENEGOTIATED AT THE TIME OF ALTERATION. SOMETIMES THE
RESTORATION WILL BE ALLOWED AFTER THE LEASE IS UP DURING A SPECIFIED
PERIOD.
UNDER THE COMMON LAW, THE LANDLORD WAS NOT REQUIRED TO MAKE REPAIRS
EITHER TO THE BUILDING OR THE DEMISED PREMISES. IT IS THE OBLIGATION OF

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THE ATTORNEY TO CREATE THIS OBLIGATION IN THE LEASE.

"THE LANDLORD
AGREES TO MAKE STRUCTURAL REPAIRS, INCLUDING PLUMBING, ELECTRICAL,
ELEVATOR, FOUNDATION, BEARING WALLS, ETC.
ANYTHING WITHIN THE DEMISED
PREMISES IS THE RESPONSIBILITY OF THE TENANT".
THE TENANT AGREES TO MAINTAIN THE AREA IN THE DEMISED AREA.
IF THE
TENANT'S COURSE OF CONDUCT RESULTS IN DAMAGE TO THE STRUCTURE THEN HE IS
RESPONSIBLE TO CORRECT THE DAMAGE.
OTHERWISE THE TENANT LIMITS HIS
RESPONSIBILITY TO NON-STRUCTURAL PROBLEMS WHILE MAINTAINING THAT THE
LANDLORD IS RESPONSIBLE FOR STRUCTURAL REPAIRS.
IF THE LANDLORD NEEDS TO MAKE REPAIRS THAT THE TENANT SHOULD HAVE MADE,
HE IS ALLOWED TO CHARGE BACK THE MONEY AS ADDITIONAL RENT. THE LANDLORD
IS OBLIGATED TO FIRST GRANT THE TENANT A CHANCE TO CURE THE ITEM AND
APPROVE IT SUBJECT TO A REASONABLE CHARGE FOR THE REPAIR.
THE RIGHT TO OFFSET EXPENSES BY THE TENANT FOR WORK THAT SHOULD HAVE BEEN
PERFORMED BY THE LANDLORD IS SPECIFICALLY GUARANTEED IN SOME STATES.
DEMISED PREMISES - THE SPACE DESIGNATED BY, FOR EXAMPLE, 8TH FLOOR, 525
8TH AVENUE. ADDITIONALLY THERE IS USUALLY A FLOOR PLAN THAT IS ATTACHED
TO THE LEASE THAT IS DEFINED AS THE DEMISED PREMISES. DOES NOT INCLUDE
COMMON AREAS. THE DEMISING WALL IS THE WALL DELINEATING THE EXTENT OF
THE DEMISED PREMISES.
DOCTRINE OF INDEPENDENT COVENANTS - THE TENANTS OBLIGATION TO PAY RENT IS
INDEPENDENT OF THE LANDLORD'S OBLIGATION TO REPAIR HIS BUILDING.
THE
TENANT ALWAYS CROSSES OUT THE PROVISION THAT SAYS IT SHOULD NOT BE
RELEVANT HOW GOOD OF A TENANT HE IS, THE LANDLORD SHALL NOT BE ALLOWED TO
CUT OFF SERVICES.
YOU NEED TO HARMONIZE THE PROVISIONS THAT REQUIRE THE TENANT TO CARRY
INSURANCE, THE BANK TO COLLECT THE INSURANCE AND THE LANDLORD'S
OBLIGATION TO MAKE REPAIRS.

FOUR TYPES OF LEASES:

RETAIL LEASES
OFFICE LEASES

APARTMENT LEASES
LOFT LEASES

ONE OF THE MOST IMPORTANT PROVISIONS IS THE "REQUIREMENT OF LAW CLAUSE"

STATING THAT THE TENANT SHALL COMPLY WITH ALL LAWS EXISTING OR FUTURE,
WHETHER OR NOT ARISING FROM THE TENANTS MANNER OF USE OR OCCUPANCY. THE
TENANT MAY HAVE TO BEAR THE EXPENSE OF CHANGES IN LAW THAT WOULD
OTHERWISE HAVE BEEN BORN BY THE LANDLORD.

279

FOR EXAMPLE, LOCAL LAW 10 STATES THAT BUILDINGS SIX STORIES AND TALLER
REQUIRE INSPECTIONS EVERY YEAR WITH THOROUGH INVESTIGATIONS EVERY 5
YEARS.
THE LANDLORD WOULD BE WITHIN HIS RIGHTS TO AT LEAST PASS A
PORTION OF THIS COST ON TO THE TENANT.
THE CLAUSE COVERS SUCH MATTERS AS ZONING
CERTIFICATES OF OCCUPANCY REQUIREMENTS, ETC.

REQUIREMENTS,

EPA,

OSHA,

THEREFORE WHEN CONFRONTED WITH A STANDARD FORM OF PUTTING ALL OF THE

LIABILITIES ON THE TENANT, AS THE TENANT'S ATTORNEY YOU WOULD WANT THE
TENANT ONLY TO PAY FOR EXPENSES ATTRIBUTABLE TO HIS "MANNER OF USE". A
SPRINKLER CODE, SINCE UNIVERSALLY APPLIED TO ALL OFFICE SPACES, WOULD NOT
BE PAID FOR BY THE TENANT IF IT DOES NOT APPLY TO HIM SPECIFICALLY, AS
WOULD, SAY, A VENTILATION LAW APPLYING TO RESTAURANTS WHEN YOU OWN A
RESTAURANT.
THERE SHOULD BE A PROVISION THAT STATES THAT A TENANT'S SHARE SHOULD BE
PRO-RATED AS PER THE REMAINING TERM IN THE LEASE RELATIVE TO THE TOTAL
LEASE PERIOD.
YOU WILL WANT TO EXCLUDE ALL VIOLATIONS EXTANT BEFORE
OCCUPANCY FROM TENANT RESPONSIBILITY.
LOCAL LAW 5 REQUIRES CONTAINERIZATION OF OFFICE SPACE FOR PROTECTION FROM
THE SPREAD OF FIRE. THE TENANT WILL AGREE TO COMPLY WITH THE
RECOMMENDATIONS OF THE BOARD OF FIRE UNDERWRITERS. IF IMPLEMENTING THE
RECOMMENDATIONS SAVES INSURANCE PREMIUMS, THE TENANT WILL WANT A SHARE OF
THOSE SAVINGS.
THE OPTIONS FOR THE LANDLORD TO TERMINATE THE LEASE IF A REPAIR EXCEEDS A
GIVEN SUM SHOULD NOT BE AGREED TO BY THE TENANT, UNLESS THE TENANT HAS
THE EXPRESSED RIGHT TO PAY THE AMOUNT TO SAVE THE LEASE.
THE SUBORDINATION PROVISION- PRIORITY OF POSITION: WHICH INTEREST HAS THE
SUPERIOR POSITION? WE LUMP IN THIS TOGETHER ALL POTENTIAL ENCUMBRANCES
AND LIENS. GENERALLY THIS IS DETERMINED BY WHICH WAS RECORDED FIRST. A
RECORDED MORTGAGE HAS WILL NEED PRIORITY OVER ALL LEASES BEFORE IT. A
RECORDED LEASE HAS PRIORITY OVER MORTGAGES AFTER IT. IF A TENANT TAKES
POSSESSION OF A SPACE PURSUANT TO A LEASE, AND SUBSEQUENT TO THAT THE
BANK PUTS A MORTGAGE ON THE PROPERTY, THE LEASEHOLD IS SUPERIOR EVEN
THOUGH THE LEASE IS NOT RECORDED.
THE POSSESSION OF THE SPACE IS
EVIDENCE OF "GIVING NOTICE" TO THE WORLD OF THE TENANCY LEASEHOLD.
A MORTGAGE TAKING PLACE AFTER THE LEASE IS SUPERIOR TO A LEASE SINCE THE
SUBORDINATION CLAUSE STATES THAT THE TENANTS AGREE TO MAKE THE MORTGAGE
SUPERIOR IN LIEN TO THE LEASEHOLD.
A MORTGAGE ADJUSTMENT TO AN AMOUNT GREATER THAN THE MORTGAGE AMOUNT AT
THE TIME OF THE LIEN IS SECOND IN LIEN AFTER THE LEASEHOLD.
WITH
PROVISIONS IN AN AGREEMENT,
A MORTGAGE IS SUPERIOR TO THE LEASE.
A
GROUND LEASE IS SUPERIOR TO THE LEASE, AND WIPES THEM OUT WHEN IT IS
WIPED OUT.

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A NON-DISTURBANCE AGREEMENT
UNDERMINING THE TENANT'S USE
OUT THE LEASEHOLD. THIS IS
THE LEASEHOLD SUBSERVIENT TO

IS DESIGNED TO PREVENT THE LANDLORD FROM

OF THE LEASEHOLD WHEN SUPERIOR INTEREST WIPE
GENERALLY DONE IN TURN FOR AGREEING TO MAKE
THE MORTGAGES.

THE ATTORNMENT PROVISION: THE LANDLORD SAYS THAT HE WILL GIVE THE NONDISTURBANCE PROVISION IF THE TENANT AGREES TO "ATTORN" TO THE GROUND
LESSOR. ATTORN MEANS THAT THE TENANT RECOGNIZES THE GROUND LESSOR AS THE
NEW LANDLORD IN THE EVENT THE GROUND LEASE WIPES OUT THE BASE LEASEHOLD.
FOR SMALL TENANTS IN A BIG BUILDING, NON-DISTURBANCE PROVISIONS ARE NOT
USUALLY GRANTED, AND YOU EMBARRASS YOURSELF BY INSISTING ON IT.
THE TENANT AGREES THAT HE WILL NOT MODIFY THE LEASE WITHOUT NOTIFYING THE
MORTGAGEE. THIS PREVENTS THE TENANT FROM PREPAYING RENT, SO THAT IF THE
BANK FORECLOSES, THEY ARE ASSURED OF A FULL SUPPLY OF CASH FOR RENT.
WHETHER OR NOT TO GRANT NON-DISTURBANCE
DECISION, BASED ON FOUR CRITERION:
1.
2.
3.
4.

IS

ULTIMATELY

THE

BANK'S

RENTAL RATE PER SQUARE FOOT >> IS IT MARKET RATE OR BETTER?

ESCALATION PROVISIONS
THE SIZE OF THE SPACE - SMALL SPACES WILL NOT GET IT.
THE CREDITWORTHINESS OF THE TENANT.

IF YOU CAN NOT GET A NON-DISTURBANCE GUARANTEE, THE LANDLORD WILL

TYPICALLY ATTEMPT TO GET IT "AFTER THE FACT".
"BEST EFFORTS" WILL BE
EXPENDED BY THE LANDLORD IN GETTING THE BANK TO OFFER THE NON-DISTURBANCE
GUARANTEE, AND IS THE NEXT BEST WAY OF ATTEMPTING TO SECURE THE
GUARANTEE. THE LANDLORD WILL STIPULATE, HOWEVER, THAT "BEST EFFORT" DOES
NOT INCLUDE THE SPENDING OF MONEY. IF THE TENANT IS A MAJOR TENANT, THEN
THE ATTORNEY WILL WANT TO EXAMINE THE GROUND LEASE AND THE LEASEHOLD.
YOU WILL WISH TO EXAMINE THE GROUND LEASE. IF THE GROUND LEASE HAS, FOR
EXAMPLE, A DEMOLITION AGREEMENT THAT ALLOWS THE BUILDING TO BE TORN DOWN
TO TERMINATE THE LEASE, YOU SHOULD KNOW THIS SINCE YOUR LEASE WILL BE
WIPED OUT BY THE TERMINATION OF THE GROUND LEASE.
YOU WILL WANT A REPRESENTATION IN THE LEASE AS TO WHAT GROUND LEASES AND
MORTGAGES THERE ARE ON THE BUILDING.
DELIVERY OF POSSESSION OF THE SPACE - THE TENANT WANTS TO NOT ONLY KNOW
WHEN HE WILL GAIN POSSESSION OF THE LEASE, BUT WILL NEED TO ARRANGE FOR
MOVING INTO THE SPACE. THE GENERAL UNDERSTANDING IS THAT THE POSSESSION
TAKES PLACE ON COMMENCEMENT. THE TENANT HAS THE RIGHT TO DAMAGES IF THE
POSSESSION IS NOT DELIVERED ON TIME, AND HAS THE RIGHT TO BACK OUT OF THE
LEASE.
THE LANDLORD WILL PUT IN A PROVISION THAT THE TENANT WAIVES HIS RIGHT TO

281

THIS, AS HE WILL NOT WANT TO RISK THE POSSIBILITY OF THE OLD TENANT
LEAVING BY THE PROPER TIME. IF THE TENANT DOES NOT GAIN POSSESSION, HE
WOULDN'T HAVE TO PAY RENT YET.
THE COURTS WILL ALWAYS ALLOW A TENANT TO HOLD OVER FOR THREE MONTHS.
OFTEN THE LANDLORD WILL BUILD INTO THE LEASE THAT THE RENT WILL BE TWICE
THE TOTAL RENT WHEN HOLD OVERS OCCUR.
KEEP IN MIND THAT THE LANDLORD WILL COMMIT TO PROVIDING THE SPACE TO THE
TENANT. THIS HAS TO BE KEPT IN MIND IN DETERMINING WHEN POSSESSION TAKES
PLACE; SINCE THE SPACE IS BEING AMENDED FOR THE TENANTS BENEFIT,
POSSESSION MAY TAKE PLACE WHEN CONSTRUCTION BEGINS RATHER THAN WHEN THE
TENANT MOVES IN.
END OF CLASS EIGHT
CLASS NINE
7/23/90
PAPER DUE NEXT WEEK, MIDTERM RETURNED TODAY
SECTION 255
MORTGAGES.

DEALS

WITH

THE

ASSIGNMENT

OF

MORTGAGES

AND

DORMANT

SECTION 275 - DEALS WITH THE MORTGAGE TAX WHEN THE INDEBTEDNESS ALREADY
EXISTS.
TENANCY BY THE ENTIRETIES
COMMUNITY PROPERTY IS ANY
THE MARRIAGE.
IN N.Y.,
STATUS OF TENANCY WITH
SPECIFIED.

VS. COMMUNITY PROPERTY;

TYPE OF PROPERTY BROUGHT INTO A MARRIAGE DURING
REAL ESTATE PURCHASED DURING MARRIAGE HAS THE
THE RIGHT OF SURVIVORSHIP UNLESS OTHERWISE

RENT
A CONTRACT CAUSE OF ACTION IS THE RECOURSE THROUGH THE COURTS WHEN
ADDITIONAL RENT IS CALLED "ADDITIONAL RENT". IF NOT, THEN THE RECOURSE
IS IN THE TORT COURT, WHERE THE SETTLEMENT MAY BE AFTER A LONG LITIGATION
PERIOD.

ESCALATIONS
FOUR TYPES OF ESCALATIONS:

282

1.
2.
3.
4.

PORTER'S WAGE
CONSUMER PRICE INDEX
DIRECT OPERATING EXPENSE
REAL ESTATE TAXES

COMMON QUALITIES OF ESCALATIONS:

1. WHATEVER YOU CALL IT, BE IT AN ESCALATION, RENT, SURCHARGE, ETC., YOUR
NEGOTIATING STANCE SHOULD BE FROM THE PERSPECTIVE THAT IT IS MONEY FROM
THE TENANT TO THE LANDLORD.
2. ALL ADDITIONAL RENT OF ONE FORM OR ANOTHER.
3. THE PURPOSE OF THEM IS TO DEFRAY THE COSTS OF OPERATING THE BUILDING.
4. THEY ARE ALL CALCULATED FROM A STARTING POINT CALLED THE BASE YEAR, A
POINT NEGOTIATED WITH CARE.
TYPICALLY, THE BASE YEAR IS A CALENDAR
YEAR...THE QUESTION IS "WHICH" CALENDAR YEAR. USUALLY YOU TRY TO GET THE
BASE YEAR TO BE THE YEAR ONE YEAR AFTER THE LEASE BEGINS IF YOU ARE THE
TENANT.
5. CALCULATED WITH REGARD TO THE SIZE OF THE SPACE OCCUPIED BY THE TENANT
EITHER IN S.F., OR AS A PERCENTAGE OF THE SQUARE FOOTAGE INT HE BUILDING
USING RENTABLE S.F.
6. THE PRACTICAL ASPECT OF CONCERN FOR WHAT THE FUTURE WILL HOLD WITH
RESPECT TO THE INCREASES. YOU MAY WANT TO LIMIT THE ESCALATIONS WITH A
CAP, WHICH IS A FUNCTION OF NEGOTIATIONS.
THERE IS A CLAUSE IN LEASE CONTRACTS THAT IS A STOP GAP, FROM THE
LANDLORD'S POINT OF VIEW, TO PREVENT RENT FROM FALLING BELOW BASE RENT IN
THE EVENT THAT EXPENSES DECREASE BELOW THAT OF THE BASE YEAR.
WITH PORTER'S WAGE INCREASES, THE LANDLORD WISHES TO COLLECT THE
ESCALATION WITHIN TEN DAYS OF THE STATEMENT.
THIS DOES NOT RAISE A
QUESTION WITH PREPAYMENT TO THE BANK BECAUSE THE COLLATERAL IS ENHANCED
BY THE PREPAYMENT AND IS ENDANGERED BY ITS ABSENCE.
BASE RENT IS MANY TIMES SUBJECT TO ESCALATIONS, SOMETIMES ON A STRAIGHT
LINE BASIS, SOMETIMES ON A CPI BASIS. LEASING COMMISSIONS ARE BASED ON
THE BASE RENT WITHOUT CPI INCREASES IN THE VAST MAJORITY OF CASES.
YOU DO NOT USUALLY SEE PORTER'S WAGE ESCALATIONS AS A COMPONENT OF
OPERATING EXPENSES.
YOU WILL SEE EITHER PORTER'S WAGE, CONSUMER PRICE
INDEX, OR DIRECT OPERATING EXPENSE, BUT NOT ALL THREE AT ONCE IN THE SAME
LEASE WITH REAL ESTATE ESCALATIONS.

OPERATING EXPENSES

283

STEP ONE: DEFINE OPERATING EXPENSES!

"ALL COSTS AND EXPENSES INCURRED BY THE LANDLORD IN THE OPERATION AND
MAINTENANCE OF THE LAND AND BUILDING TO COMPLY WITH LOANS AND MAINTAIN
LANDSCAPING, ETC. ARE OPERATING EXPENSES".
"OPERATING EXPENSES SHALL SPECIFICALLY INCLUDE BUT NOT BE LIMITED TO THE
FOLLOWING:"
TAXES TO THE EXTENT UNPAID BY SALARIES AND FRINGE BENEFITS
THE TENANT
PAYMENTS TO INDEPENDENT CONTRACTORS
DUES AND FEES TO TRADE GROUPS
FUEL, WATER, SEWER
DEPRECIATION (!?)
INSURANCE
OVERHEAD
SUPPLIES
BROKER'S COMMISSIONS
REPAIRS AND ALTERATIONS
MANAGEMENT (!?)
PROFESSIONAL FEES
ALL OF THESE ARE, OF COURSE, NEGOTIABLE.
THE QUESTION IS, ONCE AGAIN, "WHAT ARE YOU PAYING OUT AS THE TENANT".
STEP TWO:
DETERMINE THE BASE YEAR -- LENDS ITSELF TO A CALENDAR YEAR BASE.
"IT IS AGREED THAT IN THAT YEAR THE OPERATING EXPENSES WERE XX DOLLARS.
IN ANY SUBSEQUENT YEAR THE OPERATING EXPENSES EXCEED XX, THE TENANT WILL
PAY YY PERCENT OF THE OPERATING EXPENSES."
"YY PERCENT" IS
REPRESENTATIVE OF
SQUARE FOOTAGE.

A NEGOTIATED FIGURE, AND MAY NOT BE EXACTLY

THE TENANT'S PROPORTIONAL SHARE OF THE BUILDING'S

A COMMON CLAUSE IS, "IF A LABOR SAVINGS OR COST SAVINGS DEVICE SHALL BE
IMPLEMENTED BY THE LANDLORD, THAT CORRESPONDING ITEM ALSO GETS TAKEN OUT
OF THE BASE SO THAT IT IS RECOGNIZED AND REFLECTS THE TRUE COST OF
OPERATING THE BUILDING".
(IE. A SELF-OPERATING ELEVATOR, WHICH WAS
PREVIOUSLY OPERATED BY AN ELEVATOR OPERATOR). TYPICALLY THE STATEMENT OF
OPERATING EXPENSE WILL BE PREPARED BY AN ACCOUNTANT, AND IS NOT USUALLY
CERTIFIED. THE TENANT MUST RESERVE THE RIGHT TO CHALLENGE THIS, BUT THE
LANDLORD WILL INSIST ON A "PAY NOW FIGHT LATER" PAYMENT CLAUSE, AND THE
TENANT MUST PAY HIS OWN ACCOUNTANT. THE CLAUSE WILL ALSO STATE THAT THE
PAYMENT WILL BE DUE IN 10 TO 30 DAYS, AND THE TENANT WILL TRY TO EXPAND
THIS TO A LONGER PERIOD OF TIME.
BECAUSE ESCALATIONS ARE SUBJECT TO MANIPULATION BY THE LANDLORD, THE
TENANT SHOULD INSIST ON A CAP ON THE ESCALATION INCREASES.

284

PORTER'S WAGE INCREASES

THE HOURLY RATE PLUS FRINGES IN A GIVEN BASE YEAR FOR PORTERS IN A
PARTICULAR CLASS OF OFFICE BUILDING AS ESTABLISHED BY NEGOTIATION BETWEEN
THE REAL ESTATE BOARD OF ADVISORY SERVICES AND LOCAL 34B OF THE AFLCIO...CONSIDERED A GOOD MEASUREMENT OF THE INCREASE IN THE COST OF
OPERATION.
THE PORTER'S CLASSIFICATION IS A SPECIFIC LABOR CATEGORY.
NOT UNUSUAL TO HAVE THIS CLAUSE EVEN IF YOU HAVE NO PORTERS IN THE
BUILDING. IF THE LABOR RATE IN A SUBSEQUENT YEAR INCREASES OVER THE BASE
YEAR, THE INCREASE WILL BE REMUNERATED AT THE RATE OF "PENNY FOR PENNY"
UPON THE AGREED UPON SQUARE FOOTAGE OF THE BUILDING (AGREED UPON BECAUSE
THE LANDLORD DOES NOT WANT TO WARRANT THE SQUARE FOOTAGE OF THE BUILDING
IN THE CASE THAT HE MAY WANT TO "INCREASE" IT LATER WITH PSEUDOADDITIONAL SPACE.
THE INCREASE CAN BE NEGOTIATED TO INCLUDE FRINGE
BENEFITS, OR TO EXCLUDE THEM AS THE CASE MAY BE.

YEAR WAGE RATE

INCREASE
40% FRINGE TOTAL INCREASE
*********************************************************************
D.P. = 10,000 S.F.
1991 11.00
NA
NA
NA
1992 11.50
0.50
0.20
0.70
1993 11.75
0.75
0.30
1.05
(1992) 10,000 S.F. X 0.70 = 7,000 ESCALATION
(1993) 10,000 S.F. X 1.05 = 10,500 ESCALATION
THIS IS AN EXAMPLE OF A PENNY FOR PENNY PORTER'S WAGE ESCALATION
SCHEDULE. IF WE HAVE A 3/4 PENNY FOR PENNY ESCALATION, THIS TABLE WOULD
BE DECREASED IN THE "TOTAL INCREASE" COLUMN BY 25%.
SOMETIMES IT MAY
EVEN BE 1.25 PENNY FOR PENNY!
CONSUMER'S PRICE INDEX ESCALATION (CPI)
SIMILAR TO "PORTER'S WAGE" IN THAT IT SUPPLIES AN OBJECTIVE SCALE FOR
INCREASES NOT SUBJECT TO MANIPULATION BY THE LANDLORD.
YOU STIPULATE
THAT IT WILL BE THE FIGURE PUBLISHED BY THE BUREAU OF LABOR STATISTICS OF
THE DEPARTMENT OF LABOR FOR THE NEW YORK/NEW JERSEY AREA.
THE CPI IS
BASED ON A THEORETICAL "BASKET OF GOODS AND SERVICES" WITH 100 BEING THE
BASE IN THE YEAR 1967. ANNUAL INCREASES IN THE COST OF THIS BASKET OF
GOODS AND SERVICES IS DESCRIBED NUMERICALLY.
A 200% INCREASE WOULD
REGISTER AS A CPI OF 300 (100 IN THE BASE YEAR + 200% INCREASE)
THERE ARE TWO APPROACHES.
1. BASED ON THE CHANGE OF CPI IE. 1991 = 303; 1992 = 315; THE CHANGE IS

285

12 POINTS.
2. TAKE THE CHANGE IN POINTS, IE. 12, AND DIVIDE IT BY THE PREVIOUS YEAR;
IE. 12/303 = .04; .04 X 100 = 4 (A 4 PERCENT CHANGE).
CPI IS CALCULATED MONTHLY. YOU WILL EITHER USE AN ANNUALIZED AVERAGE, OR
COMPARE IT TO THE CPI IN THE SAME MONTH OF EVERY YEAR. THE BASE RENT
WILL THEN BE MULTIPLIED BY THE PERCENT OF CPI.
THIS IS THE FIRST
ESCALATION WE SEE BASED ON A PERCENTAGE OF THE BASE RENT. 4% X THE BASE
RENT, IN THE PAST EXAMPLE, WOULD BE THE INCREASE IN THE CPI ESCALATION.
THE INCREASE MAY BE NEGOTIATED AS 80%, 120%, OR ANOTHER PERCENTAGE OF THE
CHANGE IN THE INCREASE, OR MAY BE BASED ON 4% OF THE LAST YEAR'S RENT.
IE. 10,000 = LEASED AREA RENT
BASE YEAR = CPI OF 102
IN A GIVEN YEAR THE CPI BECOMES 105, A CHANGE OF THREE POINTS.
THE BASE CPI = 2.941 PERCENT.

3/102 =

2.941 PERCENT X 10,000 = 2,941 DOLLAR INCREASE = CPI ESCALATION FOR THE
GIVEN YEAR.
THE LANDLORD WILL ISSUE THE STATEMENT, USUALLY ANNUALLY, WITH THE ABOVE
EXAMPLE DISPLAYED ON IT. TYPICALLY A STATEMENT IS MADE THAT IF THE CPI
IS NO LONGER PUBLISHED BY THE BLS, ANOTHER METHOD WILL BE USED THAT IS
THE EQUIVALENT.
THE CPI ESCALATION CLAUSE IS DIFFICULT TO WRITE, AND USUALLY CONTAINS AN
EXAMPLE FOR CLARITY.
REAL ESTATE TAX ESCALATION
YOU
ONE
TAX
THE
THE

START WITH A BASE YEAR. IN NEW YORK CITY, THE FISCAL YEAR IS JULY
TO JUNE 30. WE ARE CURRENTLY IN THE 1990 TO 1991 TAX YEAR. IF NOT A
YEAR, IT IS LEASED ON A CALENDAR YEAR; YO AVERAGE THE SECOND PART OF
FIRST YEAR WITH THE FIRST PART OF THE SECOND YEAR IN THIS CASE, SINCE
TAX YEAR DOES NOT COINCIDE WITH THE CALENDAR YEAR.

THE OPERATING EXPENSE AND THE REAL ESTATE TAX ESCALATION WILL BE BASED ON
THE SAME PERCENTAGE OF THE SHARE OF THE BUILDING, BECAUSE THIS IS USUALLY
THE NEGOTIATED AGREEMENT.
INCLUDED:
REAL ESTATE TAXES
SPECIAL ASSESSMENTS
OTHER TAXES, FEES, OR IMPOSITIONS ASSESSED BY THE LANDLORD.
REVIEW CAREFULLY TO EXCLUDE THE INCOME TAX FROM THIS TAX PROVISION.
THE LEASE STATE SPECIFICALLY THAT THEY ARE NOT INCLUDED.

286

HAVE

"TAXES PAYABLE BY LANDLORD" SHOULD BE REPLACED BY "TAXES PAID BY

LANDLORD" SINCE CONCEPTUALLY A TAX LIEN CAN WIPE OUT THE LEASE IF THE
TAXES ARE NOT PAID. YOU WANT TO BE CERTAIN THAT THE MONEY WILL BE USED
TO PAY TAXES. IF THE TAXES PAYABLE IN A GIVEN YEAR ARE MORE THAN IN A
BASE YEAR, THE TENANT PAYS HIS SHARE OF THE GAIN.
IE. TAX PAID IN BASE YEAR
SUBSEQUENT YEAR
INCREASE
TENANT PORTION (10%)

10,000
12,000
2,000
2,000 X 10% = 200.00

ISSUES THAT THE TENANT WILL WISH TO COVER:

1. APPLIES TO ALL ESCALATIONS: THE CAP.
MOST DIFFICULT TO GET NEGOTIATED, YET NOT IMPOSSIBLE.
2. DEFINITION OF REAL ESTATE TAXES IS LIMITED.
3. REAL ESTATE TAXES ARE REASSESSED AT A SALE. RULE OF THUMB: UP TO 45%
EACH TIME PROPERTY IS SOLD. THIS IS FOCUSED ON BY TELLING THE LANDLORD
THAT THE TENANT WILL NOT PAY INCREASED TAXES ATTRIBUTABLE TO THE SALE OF
THE BUILDING.
4. WHEN IS THE ESCALATION PAYABLE?
LUMP SUM IN AUGUST (JULY IS WHEN
INCREASE IS DETERMINED), TWO PAYMENTS (SINCE THE LANDLORD MAKES TWO
PAYMENTS WHEN PAYING TAXES), OR MONTHLY.
*OTHER PROVISIONS OF COMMERCIAL LEASING*
DELIVERY OF POSSESSION - UNDER NEW YORK LAW, THERE IS A STATUTORY
PROVISION THAT THE LANDLORD MUST DELIVER THE PREMISES TO THE TENANT AT
THE COMMENCEMENT OF THE LEASE. IF NOT, THE TENANT HAS A RIGHT TO BACK
OUT. SEE PREVIOUS LECTURE.
ASSIGNMENT & SUBLETTING PROVISION
GENERALLY SPEAKING, THE LANDLORD WANTS TO CONTROL THE PROFITS DERIVED
FROM THE PROPERTY.
THE TENANT WANTS MAXIMUM FLEXIBILITY.
GENERALLY,
WITHOUT CONSENT, THE ASSIGNMENT OR SUBLETTING OF THE LEASE IS NOT
PERMISSIBLE.
THE TENANT AGREES, BUT SAYS PERMISSION MUST BE
"REASONABLE".
THE LANDLORD WILL THEN DEFINE IT AS "REASONABLE" TO
DECLINE THE SUBTENANT:
1. WHEN THE NET WORTH OF THE ASSIGNEE IS NOT SATISFACTORY IN
THE
JUDGEMENT
OF
THE
LANDLORD,
SUCH
AS
LACK
OF
CREDITWORTHINESS, OR
COMPARATIVE WORTH TO THE LESSEE.
2. IF THE USE IS NOT COMPARABLE TO THAT OF THE LESSEE.
THE USE CLAUSE IS IMPORTANT BECAUSE IT DOVETAILS WITH THE
ASSIGNMENT CLAUSE.
THE TENANT WILL WANT A BROAD USE CLAUSE, ALLOWING
ALL LEGAL
USES. THE LANDLORD WILL WANT A RESTRICTIVE CLAUSE, SUCH AS A
LAW
OFFICE USE ONLY. CERTAIN USES MAY BE SPECIFICALLY EXCLUDED, SUCH AS

287

GOVERNMENT AGENCIES, VOCATIONAL SCHOOLS, EMPLOYMENT AGENCIES, OR

MESSENGER SERVICES.
3. PRINCIPALS OF THE ASSIGNEE - MUAMMAR QUADAFFI MAY NOT BE AN
ACCEPTABLE PRINCIPAL.

THE DIFFERENCES BETWEEN A SUBLET AND AN ASSIGNMENT:

WHEN YOU TAKE A LEASE YOU HAVE A DIRECT RELATIONSHIP WITH THE LANDLORD
CALLED PRIVITY.
WHEN YOU SUBLET, YO ARE THE MIDDLEMAN AND THE NEW
LANDLORD TO THE SUBLESSEE.
WHEN YOU ASSIGN, EVEN THOUGH YOU STEP OUT OF
POSITION, YOU ARE STILL LIABLE IF THE ASSIGNEE VIOLATES THE LEASE; YOU
CAN BE "LOOKED TO" BY THE LANDLORD TO MAKE GOOD.
A NOVATION IS A TRUE SUBSTITUTION OF PARTIES IN EVERY RESPECT, INCLUDING
PRIVITY AND LIABILITY. THE LANDLORD IS SAYING, "TENANT, YOU ARE OFF THE
HOOK...I AM HAPPY WITH THE NEW TENANT". THIS IS VERY RARE.
THE ENTIRE PERIOD REMAINING ON THE LEASE IS CONVEYED IN AN ASSIGNMENT.
IN A SUBLET, A PORTION OF THAT PERIOD IS CONVEYED.
ANOTHER DIFFERENCE IS THAT A SUBLET IS TYPICALLY FOR A PORTION OF THE
DEMISED PREMISES.
ASSIGNMENT IS FOR THE WHOLE SPACE.
A LANDLORD WILL SOMETIMES RETAIN THE OPTION TO "RECAPTURE" THE SQUARE
FOOTAGE WHEN THERE IS A TENANT WHO WOULD OTHERWISE SELL HIS LEASE. THE
BASIS FOR THIS IS THE LANDLORD'S FEELING THAT IF THE TENANT "WANTS OUT",
THE LANDLORD SHOULD HAVE THE RIGHT TO ALLOW IT AND TAKE BACK THE LEASE.
THE LANDLORD WILL INSERT A CLAUSE LIMITING HIS "REASONABLENESS" TO THE
SPECIFIC CLAUSES MENTIONED, AND THE TENANT WILL WISH TO LIMIT THE PERIOD
OF TIME FOR RECEIVING THE LANDLORD'S RESPONSE TO THE SUBTENANT. SILENCE
WILL BE CONSTRUED AS APPROVAL.
IF THE LANDLORD HAS THE AFFIRMATIVE DUTY TO BE REASONABLE IN CONSENTING
TO THE ASSIGNMENT, THEN THE UNREASONABLE LANDLORD MAY BE SUBJECT TO
MONETARY DAMAGES. THIS RARELY OCCURS.
IF THE TENANT IS IN A POSITION TO MAKE A PROFIT FROM THE SUBTENANCY, THIS
IS A NEGOTIATED ITEM. COULD SAY "ALL REMUNERATION PAID OR PAYABLE TO THE
TENANT TO BE SPLIT AT (NEGOTIATED PERCENTAGE) WITH THE LANDLORD".
IF YOU ARE THE TENANT, YOU WILL NOT LIKE THE WORD "PAYABLE" SINCE WHEN
THE AMOUNT IS TO BE SPLIT WITH THE LANDLORD THE TENANT WILL HAVE TO PAY
THE LANDLORD EVEN THOUGH HE HAS NOT RECEIVED MONIES FROM THE SUBTENANT.
THE RIGHT TO RECAPTURE SHOULD BE LIMITED ONLY TO A POINT WHERE A CERTAIN
PERCENTAGE OF THE DEMISED PREMISES FOR A CERTAIN PERIOD OF TIME WAS

288

SUBLETTED BEFORE THE RECAPTURE CLAUSE KICKS IN.

UNDER CERTAIN CIRCUMSTANCES, THE RIGHT TO RECAPTURE MAY NOT BE THE SAME
AS A NOVATION. WHEN THE LANDLORD RECAPTURES THE SPACE, HE MIGHT BECOME A
SUBTENANT OF THE TENANT!
IF THIS HAPPENS, THE LANDLORD WILL WISH TO
PROTECT THESE INTERESTS FROM MERGER, WHICH WOULD IN COURSE CANCEL THE
TENANT'S LIABILITY.
IF THE LANDLORD WAVES THE RIGHT OF RECAPTURE, THEN THE TENANT SHOULD HAVE
THE RIGHT TO FIND A SUBTENANT WITHOUT THE LANDLORD'S CONSENT FOR A GIVEN
PERIOD OF TIME.
THE LANDLORD WILL TRY TO AVOID THE POSSIBILITY OF DAMAGES BY PLACING A
CLAUSE THAT THE TENANTS SOLE REMEDY SHALL BE SPECIFIC PERFORMANCE WHEN
THE LANDLORD IS NOT REASONABLE IN CHOOSING THE SUBTENANT.
THIS
EFFECTIVELY KILLS THE POTENCY OF THE "REASONABLE" CLAUSE AS THE POTENTIAL
ASSIGNEE IS OUT OF THE PICTURE BY THE TIME THE COURTS FIND THE LANDLORD
TO BE UNREASONABLE.
THE ASSIGNMENT OF STOCK IN A LEASE IS CONSIDERED AN ASSIGNMENT WITH
RESPECT TO THE ASSIGNMENT AND SUBLEASE CLAUSE AND MUST BE APPROVED BY THE
LANDLORD. THE LEASE COULD BE TERMINATED BY THE LANDLORD IF THE STOCK IS
CONVEYED WITHOUT APPROVAL. THE LANDLORD DOES NOT HAVE TO BE "REASONABLE"
IN APPROVING AN ASSIGNMENT UNDER THESE CONDITIONS.
A LANDLORD WILL RATIFY THE ASSIGNMENT BY ACTIVELY ACCEPTING A CHECK FOR
RENT FROM THE NEW SHAREHOLDER, OR BY, FOR EXAMPLE, CHANGING THE NAME ON
THE DIRECTORY TO THAT OF THE NEW SHAREHOLDER.
RULAND AND DUMBPHORS CASE - 100 YEARS AGO IN ENGLAND. ONCE THE LANDLORD
HAS WAIVED HIS RIGHT WITH RESPECT TO DENYING CONSENT, THEN FOR THAT
SPACE, EVERY TENANT HAS A RIGHT TO ASSIGN.
EVEN IF THE LANDLORD CONSENTS TO ONCE CASE, A CLAUSE IS NOW INSERTED INTO
THE LEASE STATING THAT LIMITS THE CONSENT TO THE SPECIFIC WAIVER OF
CONSENT, SO AS NOT TO INCLUDE THE OTHERS.
THE SUBTENANT CONTRACT ASSIGNS ALL OF THE RIGHTS OF THE TENANT, THE
ASSIGNOR, TO THE ASSIGNEE.
THE LIABILITIES UNDER THE LEASE ARE ALSO
ASSUMED.
THE LANDLORD WILL WANT TO SEE THE SUBTENANT PERFORM ON THESE
OBLIGATIONS.
THE SUBLESSOR WILL ATTEMPT TO ASSIGN AS MUCH OF THE SUBLESSOR'S
OBLIGATIONS TO THE SUBLESSEE.
THE SUBLESSOR CAN NOT PASS ALONG MORE
THAN HE HAS. THE SUBLESSEE WILL REQUIRE THE SUBLESSOR'S PRIVITY WITH
THE LANDLORD TO ENFORCE REPAIRS OR OTHER OBLIGATIONS OF THE LANDLORD TO
THE SUBLESSOR. THE SUBLESSEE WILL REQUIRE AN AFFIRMATIVE OBLIGATION ON
BEHALF OF THE SUBLESSEE FOR THE SUBLESSOR TO GO TO COURT AGAINST THE
LANDLORD TO ESTABLISH PERFORMANCE BY THE LANDLORD THROUGH THE PRIVITY
BETWEEN THE SUBLESSOR AND THE LANDLORD.
THE PAYMENT OF LEGAL FEES IN
THIS EVENT IS THE SUBLESSEE'S RESPONSIBILITY.

289

THE SUBLESSEE LOOKS FOR A NON-DISTURBANCE PROVISION

IF THE SUBLESSOR DOES NOT PAY THE RENT, THE SUBLESSEE
PAY THE RENT SO AS NOT TO BE EVICTED.
IF THIS IS
AGREEMENT WITH THE PRIME TENANT CAN BE ESTABLISHED TO
THE DIFFERENCE IS THAT IN THE SECOND CASE NO PRIVITY
LANDLORD.

FROM THE LANDLORD.

WANTS THE RIGHT TO
NOT ACCEPTABLE, AN
DO THE SAME THING;
IS EXTENDED TO THE

THE SUBTENANT WILL WANT TO AGREE AS TO HOW ESCALATIONS ARE SHARED WITH
THE PRIME TENANT.

ASSIGNMENTS
ELEMENTS:
1. NEED EFFECTIVE DATE OF THE ASSIGNMENT.
2. A STATEMENT THAT THERE ARE NO DEFAULTS UNDER THE LEASE.
3. IF YOU CAN GET IT, AN ESTOPPEL CERTIFICATE FROM THE LANDLORD - AT
LEAST GET A CONSENT TO THE ASSIGNMENT. YOU DO NOT WANT TO GIVE MONEY TO
THE ASSIGNOR AND LATER FIND YOURSELF IN LITIGATION WITH THE LANDLORD
BECAUSE OF LACK OF CONSENT.
4. THE SECURITY DEPOSIT. THE TENANT WILL WISH TO BE REIMBURSED FOR HIS
SECURITY DEPOSIT BY THE ASSIGNEE.
THE ASSIGNEE WILL WANT A
REPRESENTATION THAT THE SECURITY HAS NOT BEEN UTILIZED OR DIMINISHED BY
THE LANDLORD.
IF THE ASSIGNEE DOES NOT SPECIFICALLY ASSUME THE TENANT'S OBLIGATIONS AND
THERE IS A BREECH, THE ASSIGNEE IS NOT LIABLE FOR DAMAGE.
SECURITY DEPOSIT
SECTION 5-107 OF THE GENERAL OBLIGATIONS LAW OF THE STATE OF NEW YORK
COVERS SECURITY DEPOSITS.
THIS SECTION REQUIRES THE LANDLORD TO
SEGREGATE THE SECURITY DEPOSIT FROM GENERAL OR OPERATING FUNDS. IT NEED
NOT BE IN AN INTEREST BEARING ACCOUNT OR IN A BANK UNLESS THE RENTAL UNIT
HAS SIX RESIDENCES OR MORE. ONE PERCENT OF THE INTEREST IS RETRIEVED BY
THE LANDLORD AS AN ADMINISTRATIVE FEE.
THE SECURITY IS USED TO COVER A "BREECH". A WELL DRAFTED CLAUSE STATES
THAT IF THE LANDLORD HAS TO USE A PORTION OF THE SECURITY, THE TENANT
MUST REPLENISH IT. IN LARGE DEALS, A LETTER OF SECURITY OR A CERTIFICATE
OF DEPOSIT CAN BE USED.
END OF CLASS NINE
CLASS TEN
7/30/90

290

COMMERCIAL LEASING (CONT.)

ELECTRICITY AND INSURANCE
ELECTRICITY PROVISION - THE SINGLE MOST COMPLICATED PROVISION IN THE
LEASE.
THERE ARE 3 DIFFERENT ARRANGEMENTS DEALING WITH THE COST OF
ELECTRICITY.
1. DIRECT METERING
2. SUBMETERING
3. RENT INCLUSION
DIRECT METERING - METER IN THE SPACE OF THE TENANT, DIRECT PAYMENT BY
TENANT TO UTILITY. AS A RESULT THERE IS A BUILT IN INCENTIVE TO CONSERVE
ELECTRICITY.
SUB-METERING - MORE COMMONLY, THERE IS ONE METER FOR THE BUILDING WITH
"SUB-METERS" RUNNING INTO THE DIFFERENT SPACES IN THE BUILDING.
THE
LANDLORD IS BUYING THE ELECTRICITY AT A BULK RATE.
THE LEASE MUST
ADDRESS WHETHER THE TENANT IS GETTING THE PASSED-ON SAVINGS AT WHOLESALE,
OR IS HE PAYING THE MARKED UP RETAIL COST FROM THE LANDLORD.
THIS IS
NEGOTIABLE.
RENT INCLUSION - ONE METER WITH NO SUBMETERS. THE LANDLORD'S CONSULTANT
ESTIMATE WHAT THE INDIVIDUAL TENANTS ELECTRIC USE WILL BE BASED ON
EQUIPMENT AND HOURS OF SERVICE OF THE BUSINESS.
THE PROBLEM WITH THIS IS YOU WONT KNOW IF YOU ARE OVERPAYING IF YOU ARE
THE TENANT. TYPICALLY, THE CONSULTANT WILL GIVE THE LANDLORD A QUOTE OF,
SAY, $2.25 PER S.F. THE LANDLORD MAY ADD A "SAFETY BUFFER" OF 50 CENTS
TO RAISE IT TO $2.75 PER S.F. IN ANY GIVEN BUILDING THE RENT MAY VARY
CONSIDERABLY FOR EACH TENANT SO THIS MAY VARY CONSIDERABLY FOR EACH
TENANT SO THIS MUST BE MONITORED CAREFULLY. $3.00 PER S.F. IS TYPICAL
TODAY.
THE LANDLORD MAY HAVE THE OPTION TO SWITCH FROM ONE SYSTEM TO
ANOTHER. IF MOVING FROM METERING TO RENT INCLUSION, YOU MIGHT HAVE TO
PAY FOR THE METERING INSTALLATION.
MORE IMPORTANTLY, YOU MUST RECEIVE
"REASONABLE NOTICE" FROM THE LANDLORD.
INSURANCE PROVISION - IN MOST LEASE SITUATIONS, THERE WILL BE A GENERAL
LIABILITY AND PROPERTY DAMAGE INSURANCE PROVISION REQUIREMENT THAT THE
TENANT PROTECT THE LANDLORD.
IN ADDITION, THE LANDLORD WILL WANT THE
TENANT TO PAY WORKER'S COMPENSATION INSURANCE IN CASE A MECHANIC IS HURT
WHILE WORKING IN THE SPACE.
PLATE GLASS INSURANCE - THE TENANT IS RESPONSIBLE FOR BROKEN GLASS IN
RETAIL SPACE.
RENTAL INSURANCE - A LANDLORD PROTECTION WHEREBY IF THE TENANT IS UNABLE
TO DO BUSINESS HE WILL BE PAID HIS RENT.

291

BUSINESS INTERRUPTION INSURANCE - THE TENANT IS COVERED WHEN THERE IS A

CASUALTY INT HE SPACE, SO THAT RENT CAN BE PAID.
THE TENANT NAMES THE LANDLORD, MANAGING AGENT AND SOMETIMES THE MORTGAGEE
AS CO-INSUREDS.
A CERTIFICATE OF ENDORSEMENT SHOULD BE SENT TO THE
PARTIES.
BE CERTAIN THAT IT IS AN "ENDORSEMENT", AND NOT FOR
"INFORMATION PURPOSES ONLY" IF YOU ARE THE LANDLORD. THE APPEARANCE OF
CERTIFICATE IS THE SAME, SO BE CAREFUL.
THE AMOUNT OF COVERAGE IS NEGOTIABLE. ALWAYS AGREE ON THE COVERAGE. DO
NOT ALLOW IT TO BE OPEN ENDED. YOU WANT TO LOCK IN THE COVERAGE AT ONE
TO TWO MILLION IN AN OFFICE SITUATION.
RETAIL COVERAGE IS USUALLY
HIGHER, SAY 3 MILLION, BECAUSE OF THE RISK OF PROBLEMS WITH TRANSIENTS.
"COMBINED SINGLE LIMIT" IS THE SUM TOTAL OF INSURANCE COVERAGE.
AS A
TENANT YOU WILL WANT TO DIVIDE A MINIMUM 2 MILLION DOLLAR COVERAGE INTO 1
MILLION BASIC AND 1 MILLION UMBRELLA COVERAGE.
BUILD THIS INTO THE
LEASE; IT WILL SAVE YOU MONEY.
EVERY LEASE HAS BUILT INTO IT A WAIVER OF SUBROGATION. IT IS A CONCEPT
WHEREBY THE INSURANCE COMPANY HAS THE RIGHT TO TAKE OVER FROM THE PARTY
TO WHOM THEY ARE MAKING THE PAYMENT AND WHOM THEY ARE INSURING.
THIS
GIVES THE INSURANCE COMPANY THE RIGHT TO SUE THE PARTY THAT CAUSED THE
DAMAGE.
THIS WAIVER DISALLOWS THE INSURANCE COMPANY FROM TAKING OVER,
SINCE IN ITS ABSENCE, PRIVITY IS NON-EXISTENT.
IF THERE IS A DIFFERENCE IN PREMIUMS RESULTING FROM THE WAIVER OF
SUBROGATION, THE PARTY REQUESTING THE WAIVER WILL PAY THE DIFFERENCE. ON
THE OTHER HAND, IF A TENANT'S USE (IE. A RESTAURANT) INCREASES THE
LANDLORD'S INSURANCE PREMIUM, THE TENANT WILL PAY THE DIFFERENCE.
IF YOU ARE THE TENANT, YOU WILL WANT THE LEASE TO SAY THAT THE LANDLORD
WILL LOOK TO THE INSURANCE PROCEEDS FIRST TO PAY FOR DAMAGE BEFORE
LOOKING TO THE TENANT.
THE TENANT SHOULD TRY TO LIMIT ITS EXPOSURE FROM THE LANDLORD'S WISH TO
MAKE HIM PERSONALLY LIABLE FOR DAMAGE TO PROPERTY OR PERSON'S IN THE
RENTED SPACE.
PROPERTY DAMAGE INSURANCE (CASUALTY INSURANCE) - IN A CASUALTY, THE FIRST
TWO THINGS THAT HAPPEN UNDER MOST LEASES IS THAT:
1. THE LANDLORD HAS A PERIOD OF TIME TO DECIDE ON MAKING THE
REPAIR.
2. THE LANDLORD HAS A CERTAIN PERIOD OF TIME TO MAKE THE REPAIR.
THE LANDLORD WILL WANT TO MAXIMIZE BOTH PERIODS, AND THE TENANT WANTS IT
MINIMIZED.

292

IF THE LANDLORD DECIDES TO REPAIR, THE TENANT SHOULD BE ENTITLED TO A

RENT ABATEMENT FOR THE PERIOD BETWEEN "LOSS OF USE" AND "SUBSTANTIAL
COMPLETION" OF REPAIRS.
IN A NET LEASE SITUATION, IT IS IMPERATIVE THAT THE TENANT HAVE BUSINESS
INTERRUPTION INSURANCE.
TRIPLE NET LEASE - LANDLORD IS NOT RESPONSIBLE FOR ANYTHING.
MORTGAGE PAYMENTS ARE THE TENANTS.

EVEN THE

DOUBLE NET LEASE - TENANT PAYS ALL EXCEPT THE MORTGAGE.

NET LEASE - THE TENANT PAYS ALL (100 PERCENT) OF CERTAIN EXPENSES, LIKE
TAXES. THE TENANT IS NOT RESPONSIBLE FOR ALL COSTS SUCH AS THE OPERATING
EXPENSES OF THE BUILDING. NOT THE SAME CONCEPT AS BEING RESPONSIBLE FOR
THE ANNUAL INCREASES IN EXPENSES WITH THE LANDLORD RESPONSIBLE FOR THE
BASE AMOUNT, DERIVED FROM THE BASE YEAR.
A MAJOR TENANT (IE. AN ANCHOR STORE) WILL RESERVE THE RIGHT TO TERMINATE
THE LEASE IF THE DEMISED PREMISES CAN NOT BE REPAIRED IN A SPECIFIED
AMOUNT OF TIME.
TO EVADE THIS ONEROUS CLAUSE, THE LANDLORD MIGHT OFFER ALTERNATIVE SPACE
IN THE SHOPPING CENTER.
WHO DOES IT? COVERED IN THE LEASE
WHO PAYS FOR IT?

WHEN WILL IT BE DONE?

IF THE TENANT CAN NOT GET A LEASE TERMINATION, IT WILL WANT TO FIRM UP
THE THREE ITEMS ABOVE.
IT WILL WANT A RENT ABATEMENT TO COMPENSATE IT FOR WORK THAT IT PERFORMS
FOR ITSELF (SELF-HELP) WITH INSURANCE MONEY.
THE PRINTED LEASE WILL HAVE A WAIVER OF SECTION 227 THAT GIVES TENANTS
THE RIGHT TO CANCEL THE LEASE WHEN SEVERE DAMAGE TAKES PLACE.
THE
PARTIES ARE PERMITTED TO WAIVE THIS CLAUSE.
UNDER SECTION 5-321 OF THE GENERAL OBLIGATIONS STATUTE (NYS LAW) THE
LANDLORD IS PROHIBITED FROM EXCULPATING ITSELF FROM ITS OWN NEGLIGENCE.
THE LANDLORD CAN NOT HAVE A VALID LEASE CLAUSE IF HE FORCES THE TENANT
NOT TO ACCEPT A WAIVER OF THE LANDLORD'S LIABILITY.
THE LANDLORD WILL
WANT THE CLAUSE ANYWAY BECAUSE IT WILL INSULATE HIM FROM THIRD PARTY
CLAIMS IN THE EVENT OF AN ACCIDENT.
REAL ESTATE TAXATION

293

*******************************
PROPERTY VALUES AND ASSESSMENTS
*******************************
THERE IS A DIFFERENCE
ARE ASSESSED BASED ON
IS THE ASSESSMENT OF
NEW CONSTRUCTION AS A

BETWEEN ASSESSED VALUATION AND ASSESSMENTS. VALUES

INCOME FROM THE PROPERTY, OR BY COMPARABLES, WHICH
SIMILAR PROPERTIES IN THE AREA'S RESALE VALUE AND
FUNCTION OF RESALE VALUE.

REAL PROPERTY TAX LAW REQUIRES THAT PROPERTY BE ASSESSED AND VALUED ON AN
OBJECTIVE AND FAIR STANDARD.
N.Y.C.

TAX ASSESSMENTS

CLASS I PROPERTY.........................1 TO 3 FAMILY HOMES

CLASS II PROPERTY........................RESIDENTIAL MULTIPLE DWELLINGS
(APARTMENTS AND COOPS WITH
MORE THAN 3 APARTMENTS)
CLASS III PROPERTY.......................OWNED BY A UTILITY
CLASS IV PROPERTY........................VACANT LAND OR COMMERCIAL
PROPERTY.
CLASS I, II, AND IV ASSESSED AT 10 PERCENT OF VALUE.
CLASS III ASSESSED AT A LITTLE MORE THAN 15 PERCENT OF VALUE.
THE SALE OF A PROPERTY WILL TRIGGER A REASSESSMENT. THE RULE OF IS THAN
ANYTHING BUT A PRIVATE HOUSE IS REASSESSED AT 45 PERCENT OF SALES PRICE,
PHASED IN OVER 5 YEARS (20 PERCENT PER YEAR).
THE CITY CALLS THIS AN
"ACTUAL ASSESSMENT" AND A "TRANSITIONAL ASSESSMENT".
IE. A SMALL COMMERCIAL BUILDING WITH A 100,000 DOLLAR ASSESSMENT.
THE BUILDING SOLD FOR 1,000,000 DOLLARS.
THE NEW ASSESSMENT IS 450,000 DOLLARS (1 MILLION X 45%)
TAXES INSTITUTED AT THE RATE OF 70,000 INCREASE ANNUALLY.
YEAR
YEAR
YEAR
YEAR
YEAR
YEAR

0........100K
1........170K
2........240K
3........310K
4........380K
5........450K

A HOUSE IS REASSESSED AT 20 PERCENT OF SALES PRICE AS PHASED IN OVER A 5

YEAR PERIOD AT NO GREATER THAN SIX PERCENT PER ANNUM.
TAX EXEMPTION IS COVERED UNDER SECTION 421a OF THE REAL PROPERTY TAX LAW.
THE STATUTE WAS PASSED IN 1971 TO PROMOTE HOUSING DEVELOPMENT IN
"UNDERUTILIZED AREAS".
THE PROGRAM PROVIDES FOR A TEN YEAR EXEMPTION

294

FROM INCREASES IN TAXES.

IE. THE BASE YEAR ASSESSMENT IS 100K ON VACANT LAND.
YOU DECIDE TO BUILD A BUILDING AT A COST OF 1.1 MILLION DOLLARS.
YEAR ONE AND TWO........IN THE FIRST TWO YEARS YOU HAVE A 100 PERCENT
EXEMPTION (PAY ON 100K OF ASSESSED VALUE)
YEAR THREE AND FOUR........IN THE SECOND TWO YEARS YOU HAVE AN 80 PERCENT
EXEMPTION (PAY ON 300K OF ASSESSED VALUE)
YEAR FIVE AND SIX........IN THE THIRD TWO YEARS YOU HAVE A 60 PERCENT
EXEMPTION (PAY ON 500K OF ASSESSED VALUE)
YEAR SEVEN AND EIGHT........IN THE FOURTH TWO YEARS YOU HAVE A 40 PERCENT
EXEMPTION (PAY ON 700K OF ASSESSED VALUE)
YEAR NINE AND TEN........IN THE FIFTH TWO YEARS YOU HAVE A 20 PERCENT
EXEMPTION (PAY ON 900K OF ASSESSED VALUE)
YEAR ELEVEN AND INTO THE FUTURE........THERE IS NO LONGER AN EXEMPTION;
PAY ON THE FULL ASSESSED VALUE OF 1.1 MILLION.
IF YOU HAVE A PROPERTY THAT IS APPROVED WITH A NON-CONFORMING USE, IS
UNDER-UTILIZED, OR VACANT, YOU CAN QUALIFY FOR A 421a TRANSITIONAL
EXEMPTION.
THE OTHER AREA THAT COMPLIMENTS THE SECTION 421a IS THE J-51. IT IS THE
"FLIP SIDE" OF TAX BENEFITS FOR COMMERCIAL REAL ESTATE AND IS APPLICABLE
TO RENOVATIONS AND CONVERSIONS OF RESIDENTIAL BUILDINGS. TO APPLY, YOU
MUST END UP WITH A CLASS II BUILDING. YOU HAVE A 12 YEAR EXEMPTION. THE
INCREASE IN THE ASSESSMENT IS ON THE BUILDING PORTION ONLY, WHICH IS
EXEMPTED FROM INCREASES FOR 12 YEARS; THERE IS NO PHASE OUT.
THERE IS
AN ABATEMENT FOR THE COST OF THE WORK DONE.
THE CITY ESTABLISHES THE
REASONABLE COST OF THE WORK AND CREDITS WITH AN ABATEMENT EQUAL TO A
PERCENTAGE OF THAT NUMBER.
TAKE A "GUT RENOVATION" STARTING OFF WITH A BASE ASSESSMENT OF 100,000
DOLLARS. COMPLETE RENOVATION IS UNDERGONE, WITH THE ASSESSMENT GOING UP
TO 1 MILLION DOLLARS.
THE ENTIRE INCREASE OF 900,000 DOLLARS IS
ATTRIBUTABLE TO THE BUILDING, AND IS EXEMPT FOR TWELVE YEARS. YOU ONLY
PAY TAX ON THE 100,000, THEREFORE.
THE CITY DETERMINES THAT THE
REASONABLE COST OF THE RENOVATION IS 1 MILLION DOLLARS (CERTIFIED
REASONABLE COST (CRC)). THE MAXIMUM ABATEMENT YOU CAN GET IS 90 PERCENT
OF THE CRC, WHICH IN THIS CASE IS 900,000 DOLLARS.
YOU CAN NOT USE THE ENTIRE AMOUNT IN A YEAR; YOU CONSUME IT AT 8 1/3
PERCENT PER YEAR OF THE CRC OF 1 MILLION DOLLARS IN THIS CASE.
THE
ABATEMENT IN YEAR ONE IS 83,000 DOLLARS TO APPLY AGAINST THE TAXABLE

295

ASSESSMENT OF 100,000 X 10% = 10,000 DOLLARS. TAXES ARE 10,000 - 83,000

DOLLARS = ZERO DOLLARS (TAXES CANNOT BE LESS THAN ZERO). YOU ROLE OVER
THE 73,000 DOLLARS EXTRA TO THE NEXT YEAR, AND SO ON UP TO TWENTY YEARS
WHEN THE ROLE OVER IS LOST.
IN YEAR 13, THE 900,000 DOLLAR EXEMPTION DISAPPEARS AND ASSUMING NO
INCREASES YOU ARE PAYING 100,000 PER YEAR IN TAX. (1,000,000 X 10%)
BECAUSE YOU CAN NOT USE MORE THAN 8 1/3 PERCENT PER YEAR, YOU CAN ONLY
SUBTRACT 83,000 FROM THE 100,000 FOR 17,000 IN TAX DUE. YOU CAN USE THE
CARRYOVER, AS MENTIONED ABOVE, FOR UP TO THE 20TH YEAR TO COVER TAXES
DUE, SUCH AS IN THE ABOVE EXAMPLE IN THE THIRTEENTH YEAR.
THE EXEMPTION AND ABATEMENT RUN WITH THE LAND, CREATING A BURDEN WITH THE
BUYER TO MAKE CERTAIN THAT THE BENEFITS ARE STILL IN PLACE.
MULTIPLE DWELLING LAW
INTERIM MULTIPLE DWELLING ACT (IMD)
MANUFACTURING
BUILDINGS
IN
LOWER
MANHATTAN
WERE
TOO
OLD
FOR
MANUFACTURING, SO LOFT DWELLINGS CAME INTO BEING BECAUSE MANY BUSINESSES
MOVED OUT OR WENT BUST AND RESIDENTIAL TENANTS PAID AS MUCH OR MORE THEN
THE OLD COMMERCIAL TENANT.
THE COURTS DECIDED ONCE ENOUGH LOFTS WERE
RESIDENTIAL A BUILDING WOULD BE DE FACTO A RESIDENTIAL MULTI-FAMILY
DWELLING.
THIS WAS NO GOOD BECAUSE OF THE APPEARANCE OF BEING "SOFT"
WITH RESPECT TO ENFORCING BUILDING CODES.
SO IN 1980 - 82, THE CITY TRIED TO PASS THE LOFT LAW WHICH WAS SUPPOSED
TO BRIDGE THE GAP BETWEEN COMMERCIAL AND RESIDENTIAL USES, ALLOWING THE
TENANTS NOT TO HAVE RENTS RAISED TO HIGH END, ALLOWING THE LANDLORD TO
MAKE MORE MONEY.
IT DID NOT PASS.
INSTEAD THE CITY CREATED THE LOFT
BOARD. THE CITY PASSED LAW WHICH SAID THAT LANDLORDS MUST FILE I.M.D.
PAPERS AND MEET ARTICLE 7B REQUIREMENTS (SOFTY STANDARDS). THE TENANTS
ALSO GOT RENT STABILIZATION, HOWEVER THE LANDLORD CAN RECOUP COSTS OF
BRINGING THE OLD BUILDING UP TO CODE.
RENT CONTROL - END OF WORLD WAR II - AS SOLDIERS CAME BACK TO THE STATES,
THE DEMAND FOR HOUSING WAS GREAT.
THE GOVERNMENT DECIDED TO CURB
INFLATIONARY PRESSURES ON RENTS TO CONTROL RENT INCREASES IN THE 1940'S
THROUGH THE 1960'S.
RENT CONTROL COVERED EVERYTHING THAT WAS HOUSING.
AS A RESULT VERY LITTLE NEW HOUSING WAS BEING PRODUCED SO THERE WAS A
MOVEMENT AWAY FROM RENT CONTROL IN THE 1960'S TO CREATE HOUSING.
IN THE
LATE 1960'S, BECAUSE MARKET RENTS WERE INCREASING AND TENANTS WERE BEING
EVICTED, BUILDINGS WITH SIX OR MORE APARTMENTS HAD THEIR RENTS REGULATED
BUT NOT THE EXTENT OF RENT CONTROL. RENT STABILIZATION WAS A COMPROMISE
BETWEEN RENT CONTROL AND MARKET RENT.
THE RENT GUIDELINES BOARD WAS ESTABLISHED TO REGULATE RENTS. IT CONSIST
OF 2 TENANT, 2 LANDLORD AND 3 AT LARGE REPRESENTATIVES WHO GET TOGETHER
ONCE A YEAR TO DECIDE WHAT THE RENT INCREASE SHOULD BE FOR THE FOLLOWING

296

YEAR'S LEASES.
EMERGENCY
POSSIBLE.

TENANT

PROTECTION

ACT

(ETPA)

MAKES

RENT

STABILIZATION

RENT STABILIZATION HAS A VACANCY INCREASE + RENT INCREASE FOR ONE OR TWO
YEAR LEASES.
RENT CONTROL STATUTORY INCREASE IS 7.5 PERCENT FOR A ONCE YEAR LEASE UPON
VACANCY.
THE RENT GOES TO MARKET RATE AND THEN THE APARTMENT BECOMES
STABILIZED.
APARTMENTS BUILT AFTER 1974 ARE NOT RENT STABILIZED UNLESS THEY ARE BUILT
UNDER J-51 OR 421a.
END OF CLASS TEN
CLASS ELEVEN
8/6/90
RULAND AND DUMBPHORS CASE
THE LANDLORD LEASED A PIECE OF LAND TO AN INDIVIDUAL, WHO IN TURN
ASSIGNED THE LEASE TO A THIRD PARTY, WHO IN TURN ASSIGNED TO A FOURTH.
IN CONSENTING TO THE THIRD PARTY, THE LANDLORD WAIVES HIS RIGHT TO
PREVENT FURTHER ASSIGNMENTS, UNLESS OTHERWISE PROHIBITED IN THE CONTRACT.
A LEASE WILL HAVE A CLAUSE THAT WILL STATE THAT CONSENT IN THE CASE OF
THE THIRD PARTY DOES NOT IMPLY CONSENT TO FURTHER ASSIGNMENTS BY WAIVER
OF LANDLORD'S RIGHTS.

ARTICLE 7B VS. ARTICLE 7C

ARTICLE 7B IS IN THE BUILDING CODE AND REGULATES SAFETY ISSUES, SUCH AS
LIGHT AND AIR, CERTAIN MINIMUM ROOM SIZES, ETC. DEALS WITH RENOVATION,
AND IS NOT AS RESTRICTIVE AS THE ADMINISTRATIVE CODE, KEEPING IN MIND
THAT RENOVATIONS DO NOT ALLOW THE DEGREE OF CONSTRUCTION FREEDOM THAT NEW
CONSTRUCTION ALLOWS, PRACTICALLY SPEAKING.
ARTICLE 7C IS THE LOFT LAW,
WHICH REQUIRES NON-RESIDENTIAL BUILDINGS
BEING CONVERTED TO RESIDENTIAL USE WITH MORE THAN THREE UNITS TO MEET
CERTAIN MINIMUM BUILDING CODES.
ADMINISTRATIVE CODE TITLE 20 - DEMANDS RIGID SET
REGULATING THE DEVELOPMENT OF RESIDENTIAL DEVELOPMENT.
**************
NOTES ON FINAL

297

OF

REQUIREMENTS

**************
6 TO 8 PM, BREAK, 1/2 HOUR WRAP-UP
25 SHORT ANSWERS, WITH 3 ESSAY QUESTIONS.
SECTION 223 F - DEALS WITH THE SPACE NOT BEING DELIVERED ON TIME, AND THE
TENANTS ABILITY TO TERMINATE THE LEASE.
SECTION 227 - RIGHT FOR TENANT TO TERMINATE AFTER CASUALTY
THE ABOVE SECTIONS 223 F AND 227 ARE USUALLY WAIVED ON THE PRINTED FORM
OF THE LEASE, THOUGH THE TERMS THESE SECTIONS SOUGHT TO PROTECT ARE
GENERALLY RENEGOTIATED BY THE TENANT AND THE LANDLORD.
*****************************
CONDOMINIUMS AND COOPERATIVES
*****************************
CONDOS AND COOPS ARE FORMED UNDER THE ENABLING ACT OF ARTICLE 23 A OF THE
GENERAL BUSINESS LAW, WHICH IS ALSO CALLED THE MARTIN ACT. IN NEW YORK
CITY, THE SECTION OF THE ARTICLE GOVERNING THEM IS SECTION 352 eeee
("QUAD-E"), AND IS SECTION 352 eee ELSEWHERE IN THE STATE.
CONDOS
COOPS
************************************************************************
ARTICLE 9-B OF REAL PROPERTY LAW
ARTICLE 23A, GBL, MARTIN ACT
13 NYCRR PT20 (DEVELOPMENT)
13 NYCRR PT 18 (OCCUPIED)
13 NYCRR PT23 (OCCUPIED)
13 NYCRR PT 21 (DEVELOPMENT)

TABLE OF "THE STATUTORY FRAMEWORK OF CONDOS AND COOPS"

CONDOS ARE DESCRIBED BY NEW YORK STATE LAW IN ARTICLE 9B (MARCH 1964).
THEY HAVE NO EXISTENCE OUTSIDE OF STATUTORY LAW.
CONDOS ARE COMMON
THROUGHOUT THE COUNTRY, ALTHOUGH COOPS ARE NOT. THE FIRST CONDO ENABLING
ACT IN AMERICA OR ITS PROTECTORATES WAS IN PUERTO RICO IN 1959.
13 NYCRR PT20 (DEVELOPMENT)

PART

NEW YORK CODES, RULES AND REGULATIONS (NYCRR)

TITLE
ALL STATUTES PERTAINING TO DEVELOPMENT OF CONDOS (NEW CONSTRUCTION) ARE
FOUND IN PART 20. CONVERSIONS ARE FOUND IN PART 23.
COOPS ARE GOVERNED BY ARTICLE 23A GBL. THIS IS ALSO CALLED THE MARTIN
ACT, WHICH IS THE STATUTE FOR COOP REFERENCES.
PART 18 OF THE NYCRR GOVERNS OCCUPIED OR CONVERSION COOPS.

298

PART 21 OF THE NYCRR GOVERNS DEVELOPMENT OF COOPS (NEW CONSTRUCTION).

PART 22 GOVERNS HOMEOWNERS ASSOCIATIONS.
WHAT ARE SOME OF THE DISTINCTIONS BETWEEN COOPS AND CONDOS?
CONDOMINIUMS:
UNIT DEED, IN MANY RESPECTS LIKE A TRUE DEED ON A SINGLE FAMILY HOME. YOU
CAN GET A MORTGAGE ON A CONDOMINIUM.
THE COLLATERAL FOR PAYING THE
MORTGAGE IS THE PROPERTY. THE CONDO CAN NOT HAVE AN UNDERLYING MORTGAGE
ON THE ENTIRE BUILDING.
COOPERATIVES:
PROPRIETARY LEASE TAKES THE PLACE OF THE DEED; YOU GET A COOP LOAN, NOT A
MORTGAGE; THE COLLATERAL IS NOT REAL PROPERTY, BUT IS SHARE OF STOCK AND
THE PROPRIETARY LEASE. THE COOP CAN HAVE AN UNDERLYING MORTGAGE ON THE
BUILDING.
IN A CONDO VS. A COOP, WITH TWO IDENTICAL UNITS, THE CONDO UNIT SHOULD BE
MORE EXPENSIVE THAN THE COOP.
HOWEVER, THE CONDO SHOULD HAVE A LOWER
MONTHLY PAYMENT BECAUSE THE MAINTENANCE PAYMENT WILL NOT INCLUDE A
PAYMENT ON THE UNDERLYING MORTGAGE ON THE COOP FACILITIES.
BECAUSE THE PROPRIETARY LEASE IN A COOP IS SUBORDINATE TO THE MORTGAGE ON
THE OVERALL COOP, THE SUBORDINATE LEASE CAN BE WIPED OUT IN A
FORECLOSURE. THE BANK TAKING OUT THE COOP LEASE TO AN INDIVIDUAL WOULD
THEN HAVE COLLATERAL WITH NO VALUE, AS THE STOCK HAS NO VALUE, AND SINCE
THE PROPRIETARY LEASE WAS WIPED OUT.
THE BANK HOLDING THE COOP LOAN
WOULD THEN TURN TO THE INDIVIDUALS FOR PAYMENT. WHEN SPONSORS OF COOP
OFFERINGS HOLD SHARES TO A LARGE PERCENTAGE OF APARTMENTS, AND THE
SPONSOR DOES NOT MAKE MAINTENANCE PAYMENTS, THE COOP WILL NOT HAVE MONEY
TO PAY THE MORTGAGE.

*********
CONDOS
*********
THE UNITS ARE OWNED IN FEE, ARE INSURABLE, ARE MORTGAGEABLE, AND IN
ADDITION TO THE UNITS THERE ARE ELEMENTS OF THE PROPERTY OWNED IN COMMON,
CALLED COMMON ELEMENTS.
COMMON ELEMENTS CONSIST OF THE ENTIRE PROPERTY LESS THE UNITS.
THE
PERCENTAGE OF COMMON ELEMENTS OWNED BY A UNIT OWNER IS EQUAL TO THE
PERCENTAGE OF OWNERSHIP THAT THE OWNER HAS IN THE ENTIRE PROPERTY.
IN A CONDO, THE PERCENTAGE OF COMMON INTEREST IS DETERMINED BY ONE OF
FOUR WAYS, ACCORDING TO SECTION 339-i.

299

1. FAIR VALUE METHOD - A CALCULATION BASED ON THE VALUE OF THE

APARTMENT AS AGAINST THAT OF THE OTHERS COMBINED. THIS DETERMINATION IS
SET BY THE SPONSOR AT THE BEGINNING OF THE CONDO FORMATION, IN THE
OFFERING. IT CAN BE CHANGED AND REASSESSED BY A SUPER MAJORITY VOTE OF
THE CONDO ASSOCIATION.
2. SQUARE FOOTAGE METHOD - THE SQUARE FOOTAGE OF EACH APARTMENT AS
COMPARED TO THAT OF THE AGGREGATE SQUARE FOOTAGE OF THE OTHER APARTMENTS.
THIS IS THE LEASE COMMON METHOD.
3. MULTIPLE FACTOR METHOD - ALL FACTORS DEALING WITH VALUE AND
MARKETABILITY FOR ONE APARTMENT IS COMPARED WITH THE ENTIRE COMPLEX OF
APARTMENTS. THIS IS THE MOST COMMON METHOD.
4. EQUAL PERCENTAGE METHOD - TAKE THE NUMBER OF UNITS, DIVIDE BY
100, AND ARRIVE AT THE PERCENTAGE OF COMMON OWNERSHIP. UNCOMMON METHOD.
COMMON CHARGES
THE CONDOMINIUM IS GOVERNED BY A BOARD OF MANAGERS, WHICH HAS LESS POWER
THAN A COOP'S BOARD OF DIRECTORS.
THIS IS BECAUSE THE COOP BOARD CAN
EFFECTIVELY PREVENT YOU FROM SELLING TO A PROSPECTIVE PURCHASER.
WITH RESPECT TO REAL PROPERTY, THERE IS A CONSTITUTIONAL PROHIBITION
AGAINST RESTRAINT ON THE SALE OF REAL PROPERTY. CONDO BOARDS OF MANAGERS
THEREFORE CAN NOT RESTRICT SALE BECAUSE CONDOS ARE REAL PROPERTY. CONDOS
HAVE A RIGHT-OF-FIRST-REFUSAL TO CONTROL WHO MAY BE THE CONDO OWNERS NEW
NEIGHBOR. COOPS MAY PREVENT A PURCHASER FOR ANY REASON OTHER THAN
DISCRIMINATORY REASONS.
YOU DO NOT HAVE (SECTION 339-r) A BLANKET MORTGAGE ON A CONDO. YOU DO
NOT SEE A CONDO BUILT OR OWNED ON A LEASEHOLD.
BY STATUTE THE
CONDOMINIUM IS A TYPE OF OWNERSHIP THAT IS AVAILABLE IN FEE ONLY. IT IS
NOT AVAILABLE AS A LEASEHOLD, AND CONDOS ARE NOT BUILT ON LAND THAT IS
LEASED, WITH THE EXCEPTION OF BATTERY PARK CITY. BATTERY PARK CITY WAS
ALLOWED, BY SPECIFIC AMENDMENTS AND STATUTORY ENACTMENTS TO ARTICLE 9B,
TO BE A CONDO BUILT UPON A LEASEHOLD OWNED BY NEW YORK CITY.
COOPS TYPICALLY HAVE BLANKET MORTGAGES AND ARE BUILT ON LEASED LAND.
LOLLIPOP CONDOMINIUMS ARE A PHENOMENON THAT ARISES FROM THE STATUTORY
RULE THAT YOU CAN NOT HAVE LEASEHOLD CONDOS. THEREFORE THE CONDO MUST BE
BUILT, IN PART, ON LAND THAT IS OWNED. THE DEVELOPER WILL SOMETIMES BUY
A SMALL PIECE OF LAND IN FEE, AND BUILD UP AND OVER ADJOINING PROPERTIES
BY BUYING AIR RIGHTS OVER THOSE BUILDINGS.
ILLUSTRATIVE DIAGRAM

300

LOLLIPOP CONDO

AIR RIGHTS AIR RIGHTS

BUILDING
BUILDING
TERRA FIRMA
THE UNIFORM CONDOMINIUM ACT SEEKS TO DO WHAT ARTICLE 9B DOES, BY CREATING
A UNIFORM CONSTRUCTION FOR THE DEFINITION OF CONDOS. UNDER THIS ACT, NOT
USED IN NEW YORK, A LEASEHOLD CONDO WOULD BE PERMISSIBLE. THE UNIFORM
CONDOMINIUM ACT IS FEDERAL LEGISLATION.
SECTION 39E - COMMON ELEMENTS
THE MOST COMMON OF COMMON ELEMENTS IS THE LAND UNDERNEATH THE BUILDING.
ALSO INCLUDED ARE GARAGES, BASEMENTS, MACHINE ROOMS, FOUNDATIONS,
SUPERINTENDENTS APARTMENTS, GARDENS, ETC.
THERE ARE ALSO LIMITED COMMON ELEMENTS. THEY ARE OWNED
BASIS BY THE OWNERS, YET NOT ALL THE OWNERS HAVE RIGHTS
THE ELEMENTS.
FOR EXAMPLE, ROOF RIGHTS CARVED OUT
APARTMENTS ON THE TOP FLOOR; PATIOS; PARKING SPACES
PARTICULAR APARTMENT.

ON A PERCENTAGE
TO USE OR OCCUPY
FOR THE USE OF
EARMARKED FOR A

CONDOS CAN BE RESIDENTIAL, INDUSTRIAL, COMMERCIAL OR OFFICE.

TYPE OF OWNERSHIP, NOT A TYPE OF LAND USE.

IT IS A

COOPS AND CONDOS ARE SIMILAR BECAUSE OF THEIR STATUTORY BEGINNINGS IN THE
MARTIN ACT. IN ARTICLE 9B, CONDOS ARE DEFINED AS "COOPERATIVE INTERESTS
IN REAL PROPERTY". CONDOS, EXCEPT TO THE EXTENT THAT THEY SPECIFICALLY
DIFFER FROM COOPS, ARE GOVERNED BY THE MARTIN ACT, ARTICLE 23A OF THE
GENERAL BUSINESS LAW.
TO CREATE THE CONDOMINIUM, IN OTHER WORDS, REFER TO THE COOP ENABLING ACT
(THE MARTIN ACT). THE MARTIN ACT IS AN UMBRELLA STATUTE FOR BOTH COOPS
AND CONDOS.
FORMING A CONDO OR COOP
THE INITIAL STAGE OF PUTTING TOGETHER A CONDO OR COOP IS TO PUT TOGETHER
AN OFFERING PLAN. THIS DISCLOSES EVERYTHING THAT THE REGULATIONS REQUIRE
BE DISCLOSED ABOUT THE PROPERTY. WITH CONDOS, YOU START WITH AN OFFERING
PLAN. AT THE POINT IN TIME WHEN YOU HAVE AN OPERATING CONDO, YOU FILE A
CONDO DECLARATION (SECTION 339n), WITH WHICH IS FILED THE BY-LAWS
(SECTION 339u) AND THE AS-BUILD CONSTRUCTION PLANS (SECTION 339p).

301

THE FOLLOWING ELEMENTS ARE NOT NECESSARY IN A COOP, THOUGH THEY ARE
REQUIRED IN A CONDO:
THE BYLAWS, GOVERNING THE OPERATION OF THE CONDO, CAN ONLY BE AMENDED
WITH A 2/3 VOTE OF THE UNIT OWNERS. YOU MUST SIMULTANEOUSLY AMEND THE
DECLARATION.
1. DECLARATION (SUBMITTED TO THE ATTORNEY GENERAL AS PART OF THE
OFFERING PLAN.
2. BY-LAWS
3. PLANS
UNDER SECTION 339v THE BYLAWS ARE TO INCLUDE A SET OF "HOUSE RULES",
WHICH ARE THE DAY TO DAY REGULATIONS OF THOSE ACTIVITIES THAT ARE
RESTRICTED BY THE CONDOMINIUM.
THE PROCESS:
OFFERING
PLAN....DECLARE
PLAN
EFFECTIVE
(YOU
HAVE
SOLD
ENOUGH
APARTMENTS)....AFTER DECLARING THE PLAN EFFECTIVE, YOU APPLY FOR A TAX
LOT
CERTIFICATION
FOR
EACH
APARTMENT....YOU
FILE
CONDO
DECLARATION....ONCE FILED, YOU CAN START CLOSINGS.
THE KEYSTONE TO THE PROCEDURE OF SELLING COOPS AND CONDOS IS

DISCLOSURE!

YOU MUST DISCLOSE TO THE PUBLIC WHAT THE LAW BELIEVES

TO BE RELEVANT TO THE OFFERING.

OFFERING PLAN

PROSPECTUS

THE OFFERING PLAN IS REVIEWED BY THE DEPARTMENT OF LAW OF THE STATE OF

NEW YORK (THE ATTORNEY GENERAL), WHOSE RESPONSIBILITY IT IS TO REVIEW AND
ACCEPT THE OFFERING PLAN. THE AGENCY DOING THIS WITHIN THE DEPARTMENT IS
THE REAL ESTATE FINANCING BUREAU.
THERE ARE TWO TYPES OF OFFERING PLANS:
1. AN EVICTION PLAN
2. A NON-EVICTION PLAN
IN ALL CONVERSION CASES YOU EITHER HAVE AN EVICTION OR NON EVICTION PLAN.
EVICTION PLANS - LESS COMMONLY USED. THE MAJORITY OF THE PLANS ARE NONEVICTION PLANS. YOU NEED A MINIMUM OF 51 PERCENT OF THE TENANTS TO FILE
AN EVICTION PLAN AND DECLARE IT "EFFECTIVE".
NON-EVICTION PLANS - 15% OF THE UNITS TO BE SOLD BEFORE BEING DECLARED
"EFFECTIVE".
IN AN EVICTION PLAN THE THRESHOLD IS BASED ON TENANTS.
PLAN THE THRESHOLD IS BASED ON UNITS.

302

IN A NON-EVICTION

FOR EVICTION AND NON-EVICTION PLANS, NO MORE THAN 10 PERCENT OF THE

APARTMENTS CAN BE OWNED BY THE SPONSOR.
THE PROCESS:
1. THE SPONSOR PUTS TOGETHER OFFERING PLAN - THE OFFERING PLAN STATES
CLEARLY THAT IT IS PRELIMINARY, AND IS SUBJECT TO APPROVAL FROM THE
ATTORNEY GENERAL.
THIS PLAN IS CALLED A "RED HERRING", AFTER THE RED
LETTERING ON THE FRONT OF THE PRELIMINARY OFFERING DECLARING ITS
"UNAPPROVED" STATUS.
2. THE ATTORNEY GENERAL REVIEWS THE PLAN, DEFICIENCIES MUST BE TOLD TO
LANDLORD BY THE SIXTH MONTH, THOUGH NOT BEFORE 4 MONTHS.
3. AFTER COMMENTS ARE ADDRESSED, THE PLAN IS ACCEPTED FOR FILING AND
BECOMES A "BLACK BOOK", IN THAT THE RED WRITING STATING ITS PREVIOUS
PRELIMINARY STATUS IS REMOVED, AND REPLACED WITH FINAL PRINT IN BLACK.
APARTMENTS MAY THEN BE SOLD.
WHEN YOU HAVE AN EVICTION PLAN YOU NEED TO TAKE INTO ACCOUNT TWO GROUPS
OF PEOPLE WHO 1) CAN NOT BE EVICTED AND 2) CAN NOT BE COUNTED IN THE 51
PERCENT.
THOSE WHO CAN NOT BE EVICTED:
AN ELIGIBLE SENIOR CITIZEN (62 YEARS OLD AND OLDER) CAN NOT BE
EVICTED UNDER AN EVICTION PLAN. THIS AGE IS AT FILING IN NEW YORK CITY,
AND AT ACCEPTANCE OF FILING ELSEWHERE IN THE STATE.
SENIOR CITIZENS STATUS IS ONLY GERMANE TO AN EVICTION PLAN FILING, NOT A
NON-EVICTION PLAN.
A HANDICAPPED PERSON CAN NOT BE EVICTED.
HANDICAPPED STATUS IS
GERMANE ONLY TO EVICTION PLANS. "HANDICAPPED" MEANS ONE WHO SUFFERS AN
IMPAIRMENT FROM A MEDICAL, PHYSIOLOGICAL, OR PSYCHOLOGICAL HANDICAP THAT
IS PERMANENT, RESULTS IN AN INABILITY TO KEEP GAINFUL EMPLOYMENT, AND
WHICH IS PROVABLE BY MEDICAL ENQUIRY.
WITHIN 60 DAYS, A HANDICAPPED PERSON AND A SENIOR CITIZEN MUST ELECT NOT
TO PURCHASE, AND NOTIFY THE SPONSOR THAT THEY ELECT NOT TO PURCHASE UNDER
THE EVICTION PLAN, IN ORDER TO STAY.
AFTER 3 YEARS MINIMUM FROM THE PLANS DECLARATION OF EFFECTIVENESS, A
TENANT UNDER AN EVICTION PLAN CAN BE REMOVED FROM HIS APARTMENT.
ONCE THE PLAN IS FILED, YOU CAN, AND EVEN MUST, AMEND THE PLAN FROM TIME
TO TIME. YOU CAN AMEND A PLAN FROM AN EVICTION PLAN TO A NON-EVICTION
PLAN IF YOU ARE NOT SELLING ENOUGH APARTMENTS, AND YOUR CONCERN IS THAT
YOU WILL NOT REACH THE THRESHOLD.

303

UNDER A NON-EVICTION PLAN, THE 15 PERCENT OF UNITS PURCHASED CAN BE

PURCHASED BY OUTSIDE PURCHASERS. THE OUTSIDE PURCHASERS MUST, HOWEVER,
INTEND TO OCCUPY THE APARTMENTS, NOT USING THEM FOR INVESTMENT PURPOSES.
THE FIRST PART OF THE OFFERING PLAN IS CALLED "SPECIAL RISK".
THIS
SECTION IS INTENDED TO HIGHLIGHT AREAS OF CONCERN THAT THE ATTORNEY
GENERAL FEELS THE PUBLIC SHOULD KNOW ABOUT, SUCH AS THE FINANCING WHICH
MATURES IN A PERIOD OF 5 YEARS OR LESS.
ANOTHER SPECIAL RISK IS A
BUILDING WHICH PAYS A MODEST TAX BILL, YET DUE TO J-51 EXPIRATION, WILL
RESULT IN AN INCREASE IN REAL ESTATE TAXES 5 TO 10 YEARS AFTER THE
TENANTS' PURCHASE.
ANOTHER SECTION INCLUDES SCHEDULE A, WHICH IS THE PRICE SCHEDULE,
NEGOTIABLE TO THE EXTENT THAT TENANTS UNDER THE PLAN WORK AS A GROUP.
THE LAW GIVES TENANTS AN EXCLUSIVE PERIOD OF 90 DAYS TO PURCHASE AN
APARTMENT. THE SPONSOR CAN NEGOTIATE WITH THE TENANTS AS A GROUP ON PRICE
PER SHARE, YET THEY CAN NOT OFFER SPECIAL DEALS TO INDIVIDUAL TENANTS.
SHARE ALLOCATION IN A COOP MUST REFLECT A REASONABLE RELATIONSHIP TO
MARKET VALUE, AS CERTIFIED BY A REAL ESTATE EXPERT. YOU CAN CONSIDER ALL
THE AMENITIES OF ONE APARTMENT RELATIVE TO ANOTHER WITH RESPECT TO VALUE.
SCHEDULE A WILL ALSO HAVE A PERCENTAGE OF THE MORTGAGE THAT EACH
APARTMENT IS RESPONSIBLE FOR.
ADDITIONALLY, ANNUAL AND MONTHLY
MAINTENANCE FOR THE BUYER OF THE APARTMENT WILL BE CITED, AS WELL AS A
COLUMN STATING THE TAX DEDUCTION FOR EACH APARTMENT BASED ON INTEREST
PAYABLE ON THE UNDERLYING MORTGAGE, REAL ESTATE TAXES ON THE BUILDING,
AND INTEREST PAYABLE ON THE COOP SHAREHOLDERS LOAN. ALL THREE OF THESE
ITEMS ARE DEDUCTIBLE UNDER SECTION 216 OF THE I.R.C.
SECTION 216 ALSO SETS FORTH THE LIMITS TO A COOP'S QUALIFICATION.
AT
LEAST 80 PERCENT OF INCOME TO THE COOP MUST COME FROM MAINTENANCE BY THE
TENANT SHAREHOLDERS; UP TO 20 PERCENT OF INCOME MAY COME FROM THE
AGGREGATE OF OTHER SOURCES.
FOR EXAMPLE: IF A COMMERCIAL TENANT PAYS THE COOP 3K PER MONTH, AND THE
INCOME TO THE COOP IS 10K, THEN THE 3K IS MORE THAN 20 PERCENT AND THE
DEDUCTIONS FOR THAT YEAR WOULD BE ENTIRELY DISALLOWED.
SECTION 216
DEDUCTIONS ARE QUALIFIED FOR ON AN ANNUAL BASIS. IT IS ALL OR NOTHING,
AND YOU CAN NOT GET A PORTION OF THE DEDUCTION IF THE TEST OF 80 PERCENT
IS FAILED EVEN BY A POINT.
SCHEDULE B IS THE COOP OR CONDO BUDGET. THE BUDGET IS THE SCHEDULE THAT
LETS THE BUYER KNOW HOW MUCH IT WILL COST TO RUN THE BUILDING, FROM YEAR
TO YEAR. IT DOES NOT PROJECT BEYOND THE PRESENT YEAR.
OTHER ELEMENTS OF THE OFFERING:

304

ENGINEER'S REPORT - EXTENSIVE AND DETAILED, YET BIASED IN FAVOR OF THE

SPONSOR.
IT IS A REPORT ON THE CONDITION OF THE BUILDING.
OFTEN THE
TENANTS WILL GET THERE OWN ENGINEER FOR A SECOND OPINION.
RELATIONSHIP BETWEEN SHARE VALUE AND MARKET VALUE.
ATTORNEY'S OPINION AS TO THE DEDUCTIBILITY OF THE ITEMS MENTIONED BEFORE.
THE RIGHTS OF RENT STABILIZED TENANTS STATED AND SET FORTH.
AS-BUILT DRAWINGS (FOR CONDO ONLY)
THE TERMS OF THE UNDERLYING MORTGAGE MUST BE DISCLOSED, INCLUDING THE
POSSIBILITY OF A WRAPAROUND MORTGAGE OR A DIRECT 2ND MORTGAGE.
BE
CONCERNED ABOUT A DUE ON SALE CONVERSION IN THE MORTGAGE.... OFTEN IT
WILL BE DUE ON SALE EXCEPT FOR A SALE TO A COOP, BUT LOOK TO BE CERTAIN.
THE TERMS OF A LOAN FROM A SPONSOR TO THE BUYER WOULD BE SET FORTH IN A
SEPARATE SECTION OF THE PLAN.
THE RESERVE FUND IS ANOTHER IMPORTANT AREA. THE SPONSOR MUST LEAVE, WITH
THE COOP, AT LEAST 3 PERCENT OF THE TOTAL INSIDER SALES PRICE (IN NEW
YORK CITY). THE RESERVE FUND IS PURSUANT TO THE RESERVE FUND LAW, WHICH
DIRECTS MONEY TO CAPITAL IMPROVEMENT.
THE SPONSOR IS REQUIRED TO SUBMIT AN AMENDMENT TO THE OFFERING ONCE A
YEAR TO KEEP THE PLAN ACTIVE AND UP-TO-DATE. THE SPONSOR DOES THIS UNTIL
ALL UNSOLD SHARES ARE SOLD.
OFTEN THE SPONSOR WILL CARVE OUT SPECIAL EXCEPTIONS FOR HIMSELF. UP TO
FIVE YEARS FROM THE EFFECTIVENESS DECLARATION, THE SPONSOR MAY HOLD A
CONTROLLING INTEREST OF THE BOARD, AFTER WHICH HE MUST SELL THE INTEREST.
"THE SPONSOR WILL NOT HAVE TO GET COOP APPROVAL FOR SALES" IS A COMMON
INTEREST CARVED OUT FOR THE SPONSOR.
THE SPONSOR WILL PROTECT THEMSELVES FROM A 60 PERCENT TENANT MAJORITY BY
DISALLOWING, FOR EXAMPLE, TENANTS TO DO AN EXPENSIVE REDEAUX OF THE
BUILDING.
COOPERATIVE AND CONDOMINIUM ABUSE PREVENTION ACT - FEDERAL LEGISLATION:
WHERE A SPONSOR CARVES OUT A VALUABLE PORTION OF A COOP, SAY A LAUNDRY
ROOM, IF THE SPACE IS USED EXCLUSIVELY BY SHAREHOLDERS, THE LEASE CAN BE
DISAVOWED BY THE TENANTS.
END OF THE COURSE

305

ASSET MANAGEMENT IN REAL ESTATE

NOTES
PROFESSOR JOHN FRANK
WINTER 1991

ASSET MANAGEMENT
PROFESSOR JOHN FRANK
CLASS ONE
1/22/91
THREE BOOKS:
1. CORPORATE REAL ESTATE HANDBOOK
2. MANAGERIAL REAL ESTATE
3. PRINCIPLES OF REAL ESTATE MANAGEMENT
COURSE WORK SUPPLEMENTED WITH ADDITIONAL READINGS IN THE LIBRARY, AS WELL
AS FROM BRUEGGEMAN'S REAL ESTATE FINANCE AND PYHRR & COOPER'S REAL ESTATE
INVESTMENT: STRATEGY, ANALYSIS, DECISIONS.
ABOUT THE PROFESSOR:
HARVARD BUSINESS SCHOOL, GRAD 1965.
MOVED TO ARTHUR D. LITTLE (A
CAMBRIDGE BASED MANAGEMENT CONSULTING FIRM), THEN TO A SAN FRANCISCO
FIRM, AND FINALLY TO COOPERS AND LYBRAND'S REAL ESTATE ADVISORY SERVICES
DIVISION.
ASSET MANAGEMENT IS NOT AN ESTABLISHED FIELD OF STUDY, AND WAS NOT EVEN A
COINED PHRASE UNTIL THE MID 1970'S. REAL ESTATE ASSET MANAGEMENT IS THE
MANAGEMENT OF RIGHTS, LAND AND APPURTENANCES (INCLUDING PARTIAL
INTERESTS) OF ALL PROPERTY IN A PORTFOLIO. THE PLAN OF MANAGING PLANNING
AND CONTROLLING THE USE OF A PROPERTY FROM CONCEPTION TO ACQUISITION, TO
STEWARDSHIP AND TO DISPOSITION.
IT IS THE MANAGEMENT OF LOANS AND
INVESTMENTS TO ACHIEVE THE HIGHEST POSSIBLE RETURN.
REAL ESTATE EARNINGS ARE CREATED THREE WAYS:
1. BUY WELL
2. OPERATE WELL
3. SELL WELL
"YOU CAN MOST EASILY REDUCE CORPORATE COSTS BY REDUCING FIXED CORPORATE
FACILITIES".
THE FIXED CORPORATE FACILITY IS ASSET CONSUMING BECAUSE IT CONSISTS OF
THE FOLLOWING THREE ELEMENTS:
1. MATERIALS
2. LABOR
3. OCCUPANCY COSTS
NATIONWIDE, 25 PERCENT OF CORPORATE ASSETS ARE IN REAL ESTATE.

47

IN MANAGING ASSETS, YOU MUST FORM THREE TYPES OF PLANS. THEY ARE:
1. A LONG RANGE STRATEGY THAT PUTS ASSETS INTO SERVICE AND EFFECTUATING A
BENEFIT.
2. A THREE TO FIVE YEAR PLAN, COVERING ENHANCEMENTS AND REPOSITIONING.
REPOSITIONING IS THE REASSESSMENT OF ASSETS AND EVENTUAL REWORKING OF IT
TO "BREATH NEW LIFE" INTO FACILITIES THAT MAY BE PHYSICALLY DATED, OR
THAT MAY NOT FULFILL THE NEEDS OF NEW MARKET DEMANDS TO REMAIN
COMPETITIVE.
3. AN OPERATING PLAN THAT COVERS DAY TO DAY OPERATIONS, FROM INSPECTIONS
TO FLOOR SWEEPING.
AN ASSET MANAGER HAS CHARACTERISTICS THAT ARE A BLEND OF THOSE COMMON IN
A PROPERTY MANAGER AND IN A DEVELOPER.
PROPERTY MANAGER
*
*
*
*
*
*
*
*

GOOD SUPERVISORY ABILITIES

SENSITIVE AND SKILLED IN DEALINGS WITH PEOPLE
TOUGH - KNOWS WHEN TO SAY "NO"
GOOD ORGANIZATIONAL ABILITIES, PAYS ATTENTION TO DETAIL
EDUCATION: SOME COLLEGE; MECHANICAL KNOWLEDGE AND/OR SKILLS
CREATIVE PROBLEM SOLVER
FORWARD-LOOKING; MARKETING ATTRIBUTES; COGNIZANT OF DEMOGRAPHIC TRENDS
REALIST

DEVELOPER
*
*
*
*
*
*

CREATIVITY
MONEY
SALESMAN / PROMOTER
RISK ASSESSOR
OPTIMIST
ABILITY TO PLEASE A VARIETY OF CONSTITUENCIES

AN ASSET MANAGER'S ROLE IS BETWEEN THE DEVELOPER AND PROPERTY MANAGER.

HE COMES IN AFTER THE PROJECT HAS BEEN DEVELOPED. HE MAY NOT HAVE ALL OF
THE DEVELOPER'S CREATIVITY, YET HE MAY BE ASKED TO REPOSITION THE
PROPERTY AND MANAGE IT WITH THE SAME SKILLS AS THE PROPERTY MANAGER.

MAXIMS
"DON'T DO WORK WITH SOMEONE THAT HASN'T FAILED AT LEAST THREE

48

TIMES".

SOURCE UNKNOWN.

THE DEVELOPER'S CREDO:

A DOLLAR BORROWED IS A DOLLAR EARNED.
A DOLLAR REFINANCED IS A DOLLAR SAVED.
A DOLLAR REPAID IS A DOLLAR LOST FOREVER.
SOURCE UNKNOWN.
THERE ARE THREE FUNCTIONS OF MANAGEMENT (POSSIBLY FOUR)
1.
2.
3.
(4).

DEVELOPMENT OF STRATEGY
MANAGEMENT CONTROL
OPERATIONS
TRANSACTION

THE OUTLOOK ON MANAGEMENT OF REAL ESTATE ASSETS DIFFERS BETWEEN THE

DEVELOPER'S STAFF (THE SERVICE SUPPLIER) AND THE CORPORATE REAL ESTATE
MANAGEMENT'S STAFF (THE CUSTOMER).
VENTURE

PORTFOLIO MANAGEMENT
(NATIONAL)

CORPORATE PORTFOLIO STRATEGIES

LINES OF BUSINESS (L.O.B.) AND
STRATEGIC BUSINESS UNIT (S.B.U.)
FACILITY REQUIREMENTS

ASSET MANAGER

FACILITIES MANAGEMENT

ASSET MANAGEMENT
(REGIONAL)
SUBPORTFOLIOS (4 TO 6)
BETWEEN 10 TO SEVERAL
HUNDRED PROPERTIES
PROPERTY MANAGERS

CORPORATE REAL ESTATE MANAGEMENT

A STRATEGIC BUSINESS UNIT IS A BUSINESS UNIT THAT HAS A LOGICAL

CONNECTION WITH OTHER BUSINESS UNITS IN A CONGLOMERATE. AN EXAMPLE OF A
STRATEGIC BUSINESS UNIT WOULD BE SEVERAL SOFT DRINK COMPANIES OWNED BY A
LARGE FOOD CONGLOMERATE. A BUSINESS UNIT GENERAL MANAGER WOULD OVERSEE
OPERATIONS IN THE STRATEGIC BUSINESS UNIT, COMBINING AND CONDENSING
SUPPORT SERVICES THAT WOULD OTHERWISE BE REDUNDANT IF THE SMALL COMPANIES
FORMING THE UNIT WERE UNDER SINGLE AND SEPARATE OWNERSHIPS.

49

EACH STRATEGIC BUSINESS UNIT MAY HAVE, FOR EXAMPLE, A MANUFACTURING,

SALES, RESEARCH AND DEVELOPMENT, FINANCE AND HUMAN RESOURCES FUNCTION.
IN LARGE CORPORATE CONGLOMERATES, THERE MAY BE DOZENS OF STRATEGIC
BUSINESS UNITS FORMING THE FUNCTIONAL CORPORATE STRUCTURE.
A LINE OF BUSINESS IN A STRATEGIC BUSINESS UNIT MIGHT BE, FOR EXAMPLE,
LIFE INSURANCE, WHOLE LIFE INSURANCE, PENSION FUNDS, ETC.
HOMEWORK: BETWEEN SERVICE SUPPLIER AND CUSTOMER IN THE ABOVE TABLE THERE
IS AN OVERLAP AREA THAT IS A CONCERN BOTH OF THE PROPERTY MANAGER AND THE
FACILITIES MANAGER. SPEND 15 MINUTES IN "FREE ASSOCIATION" ON THE NATURE
OF THESE OVERLAPS. FOR EXAMPLE, THE PROPERTY MANAGER WOULD BE INTERESTED
IN SUPPLYING THE TELEPHONE LINE CHANNELIZATION IN HIS BUILDING SO THAT
THE ASSET MANAGER COULD CONCERN HIMSELF WITH HIS "TENANT IMPROVEMENTS".
THIS MAY CONCERN THE BAUD RATE OF THE TELEPHONE LINES, THE NUMBER OF
LINES, ETC. THIS IS NOT THE CONCERN OF THE PROPERTY MANAGER BECAUSE IT
IS A TENANT IMPROVEMENT.
END OF CLASS ONE
CLASS TWO
1/29/91
ASPECTS OF MANAGEMENT
VENTURE
CORPORATE R.E.

STRATEGIC MANAGEMENT
PORTFOLIO
CORPORATE STRATEGY
structure of business
sensing market
positioning
promoting
MANAGEMENT CONTROL
ASSET MANAGEMENT
managing the asset
OPERATIONAL
carrying out the
strategy

CORPORATE ASSET MGT.

PROPERTY MANAGEMENT

FACILITIES MGT.

SEE CHAPTER FOUR (DOWNS) FOR "MANAGEMENT PLAN FOUR PROPERTY".

THE
MANAGEMENT PLAN IS THE BENCHMARK FROM WHICH YOU CONTROL A PROPERTY
MANAGER.
HISTORY OF ASSET MANAGEMENT:
AFTER THE FIRST WORLD WAR, EXPANSION FOLLOWING THE RECESSION IN
AGRICULTURE DUE TO EXPANDING INDUSTRIAL STRENGTH THROUGH 1929, THE STOCK
MARKET CRASH.
THE INCREASE OF CAPITAL EXPENDITURE LED TO INCREASED

50

APARTMENT BUILDING
CONSTRUCTION IN THIS PERIOD.
AS THE DESIRE TO
EXPERIENCE THE "GOOD LIFE" INCREASED AMONGST RESIDENT LANDLORDS, THEY
MOVED OUT TO THE COUNTRY AND LEFT THEIR HOLDINGS IN THE HANDS OF THE
FIRST ASSET MANAGERS. AFTER THE STOCK MARKET CRASH AND UNTIL AFTER THE
SECOND WORLD WAR, THERE WAS LITTLE BUILDING.
THE BUILDING STOCK
EXISTING AT THE TIME WAS ABSORBED BY THE MIDDLE OF THE SECOND WORLD WAR.
AFTER THE SECOND WORLD WAR AND UNTIL 1956, A BUILDING BOOM OCCURRED.
1957 SAW A BUST.

EIGHT ROLES OF ASSET MANAGEMENT FUNCTION (ACCORDING TO KATELEY)

1. ACQUISITION
2. PROPERTY MANAGEMENT
3. PERFORMANCE MONITORING
4. RETENANTING AND RENOVATION
5. PERIPHERAL DEVELOPMENT
6. REFINANCING
7. RESTRUCTURING OWNERSHIP
8. DISPOSITION
THIS IS AN EXPANDED FORM OF THE FOLLOWING MAIN INGREDIENTS OF ASSET
MANAGEMENT:
1. PLAN
2. ACQUIRE
3. MAINTAIN STEWARDSHIP (STEPS 2 THROUGH 7 ABOVE)
4. DISPOSE
"THE VALUE OF THE INPUT (LABOR, FINANCING COSTS, EQUITY) MUST BE LESS
THAN THE VALUE CREATED OVER TIME IN ORDER TO TURN A PROFIT".
ACCORDING TO NOURSE, THE ABOVE INGREDIENTS ARE REFORMULATED AS FOLLOWS:
1. PLAN CAPACITY - PLACING NEEDS FOR THE FUTURE AND DEVELOPING A PLAN TO
PROVIDE THE NEEDED FACILITIES.
2. SITE SELECTION - INCLUDES THE FINANCIAL STRUCTURE

51

3. MANAGEMENT
4. REDEPLOYMENT
5. FINANCIAL ALTERNATIVES -"MINING THE GOLD IN THE CONCRETE CANYONS"
6. NEGOTIATION
A JEWEL OF MARKETING WISDOM: "THE KEY TO RUNNING A BUSINESS IS TO FIND A
PLACE (GEOGRAPHY, DEMOGRAPHY) AND A PRODUCT".

CORPORATIONS OPERATE ON A VARIANT OF THE CLOSED CONTROL CYCLE.

THE CYCLE CAN BE UNDERSTOOD THROUGH ANALYZING A MATRIX.
ACQUISITION
STRATEGIC MANAGEMENT
MANAGEMENT CONTROL
OPERATIONS

POLICYPROCEDURE
O
X
X
O

EXECUTION

MONITOR
XO
X

X = CENTRALIZED MANAGEMENT
O = DECENTRALIZED MANAGEMENT
/
POLICY\

\/
PROCEDURES
MONITOR

/\

/ EXECUTION
POLICY, PROCEDURES, EXECUTION AND MONITORING ALL FEED OFF OF EACH OTHER
IN A CYCLICAL FASHION.
CORPORATIONS HAVE PLANNING CYCLES THAT THE ASSET MANAGER HAS TO BE AWARE
OF BECAUSE THEY HAVE A DIRECT IMPACT ON HIS ASSESSMENT OF FUTURE
FACILITIES NEEDS.
THERE IS THE STRATEGIC PLANNING CYCLE, WHICH TAKES PLACE EVERY 5 TO 10
YR.
THERE IS THE DEVELOPMENT PLANNING CYCLE , " " "
" 2 TO 4 YEARS
THERE IS THE OPERATIONS PLANNING AND BUDGETING CYCLE, " " " EVERY YEAR.
THE OPERATIONS PLANNING AND BUDGETING CYCLE HAS TWO COMPONENTS:

52

THEY ARE THE CAPITAL BUDGET AND THE INCOME AND EXPENSE BUDGET.
THE CORPORATE REAL ESTATE STRUCTURE MUST BE MINDFUL OF HOW CORPORATIONS
OPERATE.
THE REAL ESTATE PLANNING MUST BE INTEGRAL WITH THE ABOVE
CYCLES.
THERE IS A SIMILARITY BETWEEN CORPORATE REAL ESTATE AND CORPORATE ASSET
MANAGEMENT BECAUSE, IN ESSENCE, THE MANAGER RELATES TO THE REAL ESTATE AS
AN ASSET.

E X T E R N A L
M A R K E T
* * * * * * * * * * * * * * * *
\/ INDEPENDENT MARKET /\
\//\
MANAGEMENT CONTROL

COST / BENEFIT

USERS

\/
/\
\/ DEPENDENT MARKET
/\ SERVICES
\/
/\
\/
/\

ASSET MANAGEMENT

TYPE OF FACILITY, S.F., OUTSOURCING

FACILITIES MANAGER

IF THE MANAGEMENT CONTROL FUNCTION DOES NOT HAVE A PLAN FOR THE UPCOMING
CYCLE AS TO THE QUANTITY OF ASSETS IT WILL NEED AT ITS DISPOSAL, YOU AS
THE ASSET MANAGER WILL HAVE TO LOOK UP AND THROUGH THE MANAGEMENT CONTROL
FUNCTION TO THE EXTERNAL MARKET AND DETERMINE AN ESTIMATE OF THOSE NEEDS
BASED UPON THE DEMAND FOR THE SERVICES OFFERED BY THE USER'S COMPANY.
THE CORPORATE REAL ESTATE OPERATING PLAN AND BUDGET MUST BE CONSTRUCTED
IN LINE WITH THE DEVELOPMENT PLANNING AND OPERATIONAL PLANNING PHASES OF
THE BUSINESS CYCLE.

53

THE UPCOMING PROJECT:

STEPS TO THE ASSET MANAGEMENT PLAN
1. SCAN THE ENVIRONMENT:
LOOK
INDUSTRY, COMPETITION, ABSORPTION

AT

THE

DEMOGRAPHICS,

BUSINESS

2. ANALYZED THE ALTERNATIVES FOR RETENANTING AND REDEVELOPMENT.

KATELEY MANAGEMENT CYCLE.
3. DEVELOP A SERIES
INVESTMENT CRITERIA.

OF

ALTERNATIVE

STRATEGIES:

PORTFOLIO

AND
SEE

STRATEGY,

4. MAKE RECOMMENDATION TO CLIENT : TRANSLATE THE RECOMMENDATION INTO AN

OPERATING BUDGET ( INCOME AND EXPENSE, AND CAPITAL BUDGETS) FOR THE
PROPERTY.

DEVELOP A MANAGEMENT PLAN FOR A PROPERTY OF YOUR CHOICE IN THE NEW YORK
AREA.
CAN BE RESIDENTIAL PROJECT OF SOME SIZE, OR AT LEAST A 250,000
S.F. OFFICE BUILDING. IN A ONE TO FOUR YEAR TIME PERIOD, CREATE VALUE
FOR THE CLIENT.
END OF CLASS TWO
CLASS THREE
2/5/91
REAL ESTATE HAS TWO HALVES:
1. WHAT YOU WANT TO DO
2. WHAT YOU CAN DO
ASSET MANAGEMENT IS ABOUT FOLDING THE FIRST INTO THE SECOND.
THE AGREEMENT BETWEEN THE ASSET MANAGER AND THE CLIENT IS A REGURGITATION
OF THE AGREED UPON AUTHORITY FOR THE MANAGER TO ACT ON BEHALF OF THE
CLIENT.
THE MANAGEMENT PLAN, WHERE THE MANAGER DETAILS HOW HE WILL ATTEMPT TO
ACCOMPLISH THE GOALS OF THE CLIENT, LIMITS THE EXTENT OF RESPONSIBILITY
FOR THE ASSET MANAGER.

BANK,
INVESTMENT,
STRATEGY
STRATEGY
(4%)

54

R.E.

PORTFOLIO

 LINK
POLICY (GOALS,
MANAGEMENT CONTROL (16%)
OBJECTIVES, &

MISSION OF THE A.M.)

LINK

OPERATIONS
(80%)

PROCEDURES (PLANNED

ACTION)

DIAGRAM OF THE MAKE-UP OF THE ROLE OF ASSET MANAGER

THE KEY IS TO MAKE THE POLICIES AND PROCEDURES CORRESPOND TO THE CLIENT'S
PROFIT OBJECTIVES.
WHAT IS THE OBJECTIVE OF AN ASSET MANAGER WORKING FOR THE WORKOUT
DEPARTMENT OF AN INVESTMENT BANK AS OPPOSED TO THAT OF A MAJOR DEVELOPER?
THE OBJECTIVES ARE DIFFERENT FOR DIFFERENT CLIENT-TYPES.

METHOD OF ANALYZING ANY BUSINESS, AS APPLIED TO REAL ESTATE MANAGEMENT.

1. LOOK AT THE MARKET FOR THE SERVICE (ENVIRONMENT). PERTAINS NOT ONLY
TO THE PURCHASING MARKET, BUT THE NATURE OF THE MARKET FROM A LEGAL,
REGULATORY AND OTHER POINTS OF VIEW. DEFINE THE REGION.
- NUMBER OF COMPETITORS
- TRENDS IN USE OF MANAGEMENT SERVICES
- NEW CONSTRUCTION (TARGET MARKET)
- ABSORPTION FROM THE POINT OF VIEW OF SUCCESS IN ACCOMPLISHING THE
CLIENTS OBJECTIVES
- FEES, PROCUREMENT PRACTICES, CONTRACTS.
2. DEFINE STRATEGIC ALTERNATIVES
- FRANCHISING
- PURCHASE OF EXISTING PRACTICE.
3. EVALUATE ALTERNATIVES
- QUALITATIVE CRITERIA (NON-FINANCIAL CRITERIA)
- QUANTITATIVE CRITERIA (NUMBERS, FINANCIALLY ORIENTED CRITERIA)
4. REFINE ALTERNATIVES - TIME PHASED ACTION PLAN
- BALANCE SHEET
- INCOME SHEET
- BUDGET SHEET

55

SEE CHAPTER FOUR OF DOWNS, PAGE 78, FOR MANAGEMENT PLAN ISSUES.
ASSET MANAGEMENT IS BEST SUITED TO MANAGING INCOME STREAMS FROM
PROPERTIES, SUCH AS RENTALS AND LEASES. THE MANAGEMENT OF PROPERTIES FOR
PURCHASE, SUCH AS A SINGLE FAMILY SUBDIVISION, IS MORE DIFFICULT BECAUSE
CASH FLOWS ARE NOT PREDICTABLE AND ARE SUBJECT TO "LUMPINESS" IN DEMAND.
THEREFORE, ATTEMPT TO CREATE A MATRIX OF BEST, PROBABLE AND LEAST
PROBABLE RETURNS PER TIME PER TIME PERIOD IN ORDER TO GET A HOLD ON THE
LIKELY RETURNS.
END OF CLASS THREE
CLASS FOUR
2/19/91
WAYS OF IDENTIFYING LOANS IN DANGER OF BECOMING DELINQUENT
1. NON PAYMENT OF INTEREST AND/OR PRINCIPAL
2. DOLLAR EXPOSURE
3. CONDITION OF COLLATERAL (IE. A PERFORMING NON-PERFORMING LOAN)
A PERFORMING NON-PERFORMING LOAN IS, FOR EXAMPLE, A LOAN THAT IS MAKING
SCHEDULED PAYMENTS OF INTEREST AND PRINCIPAL, YET MAY HAVE BECOME
UNDERCAPITALIZED AS THE VALUE OF THE PROPERTY DROPS DUE TO MARKET FORCES.
STANDARDS FOR CONDITION OF COLLATERAL VARY WITH THE SOURCE OF THE FUNDS.
FOR EXAMPLE, AN INSURANCE COMPANY WOULD REQUIRE A STABILIZED RETURN, 75%
LTV, GOOD GEOGRAPHICAL DIVERSIFICATION, WOULD ACCEPT NON-RECOURSE LOANS,
AND WOULD NOT MAKE CONSTRUCTION LOANS.
ELEMENTS OF A TYPICAL MANAGEMENT AGREEMENT (SEE DOWNS, PAGE 333)
*
*
*
*
*

OWNER RELATIONS AND RECORD KEEPING

INDEMNIFICATION OF MANAGER
REPORTING DATES
COMPENSATION
RESPONSIBILITIES

THE FUNCTION OF A MANAGEMENT CONTRACT IS TO ADDRESS THE FOLLOWING:

1. IDENTIFIES OWNER AND PREMISES
2. AGREEMENT TO MANAGE PROPERTY, MONTHLY STATEMENT OF RECEIPT, REMITTAL
OF PROCEEDS AS PER AGREEMENT.
3. IF RENTS DO NOT COVER EXPENSES, OWNER WILL ADVANCE FUNDS TO COVER
OPERATIONS.
4. FIDELITY BOND
5. OWNER AGREES TO GIVE MANAGER RIGHT TO ADVERTISE PROPERTY AND TO SIGN
LEASES FOR A SPECIFIED NUMBER OF YEARS.

56

6.
7.
8.
9.
10.
11.
12.
13.
14.
15.

TERMINATE TENANCY
SIGN AND SERVE NOTICES
REIMBURSEMENT OF EXPENSES
SUE FOR AND RECOVER RENT
HIRE PROFESSIONALS AND WORKERS TO OPERATE BUSINESS
HANDLE SECURITY DEPOSITS ON AN OWNER'S BEHALF
X% PAYMENT ON LEASES OR RENT
POWERS SPECIFICALLY WITHHELD FROM MANAGER.
TERMINATION AND CANCELLATION OF AGREEMENT
ARBITRATION.

SEE PAGE 109, DOWNS, MONTHLY STATEMENT

TYPICAL MONTHLY STATEMENT FORMAT:
RENT ROLL
PROPERTY A

TENANT
ONE
TWO
THREE
ONE
TWO
THREE

MONIES COLLECTED
X
Y
Z
PROPERTY B
X
Y
Z
TOTAL RENT COLLECTED
ABC

\/ ....FEEDS BACK TO BALANCE SHEET.....

INCOME STATEMENT> BALANCE SHEET> CASH FLOW STATEMENT> ACCTS.
PAYABLE/DISTRIBUTIONS> REVENUE
> EXPENSE

THE BALANCE SHEET CONTAINS CASH (LISTED FIRST) AND NON-CASH ITEMS, AND IS
BALANCED BY THE ACCOUNTS RECEIVABLE AND ACCOUNTS PAYABLE/ DISTRIBUTION
SHEETS.
THE ACCOUNTS RECEIVABLE SHEET WILL CONTAIN AN AGED TRIAL BALANCE IN DAYS
SUCH AS THE FOLLOWING:
MARCH-APRIL
ACCOUNTS RECEIVABLE - AGED TRIAL BALANCE
DAYS

0-5
A,1

5-10

10-30
B,2

30<

A IS PROPERTY
# IS TENANT
THERE ARE THREE PARTS TO A MANAGEMENT AGREEMENT:
1. CONTRACT

57

2. MANAGEMENT PLAN
3. MONTHLY REPORT
THE MANAGER MUST PROJECT VARIABILITY IN BUDGETING YOUR VARIOUS ELEMENTS.
FUEL, FOR EXAMPLE, IS MORE EXPENSIVE IN THE DEPTH OF THE WINTER AND IN
THE MIDST OF SUMMER, AND CAN NOT BE BUDGETED IN EQUAL AMOUNTS THROUGHOUT
THE 12 MONTHS OF THE YEAR OR IN STRAIGHT LINE INCREMENTS. THE MONTHLY
BUDGET IS ALSO A GUIDE FOR DETERMINING PERFORMANCE OF THE BUDGET AND
POINTING OUT PROBLEMS IN THE EXPENSE SIDE.
THE MONTHLY MANAGEMENT DISCUSSION OF OPERATIONS HAS THREE PARTS:
1. OVERVIEW
2. REVENUES
3. PROPOSED ACTION (PHYSICAL AND FINANCIAL)
ANALOGY:
IN A FACTORY YOU HAVE:
MANAGEMENT > FOREMEN > WORKERS
IN A PROPERTY YOU HAVE:
OWNER (ASSET MANAGER) > PROPERTY MANAGER > TENANT
THE DIFFERENCE BETWEEN A QUALITY AND A SEEDY BUILDING IS IN THE ATTENTION
TO SERVICES AND TO MAINTENANCE.
END OF CLASS FOUR
CLASS FIVE
2/26/91
10 MINUTE PRESENTATION NEXT WEEK ON PROJECT, DUE AT THE BEGINNING OF
CLASS.
GUEST SPEAKER: STEVE COWAN, COOPERS AND LYBRAND
TOPIC: HOW A DEAL IS CONSTRUCTED
*************
ADVERTISING FOR PROPERTIES:
5 METHODS:
BANNERS
DIRECT MAIL
RADIO ADS
NEWSPAPER ADS
T.V. ADS
TOUT THE COMPARATIVE ADVANTAGE OF AMENITIES TO THE TENANT'S NEEDS.
**********
IN A CORPORATION YOU ARE PLEASING A COMMITTEE, NOT A BUYER OR OWNER.

58

TYPICAL CORPORATE STRUCTURE (COMMITTEE)

CHIEF OF OPERATIONS

C.R.E
H.R.
C.I.O.C.F.O
C.R.E. = CHIEF OF REAL ESTATE
H.R.
= HUMAN RELATIONS
C.I.O. = CHIEF INFORMATION OFFICER
C.F.O. = CHIEF FINANCIAL OFFICER
SEE DOWNS CHAPTER 8, TENANT RELATIONS

MARKETING AND
SIGNING OF
ARRAY OF TENANT
CREDIT &
LEASING
LEASE
SERVICES
COLLECTION
>

DUE DATE, TRIGGER FOR VARIOUS

TIME LINE OF TENANT RELATIONS
LEVELS OF TREATMENT
END OF CLASS FIVE
CLASS SIX
3/5/91
CLASS PRESENTATIONS TODAY, NO LECTURE
END OF CLASS SIX
CLASS SEVEN
3/19/91
TOPIC: CREATION OF SHAREHOLDER WEALTH
REAL ESTATE, OTHER THAN THE PRODUCT OF A CORPORATION, IS THE SINGLE MOST
IMPORTANT ELEMENT OF A CORPORATION'S ASSET VALUE.

REVENUE
COST OF PRODUCT
GROSS MARGIN 40
SALARIES
OVERHEAD
TAXES
NET INCOME

100
60*
10
20#
10
5
5

* 40 PERCENT PURCHASED MATERIALS

7 TO 8 PERCENT LABOR

59

12 TO 13 PERCENT OVERHEAD, MUCH OF WHICH IS OPERATION COST FOR

BUILDINGS, DEPRECIATION, ETC.
# SELLING, GENERAL AND ADMINISTRATIVE OVERHEAD
THREE ROLES FOR A REAL ESTATE ASSET MANAGER IN A CORPORATION
1. FACILITIES MANAGER
2. ASSET MANAGER
3. ENTREPRENEURIAL
THERE ARE TWO TYPES OF CORPORATE ORGANIZATIONS; A FUNCTIONAL ORGANIZATION
AND A BUSINESS UNIT (MULTI DIVISIONAL ORGANIZATION).
CHIEF EXECUTIVE OFFICER

LEGAL
CHIEF OPERATIONS OFFICERACCOUNTING AND FINANCE

FUNCTIONAL ORGANIZATION
HUMAN RESOURCES

1. MARKETING AND SALES

1 THROUGH 4 ARE "COST CENTERS"
2. MANUFACTURING
(ALSO CALLED "PERFORMANCE
CENTER")
3. DISTRIBUTION
4. RESEARCH AND DEVELOPMENT
"SALES"IS THE SHORT TERM EXECUTION OF LONG TERM STRATEGY.
"MANUFACTURING" IS WHAT YOU DO AFTER YOU "SELL".
"RESEARCH AND DEVELOPMENT" IS WHAT YOU DO BEFORE YOU CAN SELL OR
MANUFACTURE.

FUNCTIONAL ORGANIZATIONS
ARE USED FOR SMALLER BUSINESS.
ESTATE DEVELOPERS HAVE FUNCTIONAL ORGANIZATIONS.
CHIEF EXECUTIVE OFFICER

MOST REAL

LEGAL
CHIEF OPERATIONS OFFICER
ACCOUNTING AND FINANCE

MULTI DIVISIONAL ORGANIZATION HUMAN RESOURCES
MATRIX

BUSINESSUNIT MANG'R
APPROVES
REGION
CHIEF OF REAL ESTATE---ACTIONS>-|
REGION STORE STORE STORE
|

60

 REGION

HIRES AND FIRES>REAL ESTATE MANAGER-|

A MATRIX IS A CONNECTION BETWEEN DIFFERENT MANAGEMENT LEVELS. IN THE

MULTI-DIVISIONAL ORGANIZATION, THE CORPORATE REAL ESTATE OFFICER MAY
OVERSEE AND APPROVE DIVISIONAL DECISIONS OF REAL ESTATE MANAGERS HIRED BY
BUSINESS UNIT MANAGERS.
THIS ASSURES THAT BUSINESSES WITHIN VARIOUS
REGIONS ARE WORKING TOWARD THE OVERALL CORPORATE GOALS OF THE
CORPORATION.
THE C.R.E.O. ACTS MUCH LIKE A CONDUCTOR WHILE THE
INDIVIDUAL REAL ESTATE MANAGERS ARE LIKE MUSICIANS. THE INDIVIDUAL REAL
ESTATE MANAGERS PLAY THEIR SCORE WHILE THE C.R.E.O. MAKES CERTAIN THAT
THE RESULTS OF THESE EFFORTS ARE NOT DISSONANT WITH THE OVERALL SYMPHONY
OF STRATEGY.
STRATEGY >>>> STRUCTURE >>>> MANAGEMENT PROCEDURE >>>>v
^^^
v
^^^
v
<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<<v
STRATEGY DRIVES THE STRUCTURE OF THE ORGANIZATION, WHICH IN TURN DEFINES
MANAGEMENT PROCEDURES.
MANAGEMENT PROCEDURES ARE THEN EVALUATED AND
STRATEGY REFORMULATED AS THE PROCESS CYCLES OVER AND AGAIN.
"HOW THINGS ARE DONE"
1. POLICIES
2. PROCEDURES
3. PRACTICES
THESE DETERMINE THE QUALITY OF ACTIONS BY THE CORPORATION.
QUESTIONS SUCH AS "WHERE DO WE BUY OUR FACILITIES" AND "WHICH FACILITIES
DO WE BUY" AND "HOW MUCH DO WE PAY FOR IT AND HOW MUCH DO WE BUY" ARE ALL
ANSWERED WITHIN THE FRAMEWORK CONSTRUCTED BY THE CORPORATION'S POLICIES,
PROCEDURES AND PRACTICES.
HOW DO YOU DECIDE WHETHER TO ACQUIRE PROPERTY IN THE CORPORATE REAL
ESTATE WORLD?

THE FOLLOWING MODEL IS AN EXAMPLE OF HOW THE DECISION IS MADE

oTOTAL COST
C + o
o
O
+
ooFIXED COST
S
+
T
+
+
+ FREIGHT COST

GRIDDED AREA IS "SAVINGS"

61

# OF WAREHOUSES

EXPLANATION OF ABOVE: AS THE NUMBER OF WAREHOUSES INCREASES, FIXED COSTS

INCREASE.
HOWEVER, THE COST OF FREIGHT DELIVERY DECREASES SINCE THE
WAREHOUSES ARE BETTER POSITIONED RELATIVE TO THE CUSTOMER. THE GRIDDED
AREA REPRESENTS THE MAXIMIZED PROFIT POTENTIAL CAUSED BY THE SAVINGS IN
FREIGHT COSTS THAT EXCEED THE FIXED COSTS BORN BY UTILIZING MORE
WAREHOUSES.
AS A CORPORATE REAL ESTATE EXECUTIVE, YOU ARE CONCERNED ABOUT THE COST OF
OCCUPANCY, AS WELL AS THE COST OF OPERATION WITH RESPECT TO FREIGHT, FOR
EXAMPLE.
AS A DEVELOPER / INVESTOR, OPERATIONS COSTS AND YOUR LESSEE'S BUSINESS IS
NOT YOUR CONCERN AS LONG AS HE IS A GOOD CREDIT RISK.
CORPORATE PLANNING CALENDAR
(THIS YEAR)
PLANNING YEAR
JULY, AUGUST, SEPTEMBER
ON THE "BUSINESS UNIT MANAGER"
LEVEL. STRATEGIC PLAN (5 TO 6 YR)
AND OPERATING PLAN (1 YEAR) ARE
DETERMINED
V
V
PLANT LEVEL: OPERATING BUDGET
FOR YEAR ONE OF STRATEGIC PLAN
V
V
CAPITAL BUDGET
V
V
FINALIZE OPERATING PLAN, CAPITAL
AND OPERATING BUDGETS

(NEXT YEAR)
ACTION YEAR

AS A REAL ESTATE EXECUTIVE, YOU NEED TO KNOW THE PROCESS SO YOU CAN BRING
UP THE FOLLOWING ISSUES IN THE BUDGET PLANNING STAGE:
1. LIBERATE EXCESS APPRECIATION?
2. OCCUPANCY COSTS CORRECT?
3. CONSIDERATION OF LOCATIONAL ISSUES, MARKETS, LEASES, ETC.?
IT DOES NO GOOD TO TALK ABOUT REAL ESTATE MARKETS TO A C.E.O. IF YOU
CAN'T RELATE IT BACK TO THE CORPORATIONS STRATEGIC PLAN.
END OF CLASS SEVEN

62

CLASS EIGHT
3/26/91
PAGE 29 -NOURSE TEXT:
EXPECT TO SEE QUESTION ON THIS CHART ON THE EXAMINATION
ROLE OF CORPORATE REAL ESTATE EXECUTIVES IN THE NETWORK OF ROLES.
"YOU ONLY INVEST IN CAPACITY IF YOU CREATE WEALTH FOR YOUR SHAREHOLDERS".
MEANING, YOU ONLY INVEST CORPORATE CASH ASSETS IN A FACILITY IF THAT
FACILITY WILL GIVE YOU AT LEAST THE SAME PERFORMANCE, MEASURED IN NPV OR
IRR, AS AN EQUIVALENT CASH INVESTMENT IN THE COMPANY'S PRODUCTION
CAPACITY.
SEE PAGE 30, EXAMPLE TABLES 3.1 AND 3.2
MAKE DECISION BASED ON:
/ DO NOTHING (NPV=0)
/
/
---------------------/--------NPV = ?
INT. RATE = ?
\
\
\NPV = ?
INTEREST RATE TO BE DETERMINED BY THE CAPITAL ASSET PRICING MODEL.
ANECDOTE:
DEPARTMENT OF HEALTH, EDUCATION AND WELFARE HAS A STANDARD THAT
INSTITUTIONS THAT IT HELPS FINANCE (SUBSIDIZE), SUCH AS BLUE CROSS / BLUE
SHIELD, CANNOT HAVE A LEVEL OF CORPORATE STANDARD OF LIVING THAT IS
HIGHER THAN 135 SQUARE FEET PER EMPLOYEE. THIS STANDARD WAS SET BY THE
GENERAL ACCOUNTING OFFICE.
HOWEVER, THE PRESIDENT OF BLUE CROSS WANTS MORE SQUARE FEET.
BREAKDOWN MIGHT BE AS FOLLOWS:

A TYPICAL

PRESIDENT - 250 SF.

EXEC. COMMITTEE - 190 S.F.
V.P.- 180 S.F.
DEPARTMENT HEADS - 150 S.F.
KEY PUNCHER - 60 S.F.

ALL EMPLOYEES AND THEIR SPACE NEEDS SHOULD BE ADDED UP.

THE AVERAGE
SQUARE FOOTAGE PER PERSON SHOULD NOT, IN THIS INSTANCE, BE
MORE
THAN
135 SQUARE FEET PER EMPLOYEE. OFTEN, DUAL SHIFTS WILL HELP TO INCREASE
THE SQUARE FOOTAGE USEABLE BY EMPLOYEE PER SHIFT, ALTHOUGH DUAL SHIFTS

63

HAS IMPLICATIONS FOR EFFICIENCY.

THE PROFESSION CHARGED WITH DETERMINING THE SIZE OF FACILITIES IS CALLED
FACILITIES MANAGEMENT.

WHEN EXAMINING AN EXISTING SITUATION TO DETERMINE IF THE SPACE

ALLOCATIONS ARE ADEQUATE OR SUPERFLUOUS, IT PAYS TO MAKE A RANDOM
SAMPLING OF SPACES TO SEE HOW MUCH THEY ARE USED.
FOR EXAMPLE, "THE
COFFEE ROOM IS USED BY 53 EMPLOYEES PER DAY, FOR AN AVERAGE OF 3 MINUTES
EACH.
NEVER ARE THERE MORE THAN 2 EMPLOYEES AT A TIME, ACCORDING TO
OBSERVATIONS CONDUCTED ON SITE."

YOU NEED TO MAKE AN ESTIMATE OF VOLUME INCREASES IN POLICY HOLDERS, OR

WIDGET PRODUCTION, ETC. IN ORDER TO BACK INTO GROWTH ESTIMATES FOR THE
PROPOSED FACILITY.
THESE ESTIMATES WILL ENABLE YOU TO PLAN FOR FUTURE
SPACE BY DETERMINING THE NUMBERS AND TYPES OF EMPLOYEES, AND THEREFORE
THE SQUARE FOOTAGE REQUIRED.
DO A SURVEY - WHO IS ON THE FLOOR ON THE DATE SAMPLE? WHAT DOES EACH
PERSON ON THE FLOOR DO?
HOW MUCH SPACE SHOULD EACH PERSON HAVE TO
PERFORM THEIR JOB?
ie.
DEPARTMENT # EMPLS.
MAIL
22
FIRST PROC.
CONF. ROOM
KEY ENTRY
SUPERVISOR

STD. S.F./ ACTUAL S.F.

3700/3500

-800000

64

INDEX OF ACTIVITY VOLUME

# OF MAIL PCS.
95


< RENTABLE/USEABLE S.F.

!
#
-700000

!
*

#
-600000
!
*

!
#
*

-500000
*

!
#

0
-400000 X
X = STANDARD

0 = ACTUAL

* = LOW EXPECTATION
# = EXPECTATION ! =HIGH
EXPECTATION

/91/92/93/94

CHART OF SPACE REQUIREMENT GROWTH

END OF CLASS EIGHT
CLASS NINE
4/2/91
BUSINESSES OFFER PRODUCTS. THESE PRODUCTS WILL GENERALLY GO THROUGH FOUR
DISTINCT PHASES IN ITS MARKETABLE LIFETIME.
THE FIRST PHASE IS "SELLING THE CONCEPT", AND HAS A CHARACTERISTIC
FEATURE ONLY A SLIGHT INCREASE IN BUSINESS VALUE OVER TIME.
THE SECOND PHASE IS "THE CONCEPT IS SOLD".
THIS IS THE PERIOD WHERE
EVERYONE IS JUMPING ON THE BANDWAGON TO BUY YOUR CONCEPT.
THIS IS A
PERIOD OF STEEP GROWTH IN THE VALUE OF THE BUSINESS.
THE THIRD PHASE IS WHEN THE "MONEY ROLES IN", YET GROWTH IS DECELERATING
AND DECREASING.
THE LAST PHASE IS "THE POINT OF DIMINISHING RETURNS". AT THIS STAGE IN A
PRODUCT, THE EXPENSE OF DELIVERING THE PRODUCT NO LONGER OFFERS AN
ADEQUATE RETURN. THIS IS WHEN THE BUSINESS OR PRODUCTS STARTS ITS PHASEOUT.

65

X
X

PHASE ONE
PHASE TWO
PHASE THREE
PHASE FOUR

=
=
+
=
=

=
=

=
=
0=

=
=

=
=
=
CASH FLOW DIAGRAM - SHOWS NEGATIVE AND POSITIVE CASH FLOWS BY PHASE

66

DIAGRAM OF A REAL ESTATE INVESTMENT CASH FLOW

+

X
0}--1-2X-3-4-5-6-7
}_X
} _X
_
}
_ -X
_
}
X_
_
X
_
]
_

_
]
_
]
X
}
_
]

=
=
=
=
=

_
_
_
-8
_

INFLATION GAIN (ECONOMIC APPRECIATION)

TRANSACTION COST
CASH FLOW
NET INCOME
DEPRECIATION

CASH FLOW BREAKS EVEN BETWEEN YEAR FIVE AND SIX

ACCRUED NET INCOME BREAKS EVEN BETWEEN YEAR SEVEN AND EIGHT, WHICH IS THE
POINT OF DIMINISHING RETURNS, AND IS WHY MANY REITS SELL AT THIS STAGE IN
A PROPERTY'S LIFESPAN.
IN LOCATING A FACILITY, AMONGST THE CONSIDERATIONS ARE:
THE COST OF UTILITIES
THE COST OF RAW MATERIALS
LABOR COSTS
ACCESS TO TRANSPORTATION
TAX RATES
END OF CLASS EIGHT
CLASS NINE
4/9/91
GUEST SPEAKER:
BILL ANTHONY, TEXAN
OF COOPERS AND LYBRAND

67

ON: WORKOUTS AND "DOG" ECONOMIES

ZOMBIE INSTITUTIONS ARE THOSE THAT HAVE A NON PERFORMING PROPERTY, YET
CANNOT MAKE A DECISION AS TO HOW TO DEAL WITH OR DISPOSE OF IT.
ORGANIZATION OF CORPORATE REAL ESTATE DEPARTMENT:
THE PORTFOLIOS OF CORPORATE CLIENTS ARE STATIC, AND ASSET MANAGEMENT
ROLES RESEMBLE MOST THAT OF A PROPERTY MANAGER, DUE TO THE GOALS OF THE
CORPORATION RATHER THAN THE CONTRASTING STRATEGY OF REAL ESTATE
INVESTORS.
VIEW CORPORATE REAL ESTATE AS A VERTICAL INTEGRATION COMPANY.
IE. SUBSIDIARY WILL DEVELOP
FRANCHISES (PROFIT CENTER)

AND

OWN

SITES

THAT

WILL

BE

LEASED

TO

SUBSIDIARY OWNING SITES FOR LEASING TO OTHER SUBSIDIARIES.

AT&T - 195 BROADWAY
STRATEGY - BE CORPORATE LANDLORD FOR PROPERTIES OWNED BY AT&T IN THE
METRO NEW YORK AREA.
GENERAL DEPARTMENTS

ADMINISTRATIVE SERVICES ORGANIZATION

195 BROADWAY

LIMOUSINES

EXECUTIVE AIR FORCE

LEGAL
BELL LABS
CONTROLLER
LONG LINES
NEW YORK TELEPHONE
WESTERN ELECTRIC
ETC.
REFLECTS THE THEORETICAL CONFLICT THAT YOU ARE SUPPORTING A LINE OF
BUSINESS AS A REAL ESTATE EXECUTIVE. WHEN COSTS ARE AVERAGED OUT TO SHOW
NO NET GAIN, IT'S HARD TO SHOW THE VALUE OF THE REAL ESTATE ROLE, WHICH
IS AN ISSUE SINCE YOUR BONUS DEPENDS ON IT!
END OF CLASS NINE
CLASS TEN
APRIL 16, 1991
GUEST SPEAKER:

68

ART KARLIN
HOW TO MAKE MONEY ON LOUSY PROPERTY
STARTED WITH HOWARD HOFFMAN IN 1963, THE FIRST CORPORATE ASSET MANAGERS
IN INDUSTRIAL SPACE, THERE ARE 1000 SMALL USERS (100,000 S.F.) FOR EVERY
LARGE USER (250,000 S.F.). DIVIDE LARGE USES SINCE LARGE USERS USUALLY
BUILD THEIR OWN BUILDINGS. MARKET TO SMALLER USERS.
TYPICAL DEAL
RECUPERATED

STRUCTURE:

75:25

IN

FAVOR

OF

THE

OWNER

UNTIL

COST

75:25 IN FAVOR OF BUYER/DEVELOPER UNTIL MONEY

RECUPERATED
50:50 THEREAFTER
"NEVER SAY "ASKING", OR "FOR SALE".

ONLY RENT AT A PRICE THAT'S FAIR.

GIVE BROKERS SOMETHING TO WORK WITH OR THEY WILL GIVE YOU TOO MANY CHAFF
POTENTIAL TENANTS AND NOT ENOUGH WHEAT POTENTIAL TENANTS.
STAY AWAY FROM THE REAL ESTATE GUY WHEN COURTING A CORPORATION AS A
CLIENT. YOU ARE COMPETITION FOR HIM. GO THE CHIEF FINANCIAL OFFICER, YOU
HAVE HIS INTERESTS AT HEART.
L.B.O. = LEVERAGED BUY OUT
END OF CLASS TEN
CLASS ELEVEN
APRIL 23, 1991
WORKOUTS AND NEGOTIATIONS; CHAPTER 13, NOURSE
GAME THEORY PRISONER'S DILEMMA; TWO PRISONERS CAUGHT PERFORMING A CRIME.
THEY ARE
CAPTURED AND SEPARATED AT THE POLICE STATION. THE POLICE OFFICER OFFERS
EACH A DEAL, WHICH IS, COOPERATE AND RAT ON YOUR BUDDY.
YOU HAVE X
PERCENT OF SEEING TIME. IF YOU DO NOT COOPERATE AND YOU HAVE A 3X CHANCE
OF SEEING TIME. IF NEITHER COOPERATES, THEIR CHANCES ARE BEST. IF BOTH
COOPERATE, THEIR CHANCES ARE WORSE. EVALUATE CHOICES NOT ONLY BASED ON
OUR OWN PRIORITIES, BUT ON YOUR ENEMIES PRIORITIES.
ZERO-SUM GAME IS WHERE WHAT ONE PARTY GETS, THE OTHER LOSES. THEIR IS A
LIMITED SUPPLY OF "STUFF" UNDER NEGOTIATION, AND WHAT ONE GETS, THE OTHER
LOSES.
IN NEGOTIATIONS BETWEEN A FINANCIER AND A FAILED DEVELOPER, WHAT EACH HAS
TO OFFER THE OTHER, AND WHAT YOU CAN DO IF THE PROBLEM IS NOT THE DEBTOR

69

BUT THE PROPERTY, IS CENTRAL TO HOW THE WORKOUT WILL FIND ITS WAY TO
REALITY.

BARGAINING POSITION DIAGRAM: WHAT THE OTHER GUY IS CONCERNED WITH.

BANKER
SILENT PARTNER*

DEBTOR

HARD $
HIRE PROPERTY MGR ($) AVOID
A
TRANSACTION
THAT

CAPITAL

TRIGGERS A TAX

GAIN

(DIFFERED)

THREATEN

BANKRUPTCY

SOFT$
FORBEARANCE

PROP.
MGMT.

PLAN

SWEAT
EQUITY
IN
PROPERTY
* GOVERNMENT TAX AUTHORITY
WHAT YOU WOULD LIKE TO KNOW ABOUT YOUR BANK:
STRATEGIC - YOU WOULD LIKE TO KNOW THE BANK'S STRATEGIC FINANCIAL
OBJECTIVES. ARE THEY WELL CAPITALIZED? CAN IT TAKE THE HIT OF A WRITE
DOWN ON A PROPERTY? DOES IT HAVE THE RESOURCES TO BE HARD NOSED?
MANAGERIAL- (LENDING OFFICER) WHAT IS HIS AUTHORITY? WHAT LIMITS HAS HE
GOT?
DOCUMENTATION...GIVE HIM WHAT HE NEEDS TO HELP HIGHER LEVEL
MANAGEMENT TO MAKE A DECISION YOU CAN LIVE WITH. WHAT RECOURSE DOES HE
HAVE TO HIGHER UPS?
OPERATIONAL - DO THEY HAVE AN IN HOUSE PROPERTY MANAGER OR A SWEETHEART

70

ARRANGEMENT WITH A PROPERTY MANAGER THAT CAN TAKE YOUR PLACE?

WHAT THE BANK WANTS TO KNOW ABOUT YOU:
STRATEGIC - WHAT IS YOUR PORTFOLIO? IS PROPERTY GENERATING CASH THAT IS
BEING SIPHONED OFF INTO ANOTHER BUILDING? IE. A TENANT IN ONE STABLE
BUILDING IS MOVED TO YOUR NEW BUILDING, AT THE LENDING INSTITUTION'S (FOR
THE STABILIZED BUILDING) RISK.
PROPERTY MANAGEMENT CAPABILITY, ASSET MANAGEMENT CAPABILITY, AUTHORITY OF
ASSET MANAGERS WITHIN COMPANY, ENVIRONMENTALISM ISSUES IN PROPERTY,
FINANCIAL WORTH IN CASE THE BANK HAS TO FORECLOSE AND GET A DEFICIENCY
JUDGMENT. ARE YOU LIQUID (NO CASH FLOW) OR INSOLVENT (MORE LIABILITIES
THAN YOU CAN COVER).

READ CHAPTER 13 FOR TUESDAY. LOOK FOR THREE PART DIAGRAM, "ASSET MANAGER
FRAMEWORK FOR UNDERSTANDING REAL ESTATE MANAGEMENT"
CEILING PRICE FOR BUYER IS BASED ON SHAREHOLDER VALUE, INTERNAL RATE OF
RETURN AND NET PRESENT VALUE.
CEILING PRICE = PRICE + TERM = NPV OF 0 OR IRR THAT IS ACCEPTABLE,
MEANING JUST OVER CORPORATE HURDLE RATE.
OR, USING A STUDY OF ALTERNATIVE SITES THAT GIVES YO A NET PRESENT VALUE
OF ONE MILLION, THEN YOU WOULD NOT ACCEPT THE OTHER PROJECTS UNLESS THEY
ALSO GIVE YOU A NPV OF AT LEAST ONE MILLION.
CORPORATION

\/

CEO
OFFICE OF GENERAL COUNSEL
CHIEF FINANCIAL OFFICER

CONTROLLER

TREASURY
GROUP

PARTNER IN CHARGE

NEGOTIATION
VP. REAL ESTATE BACK AND FORTH
FACILITIES MANAGER

STAFF

CORPORATE/DEVELOPE
R

71

ASSET MANAGER

PROPERTY MANAGER
STAFF

NEGOTIATION BORDER

DEVELOPER /\
UNDERSTAND THAT THE STRUCTURE OF REAL ESTATE WORKS BOTH WAYS, FROM THE
DEVELOPER INTO THE CORPORATE REAL ESTATE DIVISION, AND FROM THE
CORPORATION INTO THE REAL ESTATE DIVISION. YOU THE CORPORATE REAL ESTATE
EXECUTIVE ARE THE CONDUIT FOR THE CORPORATE STRUCTURE AND THE DEVELOPER
TO GET THE FACILITIES LEASED.
|----------------PROPERTY MANAGEMENT--------|
\/
\/
ASSET MANAGER
WORKOUTS AND NEGOTIATIONS
/\
/\
|
CORPORATE REAL ESTATE------|
|---------------- MANAGEMENT, REPRESENT CLIENT

S T R A T E G Y

__

M A N A G E M E N T

T__T

OPERA
OPERA-
TIONAL

TIONAL

72

O P E R A T I O N A L

{ COMMON KNOWLEDGE OF R.E.}

{CORPORATE REAL ESTATE}

{ASSET MANAGER}
HURDLE RATES
CONSTRUCTION ISSUES
LOCATION
INVESTORS
EFFICIENCY
OCCUPANCY
PROCEDURES
THE CORPORATE REAL ESTATE EXECUTIVE AND THE DEVELOPER'S ASSET MANAGER
HAVE THEIR OWN SPECIFIC CONCERNS, YET THEY SHARE AN OVERARCHING BODY OF
KNOWLEDGE IN THE STRATEGIC, MANAGEMENT AND OPERATIONAL AREAS OF REAL
ESTATE THEORY.
THEIR SPECIFIC CONCERNS LEAD TO A DISTINCT AND
SPECIALIZED BODY OF KNOWLEDGE THAT IS USED FOR THEIR DIFFERENT
CIRCUMSTANCES, DIFFERING STRATEGIES, AND DIFFERING OBJECTIVES.
FINAL EXAMINATION NEXT WEEK
END OF CLASS ELEVEN
END OF COURSE

73

ADVANCED SPECIAL PROJECT

PROFESSORS KUHN AND ROSAN
WINTER 1991

ADVANCED SPECIAL PROJECT

1/28/91
CLASS ONE
PROFESSOR JAMES KUHN
26 E. 64TH ST. SUITE 400
212 308-4400
SECRETARY, LORETTA
IN BUSINESS SINCE 1972, RIGHT BEFORE THE WORST RECESSION IN NEW YORK CITY
HISTORY. 30 PERCENT VACANCY.
1972 TO 1977, WORKED WITH METLIFE DOING WORKOUTS, FORECLOSURES, ASSET
MANAGEMENT, ETC. "YOU LEARN THE MOST WHEN THINGS ARE BAD".
*******************
GROUND RULES
*******************
DEPENDING ON THE SITE AND THE BUILDING, YOU MAY BUILD OFFICE
RESIDENTIAL. IT MUST BE WITHIN THE FRAMEWORK OF THE ZONING CODE.

OR

YOUR GRADE WILL BE GOOD IF:

1. YOUR FACTS ARE CORRECT
2. YOUR ASSUMPTIONS ARE CORRECT
THE PROJECT DOES NOT NEED TO "PENCIL OUT".
IN THE REAL WORLD, THE
RECONNAISSANCE UNDERGONE BEFORE MAKING AN OFFER FOR A PROJECT DOES NOT
PENCIL OUT EITHER.
UNLESS NOTED OTHERWISE, YOU MAY ASSUME THAT THE PROPERTY HAS NO RENT
CONTROLLED TENANTS. YOU MAY TEAR THE BUILDING DOWN IF YOU TAKE CARE OF
ASBESTOS, OR OTHER SUCH ISSUES.
YOU CAN TRY TO INCREASE YIELD BY ACQUIRING OTHER SITES IF YOU CAN
CONVINCE THE PROFESSOR OF YOUR REASONS.
ONCE YOU HAVE THE SITE AND PRICE, YOU ARE "MARRIED" TO THE SITE AND
PRICE. ONCE YOU HAVE THE PROJECT YOU WILL BE DESIGNATED THREE MENTORS.
EACH STUDENT WILL HAVE A LEASING, FINANCING AND CONSTRUCTION MENTOR.
THERE ARE EIGHT TEAMS OF MENTORS, EACH WITH THREE MEMBERS.
AS SOON AS YOU GET THE SITE YOU WILL START YOUR PLAN.
AS SOON AS
POSSIBLE, SEE YOUR CONSTRUCTION MENTOR.
DO NOT EXPECT HIM TO DO THE
PROJECT FOR YOU.
HE WILL, HOWEVER, HELP YOU DECIDE THE "WHAT", "HOW
MUCH" AND "HOW" OF YOUR PROJECT.
THE GRADE CONSISTS OF AN ORAL EXAM (40%) AND THE FINAL PROJECT (60%).
SOMETIME AROUND MAY 5TH, CONTACT YOUR CONSTRUCTION MENTOR. HE WILL

72

ARRANGE TO SEE YOU.

CRITERIA FOR OUTLINE AT ORAL PRESENTATION

ZONING ANALYSIS
PHYSICAL CHARACTERISTICS OF THE BUILDING
HARD AND SOFT COSTS / BUDGET
PRO FORMA INCOME AND EXPENSE
RENT COMPS AND STACKING PLAN
FINANCING OR JOINT VENTURE STRUCTURE
PROJECT DUE THE LAST DAY OF CLASS, MAY 13TH.
TWO COPIES, ONE TO MENTOR AND ONE TO KUHN.
IF YOU ARE GOING TO HAVE IRR'S AND DCF'S IN YOUR ANALYSIS, DEMONSTRATE
THAT YOU CAN WEATHER THE DOWNTURNS WITH CASH FLOW PROJECTIONS.
"IT DOESN'T MATTER WHAT YOU PUT INTO YOUR COMPUTER IF YOU CAN'T AFFORD
THE DOWNTIME, WHICH IS DURING THE CONSTRUCTION AND LEASE UP PHASES, AND
IN AN UNPREDICTABLY POOR ECONOMY AND MARKET."
"YOU CAN'T CONTROL WHAT THE MARKET IS GOING TO BE SEVEN YEARS DOWN THE
LINE WHEN THE PROJECT BEGINS CONSTRUCTION. YOU DON'T KNOW THE INTEREST
RATE, AND YOU CAN'T STOP THE COMPETITION FROM OVERBUILDING. REAL ESTATE
IS A TOUGH BUSINESS."
"NEW BUILDINGS ARE EASIER THAN REHABS BECAUSE YOU DO NOT HAVE TO WORRY
ABOUT WHAT YOU WILL FIND WHEN YOU TEAR DOWN THE WALLS."
END OF CLASS ONE
CLASS TWO
2/4/91
NEXT WEEK, THE BIDDING ON THE PROJECTS WILL BEGIN.
BIDDING WILL TAKE PLACE IN 500,000 DOLLAR INCREMENTS ON PROPERTIES PLACED
RANDOMLY ON THE BOARDS. ONCE A BID IS WON, A SECOND PERSON MAY WIN THE
SITE FOR 500,000 DOLLARS ABOVE THE PROPERTY'S WINNING BID.
THE SECOND BIDDER MAY POTENTIALLY BID 500,000 DOLLARS MORE THAN THE
MAXIMUM ALLOWED IF THE WINNING BID IS AT THE MAXIMUM.
GUEST SPEAKER: MICHAEL PARLEY, ZONING EXPERT
CITY OF NEW YORK ZONING MAPS:

73

R= RESIDENTIAL
C= COMMERCIAL
"USUALLY"
M= MANUFACTURING
THE GRAY TONES ARE SPECIAL DISTRICTS.
IN A RESIDENTIAL ZONE, YOU CAN ALSO HAVE COMMUNITY FACILITY USES FOR NOTFOR-PROFIT USES.
IN A COMMERCIAL ZONE, YOU CAN ALSO USUALLY HAVE RESIDENTIAL AND COMMUNITY
FACILITIES.
IN A MANUFACTURING ZONE, YOU CAN HAVE ALL OF THE ABOVE, USUALLY.
IF YOU HAVE, SAY, R3A, THE "A" IS A CONTEXTUAL ZONE WHICH REPRESENTS A
CERTAIN BUILDING TYPE.
IF YOU HAVE A C5-3, THE
"DIRTINESS" OF THE ZONE.

TWO

NUMBERS

REPRESENT

THE

INTENSITY

AND

C1 & C2, FOR EXAMPLE, IS A NEIGHBORHOOD RETAILER ON THE GROUND FLOOR.

C5 IS A CENTRAL BUSINESS DISTRICT. THE "5" IS A DIRTIER ZONE THAN THE 1
OR 2.
M1-1 IS LIGHT MANUFACTURING.
USE IN FLOOR TO AREA RATIO.

THE SECOND "1" INDICATES THE INTENSITY OF

M1-5 IS MORE INTENSE THAN M1-1.

M3 IS HEAVY INDUSTRY.
SECTION 81-00 IS THE SECTION DEALING WITH THE SPECIAL MIDTOWN ZONING
DISTRICT.
MIDTOWN IS RECOGNIZED BY MOST AS EAST OF 3RD, WEST OF 8TH, AND NORTH OF
30TH AND SOUTH OF 60TH.
STREET WALL REGULATION- SOME BUILDINGS HAVE TO BE BUILT WITHIN 10 FEET OR
ON THE STREET LINE TO EFFECTUATE FACADE CONTINUITY ON THE STREET.
ZONING LOT- LAND ZONED IN FEE, OR SEVERAL PLOTS MERGED BY DIFFERENT
OWNERS AND PUT UNDER ONE APPLICATION.
LOOK UP DISTRICT DESIGNATION AND THE USES PERMITTED. IF, FOR EXAMPLE,
C5-3, FAR IN MIDTOWN IS "15". IT CAN ABE ENHANCED BY THE USE OF BONUSES
(IN LOCATIONS, USUALLY, WHERE FAR IS GREATER THAN TEN).
PLAZAS AND
SUBWAY IMPROVEMENTS ADD FAR.
WHAT KINDS OF FLOORS DO YOU WANT?
THEY ARE POSSIBLE?

WILL THE SETBACK ANALYSIS SHOW THAT

74

LOOK FOR STREET WALL REQUIREMENTS. PLAZA MUST BE ON THE SOUTH SIDE OF A
BLOCK, BUT THE FLOOR SIZE MIGHT BE HURT BY THE NEED FOR THE PLAZA TO BE
OPEN TO THE SKY. PLAZA BONUSES ARE FOR 1 FAR.
WHAT IF THE FIRST 150 FEET OF THE LOT IS C5-3 (15 FAR) AND THE LAST 50
FEET IS A C5-2.5 (12 FAR). THERE IS A WAY TO TRANSFER SOME OF THE FAR
OVER THE ZONING DISTRICT LINES.
THEY ARE: IF THE LOT EXISTED BEFORE THE ZONE CHANGE. SEE ALSO LANDMARK
SPECIAL PERMITS. A ZONING LOT MERGER IS NOT A TRANSFER. IT IS LIKE TWO
PEOPLE GETTING MARRIED BUT NOT PERMITTED TO DIVORCE, ACCORDING TO THE
GUEST LECTURER.
YOU CAN'T TRANSFER DEVELOPMENT RIGHTS OVER ZONING DISTRICT LINES.
MINIMUM PLAZA WIDTH IS 40 FEET.
END OF TALK FOR FIRST GUEST LECTURER.
NEXT GUEST LECTURER:

DOUG DIERCKSEN, TURNER CONSTRUCTION.

CONSTRUCTION IS ONE OF THE CRITICAL PARTS OF A SUCCESSFUL REAL ESTATE

PROJECT. THE "TEAM" IS VERY IMPORTANT.
IN THE EARLY DEVELOPMENT PROCESS, YOU NEED A CONSTRUCTION MANAGER TO KEEP
ON TRACK.
DISADVANTAGE OF LUMP SUM CONTRACT (AKA, FIXED PRICE CONTRACT)
NO CHANGES WITHOUT ADDITIONAL FEES, THE VALUE OF WHICH MAY BE
DISPUTED, AND WHICH COULD EASILY LEAD TO AN ADVERSARIAL RELATIONSHIP
BETWEEN THE DEVELOPER AND THE CONTRACTOR.
GUARANTEED MAXIMUM PRICE - BASED ON A GIVEN SET OF DRAWINGS AT A CERTAIN
DEGREE OF COMPLETION (65 PERCENT TO 80 PERCENT), THE COST WILL BE SO AND
SO.
COST PLUS - SELF EXPLANATORY - LEAST ADVERSARIAL.
RENOVATIONS ARE NOT LUMP SUM DUE TO CONSTANT CHANGES.
IN THE 60'S TO 70'S LOTS OF ASBESTOS USED FOR FIRE PROOFING.
IT WAS ONLY USED FOR PIPE COVERINGS.

PREVIOUSLY,

YOU OFTEN NEED TO CHOP THROUGH A WALL TO SEE IF THE STRUCTURE IS CONCRETE
AS OPPOSED TO STEEL, SINCE THIS FACT IS A FACTOR IN THE COST OF THE
RENOVATION.
RENOVATIONS COST BETWEEN 130 AND 180 DOLLARS PER SQUARE FOOT, 200 DOLLARS
FOR A SLIVER BUILDING. UPTOWN FOUNDATIONS ARE IN ROCK, DOWNTOWN IN MUCK.
DETERMINE WHETHER THE CONCRETE OR STEEL CAN TAKE THE ADDITIONAL LOADING
THE RENOVATIONS REQUIRE.

75

GRANITE AND GLASS CURTAIN WALLS COST 80 DOLLARS PER S.F., WHILE PRECAST
CONCRETE PANELS ARE 50 DOLLARS PER S.F.
DO YOU HAVE TO REPLACE MECHANICAL SYSTEMS?
DO REINFORCED FOUNDATIONS OR STRUCTURES NEED TO BE INSTALLED?
END OF CLASS TWO
CLASS THREE
2/25/91
GUEST SPEAKER: ARCHITECT, EGGERS GROUP, RICK MORRIS
GUEST SPEAKER: ARCHITECT, EGGERS GROUP, HANNY HASSAN

FINANCE MENTOR DESIGN

MENTOR

MARKETING AND

LEASING MENTOR

THE MENTOR CYCLE

THE SKY EXPOSURE CURVE IS NOT THE SAME AS A SKY EXPOSURE PLANE. UNLIKE
THE PLANE, A CURVE MAY NOT BE INTRUDED UPON BY THE PROPOSED BUILDING.

**
**

***

**

**

**

SKY EXPOSURE PLANE

AS IN C5-2 ZONING
* =THE PLANE

**

**

**

**

**

**

SKY EXPOSURE CURVE

AS IN C5-3 ZONING
* = THE CURVE

76

- =THE BUILDING

- = THE BUILDING

FOR MIDTOWN DISTRICT

SKY EXPOSURE CURVES - 3 CHARTS DESIGNATED BY STREET WIDTHS
60' WIDE STREET IS A NARROW STREET
75' WIDE STREET IS A MEDIUM STREET
100' WIDE STREET IS A WIDE STREET

THERE IS A MEASUREMENT IN FEET, X, THAT IS THE MAXIMUM HEIGHT OF THE

FIRST TIER OF THE BUILDING ALONG THE BUILDING'S FRONT. FROM THAT POINT
SKYWARD, THE SKY EXPOSURE CURVE BEGINS.
FOR A NARROW STREET, THE X IS 90 FEET, AND FOR A WIDE STREET IT IS 150
FEET. YOU CAN PENETRATE THE CURVE TO A LIMITED DEGREE USING THE "THIRD
RULE". YOU DIVIDE THE FACE OF THE BLOCKFRONT SITE INTO THIRDS, AND THE
AREA YOU INTRUDE INTO THE SKY EXPOSURE CURVE MUST BE EQUALED BY THE AREA
PULLED AWAY FROM THE CURVE. A CORNER BLOCK LOT IS DIVIDED BY TWO, NOT
THREE, AND THE SAME CONCEPTS APPLY. THE SKY EXPOSURE CURVE WILL SUGGEST
A DIFFERING REGULATORY CROSS-SECTIONS FOR THE BUILDING AT VARYING HEIGHTS
FROM THE GROUND. AT EACH REGULATORY CROSS SECTION, THE AREA INTRUDING
INTO THE PORTION OF AIR SPACE BETWEEN THE SETBACK FROM THE PROPERTY LINE
AND THE PROPERTY LINE ITSELF MUST BE EQUALED IN SQUARE FOOTAGE BY A
PENETRATION INTO THE PERMITTED LOCATION FOR THE BUILDING. IN ANY CASE,
THE BUILDING MAY NOT PENETRATE BEYOND THE SETBACK EXPOSURE LINE BY MORE
THAN HALF THE DISTANCE TO THE PROPERTY LINE. FOR EXAMPLE, IF THE SETBACK
AT 210 FEET HIGH IS 54 FEET, THE BUILDING MAY PENETRATE INTO THE SETBACK
BY NO MORE THAN 27 FEET.
ELEVATORS - RULE OF THUMB: 40,000 S.F. PER ELEVATOR. FACTORS RELATING TO
ELEVATOR SERVICE ARE WHETHER THERE ARE SINGLE OR MULTIPLE TENANTS, AND
THE HEIGHT OF THE BUILDING.
ELECTRICITY - 9 TO 10 WATTS PER S.F.
WATTS PER S.F.

OLD BUILDINGS GENERALLY HAVE 6

THE CONSTRUCTION OF FLOORS SHOULD ACCOMMODATE A NINE FOOT CEILING TO

CEILING HEIGHT.
STAIRS - YOU CAN'T HAVE MORE THAN 12 FEET OF RISE IN A SINGLE RUN OF
STAIRS ACCORDING TO THE CODE. TO INCREASE TO MORE THAN 12 FEET, YOU HAVE
TO HAVE AN INTERCEDING LANDING AREA.
THIS CAUSES THE PERCENTAGE OF
LEASABLE AREA TO BE REDUCED AS MORE OF THE BUILDING IS USED IN PROVIDING
THE STAIRCASE.
DESIGN ISSUES

77

* THE RELATIONSHIP TO THE SURROUNDING BUILDINGS

* CHOICE OF MATERIALS AND FINISHES
* LOCATION IN BLOCK
MIDBLOCK
CORNER BLOCK
FULL BLOCK FRONT
* CORE LOCATION FOR BUILDING

CORE LOCATION DIAGRAMS

BLOCKFRONT W/ 2
LOCATIONS FOR CORE

CORNERBLOCK

MIDBLOCK

METHODS OF INCREASING FAR

ARCADE - PEDESTRIAN SPACE: 3 S.F. PER S.F. OF ARCADE.
MUST HAVE DEPTH OF TEN FEET, SPACING BETWEEN COLUMNS OF 20 FEET MINIMUM
AND A MINIMUM AREA IN TOTAL.
SUBWAY ENTRANCE IMPROVEMENT - 2 S.F. FOR EACH S.F. OF IMPROVEMENT AREA.
GETTING A BONUS TAKES 8 TO 12 MONTHS.
THE LACK OF ASSURANCE ON THE
RESULTS MAKES MOST DEVELOPERS PLAN AS-OF-RIGHT BUILDINGS.
NO CLASS NEXT WEEK, PRESIDENT'S DAY.
END OF CLASS THREE
CLASS FOUR
2/25/91
C. KONDYLIS, MANHATTAN RESIDENTIAL TOWER ARCHITECT, GUEST SPEAKER

78

ELEMENTS OF FINE DESIGN IN RESIDENTIAL TOWERS:

*
*
*
*
*
*
*
*
*
*
*
*
*

DAYLIGHT IN THE CORRIDORS (BONUSABLE)

ELEVATOR VISIBLE FROM THE STREET
CORNER LIVING ROOM
WRAP-AROUND GLASS, WIDE VIEW, LOTS OF LIGHT
SMALL NUMBER OF APARTMENTS PER FLOOR
TUB IN POWDER ROOM AND IN FLEXIBILITY FOR ALLOWING THE DEN TO BE
CONVERTED TO AN ADDITIONAL BEDROOM
FEELING OF SPACIOUSNESS BY PLACING DINING AREA ADJACENT TO LIVING AREA
ADEQUATE CLOSET SPACE
MAXIMIZE SELLABLE AREA (85% MINIMUM), WITH AS LITTLE SPACE AS PRACTICAL
TAKEN UP BY ELEVATORS, STAIRCASES, HALLWAYS, ETC.
VIEWS, HIGH FLOOR = PREMIUMS
"JUNIOR 4" - ALLOWS CONVERSION OF DINING ROOM TO A NURSERY
BAY WINDOW
BALCONY

AMENITIES (CONTINUED)
*
*
*
*

LANDSCAPING AND PLAZA

SWIMMING AND HEALTH CLUB
FOYERS, GALLERIES, DENS (PREWAR FEATURES)
TERRACES / DECKS / VERANDAS

BONUSES ARE AVAILABLE FOR INCLUSIONARY HOUSING, AND PLAZAS. PLAZAS ARE
AN ENDANGERED BONUS.
FORCES ARE FORMING ALLIANCES TO BAR BONUSES FOR
THIS AMENITY.
RESIDENTIAL TOWER DESIGN
* MAP VIEW OPPORTUNITIES BY COLOR-CODING ADJACENT BUILDING HEIGHTS AROUND
THE SITE.
10 PERCENT OF YOUR LOT LINE FACADE CAN BE COVERED IN WINDOWS. ADJACENT
BUILDINGS, HOWEVER, HAVE THE RIGHT TO CLOSE THESE WINDOWS OFF.
THESE
WINDOWS ARE CALLED LOT LINE WINDOWS.
SQUARE FOOTAGE THAT GOES INTO A HEALTH CLUB AMENITY IS NOT HELD AGAINST
THE MAXIMUM FAR. THE CONDITIONS FOR THE DESIGN OF THE HEALTH CLUB ARE
SPECIFIED IN THE CODE.
OUTSIDE MEMBERSHIP IS NOT PERMITTED, SO COSTS
CANNOT BE OFFSET BY OUTSIDE MEMBERSHIP FEES.
PUTTING THE CLUB ON THE
FIRST OR SECOND FLOOR IS A GOOD IDEA SINCE THE LOWER FLOORS ARE NOT
DESIRABLE FOR RESIDENTIAL USES.
MOST PEOPLE PREFER RECTANGULAR ROOMS UNLESS THE PROPORTIONS OF THE ROOM
PERMIT OTHERWISE.
MEET NEXT WEEK AT THE "LIPSTICK BUILDING", 885 THIRD AVE. (GERALD HINES

79

BUILDING) FOR A MARKETING PRESENTATION ON "450 LEXINGTON".

END OF CLASS FOUR
CLASS FIVE
3/4/91
MARKETING PRESENTATION FOR "450 LEXINGTON" TAKES UP THE FIRST 3/4 OF THE
CLASS. THE REST OF THE CLASS WAS A SHORT LECTURE ON LEASING.
ISSUES:
WHO IS SIGNING THE LEASE? YOU USED TO ASK ALL PARTNERS OF THE ASSIGNEE
COMPANY TO SIGN THE LEASE. NOT SO ANYMORE. YOU DID THIS TO GUARANTEE
THAT IF THE COMPANY FOLDS, YOU HAVE RECOURSE TO THE COMPANY'S PARTNERS.
LEASE OBLIGATIONS FROM THE LESSEE'S PARTNERS ARE RESISTED BY THE LESSEE
COMPANY. YOU WILL USUALLY GET THE PARTNERSHIP ENTITY TO SIGN ON, BUT NO
LONGER THE PARTNERS IN THE PARTNERSHIP ENTITY.
ON THE COUNTERSIDE IS WHEN THE TENANT SAYS "THE PAST LANDLORDS HAVE GONE
BROKE.
IF I SIGN THE LEASE, HOW WILL I KNOW THE TENANT WORK WILL BE
COMPLETED AND THE BUILDING DELIVERED?
OMNIBUS AGREEMENT - THE BANKS "BLESS" THE TAKING OF MONEY FROM CASH FLOW
TO PAY COMMISSIONS, ETC.
TENANTS FEAR THAT TAXES WILL INCREASE ON A SALE, AND BE PASSED ON TO
THEM. HOW ARE THEY PROTECTED FROM THIS. NOW ANSWER. LANDLORDS DO NOT
WANT TO SIGN AWAY THE RIGHT TO SELL THEIR PROPERTY.
SUBTENANTING - IN COMPETITIVE MARKETS, TENANTS WILL SEEK CAPS TO
INCREASES.
THOSE WHO DO THIS WILL MANY TIMES GO BROKE.
FUEL COSTS,
INSURANCE, TAXES, ETC. ARE MAJOR CONCERNS.
REPLACEMENT VS. REPAIR - ARE REPLACEMENT COSTS PASSED THROUGH TO TENANTS
AS REPAIRS? OVER ONE YEAR, MAYBE? OVER SEVERAL YEARS? NOT AT ALL?
ISSUE: BELOW MARKET RENT SPACE SUBTENANTED, WHO GETS THE PROFIT; THE
TENANT? THE LANDLORD? USUALLY SPLIT FIFTY/FIFTY.
PARTIAL SUBLET FOR A SPECIFIC PERIOD OF TIME IS A NEGOTIABLE ISSUE, IF:
1. THERE IS NO PROFIT.
2. IF RENTER IS NOT IN DEFAULT
SUBLETTING TO OTHER TENANTS IN THE BUILDING IS USUALLY A "NO NO" WITH
LANDLORDS. THEY DO NOT WANT TO COMPETE WITH OTHERS IN THEIR OWN BUILDING
FOR SPACE.
THE RULE IS "THERE ARE NEVER LONG TERM LEASES", EVEN WHEN
THEY ARE, IN ACTUALITY, LONG TERM LEASES. THE REASON FOR THIS RULE IS
THAT SHRINKING, BANKRUPTCY, MOVING, ETC. IS ALWAYS POSSIBLE, AND EVEN

80

PROBABLE OVER A LONG PERIOD OF TIME.

GENERALLY, A TENANT WILL NEVER
LIVE OUT A LONG TERM LEASE. WHEN THEY GET OUT OF THE LEASE, YOU HAVE
ANOTHER CHANCE TO MAKE MONEY ON THE LEASE IF THE MARKET IS GOOD. IN A
BAD MARKET, YOU DO NOT HAVE TO ALLOW THE SUBTENANCY.
YOU DO NOT WANT THE TENANT TO ADVERTISE HIS SPACE IN THE PRESS FOR A
SUBLEASE.
FIRE - IF AN ENGINEER SAYS THE SPACE CAN BE REBUILT IN 9 MONTHS, THE
TENANT CAN'T BACK OUT OF THE LEASE. WHAT HAPPENS IF THE ENGINEER SAYS
THAT THE RECONSTRUCTION WILL LESS THAN NINE MONTHS, BUT IT TAKES MORE
TIME? THE LEASE WILL SAY THAT THE TENANT CAN'T BACK OUT ONCE CONSTRUCTION
BEGINS.
A NEW BUILDING IS EASY TO DESIGN EFFICIENTLY. WITH 350 MILLION SQUARE
FEET IN NEW YORK, CON ED HAS LITTLE ABILITY TO GIVE OLDER BUILDINGS THE
POWER THEY NEED FOR TODAY'S POWER HUNGRY TENANTS.
NEW BUILDINGS ARE
GENERALLY GRANTED ALL THE POWER THEY NEED.
COLUMN SPACING SO CLOSE TOGETHER IN MANY BUILDINGS THAT YOU CAN'T LAY OUT
THE SPACES EFFECTIVELY.
END OF CLASS FIVE
CLASS SIX
3/18/91
GUEST SPEAKER: NEIL LYNCH
34 YEARS WITH PORT AUTHORITY OF N.Y. & N.J.
PRESENTLY WITH SILVERSTEIN PROPERTIES
TOPIC: 7 WORLD TRADE CENTER
SILVERSTEIN DOES NOT OWN IT, HE ONLY BOUGHT AIR RIGHTS.
39 YEAR LEASE WITH 3 20 YEAR OPTIONS AT MARKET RATE = 99 YEARS
"A LESSON THAT PUBLIC AND PRIVATE SECTORS CAN WORK TOGETHER FOR A BETTER
PRODUCT THAN EITHER CAN ACHIEVE INDIVIDUALLY".
END OF CLASS SIX
NOTE: CLASSES SIX THROUGH THE END OF THE COURSE WERE FIELD VISITS, WITH
MOST OF THE LECTURE CONTENT BEING ANECDOTAL. THEREFORE, NOTES WERE NOT
TAKEN FOR THE REMAINDER OF THE COURSE.
ADVICE FOR SITE SELECTION OF PROJECTS.
* USE AVERAGE EFFECTIVE RENT OF 38 DOLLARS PER SQUARE FOOT.
* TRY TO BUY AVENUE PROPERTIES RATHER THAN STREET PROPERTIES.

81

ATTEMPT TO GET PROPERTIES IN THE PARK AVENUE AREA, OR NORTH OF 48TH

STREET IN THE VICINITY OF MADISON AND FIFTH AVENUES.
* FIGURE TAX AT ROUGHLY 20 PERCENT OF GROSS RENT
* FIGURE OPERATING EXPENSES AT ROUGHLY $7.50 PER S.F.
* FIGURE AN ESCALATION OF ROUGHLY 2 PERCENT PER YEAR.
* USE A CAP RATE OF NO LOWER THAN 8 TO 8.5 PERCENT.
* PROJECT INCOMES OUT NO FURTHER THAN 7 TO 10 YEARS.
* ESTIMATE CONSTRUCTION COSTS (SOFT AND HARD) AT ROUGHLY 320 DOLLARS PER
SQUARE FOOT, INCLUDING 45 DOLLARS FOR TENANT IMPROVEMENTS.
END OF DEGREE

82

TABLE OF CONTENTS
"ABLE"
248
"RATIONALLY SUPPORT"..................................................
"READY, WILLING, AND ABLE"...........................................
"SUBSTANTIALLY ADVANCE"...............................................
"TIME IS OF THE ESSENCE".............................................
"WILLING"
247
14TH AMENDMENT........................................................
80/20 FINANCING......................................................
ABANDONMENT 16
ABSORPTION 25, 26, 75, 76, 79, 148-150, 159, 173, 208, 212, 216,
309, 311
ABSTRACTS
185
ACCELERATED COST REDUCTION SYSTEM.................................
ACCELERATED DEPRECIATION.....................................60, 68, 213
ACCELERATED PAYMENT..................................................
ACCELERATION 186, 216, 271
ACCOUNTING FOR CONSTRUCTION...........................................
ACCOUNTING FOR HOLDING COSTS..........................................
ACCOUNTING FOR LEASING TRANSACTIONS...................................
ACCOUNTING ISSUES OF SYNDICATION......................................
ACCOUNTS RECEIVABLE..........................6, 9, 23, 27, 221, 224, 313
ACCRUAL
6, 7, 11, 13-15, 18, 24, 25, 34, 39, 42
ACCRUAL ACCOUNTING............................................15, 18, 39
ACCRUAL METHOD.................................7, 11, 13, 14, 24, 25, 34
ACCRUED EXPENSES......................................................
ACCUMULATED DEPRECIATION ACCOUNT......................................
ACQUIRING PROPERTY THROUGH THE SALE LEASEBACK.........................
ACQUISITION COST......................................................
ACRS
45, 60
ACTIVE INCOME.........................................................
ACTUAL ASSESSMENT....................................................
ACTUARIAL MORTGAGE SECURITY..........................................
ADDITIONAL RENT...................................37, 276, 277, 280, 281
ADJUSTABLE RATE MORTGAGE........................................207, 273
ADJUSTED BASIS.......44, 52, 54, 55, 59, 62, 67, 128, 132, 213, 216, 231,
252, 273
ADJUSTMENT (APPORTIONMENT) SCHEDULE..................................
ADMINISTRATIVE APPEAL................................................
ADMINISTRATIVE CODE TITLE 20.........................................
ADMINISTRATIVE DETERMINATION.........................................
ADVANCES TO OFFICERS..................................................
ADVERSE POSSESSION...................................................
AESTHETIC UNIQUENESS.................................................
AFFIDAVIT OF ENTITLEMENT.............................................
AFFIRMATIVE COVENANTS................................................
AFFIRMATIVE INSURANCE OF CONTIGUITY..................................
AGGLOMERATION........................................................
AGRIBUSINESS 163, 165

83

ALLOCATION OF CAPITALIZED COSTS TO COMPONENTS OF A PROJECT............

ALLOCATION OF INCOME TO PARTNERS.......................................
ALLOCATION OF RENT UP COSTS...........................................
ALLOCATION OF THE COST OF AMENITIES...................................
ALLOWANCE ACCOUNT.....................................................
ALTERATIONS 18, 276, 282
ALTERNATIVE MINIMUM TAX.......................................45, 60, 68
AMENITIES
35, 79, 80, 97, 301, 314, 335
ANACONDA CLAUSE......................................................
ANNUAL PERCENTAGE RATE...............................................
APPLICATION 25, 62, 64, 73, 93-96, 101, 105, 144, 175, 204, 206,
265, 330
APPORTIONMENT...............................................25, 251, 259
APPRAISALS 13, 32, 68, 69, 111, 194, 196, 205, 228
APPROACH
36, 77, 112, 180, 228
ARBITRARY AND CAPRICIOUS..............................................
ARCHITECTURAL UNIQUENESS.............................................
ARTICLE 23 A 295
ARTICLE 23A GBL......................................................
ARTICLE 31B 257
ARTICLE 78 99
ARTICLE 7B 294, 295
ARTICLE 7c 243, 295
ARTICLE 9B 295, 297, 298
AS-OF-RIGHT 90, 95, 96, 99, 334
ASSEMBLY PLANT..............................................146-149, 178
ASSET ACCOUNT.........................................................
ASSET MANAGEMENT.............................303, 305-311, 323, 325, 328
ASSET MANAGEMENT PLAN................................................
ASSET MANAGER.......................304-306, 308-310, 313, 315, 326, 327
ASSET SECURITIZATION.................................................
ASSETS
2-6, 16-19, 24, 27, 38, 40, 43, 45, 56-58, 130, 174,
187, 193,
202, 221, 225, 226, 233, 241, 253, 258, 265, 275, 303-305,
309, 318
ASSIGNMENT 48, 70, 90, 106, 228, 230, 241, 267, 268, 270, 280,
285-288
ASSIGNMENT & SUBLETTING PROVISION....................................
ASSIGNMENT LEASE.....................................................
ASSIGNMENTS 48, 105, 288, 294
AT RISK RULES.................................................58, 59, 62
AT-RISK RULES.........................................................
ATLANTA
147, 150, 151, 168, 176, 215
ATTORNEY-IN-FACT................................................259, 260
ATTORNMENT PROVISION.................................................
AUTHORITY
118, 275, 276, 310, 325, 337
AUTHORIZED STOCK......................................................
AVERAGE EQUITY RETURN................................................
AXIAL GROWTH 81
BALANCE SHEET...........................20, 24, 28, 40, 45, 206, 311

84

BALLOON LOAN 228

BALLOON PAYMENT.................................................230, 274
BAND OF INVESTMENT METHOD............................................
BANKABLE COMMITMENT..................................................
BANKRUPTCY 73, 153, 187, 325, 336
BARGAIN AND SALE DEED WITHOUT COVENANTS.........................252, 263
BASE INDUSTRY.........................................................
BASE RENT
208, 209, 276, 281, 284
BASE YEAR
281-285, 290, 292
BASIC FINANCIAL FEASIBILITY MODEL.....................................
BASIS
2, 3, 5, 6, 8, 12, 15, 17, 19-21, 35, 36, 44-46,
52-56, 58, 59,
62-64, 66, 67, 70, 71, 73, 106, 109, 117, 128, 136, 157,
168, 183, 191, 194, 195, 197, 207, 211, 213, 218, 219, 222,
224, 230, 231, 236, 241, 276, 281, 286, 298, 301
BASIS POINTS 109, 128, 207, 219, 222, 224, 231, 236
BASIS RULES 55, 58
BEGINNING OF CONSTRUCTION.............................................
BENEFICIARY 118, 176, 263
BENEFITS OF SYNDICATION..........4, 19, 21, 31, 32, 41, 65, 97, 105, 153,
176,
177, 180, 226, 282, 283, 293
BINDER
247, 261
BLACK ACRES 244
BLACK BOOK 300
BLUE BOOK
66
BLUMBERG FORM........................................................
BOARD OF MANAGERS......1, 89, 90, 93-95, 98-100, 104, 271, 275, 278, 283,
297
BOOK VALUE OF ASSET...................................................
BOOT
72
BOSTON
140, 143, 144, 160, 169, 170, 178, 179
BOUND
11, 245, 261
BREAK BULK WAREHOUSING...............................................
BREAK EVEN ANALYSIS..............................................29, 227
BRIDGE FINANCING.....................................................
BROKER
15, 33, 79, 240, 246-248, 254, 260, 272, 282
BUILDING COSTS ......4, 8, 15, 17, 18, 22, 24-27, 37, 38, 43, 45, 60, 67,
69, 79, 80, 86-92, 96, 97-101, 103-105, 108, 110-113, 124,
128-130, 133, 146, 159-161, 167, 170, 178, 180, 183, 184,
195, 197, 211-213, 216, 220, 224, 227, 229, 232, 235,
238-242, 248, 251, 261, 268-270, 277, 279, 281-285, 289,
290, 292, 293, 294-296, 298, 301, 302, 306, 310, 313, 325,
328-333, 335, 336
BULK VARIANCE.........................................................
BULK WAREHOUSING.....................................................
BULLET LOAN 228
BUNDLE OF RIGHTS................................................111, 244
BUSINESS FAILURE RISK......1, 2, 5-7, 10, 27, 31, 32, 38, 39, 52, 56, 65,
69, 72, 81, 87, 101, 130, 142, 143, 145, 149, 154, 163,

85

165-167, 169, 170, 181, 207, 213, 216, 221, 232, 236, 252,
253, 258, 276, 289, 290, 295, 298, 303, 305-307, 309, 311,
312, 315-317, 320, 323, 328-330
BUY AND SELL AGREEMENT...............................................
BUYER'S INITIAL INVESTMENT.........................................
C CORPORATION...................................3, 5, 51, 57, 58, 63, 69
CAM
82, 130
CAMPBELL CASE.....................................................
CAP
30, 32, 44, 107, 111, 114, 116, 118, 129, 130, 137,
163, 195, 198,
204, 214, 218-220, 231, 232, 273, 281, 282, 285, 337
CAP CONTRACT 218
CAP RATE
30, 32, 44, 107, 114, 116, 118, 129, 137, 163, 195,
198, 204,
214, 218, 232, 337
CAP RATES
130, 198
CAPITAL
3, 6, 7, 18-20, 22-25, 28-31, 41, 43, 45-47, 53-58,
62, 64, 66,
81, 101, 103, 104, 129, 135, 146-148, 151, 168, 171-173,
180, 193, 194, 205, 213, 214, 219, 222, 223, 233, 236, 257,
302, 306, 308, 309, 317, 318, 325
CAPITAL ASSET....................................................56, 318
CAPITAL ASSET PRICING MODEL..........................................
CAPITAL BUDGET.............................................194, 308, 317
CAPITAL GAINS OR LOSS.................................................
CAPITAL IN EXCESS OF PAR..........................................
CAPITAL LEASE................................6, 18-20, 22-25, 43, 46, 47
CAPITAL MARKET.......................................................
CAPITAL STOCK.........................................................
CAPITALIZATION CRITERIA........................................19, 21
CAPITALIZATION METHOD........................................30, 44, 115
CAPITALIZATION OF INTEREST............................................
CAPITALIZATION RATE.....................................26, 30, 114, 203
CAPITALIZE 22, 25, 34, 41, 43, 65, 108, 118
CAPITALIZED STATEMENT..................................................
CAPITALIZING 24
CAPTURE RATE 75, 76, 85
CARRYING LOAN-UP COSTS............2, 3, 16, 20-22, 34, 49, 196, 212, 306
CASH FLOW
6, 21, 24, 29, 30, 32, 53, 78, 99, 106, 115-120, 128,
134,
136-138, 158, 191, 192-194, 197, 198, 202-205, 208, 209,
212, 214, 215, 218, 219, 223, 225, 226-228, 232, 234,
237-239, 312, 321, 322, 325, 329, 336
CASH FLOW MODEL......................................................
CASH FLOW MORTGAGE...................................................
CASH METHOD 7, 42
CASH ON CASH ........................................................
CASUALTY INSURANCE.........................................289, 290, 295
CEILING PRICE........................................................
CENSUS TRACT 85

86

CENTRAL MANUFACTURING DISTRICT FORMULA (CMD).........................

CENTRALIZATION..............................................80, 141, 142
CERCLA
269
CERTIFICATE BY THE ATTORNEY-IN-FACT..................................
CERTIFICATE OF ENDORSEMENT...........................................
CERTIFICATE OF REDUCTION.............................................
CERTIFIED FINANCIAL STATEMENT......................................
CERTIFIED PUBLIC ACCOUNTANTS...........................................
CERTIFIED REASONABLE COST (CRC)......................................
CERTIFIED RENT ROLE..................................................
CERTIFIED SURVEY.....................................................
CHAIN OF PRODUCTION .................................................
CHANGE IN MATERIAL CONDITIONS CLAUSE.................................
CHANGES IN USE........................................................
CHAPTER 11 68, 187
CHAPTER 13 30, 187, 324, 326
CHAPTER 7
32, 34, 187
CHARITABLE CONTRIBUTIONS..............................................
CHATTEL MORTGAGE.....................................................
CHICAGO
130, 131, 159, 161, 175, 177
CLA
114
CLAIMANT
255
CLEAN STATEMENT........................................................
CLEARING THE TITLE..............................................240, 254
CLOSED CONTROL CYCLE.................................................
CLOSELY HELD C CORPORATION............................................
CLOSING
11, 117, 196, 206, 235, 240, 246, 247, 249, 251-260,
262, 265,
267-270, 273
CMA
1
CMD
113
COLLAR CONTRACT......................................................
COLLATERAL ASSIGNMENT OF RENTS.......................................
COLLATERAL SECURITY..................................................
COLLATERALIZED MORTGAGE OBLIGATION...................................
COLLECTION LOSS ALLOWANCE............................................
COMBINED N.Y.S. TRANSFER TAX AFFIDAVIT.........2, 111, 140, 259, 289, 297
COMMERCIAL PROPERTY.........................................60, 207, 248
COMMISSIONS 6, 33, 59, 135, 136, 198, 204, 214, 238, 246, 247,
281,
282, 336
COMMITMENT 11, 13, 14, 32, 37, 46, 206, 227, 230-232, 240,
265-267,
271, 272
COMMITMENT FEES.......................................................
COMMON AREA MAINTENANCE..........................................82, 130
COMMON AREA MAINTENANCE (CAM)........................................
COMMON CHARGES.......................................................
COMMON ELEMENTS............................................245, 297, 298
COMMON INTEREST.................................................297, 302

87

COMMON LAW 49, 242, 277

COMMON LAW SYSTEM.....................................................
COMMON STOCK 1, 28, 30, 129
COMMUNITY ANALYSIS....................................................
COMMUNITY BOARD.....................................93, 95, 97, 100, 101
COMMUNITY BOARDS.............................................93, 94, 101
COMMUNITY CENTERS.....................................................
COMPARABLES 228, 291
COMPILATION REPORT.................................................
COMPLETED CONTRACT METHOD..............................7, 12, 38, 39, 42
COMPLETION BONDS......................................................
COMPLETION RISK......................................................
COMPLIANCE ACCOUNTING..............................................
COMPOUNDING 106, 110, 126-128, 189-191
COMPUTATION OF DEPRECIATION...........................................
COMPUTATION OF GAIN OR LOSS...........................................
CONCENTRATION.........................................141, 142, 155, 156
CONCENTRATION FACTOR............................................155, 156
CONCENTRIC GROWTH.....................................................
CONCEPT OF CAPITALIZATION.............................................
CONDEMNATION 73, 91, 109, 111, 186
CONDITIONAL NEGATIVE DECLARATION..................................
CONDOMINIUMS AND COOPERATIVES........................................
CONDUIT
5, 23, 43, 51, 326
CONFERENCE COMMITTEE EXPLANATIONS.....................................
CONSOLIDATION AGREEMENT.........................................267, 271
CONSTANT
20, 21, 115-117, 121, 128, 192, 193, 199, 200, 228,
229, 331
CONSTRUCTION BUDGET..................................................
CONSTRUCTION LOAN..........37, 47, 107, 125, 183, 186, 196, 227, 228, 232
CONSTRUCTION MORTGAGE.............................................
CONSUMER'S PRICE INDEX ESCALATION (CPI)..............................
CONSUMMATION OF SALE..............................................
CONTINUING INVESTMENT CRITERIA....................................
CONTINUING INVESTMENT CRITERIA FOR ACCRUAL METHOD.....................
CONTRACT PERIOD........7, 11, 12, 38, 39, 42, 71, 129, 136, 185-187, 211,
218,
223, 232, 240, 242, 244-251, 253-258, 267, 269, 271, 272,
276, 280, 287, 294, 312, 313, 331
CONTROL ACCOUNTING.................................................
CONVERTIBLE MORTGAGE.................................................
COOPERATIVE AND CONDOMINIUM ABUSE PREVENTION ACT.....................
CORE & SHELL 195
CORPORATE JOINT VENTURES...............................................
CORPORATE STANDARD OF LIVING.........................................
CORPORATION 3, 5, 6, 24, 25, 28, 30, 38, 41, 43, 51-54, 56-58,
63-67,
69, 92, 100, 188, 211, 236, 241, 249, 252, 253, 268, 271,
275, 314-316, 323, 324, 326
CORPORATION NEGATIVES..................................................

88

CORPORATION POSITIVES..................................................
CORRECTION DEED.................................................245, 269
COST APPROACH........................................................
COST BASIS 3, 15, 17, 195
COST METHOD 1, 2, 217
COST OF OCCUPANCY RATIO..............................................
COST PLUS
157, 331
COST RECOVERY METHOD..................................................
COURT TESTIMONY......................................................
COVENANT OF SEIZIN.........................................252, 263, 270
COVERAGE
82, 116, 128, 188, 228, 289
CPA
1, 7, 8, 61
CRC
293
CREATOR
118
CREDIT ANALYSIS.................................................224, 226
CREDIT ENHANCEMENT...................................................
CREDIT LINE MORTGAGE CERTIFICATE.....................................
CUMULATIVE PREFERENTIAL RETURN.......................................
CUOMO TAX
253, 257
CURRENT ASSETS....................................................
CURRENT COUPON.......................................................
CURRENT LIABILITIES...................................................
DALLAS
130, 160, 161, 168-170, 174-176
DATE OF SALE 68
DCF
116, 124, 329
DEALERS IN REAL ESTATE................................................
DEBENTURE
203
DEBT CAPACITY........................................................
DEBT CAPITAL 6, 41
DEBT COVERAGE RATIO...................................................
DEBT SERVICE COVERAGE...........................................116, 228
DEBT SERVICE RATIO...................................................
DECISION TREE OF PROFIT RECOGNITION.......11, 28, 89, 94, 95, 97-99, 102,
104, 162, 183, 226, 279, 317, 318, 322, 325
DECLINING BALANCE..................................................
DEDUCTION OF INTEREST.................................................
DEDUCTIONS 47, 54, 60, 63-66, 301
DEED
3, 68, 185, 187, 241, 245, 248, 249, 252, 256,
258-260, 262-264,
267, 269, 296
DEFAULT
13, 14, 106, 186, 187, 204, 205, 237, 254, 266, 270,
276, 336
DEFAULT PROVISION....................................................
DEFEASANCE 187
DEFERMENT OR AMORTIZEMENT OF PROFIT ON A SALE LEASEBACK...............
DEFERRED DEVELOPMENT AND MORTGAGE COST...............21, 27, 36, 46, 127
DEFICIENCY JUDGMENT..................................................
DEFICIT ACCUMULATED DURING DEVELOPMENT STAGE..........................
DELIVERY OF POSSESSION OF THE SPACE.........101, 197, 255, 263, 279, 285,
317

89

DEMISED PREMISES...........................................277, 286, 290

DEMISING WALL........................................................
DEPOSIT ON PROPERTY...................................................
DEPRECIATION 3, 8-10, 17, 18, 25, 29, 31, 32, 43-45, 47, 49, 54-56,
58,
60, 65, 67, 68, 73, 111-113, 192, 193, 213, 214, 216, 238,
282, 315, 322
DETERMINING PROPER METHOD OF PROFIT RECOGNITION.......................
DETERMINING SALES VALUE...............................................
DEVELOPMENT PLANNING CYCLE...........................................
DEVELOPMENT STAGE COMPANY.............................................
DEVELOPMENT TEAM.....................................................
DIRECT ACQUISITION COSTS..............................................
DIRECT CAPITALIZATION METHOD.........................................
DIRECT FINANCING LEASE........................................20, 21, 23
DIRECT METERING......................................................
DISAGGREGATION........................................................
DISCOUNT RATE........13, 20, 109, 124, 127, 131, 133, 135, 137, 138, 188,
197,
203-207, 216, 217, 218, 222
DISCOUNTED CASH FLOW...............................32, 53, 116, 117, 204
DISCOUNTED CASH FLOW (DCF)...........................................
DISCOUNTING 129, 133, 189
DISCRETIONARY RELIEF..............................................
DISINTERMEDIATION...............................................224, 225
DISPLAY
146, 147, 192
DISPOSITION 15, 35, 53, 55, 56, 60, 62, 63, 66, 71, 303, 307
DISTRIBUTION 43, 80, 146-150, 180, 187, 313, 315
DISTRIBUTION PLANTS..................................................
DIVERSIFICATION........................................168-170, 219, 312
DIVISION OF LABOR........................10, 69, 140, 141, 243, 303, 326
DOCTRINE OF INDEPENDENT COVENANTS....................................
DONATIONS VALUE.......................................................
DORMANT MORTGAGE.....................................................
DOUBLE DECLINING BALANCE...........................................
DOUBLE NET LEASE.....................................................
DOWNZONING 90
DRAGNET CLAUSE.......................................................
DUCK TEST
19
DUE ON SALE CLAUSE.........................................230, 266, 272
E.P.S.
27
EARNINGS PER SHARE...................2, 11, 15, 27, 28, 30, 58, 221, 303
EASEMENT
92, 185, 244
ECONOMIC RECOVERY TAX ACT........3, 8, 9, 16, 18, 19, 22, 25, 44, 45, 60,
76,
77, 79, 81, 86, 90, 92, 96, 139, 140, 142-144, 146,
156-158, 163, 168-170, 173, 174, 176, 180, 184, 230, 232, 322
EFFECTIVE GROSS INCOME (EGI).........................................
EGI
114
ELECTION TO CHANGE TO AN S CORPORATION.......................51, 70, 187

90

ELECTRICITY PROVISION................................................
ELLWOOD FORMULA.................................................115, 116
ELLWOOD FORMULA (FAN GRAPH)..........................................
EMERGENCY REPAIR LIEN................................................
EMERGENCY TENANT PROTECTION ACT (ETPA)...............................
ENCUMBRANCE 248, 254, 258
ENGINEER'S REPORT....................................................
ENTITY
3-6, 10, 26, 27, 29, 43, 53, 57, 64, 65, 68-70, 106,
185, 258,
274, 276, 335
ENVIRONMENTAL ASSESSMENT FORM........................................
ENVIRONMENTAL REVIEW........................................98, 100, 101
ENVIRONMENTAL REVIEW PROCESS..........................................
EQUAL PERCENTAGE METHOD..............................................
EQUITY
1-3, 6, 28, 30, 40, 41, 66, 90, 107, 115-117, 121,
125-128, 138,
183, 184, 187, 188, 191-193, 197-199, 203, 205, 219-226,
232, 237-239, 250, 257, 271, 273, 274, 307, 325
EQUITY DIVIDEND......................................................
EQUITY INTEREST........................................................
EQUITY KICKER LOAN...................................................
EQUITY METHOD.......................................................
EQUITY METHOD OF ACCOUNTING............................................
EQUITY OF REDEMPTION.................................................
ERTA
45
ESCALATIONS 18, 194, 276, 281, 282, 285, 287
ESCROW PROVISION RIDER...............................................
ESTIMATED LIFE SPAN....................................................
ESTIMATED USEFUL LIFE..........................................8, 10, 21
ESTOPPEL CERTIFICATE..................................250, 269, 270, 288
ETHICS IN REAL ESTATE................................................
EUCLID V. AMBLER..............................................89, 95, 97
EVALUATION 31, 33, 156, 197, 203, 204, 216, 217, 226, 237
EVICTION PLAN..........................................185, 241, 299
EXCEPTIONS 3, 8, 9, 31, 44, 51, 73, 90, 247, 252, 258, 260, 302
EXCHANGE OF LIKE-KIND PROPERTY .........3, 11, 53, 64, 72, 73, 115, 126,
141,
160, 211, 219
EXCLUSIVE AGENCY LISTING.............................................
EXCLUSIVE RIGHT TO SELL..............................................
EXCULPATION CLAUSE.........................................265, 271, 272
EXCULPATORY 37, 241, 265, 271, 272, 275
EXCULPATORY PROVISIONS...............................................
EXISTING STRUCTURE......12, 14, 24, 33, 48, 75, 76, 79, 96, 97, 163, 183,
241, 249, 250, 278, 306, 311, 319
EXPENSE STOPS...................................................194, 208
EXPENSED AS INCURRED ......................................24, 27, 33
EXPENSES
2, 3, 6, 7, 9, 10, 16, 18, 25, 26, 28, 29, 31-34, 37,
63, 66,
82, 87, 103, 104, 114, 123, 124, 128, 133, 192, 196, 198,

91

200-203, 205, 206, 208, 209, 213, 214, 215, 218, 227-229,
235, 251, 252, 277, 278, 281, 282, 290, 312, 337
EXPENSING
24, 45
EXTERNALITIES.........................................................
FABRICATION 81, 146-148
FACILITIES MANAGEMENT...........................................305, 319
FAIR MARKET VALUE.....................................15, 20, 35, 36, 53
FAIR MARKET VALUE METHOD..............................................
FAIR PRACTICES ACT...................................................
FAIR VALUE 19, 22, 35, 46, 297
FAIR VALUE METHOD....................................................
FANNIE MAE 205, 233
FAR
89, 92, 104, 108, 112, 130, 151, 172, 194, 202, 266,
270, 330, 334, 335
FASB
1, 3, 11, 13, 15, 17, 18, 20, 26, 30, 32, 34, 38, 42,
46, 47, 51
FASB 66
3, 11, 13, 20, 32
FEDERAL FUNDS RATE...................................................
FEDERAL HOME LOAN BANK BOND INDEX....................................
FEDERAL RESERVE REGULATION Q.........................................
FEDERAL RESERVE REGULATION THREE.....................................
FEE SIMPLE INTEREST .................................................
FEE-SIMPLE 111, 185
FEE-SIMPLE ABSOLUTE ESTATE...........................................
FHLMC
205
FIFTH AMENDMENT.......................................................
FINANCIAL ACCOUNTING ..............................1, 17, 18, 24, 29, 30
FINANCIAL ANALYSIS....................................183, 184, 204, 226
FINANCIAL INTERMEDIARIES........................................221, 222
FINANCIAL PROJECTIONS................................................
FINANCIAL REPORTING...............................................
FINANCIAL STATEMENT.........................7, 8, 10, 16, 24, 38, 40, 44
FINANCIAL STATEMENTS.....................1, 2, 7, 8, 10, 29, 30, 44, 186
FINANCING EXPENDITURES................................................
FINANCING REVENUE.....................................................
FINANCING STATEMENT.............................................266, 268
FINANCING THE DEVELOPMENT.............................................
FIRPTA
69, 259
FIVE P'S OF CREDIT ANALYSIS..........................................
FIXED
25, 29, 38, 123, 200-202, 205, 211, 212, 218, 219,
224, 225, 230,
231, 251, 273, 303, 317, 331
FIXED AND VARIABLE EXPENSES...........................................
FIXED ASSET 25, 38
FIXED CORPORATE FACILITY.............................................
FIXED OPERATING EXPENSES.............................................
FIXED PRICE CONTRACT.................................................
FIXED RATE MORTGAGE.............................................230, 273
FIXTURES
195, 244, 254, 268, 270
FLEX SPACE 148, 207

92

FLOATING RATE MORTGAGE...........................177, 219, 225, 230, 231

FLOOD CERTIFICATION..................................................
FNMA
205
FORCE MAJEURE........................................................
FORECLOSURE 72, 73, 125, 187, 195, 237, 248, 265, 266, 269-271,
274, 296
FOREIGN INVESTORS REAL PROPERTY TAX ACT..............................
FOREIGN INVESTORS REPORTING TAX ACT (FIRPTA)..........................
FORGIVENESS OF DEBT...................................................
FORMING A CONDO OR COOP..............................................
FORMULA FOR PROFIT RECOGNITION (P.O.C. METHOD)........................
FORMULA FOR TAXABLE GAIN OR LOSS......................................
FORMULA FOR TAXABLE INCOME...........................................
FOUR UNITIES 264
FRANK RUSSEL REPORT..................................................
FREDDIE MAC 205, 233
FREE & CLEAR EVALUATION..............................................
FREE AND CLEAR RETURN.................................185, 199, 250, 263
FREEHOLD ESTATE......................................................
FULL ACCRUAL METHOD...............................................
FULL CONSOLIDATION METHOD..............................................
FUNCTIONAL CORPORATE STRUCTURE.......................................
FUNCTIONAL ORGANIZATION..............................................
FUNCTIONS OF MANAGEMENT..............................................
FUNDING COMPANY......................................................
FUTURE VALUE 122, 124-126, 128, 183, 188, 189
FUTURE WORTH 118, 127, 128
GAAP
1, 2, 7, 8, 17, 27, 34, 42-44
GAME THEORY 324
GENERAL AND ADMINISTRATIVE COSTS.....................................
GENERAL LIABILITY AND PROPERTY DAMAGE INSURANCE PROVISION............
GENERAL PARTNER........................................4, 5, 15, 64, 274
GENERAL PARTNERSHIP....................................................
GENERAL PARTNERSHIP NEGATIVES..........................................
GENERAL PARTNERSHIP POSITIVES..........................................
GENERAL RULE 2, 3, 14, 34, 68, 250
GENERAL WARRANTEE DEED...............................................
GIM
114
GINNIE MAE 233, 234
GOING CONCERN.........................................................
GOLDMAN-DELORENZO....................................................
GOOD AND MARKETABLE TITLE.............................113, 185, 252, 263
GRANTEE
185, 263
GRANTOR
100, 185, 263
GREEN BOOK 93
GROSS INCOME MULTIPLIER (GIM)........................................
GROSS LEASE 82
GROSS PROFIT RATIO....................................................
GROSS VOLUME OF EXPECTANCY............................................
GROUND LEASE 111, 275, 279

93

GUARANTEED INVESTMENT CONTRACT (GIC).................................

GUARANTEED MAXIMUM PRICE.............................................
HARD COSTS 195, 196
HARDSHIP
99, 104
HAWAIIAN TECHNIQUE...................................................
HAZARD INSURANCE / CONDEMNATION CLAUSE...............................
HEDGE
212, 225
HI-CUBE SPACE........................................................
HIGHEST AND BEST USE..........................76, 78, 111, 129, 168, 176
HOTEL/MOTEL 207
HOW TO OWN PROPERTY....................................................
HOWARD GELBTUCH.................................................113, 129
HUGH KELLY'S THEORY..................................................
IMPROVEMENT COST.....................................................
IMPUTED INTEREST.....................................23, 31, 43, 71, 203
INCLUSIONARY HOUSING BONUS............................................
INCOME
2-11, 15, 20-22, 24, 26, 27, 29-32, 37-39, 42-44, 46,
48, 49,
51, 53, 54, 57, 58-60, 62-66, 68, 69, 71, 73, 75, 78, 79,
82, 84, 85, 87, 97, 106, 107, 112, 114, 115, 118, 121, 123,
132, 134, 136, 142, 143, 151, 157, 159, 162, 163, 165, 166,
177, 189, 191-194, 196, 198, 200-209, 212-215, 217, 219,
220, 227, 233, 237, 270, 272, 284, 291, 301, 308, 309, 311,
312, 315, 322, 329
INCOME AND EXPENSE BUDGET............................................
INCOME APPROACH......................................................
INCOME RATIO 205
INCOME STATEMENT.................................9, 24, 39, 42, 220, 312
INDICATED VALUE.................................................108, 112
INDIRECT ACQUISITION COSTS...........................21, 33, 34, 37, 196
INDUSTRIAL 37, 82, 86, 105, 113, 130, 131, 142, 144-148, 150,
157, 168,
170, 172, 173, 178, 181, 207, 298, 306, 323
INDUSTRIAL / COMMERCIAL INCENTIVE PROGRAM............................
INDUSTRIAL PROPERTY.........................................144-146, 150
INITIAL CAP RATE.....................................................
INITIAL CAPITAL CONTRIBUTIONS..........................................
INITIAL INVESTMENT.................................................
INITIAL INVESTMENT CRITERIA...........................................
INSOLVENCY 73
INSOLVENT
73, 74, 325
INSPECTION REPORTS...................................................
INSTALLMENT METHOD......................................7, 14, 42, 70
INSTALLMENT SALE......................................................
INSTITUTIONAL .......................................................
INSURANCE PROVISION..................................................
INTEREST COSTS CAPITALIZATION.......1-5, 7, 13-16, 20, 23, 25-27, 29
34,
37, 40, 41, 43, 46, 47, 55-59, 63, 64, 66, 68, 70-72, 80,
92, 104, 106, 109-111, 115, 116, 118-125, 127, 128, 143,

94

153, 157, 167,

203, 205, 206,
228, 230, 231,
255, 263-268,

174,
207,
234,
270,

179,
212,
235,
271,

181, 186-192, 195, 196, 199, 200,

213, 216, 218, 219, 222-225, 227,
236-238, 241, 244, 248, 250, 252,
273-275, 278, 279, 288, 297, 301,
302, 311, 318, 329
INTERIM MULTIPLE DWELLING ACT (IMD)..................................
INTERNAL OVERHEAD........5, 33, 34, 42, 48, 49, 60, 78, 99, 115-117, 127,
134,
138, 141, 157, 158, 174, 183, 190, 191, 206, 223, 226, 326
INTERPLEADER 255
INVENTORY
7, 15, 25-27, 42, 56, 68, 71, 72, 76, 79, 150, 154,
160, 162,
163, 221
INVESTING EXPENDITURES................................................
INVESTING REVENUE.....................................................
INVESTMENT ANALYSIS............................75, 77, 78, 184, 204, 207
INVESTMENT ENTITIES...................................................
INVESTMENT VALUE................................................195, 217
ISSUED AND OUTSTANDING................................................
J-51
104, 105, 293, 294, 301
J-51 PROGRAM105
JOB GROWTH 143, 148-150, 163
JOINT CONTROL..........................................................
JOINT TENANT 264
JOINT VENTURE......................................1-3, 41, 43, 223, 329
JUDICIAL REVIEW.......................................................
K-1
4, 5, 58, 63-65
KANSAS CITY 164, 165, 177
L.B.O.
324
LABOR THEORY OF VALUE................................................
LAND AND ACQUISITION COSTS..........9, 15, 22, 33, 45, 82, 107, 108, 111,
185,
195, 216, 243, 282, 303
LAND ASSETS 19
LANDAUER MOMENTUM INDEX....................................143, 154, 181
LANDMARK
89, 91, 92, 96, 97, 101, 102, 202, 331
LANDMARKS COMMISSION................................91, 92, 97, 101, 102
LATE FEES CLAUSE.....................................................
LEAD AGENCY 100
LEASE
6, 10, 18-26, 32, 36, 43, 46, 47, 75, 80, 82, 92, 108,
109, 111,
124, 128, 129, 130, 132, 133, 135, 136, 185, 194, 196, 208,
214, 217, 220, 225, 227, 229, 236, 237, 241, 248, 262, 269,
275-281, 284-291, 294-297, 302, 314, 329, 335-337
LEASE ANALYSIS.............................................132, 135, 136
LEASE BY LEASE ANALYSIS..............................................
LEASE PROVISIONS INVOLVING REAL ESTATE................................
LEASE-UP RESERVE................................................196, 225
LEASED FEE 111, 125
LEASEHOLD
18, 29, 108, 109, 111, 125, 135, 185, 220, 244, 274,

95

275,
278, 279, 297, 298
LEASEHOLD ESTATE................................................109, 185
LEASEHOLD INTEREST..............................................244, 274
LEASING
19, 40, 43, 118, 135, 136, 198, 208, 210, 212, 214,
228, 246,
248, 274, 275, 281, 285, 288, 314, 323, 328, 332, 335
LEASING BROKER.......................................................
LESSOR ACCOUNTING.............................................20, 22, 23
LETTER OF COMMITMENT............................................240, 267
LEVERAGE
124, 126, 127, 199-201
LEVERAGED BUY OUT....................................................
LEVERAGED LEASE....................................................
LIABILITY

2-6, 19, 24, 27, 28, 37, 40, 45, 47, 52-54, 188, 265,
267,
269, 272, 275, 286, 289, 291
LIBOR
218, 219, 222, 225, 228, 230, 231
LIBOR OPTION 222
LICENSE
185, 244, 275, 276
LIEN
12, 14, 38, 186, 232, 233, 237, 248, 250, 251, 253,
254, 264, 266,
273, 274, 275, 279, 284
LIEN PRIORITY........................................................
LIEN THEORY STATE....................................................
LIEN THEORY STATES..............................................264, 275
LIEN WAIVERS 186
LIKE-KIND EXCHANGE....................................................
LIMITED COMMON ELEMENTS..............................................
LIMITED PARTNER.....................................................
LIMITED PARTNERSHIP NEGATIVES..........................................
LIMITED PARTNERSHIP POSITIVES .........................................
LIMITING CONDITIONS OF AN APPRAISAL...............79, 113, 179, 219, 286
LINE OF BUSINESS................................................305, 323
LIQUID
27, 233, 325
LIQUIDATION VALUE....................................................
LOAN APPLICATIONS....................................................
LOAN BALANCE 125-128
LOAN RATIO 116, 128
LOAN REVIEW PACKAGE..................................................
LOAN TO VALUE (LTV)..................................................
LOAN TO VALUE RATIO...................................225, 227, 228, 235
LOCATION QUOTIENT.........72, 79, 81, 86-88, 92, 93, 105, 109, 111, 129,
139,
141, 144, 147-150, 156, 157, 158, 271, 327, 333, 334
LOCUS SIGILLI........................................................
LOFT LAW
293, 295
LOLLIPOP CONDOMINIUMS................................................
LONDON INTERBANK OFFERING RATE ......................................

96

LONG RANGE STRATEGY..................................................

LONG TERM ASSET.......................................................
LONG TERM LIABILITY...................................................
LONG TERM LOSS OR GAIN................................................
LOOK BACK INTERNAL RATE OF RETURN....................................
LOS ANGELES 81, 160, 170, 172, 173, 179
LOSS FACTOR 276
LOT LINE WINDOWS.....................................................
LUMP SUM CONTRACT...............................................285, 331
MACROECONOMICS.......................................................
MACRS
45, 60
MADSEN'S RULE...................................................117, 135
MAJOR CAPITAL IMPROVEMENT INCREASE...................................
MANAGEMENT AGREEMENT............................................312, 313
MANAGEMENT CONTROL.....................................305, 306, 308
MANAGEMENT DISCUSSION OF OPERATIONS..................................
MANAGERIAL ACCOUNTING...................................2, 1, 29, 31, 42
MANHATTAN
97, 110, 113, 152, 153, 155, 156, 216, 293, 334
MANSION TAX 257, 259
MARKET ANALYSIS......................................75, 76, 78, 86, 215
MARKET APPROACH......................................................
MARKET VALUE RIDER...................................................
MARKETABILITY ....................................................
MARKETABILITY ANALYSIS................................................
MASTER LIMITED PARTNERSHIP...........................................
MATCHING PRINCIPLE......................................7, 8, 25, 31, 57
MATERIAL
10, 25, 231, 240, 253, 268, 272, 274
MATRIX
159, 162, 308, 311, 316
MAXIMUM BASE RENTAL FORM (MBR).......................................
MAXIMUM LOAN FORMULA............................................188, 193
McGAFFNEY PROCESS.....................................................
McKINNEY'S, CONSOLIDATED LAW EDITION.................................
MEANS COST ESTIMATES.................................................
MEDIUM OF EXCHANGE...................................................
MEDIUM STREET........................................................
MEMORANDUM OF THE CONTRACT...........................................
MERCHANT BUILDER ....................................................
METE
245
MIAMI
153, 154
MICRO ANALYSIS.......................................................
MICROECONOMICS.......................................................
MINI-PERM FINANCING..................................................
MINNEAPOLIS 131, 159, 160, 164
MINOR PORTION.........................................................
MODEL
82, 162, 194, 317, 318
MODIFIED ACCELERATED COST REDUCTION SYSTEM........................
MONETARY DEFAULT.................................143, 178, 270, 274, 286
MONTREAL
152
MORTGAGE PAYMENT......14, 15, 23, 27, 32, 37, 40, 46, 47, 52, 53, 59, 62,
66, 67, 71, 73, 103, 111, 124, 125, 127, 128, 134, 143,

97

174, 186-188, 192-194, 198-200, 202, 203, 205, 207,

219-223, 227, 230, 232, 234-239, 244, 245, 248-250, 252,
256, 257, 258, 264-275, 278-280, 290, 296, 297, 301, 302
MORTGAGES PAYABLE, CURRENT............................................
MULTIPLE LISTING SERVICES.......47, 80, 81, 161, 175, 237, 242, 247, 259,
291, 293, 297, 333
MULTIPLIER EFFECT....................................................
NARROW STREET...................................................332, 333
NATURALISTIC FALLACY.................................................
NEGATIVE COVENANTS.........51, 96, 98-100, 133, 186, 191, 199, 200, 268,
273, 321
NEIGHBORHOOD CENTERS..................................................
NET INCOME 2, 6, 37, 58, 59, 106, 107, 165, 192, 193, 213, 214,
315, 322
NET LEASE
82, 236, 290
NET OPERATING INCOME........29, 30, 44, 82, 114, 118, 123, 134, 157, 200,
201, 215
NET OPERATING INCOME (NOI)...................................30, 82, 114
NET REALIZABLE VALUE...................................15-17, 25, 33, 34
NET REALIZABLE VALUE ALLOWANCE........................................
NET SALES PROCEEDS...................................................
NO-PAR VALUE STOCK....................................................
NOI
30, 31, 44, 82, 108, 111, 113-118, 122, 128, 129, 133,
134, 137,
198, 199, 201, 204, 209, 214, 218, 220, 228, 237, 238
NOLLAN V. STATE OF CALIFORNIA COASTAL COMMISSION......................
NON RECOURSE DEBT.....................................................
NON-CLAIMEE 255
NON-DISCRETIONARY APPROVAL............................................
NON-DISTURBANCE AGREEMENT............................................
NON-EVICTION PLAN...........................................241, 299
NON-POSSESSORY RIGHTS................................................
NON-RECOURSE DEBT.........................................58, 59, 66, 73
NON-RECOURSE LOAN................................................66, 265
NON-TAXABLE TRANSACTIONS..............................................
NOTARIZATION 271
NOTE
4, 12, 15, 27, 40, 71, 86, 106, 127, 149, 155, 161,
187, 208, 232,
236, 249, 253, 265-268, 272, 275, 337
NOTES RECEIVABLE..................................................
NOVATION
241, 286
OAR
116, 117, 121, 124, 128
OCCUPATIONAL RATIO..............................................148, 149
OCCUPATIONAL RESIDUAL................................................
OCR
114
OFFERING PLAN.................111, 126, 222, 223, 241, 274, 297, 299
OMNIBUS AGREEMENT....................................................
OOPS AFFIDAVIT.......................................................
OPEN LISTING 247
OPEN MARKET OPERATION................................................

98

OPERATING EXPENDITURES................................................
OPERATING EXPENSES......9, 29, 31, 82, 192, 198, 200, 202, 205, 208, 209,
215, 218, 228, 229, 281, 282, 290, 337
OPERATING LEASE........................................18-23, 36, 43, 46
OPERATING LEVERAGE...................................................
OPERATING PLAN.............................................304, 309, 317
OPERATING REVENUE.....................................................
OPERATIONS PLANNING AND BUDGETING CYCLE..............................
OPPORTUNITY COST.....................................................
ORDINARY GAINS OR LOSS.........................................24, 55
ORIGINAL BASIS..........................21-23, 25, 55, 67, 213, 257, 277
OTHER ASSETS 27, 38, 45, 221, 265, 275
OVERAGE
157, 208
OVERALL CAPITALIZATION RATE (OCR)....................................
OVERALL RATE (OAR)...................................................
OVERFLOW EFFECT......................................................
OVERHEAD
29, 33, 34, 140, 197, 282, 315
OWNERSHIP
3, 4, 6, 11, 12, 14, 19, 22, 43, 55, 64, 72, 111, 185,
188,
244, 264, 297, 298, 307
PACIFIC RIM 171-173
PAID IN SURPLUS...................................................
PAR VALUE
28, 30
PARTICIPATIONS..................................................225, 237
PARTNERSHIP 3-6, 10, 15, 41-43, 51-54, 58, 64-66, 69, 72, 188,
226,
253, 274, 335
PARTNERSHIP VS. S CORPORATION.........................................
PASS THROUGH SECURITIES.........................................233, 234
PASSIVE INCOME.............................................3, 42, 59, 60
PASSIVE LOSS AND AT RISK RULES........................................
PASSIVE LOSS RULES.................................55, 59, 62-64, 69, 73
PASSIVE LOSSES.................................3, 41, 42, 58, 60, 64, 68
PASSIVE PARTNER........................................................
PAYMENT BONDS.........................................................
PAYMENT TO INCOME RATIO..............................................
PAYOFF LETTER...................................................240, 256
PENN CENTRAL V. NEW YORK CITY.........................................
PENNSYLVANIA COAL V. MAHAN............................................
PENNY FOR PENNY......................................................
PERCENTAGE OF COMPLETION METHOD........................7, 15, 38, 39, 42
PERCENTAGE RENT.................................................194, 208
PERFORMING NON-PERFORMING LOAN.......................................
PERIOD OF INTEREST CAPITALIZATION.....................................
PERMANENT LOAN...........................................13, 14, 37, 230
PERSONAL PROPERTY.......4, 5, 31, 37, 38, 52, 55, 56, 58, 65, 68, 70, 72,
80,
132, 188, 213, 216, 254, 265, 270
PHASE IN RULES........................................................
PHASE ONE REPORT.....................................................

99

PITTSBURGH 144, 145, 178

PLANNING COMMISSION.......33, 60, 89, 90, 93-95, 100, 101, 159, 184, 213,
232, 303, 308, 309, 317
PLATE GLASS INSURANCE................................................
PLEDGE AGREEMENT ....................................................
POCKET PART 261
POINT IN TIME................................51, 113, 167, 180, 272, 299
POINT SYSTEM 206
POINTS
29, 37, 41, 97, 109, 117, 128, 137, 140, 159, 170,
206, 207,
213, 219, 222, 224, 231, 236, 242, 265, 283, 284, 311
POPULATION CENTROID..................................................
PORTER'S WAGE INCREASES...............................194, 276, 281, 283
POSITIVE LEVERAGE.....................21, 64, 96, 98, 178, 199, 200, 321
POSSESSORY RIGHTS....................................................
POWER OF ATTORNEY...........................................49, 259, 260
PRE-CERTIFICATION.....................................................
PREACQUISITION....................................................
PREFERRED RETURN.....................................................
PREMIUM
65, 107, 109, 159, 197, 205, 252, 258, 272, 290
PREPAYMENT 186, 187, 225, 230, 234, 256, 266, 271-273, 281
PREPAYMENT CLAUSE....................................................
PREPAYMENT PENALTY CLAUSE............................................
PRESENT VALUE.........13, 19-22, 32, 40, 44, 46, 78, 109, 122, 124, 128,
129,
133, 134, 183, 187, 188-190, 193, 194, 198, 204, 225, 236,
237, 239, 326
PRESENT WORTH....................................118, 124, 127, 188, 217
PRIMARY DATA 77, 184
PRIME OPTION 222
PRINCIPAL AND INTEREST CLAUSE........................................
PRISONER'S DILEMMA...................................................
PRIVATE ACTIVITY BONDS................................................
PRIVATE PLACEMENT...............................................241, 274
PRIVATE PLACEMENT MEMORANDUM.........................................
PRIVITY
286, 287, 290
PRO FORMA
191-193, 210, 329
PRO-RATED
17, 278
PROFIT CENTER........................................................
PROFIT RECOGNITION........................................11, 14, 20, 39
PROJECT LOAN AGREEMENT...............................................
PROPENSITY TO SPEND...................................................
PROPORTIONATE CONSOLIDATION METHOD.....................................
PROPOSITION U........................................................
PROPRIETARY LEASE....................................................
PROPRIETORSHIP.........................................................
PROPRIETORSHIP NEGATIVES...............................................
PROPRIETORSHIP POSITIVES...............................................
PROSPECTUS 194, 241, 274, 299
PUBLICLY TRADED PARTNERSHIP (PTP)................................64, 202

100

PURCHASE MONEY MORTGAGE......13, 19, 22, 32, 33, 41, 64, 66, 67, 84, 103,
111, 127, 138, 171, 183, 187, 205, 210, 213, 214, 218, 229,
238, 246-250, 253, 254, 256, 257, 300, 301, 311
PUT / CALL 229
QUALIFICATIONS FOR INSOLVENCY.........................................
QUALIFIED NON-RECOURSE DEBT.......................................
QUALIFYING ASSET......................................................
QUIET TITLE ACTION...................................................
QUIT-CLAIM DEED......................................................
QUITCLAIM DEED.............................................185, 252, 263
QUIZ
121, 133, 147
R&D BALANCE 148
RANKING SYSTEM.......................................................
RATIFY
287
REAL ESTATE ESCALATIONS..........................................18, 281
REAL ESTATE INVESTMENT TRUSTS..............................202, 221, 226
REAL ESTATE SETTLEMENT AND PROCEDURES ACT (RESPA)....................
REAL ESTATE TAX ESCALATION...........................................
REAL ESTATE TAXATION ................................................
REAL PROPERTY.......17, 56, 62, 65, 66, 71, 105, 139, 183, 186, 216, 242,
248, 253, 258, 259, 261, 274, 291, 292, 295-298
REALIZED GAIN .......................................48, 70-73, 174, 257
REASSESSMENT 292, 304
REBNY FORM 275
RECAPTURE
286
RECOGNITION OF GAIN OR LOSS...........................................
RECOGNIZED GAIN...................................................
RECONCILIATION APPROACH..............................................
RECORD OF SALE........................................................
RECORDING CHARGE.....................................................
RECORDING OF ASSETS AND LIABILITIES WITH A CAPITAL LEASE..............
RECREATIONAL 207
RED HERRING 300
REDEMPTION 187
REDLINING
206
REDUCED PROFIT METHOD.................................................
REFINANCING 123, 195, 208, 228, 237, 307
REGIONAL ECONOMICS.........36, 76, 83, 130, 139, 152, 160, 168, 174, 175,
205,
207, 305
REGULAR TAX 68
REGULATORY ACCOUNTING.................................................
REHABILITATION...............................................36, 69, 146
REILLY'S LAW 84
REIT
202, 203
RELATIVE FAIR MARKET VALUE..........35, 36, 117, 129, 132, 144, 148, 150,
170,
178, 198, 236, 244, 278, 301, 317
RENT CONTROL 103, 183, 294

101

RENT CONTROLLED APARTMENT............................................

RENT GUIDELINES BOARD...........................................103, 294
RENT INCLUSION.............................................276, 288, 289
RENT REGULATION.................................................102, 241
RENT STABILIZATION..........................................91, 103, 294
RENT STABILIZATION ASSOCIATION.......................................
RENT STABILIZED APARTMENT............................................
RENT UP DEFICIT......................................................
RENTABLE SQUARE FOOTAGE..........................208, 220, 276, 281, 320
RENTAL INSURANCE.....................................................
REPORTS
3, 20, 93, 131, 139, 143, 184, 243, 259, 261, 262
REPRESENTATION..............................101, 149, 248, 272, 279, 288
REQUIREMENT OF LAW CLAUSE............................................
RESEARCH AND DEVELOPMENT.........32, 48, 61, 84, 131, 140, 143, 145
156,
171, 184, 185, 207, 260-262, 305, 315
RESERVE FUND 302
RESERVE FUND LAW.....................................................
RESIDENTIAL PROPERTY........................................60, 207, 273
RESIDUAL VALUE......8, 9, 20, 21, 108, 139, 155, 156, 166, 174, 195, 198,
214, 223, 224, 237
RESPA
206, 259, 269
RESTORATION PROVISION................................................
RETAIL LEASE 208
RETAIL MATRIX...................................................159, 162
RETAINAGE
232
RETAINED EARNINGS.............................................21, 28, 30
RETURN ON EQUITY (ROE)...............................................
REVENUE
3, 5-7, 10, 11, 18, 24, 29, 31, 33, 35, 36, 39, 42,
48, 49, 51,
60, 153, 163, 200, 201, 206, 217, 315
REVENUE BILLS.........................................................
REVENUE RECOGNITION ..................................................
REVENUE RULING........................................................
REVERSE MORTGAGE.....................................................
REVERSION
78, 117, 118, 134, 137, 194, 217
REVIEW REPORT .....................................................
ROLL-UP
226
ROLLOVER MORTGAGE...............................................202, 274
RULAND AND DUMBPHORS CASE.......................................287, 294
RULE
2, 3, 7, 11, 14, 34, 49, 55, 68, 71, 75, 92, 110, 117,
124, 126,
137, 194, 196, 250, 285, 292, 298, 333, 336
RULE OF 70'S 110, 126
RULE OF 72'S 110, 124, 126
S CORPORATION........................3, 51, 52, 54, 58, 63, 65, 188, 268
SAFETY BUFFER...................................................195, 289
SALARY
6, 10, 56, 57, 59, 65
SALE LEASEBACK........................................25, 37, 46, 47, 61
SALE OF A PERSONAL RESIDENCE..........................................

102

SALE/LEASEBACK.....................................................
SALES TYPE LEASE..............................................20, 23, 25
SALES VALUE 12, 13, 35, 36
SALES-TYPE LEASE......................................................
SALVAGE VALUE......................................................
SATISFACTION 267, 268
SCHEDULE B 57, 258, 259, 283, 301, 302
SEAWALL V. N.Y.C......................................................
SECOND MORTGAGE....................................14, 46, 125, 237, 273
SECONDARY DATA...................................................77, 184
SECONDARY MORTGAGE MARKET.......................................205, 265
SECTION 1031 72, 73
SECTION 1033 73
SECTION 108 73
SECTION 1231 56, 64
SECTION 1231 ASSET....................................................
SECTION 179 17, 65
SECTION 216 62, 301
SECTION 216 OF THE I.R.C.............................................
SECTION 223 F........................................................
SECTION 227 291, 295
SECTION 255 267, 280
SECTION 263 62
SECTION 267 58
SECTION 275 280
SECTION 339-i........................................................
SECTION 339-r........................................................
SECTION 339n 299
SECTION 339p 299
SECTION 339u 299
SECTION 339v 299
SECTION 351 53
SECTION 352 eee......................................................
SECTION 352 eeee.....................................................
SECTION 38 65
SECTION 39E - COMMON ELEMENTS........................................
SECTION 421a 97, 105, 292, 293
SECTION 421a OF THE REAL PROPERTY TAX LAW............................
SECTION 421b 105
SECTION 465 66
SECTION 469 63
SECTION 5-321 OF THE GENERAL OBLIGATIONS STATUTE.....................
SECTION 72-21.........................................................
SECTION 721 53
SECTION 73-00.........................................................
SECTOR GROWTH....................................................81, 148
SECURITY AGREEMENT..........10, 15, 18, 29, 161, 179, 186, 202, 227, 228,
233-236, 244, 265, 266, 268, 288, 312
SEGMENTATION 77, 159

103

SELLING BROKER.......................................................
SERIAL ZERO COUPON BOND..............................................
SERVICES
3, 6, 13, 32, 34, 36, 53, 59, 87, 101, 102, 139, 149,
160,
161, 169, 170, 173, 196, 213, 247, 250, 277, 283, 285, 303,
305, 309, 311, 313, 314, 323
SETBACK EXPOSURE LINE................................................
SETUP
197, 198
SHARE ALLOCATION.....................................................
SHAREHOLDERS' EQUITY..................................................
SHELL CORPORATION....................................................
SHEPHERDING 243, 261
SHORT INTEREST.......................................................
SIC CODES
79, 82, 164
SIGMOID CURVE....................................................166
SINKING FUND 120, 121, 128
SKY EXPOSURE CURVE..............................................332, 333
SMART BUILDING.......................................................
SMOKE DETECTOR AFFIDAVIT.............................................
SOCIAL UNIQUENESS....................................................
SOFT COSTS 196, 329
SPECIAL DISTRICTS................................................96, 329
SPECIAL PERMIT....................................................
SPECIAL RISK 301
SPECIAL WARRANTEE DEED...............................................
SPECIFIC IDENTIFICATION13, 26, 33-36, 68, 75-78, 84, 99, 113,
146-148,
156-158, 174, 205, 235, 241, 244, 245, 283, 286, 287, 297,
327, 336
SPECULATOR 57, 167
SPREADS
197, 224
SQUARE FOOTAGE.........35, 75, 132, 276, 281-283, 286, 297, 319, 333, 335
SQUARE FOOTAGE METHOD............................................35, 297
STAND-BY COMMITMENT..................................................
STANDARD OCCUPATION CLASSIFICATION.......42, 82, 149, 195, 225, 228, 230,
235, 266, 278, 291, 318, 320
STATE SALE TAX.......................................................
STATE TRANSFER TAX..............................................253, 257
STATED VALUE 30
STATEMENT OF CASH FLOWS...............................................
STATUTE
49, 185, 186, 240, 242, 261, 268, 291, 292, 296-298
STATUTE OF FRAUDS..........................................185, 186, 240
STATUTORY LAW.........................................242, 243, 248, 295
STRAIGHT LINE METHOD........8, 18, 20, 21, 44, 46, 52, 68, 109, 170, 281,
313
STRATEGIC BUSINESS UNIT..............................................
STRATEGIC MANAGEMENT............................................306, 308
STRATEGIC PLANNING CYCLE.............................................
SUBLEASES AND TERMINATIONS........................................
SUBLET CAPITAL LEASE..................................................

104

SUBLET LEASE 241

SUBMETERING 288
SUBORDINATION CLAUSE............................................273, 279
SUBORDINATION PROVISION..............................................
SUBSTANTIALLY ALL.............................................19, 46, 47
SUBSTANTIALLY COMPLETE PROJECT (DEFINITION)...........................
SUM OF THE YEARS DIGITS................................................
SUMMARY PROCEEDINGS..................................................
SUPER REGIONAL CENTERS................................................
SURETY BOND PROVIDERS................................................
SURVEY INSPECTION...............................................245, 256
SURVEY UPDATE........................................................
SURVIVAL AGREEMENT...................................................
SWAP UNWIND 230
SYD
9, 44
SYNDICATION 15, 40, 41, 43, 274
TAKE-OUT LOAN................................46, 183, 227, 228, 231, 232
TAKEOUT COMMITMENT....................................................
TAKINGS
92, 94
TAX ACCOUNTING............................................10, 17, 18, 45
TAX ADVANTAGE OF A SALE LEASEBACK.....................................
TAX CASE EVOLUTION....................................................
TAX COURT
50
TAX EXEMPT INTEREST...................................................
TAX REFORM ACT OF 1986...............................................
TAXABLE EVENT................................................55, 74, 237
TAXABLE GAIN 53, 55, 213, 214
TAXATION AND DEPRECIATION......40, 45, 48, 49, 61, 63, 105, 111, 216, 291
TAXES & INSURANCE CLAUSE.............................................
TAXPAYERS
68
TENANCY BY THE ENTIRETY..............................................
TENANT IMPROVEMENTS......36, 118, 135, 136, 195, 198, 209, 214, 277, 306,
337
TENANT IN COMMON TRANSFERENCE........................................
TENANT INTEREST......................................................
TENANTS BY THE ENTIRETIES............................................
TENANTS WITH THE RIGHT OF SURVIVORSHIP...............................
TERMINAL CAP RATE...............................................198, 218
THE "C" CORPORATION....................................................
THE "S" CORPORATION................................................
THE CONCEPTUAL BASIS FOR LEASING ACCOUNTING...........................
THE CONSTRUCTION PROCESS..............................................
THE DEFINITION OF A CAPITAL LEASE.....................................
THEORY OF SECTORAL SUCCESSION........................................
THEORY OF URBANIZATION...............................................
THIRD RULE 333
THREE TO FIVE YEAR PLAN.........................................210, 304
TIME HORIZON 194, 238
TIME VALUE OF MONEY..........................................31, 40, 188
TITLE INSURANCE....................................24, 38, 185, 206, 240

105

TITLE SEARCH 33, 38, 185, 254, 256, 258

TITLE THEORY STATES..................................................
TORRENS STATE........................................................
TRADE AREA 84, 85, 159
TRADE AREA ANALYSIS..................................................
TRANCHE
237
TRANSFER TAX CLAUSE..........12, 19, 22, 53, 55, 56, 67, 91, 92, 96, 160,
173,
250, 252, 253, 256, 257, 259, 330, 331
TRANSITIONAL ASSESSMENT..............................................
TRI-PARTY BUY AND SELL AGREEMENT.....................................
TRIPLE NET LEASE................................................236, 290
TRUST
32, 64, 85, 118, 145, 183, 187, 215, 264
TRUSTEE
118, 187
TRUTH IN LENDING ACT............................................206, 269
UCC1
266, 268
ULURP
93-96, 101
UNADJUSTED BASIS......................................................
UNDERWRITING 202, 226
UNDIVIDED INTERESTS....................................................
UNIFORM CAPITALIZATION RULES..........................................
UNIFORM COMMERCIAL CODE FORM ONE.....................................
UNIFORM CONDOMINIUM ACT..............................................
UNIFORM LAND USE REVIEW PROCEDURE (ULURP).............................
UNINSURABLE 251, 270
UNIT OF MEASUREMENT..................................................
UNITS
35, 103, 105, 191, 200, 216, 217, 219, 241, 272, 274,
295-297,
300, 301, 305
UNITY OF PROPERTY....................................................
UNMARKETABLE 251
UPZONING
90
URBAN ANALYSIS........................................................
URBAN SPECIALIZATION.................................................
USE VARIANCE 99
USEABLE SQUARE FOOTAGE...............................................
VA
114, 205
VACANCY ALLOWANCE (VA)...............................................
VACANCY RATES..........................................76, 145, 148, 159
VALID CONTRACT FOR REAL ESTATE.......................................
VALUATION
15, 104, 184, 215-217, 291
VALUATION ISSUES.................................................15, 184
VARIABLE
29, 37, 180, 195, 200-202, 205, 225, 230, 273
VERTICAL INTEGRATION COMPANY.........................................
VESTING RIGHTS........................................................
VIFGAGE
125
VIOLATIONS CLAUSE...............................................251, 256
VULTURE FUNDS........................................................
W-2
3, 5
WAIVER OF SUBROGATION................................................

106

WAREHOUSING 86, 87, 146-148, 150, 163, 173, 178

WARRANT
136, 241, 272, 283
WARRANTEE DEED.............................................185, 241, 263
WASHINGTON D.C..................................................130, 179
WEIGHTED AVERAGE MATURITY (WAM)..................................26, 234
WIDE STREET 332, 333
WINDOWS GUARD NOTICE ................................................
WITNESS
271
WORK LETTER 195
WORKER'S COMPENSATION INSURANCE......................................
WRAPAROUND MORTGAGE.........................................14, 268, 302
YIELD MAINTENANCE FORMULA.............................186, 225, 266, 272
ZERO COUPON 203
ZERO-SUM GAME...................................................159, 324
ZONING LOT 96, 330, 331
ZONING RESOLUTIONS...................................................

107