3) Project the resale value of the property at the end of mortgage payment period. Please use statisticsto back up your numbers. Next, please i) calculate the bond-equivalent return of your...

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3) Project the resale value of the property at the end of mortgage payment period. Please use statistics to back up your numbers. Next, please i) calculate the bond-equivalent return of your investment and ii) compare the performance with corresponding performance when you invest in stocks (for example, investing in SPY, the S&P500 index) or buying long term bonds (e.g., a 30-year treasury bond). Please show your calculations and explain the under- or out-performance of your real estate investments. FIN7037 Group 4 2 Fixed Income - Term Project - Term Project - Performance of Investing in the Housing Market 1. 1) Decide the location and the specific real estate property you would like to buy (e.g., a single-family house or a condo). Please provide justification for why the property is chosen, e.g., affordability, and the potential of price appreciation. Use some data to justify your selection, e.g., the housing price growth rate in the region. While choosing an investment property, our goal is to maximize the return from the property, which contains high rental occupancy, high rentals relative to mortgage repayments, and a low tenant default rate.  Firstly, we did research on locations. According to the website of Rocket Mortgage. Fort Wayne, the second largest city in Indiana was ranked the first best city to invest in real estate across the US in 2023. The city of Fort Wayne seems growing by 0.67% of population increase in 2021, which is the fastest-growing metro in Indiana. The city of Fort Wayne has a home appreciation rate of 14.63%, compared to Cincinnati’s home appreciation of 13.53%. The median listing price is $199,947. The rent income ratio is 18.12%. According to Redfin.com, Fort Wayne home prices increased by 11.4% compared to 2021, and homes in Fort Wayne sell after 7 days on the market compared to 37 days in 2021. When comparing the type of property to invest in, we decided to choose single-family residences because most of the time condos require a monthly HOA fee which will increase the monthly costs. And the biggest issue with condos is the problem of resale. It tends to be harder to resell a condo than a single-family home. We decided to invest in the property located at 5824 Hinsdale Ln, Fort Wayne, IN 46835. This property is a single-family residence with 3 beds and 3 baths. It was built in 1979 and 9147 sqft. The house price is $236,000, which is affordable with a $200k-400k budget and the estimated monthly cost is $1,526, including $1260 of principal and interest with a 6.654% of 30-year fixed interest rate from the Associated Bank, $169 of homeowner’s insurance, and $140 of property taxes. Monthly homeowners’ insurance is calculated based on the average homeowner’s insurance rate in Indiana is 0.86%. The property tax is calculated based on the percentage of a home’s assessed value and varies by area. 2. 2) Find out the mortgage rates for different properties and make a choice between 30/15-year mortgages and between FRM and ARM). Please justify your decision. In addition, calculate the monthly mortgage payments given the down payment you will make. Please consider prepayment in the analysis and provide information on closing expenses1 and subsequent maintenance costs as well. In the meantime, project the amount of rental you will be able to collect when you lease the property out. Provide justification for your rental projection. The above graph shows that comparison of mortgage rates for different properties. In this case, we used the average interest rate in the region. A 30-year fixed-rate mortgage has a lower payment, but a higher interest rate and more interest paid. On the other hand, a 15-year fixed-rate mortgage has higher payment, but less interest paid and a lower interest rate. 5/1 adjustable-rate mortgage is fixed for the first 5 years, the interest rate may adjust higher and lower at outset, this will be suitable for investments that will sell soon. 30-year fixed is fixed for the entire loan term, this will be suitable for pay-off and stay-put options. As we all know, loan lenders determine mortgage rates based on borrowers’ credit scores, loan-to-value ratio, inflation, job growth, federal reserve, and the overall economy, etc. Mortgage rates vary from lender to lender. Credit score and loan-to-value are factors that we can control. We can get the lowest mortgage rates if we have credit scores of 740 or higher. Otherwise, a credit score below 620 will lead to a higher interest rate. The loan-to-value is determined by the mortgage amount compared with the actual house’s price. A larger down payment gives you a smaller loan-to-value ratio and low-interest rates. According to the Associated Bank, the closing cost for this property in Fort Wayne, IN 46835 is $567. Therefore, we need $47767 in cash at settlement. We amortize maintenance expenses by the square foot rule to $1 for every square foot of livable space each month, which is $1,786/year and $148/month. On Zillow.com, it shows the property of 5824 Hinsdale Ln has a rental value of $1899/month. We researched the rental value of a 3beds and 2+baths home in IN 46835 was in the range of $1000-$2500. And we found a property with 3 beds and 2.5 baths in 1680 sqft that was valued at $1900/month for rental. Therefore, we decided to set the rental value at $1899/month to match the market price. Reference(s) · https://www.rocketmortgage.com/learn/best-places-to-invest-in-real-estate#x4 · https://www.greaterfortwayneinc.com/allen-county-posts-fifth-straight-year-of-positive-domestic-migration/ · https://www.insideindianabusiness.com/articles/fort-wayne-tops-list-of-emerging-real-estate-investment-markets#:~:text=FORT%20WAYNE%2C%20Ind.&text=The%20mortgage%20company%20says%20Fort,%2Dincome%20ratio%20is%2018.12%25. · https://www.nerdwallet.com/article/mortgages/how-are-mortgage-rates-determined · https://smartasset.com/mortgage/closing-costs#yyVjGQtQL7 · https://www.bankrate.com/mortgages/30-year-mortgage-rates/?mortgageType=Purchase&partnerId=br3&pid=br3&pointsChanged=false&purchaseDownPayment=47200&purchaseLoanTerms=5-1arm%2C5-6arm%2C30yr%2C15yr&purchasePoints=All&purchasePrice=236000&purchasePropertyType=SingleFamily&purchasePropertyUse=PrimaryResidence&searchChanged=false&showingStacked=all&ttcid&userCreditScore=740&userFha=false&userVeteranStatus=NoMilitaryService&zipCode=46835 · · 3. Project the resale value of the property at the end of mortgage payment period. Please use statistics to back up your numbers. Next, please i) calculate the bond-equivalent return of your investment and ii) compare the performance with corresponding performance when you invest in stocks (for example, investing in SPY, the S&P500 index) or buying long term bonds (e.g., a 30-year treasury bond). Please show your calculations and explain the under- or out-performance of your real estate investments. 4. Who are Fannie Mae and Freddie Mac? Describe their businesses and histories. Then provide some explanations on how Fannie Mae or Freddie Mac pools mortgages to construct MBS. What risks are faced by MBS investors? Discuss the experience with Fannie Mae and Freddie Mac in the 2007-09 financial crisis (you may relate to the well-known movie “The Big Short”) and their business today. Fannie Mae and Freddie Mac: Fannie Mae and Freddie Mac are the major suppliers of the funds to the residential mortgage market (Frank Fabozzi, 2014, p. 135). Fannie Mae provides mortgage financing to the mortgage lenders to help the people buy home. U.S. Congress chartered Fannie Mae in 1938 (Fannie Mae, n.d.) and Freddie Mac in 1970 (Wikipedia, n.d.). They issue 2, 3, 5, 10 and 30-year maturity of securities. They also work with their partners in the industry to buy or refinance a home. Freddie Mac is also a supplier of the mortgage securities who help and ensure a reliable and affordable supply of mortgage funds across the country (Freddie Mac, n.d.). United States Congress chartered it in 1970. The function of Freddie Mac is quite like that of Fannie Mae. It purchases loans from qualified lenders. After that, they pool all the mortgages and sell it to the borrowers. Explanations on how Fannie Mae or Freddie Mac pools mortgages to construct MBS: People who belong to the low- and moderate-income level and get engaged in mortgage borrowing and renting can finance their service with the help of Fannie Mae. But they are not the direct money lenders to the borrowers as they do not create mortgage loan. They purchase mortgages from the original creator of the mortgage loans. Then they pool those and sell to the borrowers. This way they smoothen the supply of money from the surplus side to the deficit side. In part of this process, they issue and guarantee mortgage related securities. Fannie mae has single family and multi family business. Both businesses acquire loans from the lenders. Then they pool all the mortgage loans and create new securities. These securities are called mortgage-backed securities. Different borrowers in the mortgage market buy these mortgage-backed securities. But all the pools of mortgages that have been securitized are secured by residential properties (Fannie Mae, n.d.). That underlies that if any borrower fails to repay his/ her loan, then, Fannie Mae would have the right sell the property and have the proceed. Along with that Fannie Mae also guarantees the timely loan and interest payment the lenders. This way all the loans are secured and then distributed to the borrowers in the mortgage market. It enhances the liquidity in the market. Risks are faced by MBS investors Prepayment Risk: Homeowners or buyers sometimes pay the principle at a higher rate than initial. If borrowers repay the principle quicker than expected rate, it results in less interest income for the mortgage investors (the balance, n.d.). Reinvestment Risk: If the borrowers pay larger amount of principle than expected, then investors might not get favorable interest rate in the market to reinvest the money. This might reduce the reinvestment return of the investors. This way mortgage investors can face reinvestment risk. Negative Convexity Risk: Negative convexity risk means the exact opposite characteristics of the bond price and yield that we usually see in case of normal bond. We know that traditional bond price goes down at a decreasing rate when yield goes up and the price goes up at an increasing rate when yield goes down. However, mortgage-backed securities show the opposite behavior. When the yield goes high mortgage price goes down at an increasing rate and when the yield goes down, the mortgage price goes up at a decreasing rate. So, mortgage borrowers can face this negative convexity behavior of this type securities. Experience with Fannie Mae and Freddie Mac in the 2007-09 financial crisis: Fannie Mae and Freddie Mac were the government sponsored employees and they used to hold less capital as government implicitly guaranteed the value of the mortgages (the balance, n.d.). However, government always want them to invest the money to the qualified borrowers and not to take high risk mortgages. However, between 2005 and 2006 they acquired a lot of subprime mortgages, interest only and negative amortized bonds. Fannie Mae had 58% subprime mortgage and Freddie Mac had 67% subprime mortgage loans (the balance, n.d.). Because doing that would help them to get more money from higher interest rate than from the fees. But the situation got worse when the started using to use the derivatives to hedge the interest rate risk of their portfolios instead of insuring the investors’ money in a proper way. So, when the housing prices went down, homeowners started defaulting. Then the derivative prices also went down. So, Fannie Mae and Freddie Mac had nothing to protect the mortgage investors from the huge loss. So, large banks of wall street faced huge loss. This spiral effect of loss on the financial institutions contributed to the 2007-2009 financial crisis. We can relate the movie “The Big Short” in this context. Michael Burry who was the Wall Street guru in 2008, sensed that home price would go down and some of the sub prime mortgage loan would get defaulted. So, threw almost $1 billion of money in the “Credit Default Swap” securities. Some other greedy opportunities also bet their money into those securities at the cost of the upcoming financial distress in the coming months (YouTube, n.d.). This could portrait how much severe was the situation back then in 2008. Their Business today: Currently both organizations are working for the supply of fund to the secondary mortgage market. Both Fannie Mae and Freddie Mac have two primary lines of businesses. Single family and multi family business. By these two instruments they operate in the U.S. secondary Mortgage market. Moreover, Freddie Mac has taken special initiative to support the borrowers of the homeowners and make the housing market more liquid in the post-covid situation. With a selective choice of mortgage loans, they are continuously supporting the supply of fund to the US mortgage market. Reference(s) · Frank j. Fabozzi, CFA, (2014), Fannie Mae and Freddie Mac, Bond markets, analysis, and strategies, Edition 9, 135. · Fannie Mae, (n.d.), About us, https://www.fanniemae.com/about-us. · The balance, (n.d), Did Fannie and Freddie Cause the Mortgage Crisis?
Nov 16, 2022
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