Abstract
REMI is a new financial instrument for Asia’s real estate market offering superior returns than those for the typical commercial bank loans. The resultant risk exposure is relatively high. With recent and robust growth of the Singapore real estate market, there is the fast-growing real estate investment trust market. This paper examines the REMI structure, the measurement and characteristics of its risks and returns via a forward-looking binomial asset tree (BAT) model. Risk neutral pricing probability is adopted to construct the BAT tree. TRs are measured by the probability weighted average returns and discussed under different scenarios. REMI bears more risk than typical commercial bank loans, resulting in higher interest rates than pure equity. Different risk issues focus on two major sources - the financial LTV ratio risk and the real estate and capital markets risk. Empirical analysis involves a rigorous discrete-time forecasting of the market rent and capital value expectations of Singapore’s prime office sector, given the conditions and assumptions unique to this market. This paper fulfils the need to close the gap concerning the REMI structure and performance in the steady state, utilizing reliable, authoritative information and data sources.
Highlights
Investors have utilized varying combinations and structures of debt and equity to finance real estate investments
The impact of LTV ratio pertaining to the senior loan and the Real estate mezzanine investment (REMI) on the total return (TR) is examined
The results are generally consistent in that the market risk, and the financial risk, are the main risk factors affecting the REMI total return. 5.1 The REMI Discrete Default Probability Initially a prime office portfolio is assumed that is 65% financed by that senior bank loan, based on a consensus among direct real estate investors and pertaining to an LTV ratio of 60% to 70% for a typical bank loan on a Singapore prime office building. 20% of that bank loan is typically financed by REMI
Summary
Investors have utilized varying combinations and structures of debt and equity to finance real estate investments. REMI became an important source of capital in Singapore, one of East Asia’s rapidly growing economy, for direct commercial real estate acquisitions, development and refinancing. REMI is debt capital that gives the lender (investor) the rights to convert to an ownership in the direct real estate asset if the loan is not paid back in time and in full. As REMI is provided to a borrower quickly with little due diligence on the part of the investor and with little or no collateral on the physical real estate asset, such REMI is aggressively priced with a substantial spread over a bank’s loan rate. An in-depth examination should throw new light on the REMI over traditional sources of financing. The series of natural default probabilities are envisaged, corresponding to the respective REMI original interest rates
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