Real Estate Funding and Finance: Liquidity Reform and Analysis

This report provides an analysis of real estate funding and finance, with a specific focus on the impact of liquidity on investment returns. The report explores various dimensions of liquidity, including tightness, depth, resilience, breadth, and immediacy, and examines how these factors influence asset pricing in the real estate sector. It discusses the role of liquidity in relation to market imperfections, such as transaction costs, asymmetric information, and imperfect competition. The report also investigates changes in lending conditions, particularly the impact of the 2007 global financial crisis and subsequent lending reforms. The study further assesses the importance of Tier 1 and Tier 2 capital in evaluating the financial strength of real estate companies and their ability to secure debt financing. Finally, the report analyzes the costs and availability of debt within the real estate sector and their effects on investment returns. The report concludes by summarizing the key findings and their implications for real estate investment decisions.

Running head: REAL ESTATE FUNDING AND FINANCE
Real Estate
Name of the Student:
Name of the University:
Author’s Note:

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Executive Summary
The aim of the assignment is to conduct an analysis on the factors affecting the real
estate investment returns. The primary factor that was particularly discussed and taken
into consideration was the liquidity factor that potentially affect the real estate sector
return. There are many factors including macro-economic and business factors that can
potentially affect the investment conditions and the associated returns. The changes in
the lending capacity including the Tier 1/Tier 2 Capital was taken into consideration.
Capital Structure of the company can also be well analyzed with the help of the real
estate lending reforms and liquidity reforms presently available within the real estate
sector. The cost and availability of debt can be analyzed with the help of the borrowings
levels and borrowings costs that can simultaneously affect the real estate returns.

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Table of Contents
Introduction........................................................................................................................3
Discussion..........................................................................................................................3
Dimensions in Liquidity..................................................................................................3
Measures of Liquidity.....................................................................................................7
Changes in Lending Conditions.....................................................................................7
Real Estate lending and Liquidity Reform......................................................................9
Costs and Availability of Debt......................................................................................10
Conclusion.......................................................................................................................11
References.......................................................................................................................12

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Introduction
The role of liquidity can be well assessed as the same is one of the crucial factor
in determining the pricing of the assets in defining the real estate sectorial returns. In
both theoretical and numerical relationships it could be well explained that the main
aspects of assets liquidity or trading can be well defined with the help of the “the ease
by which the assets are traded in the market” (Oloke, Durodola and Emeghe 2015). The
source of funding on the other hand can be well related with the help of the ways with
which the company or entity can secure finance for the purpose of financing the assets
and operations of the sector. The main theme with which we would be dealing will be
the various aspects would be marketability/liquidity that has many facets that requires a
further and a closer explanation (Freybote and Seagraves 2018).
Discussion
Dimensions in Liquidity
Liquidity in the context of real estate sector should be well understood and explained
with the help of following points:
 Liquidity not only reflects the amount or size of transactions but the impact
generated by the marketability or liquidity on the transaction price is also of
crucial importance (Zheng and Hui 2016).
 Liquidity is a broad scaled in real estate and it is essential that the same should
be considered in a detailed manner in the real estate sector (Hoesli, Kadilli and
Reka 2017).

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The five key characteristics of market liquidity can be well defined with the help of
the following clauses:
 Tightness: The cost associated with Trading, even proposing a smaller
components of the same (Zheng, Chau and Eddie 2015).
 Depth: The capacity to buy/sell without affecting a cause or effect in the
movement of the prices.
 Resilience: The speed with which the marginal impact on prices are seen as
the quantity increases.
 Breadth: Representing the total size of the traded volume
 Immediacy: The associated cost whether in the form of premium or
discounted costs that are applied when buying and selling of an asset.
The three important dimensions of liquidity is well presented in the diagram given
below where both forces of market forces such as demand and supply were taken into
consideration. The demand curves was marked with red color and blue curve was
marked for supply curve and the same can be compared with the help of one asset that
is perfectly liquid representing the horizontal dotted lines (Ametefe, Devaney and
Marcato 2016). The price in the following diagram was taken as constant, irrespective of
the trading volume and transacted volume (there would be no price impact that would
be identified for any kind of volume trading). On the demand side that is represented by
the red curve reflecting that even with a minimum amount of transacted volume, buyers
need to pay a specific amount of price for entering the transactions (reflecting the bids
with the red line) that is perfectly above the normal fundamental price that is asked for a
perfectly liquid assets. On the contrary side of the trade, the seller needs to accept for

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receive a price (Ask on the blue line) that is below the one of a perfectly liquid asset
whereby the illiquidity is represented by discount reflected in the asset price that is one
of the cost in selling to seller (Bustami and Heikal 2019). The difference between the
Bid and Ask can be also referred as the Bid/Ask Spread that is represented in the chart
with the term “Tightness”.
If the markets were in a fully efficient manner than the assets would be perfectly liquid
(the transaction price of the asset would be remaining in the horizontal line). On the
other hand, assets with similar properties and cash flows would be reflecting similar kind
of valuations (Ling, Naranjo and Scheick 2016). However, some of the characteristics or
the features of the assets may be leading to different kind of valuation and expected
returns for the purpose of investments with similar kind of cash flows and the key
reasons for a variable difference could be well linked to the market imperfections. The
categorization of the market imperfections could be well done into six main groups that
are primarily transactions and participation costs, imperfect competition, asymmetric

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information, various other constraints in terms of financing and searching costs (Wang,
Long and Wei 2018).
Participation Costs: The participation costs arises because of no immediate and
continuous access to entire population of counterparty agents. Agents have to shell out
some cost in the form of participation cost for entering the market. The willingness to
invest in a particular asset is then taken into consideration when the offered costs is
offered in terms of liquidity premium to the agents (Lux and Moss 2016).
Transaction Costs: Transaction costs are incurred by companies and entities for the
purpose of executing or making a trade effective for the purpose of buying and selling at
the same transaction diverge taking place. The key examples of the transaction costs
includes costs such as taxes and brokerage fees (Freybote and Seagraves 2017).
Asymmetric Information’s: Asymmetric Information can exist because of some access
that the traders and information’s might have access to private form of information’s that
is obtained from different sources or are processed differently (Szumilo et al., 2018).
The situation would be leading to liquidity premium whereby agents would be wanting to
invest in market with a high proportion of private information’s.
Imperfect Competition: Imperfect Competition can be well linked to the scale of
different market player’s in the real estate sector and their asymmetric impact on the
prices of the real estate is primarily due to the size of information or potential
advantage they have in the context of real estate property (Devaney and Scofield 2015).
Imperfect Competition is primarily more observable in the real estate sector where

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predominately large players play a huge role in having asymmetric information that can
potentially bring advantage to the.
Measures of Liquidity
The liquidity itself is not directly observable in the real estate sector where
proxies are created for the purpose of pricing the value of real estate property.
Moreover, some aspects of the studies can be well studies whereby the mixed results
with respect to liquidity premium may arise from the various usage of liquidity risks in
the analysis (Harding and Howe 2017). In the following stances there are various
measures of liquidity that can be identified for describing the liquidity and comparing the
associated results across various assets and market segments.
In the described section it could be well analyzed that several indicators can be
categorized into five main categories:
 Transaction Cost Measurement
 Volume Based Price Measurement
 Price Impact Measurement
 Time Based Price Affect on Property’s
 Return Based Effect on Investment Measurement.
Changes in Lending Conditions
The global financial crisis that occurred in the year 2007, that resulted in the
solvency of many banks in Europe and United States threatening the Banking Sectors
and Real Estate Sector (Abdul-Rahman, Sulaiman and Said 2018). The crisis had its
key root for the collapse of subprime mortgage crisis that was observed in the United

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States in the year 2007. The crisis was caused due to an earlier underwriting of large
volume of various sub-prime mortgages and the associated rise in the mortgage interest
rates in the markets. Banks and financial institutions were primarily exposed with the
mortgage crisis because of the large holdings associated with their financial statements.
The so called mortgaged backed securities are bonds that are well supported by claims
on the cash flows from the pool of mortgage loans which is termed as the process of
securitization.
The lending condition in the real estate sector was heavily affected with the high
amount of financial risk that was associated in the real estate operations. The
operations of the real estate sector is primarily done with the help of financial leverage
whereby the real estate companies take high amount of debt as a part of low cost
financing for the purpose of financing the various operations it undertakes (Liao et al.,
2015). There have been various changes in the lending conditions and banks and
financial institutions look at the Tier 1 and Tier 2 Capital for assessing the financial
position of the company. The Tier 1 Capital is the core measure of the bank’s financial
strength from the view approach of regulators. The Tier 1 Capital Comprises of Core
Capital, primarily including the common stocks and disclosure reserves (retained
earnings), but the same may include preference shares that are non-redeemable. The
Tier 2 Capital includes the secondary components of bank Capital in addition to the
introduced Tier 1 Capital. The key components of Tier 2 Capital are supplementary
capital and composing of key items including revaluation reserves, undisclosed
reserves, hybrid instruments and various other subordinated debts. Real Estate
Companies generally have a less amount or weightage of Tier 2 Capital including

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reserves and other hybrid investments. The Tier 1 Capital including the Core Capital of
the Real Estate Companies whereby Core Capital including Equity Capital and
Disclosure Reserves are the key part of the Tier 1 Capital of Real Estate Companies.
The lending capacity of the firms were largely impacted with the volatile real estate
sectors and the associated risks that were affecting the overall investment returns in the
Real Estate Sector (Tsai 2015). Companies that did have strong financial position and
performance were able to better garner more amount of Debt financing for the various
courses of operations of the company.
Real Estate lending and Liquidity Reform
In this crisis environment banks were reluctant and not willing to lend to each
other, given the scenario that they might be using the same for lending to institutions
with material exposures to the collapsed mortgage market. In the given scenario or case
it was found that the so called liquid assets in the form of highly rated bonds were also
found to be unmarketable. The liquidity regulations placed were almost found to be
failing during the liquidity crisis that the economy observed. Banks and financial
institutions were unable to raise new funds or generate significant amount of cash flows,
an insolvency crisis loomed up in the economy and the same needs to be solved by
government and their regulatory bodies. This crisis took the form whereby banks were
provided with short-term loans and allowing various financial institutions for swaps for a
period up to three-years of time. Certain of the bond holdings of the company were in
the form of high, quality marketable treasury bills. In the United Kingdom there was a
Special Liquidity Scheme that was organized by the Central Bank of UK that is Bank of

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England, that was initiated for a period of 2008-2011 thereby bringing liquidity back in
the banking sector and renewing the confidence of market.
There were various reforms that were brought marking the failure of existing
liquidity requirements for banks during the financial crisis that prompted regulatory
requirements for revising the aspects and factors regarding holding liquid assets. As a
result of the financial crisis the Financial Service Authority (FSA) was disbanded in the
year 2012. Overlooking the various activities of the financial institutions were being well
analyzed with the newly formed Prudential Regulation Authority (PRA) that was one of
the subsidiary of the Bank of England. In the year 2010, the FSA introduced the
Individual Liquidity Adequacy Standards (ILAS) regime for bankers and other UK
Lenders. The undertaken approach reflects and highlights many of the many of the
underlying principles for good liquidity management that were well identified in the
course. It was identified that Banks even in the normal course of actions periodically
had to draw upon assets and some of their liquidity for accommodating the associated
Cash flows, the same or associated implications on banks and financial institutions were
that they had to additionally hold upon additional set of liquid assets. There some
inevitable consequences that were seen specially in the banking sectors that under the
new regime they were required to hold a larger number of liquid assets in the overall
asset positions.
Costs and Availability of Debt
The costs associated with the real estate borrowings could be well determined
with the help of the prevailing cost of debt that is the bond yield presently prevailing.
The cost of debt can be well analyzed with the help of prevailing bond yield in the UK

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Economy. The borrowing levels could be well assisted with the amount of borrowings
levels that are changing with respect to the varying market rates of interest. The costs of
financing from the perspective of equity cost could be also determined with the help of
Capital Asset Pricing Model where the formula would be applied for the purpose of
determining the associated cost of equity. The cost of equity could be determined with
the help of important factors like risk free rate of return, market rate of return and beta of
the associated company. The company that has been taken into consideration is the
British Land Company whose share price has been taken for a sum of three-years from
the year 2015-2018. The appropriate set of data is taken for the purpose of analyzing
the correlation or the systematic risk with the FTSE 100 Index Data in order to
determine the beta of the stock. The beta of the stock was calculated to be around 0.12
times that was comparatively very low when assessing the systematic risk of the stock.
Capital Asset Pricing Model
Required Rate of Return on Equity (Re): Risk Free Rate of Return
(Rf) + Beta*(Return On Market Index - Risk Free Rate of Return)
Where;
Risk Free Rate of Return (Current 10-Year Bond Yield) 2.10%
Return on Market 4.18%
Beta (Assumption) 0.12
Required Return on Equity 2.34%
The cost of equity for the company has been determined at 2.34% which was too
low as the beta of the stock was comparatively very low. The borrowings levels is
indeed affected with the presence and availability of various sources of financing.
Availability of debt financing in the Company is comparatively much lower due to the