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Real Estate Finance: Theory and Practice, Third Edition

Clauretie, Terrence M., and G. Stacy Sirmans. Real Estate Finance: Theory and Practice, Third Edition. Upper Saddle River, NJ: Prentice-Hall, 1999, 584 pages. The scope of the book is as in-depth as the title implies. Real Estate Finance offers an upto-date, carefully documented review and thorough analysis on the theory and practice of real estate finance. It is a comprehensive text that covers every aspect of real estate finance with discussions, examples, and problem-solving demonstrations. However, the most impressive feature of this book is its attempt to examine the evolution of real estate financing markets, relevant financial economics theories, and recent empirical research findings in these areas. It draws a close link between real estate financing practice and theoretical foundations. Clauretie and Sirmans approach this text with extraordinary enthusiasm, knowledge, skills, and hard work, making the book a unique collection of facts on theory, empirical findings, and historical events, as well as financial methodology.

Users will find the new edition especially user friendly. The authors added more numerical examples and problems (e.g., on valuation of mortgage securities and CMOs (Chapter 11) and permanent financing of commercial real estate properties (Chapter 19) on various leasing topics). Their timely updates on various topics are noticeable. For example, the enhanced coverage of housing-related law and regulations included the 1997 Taxpayer Relief Act and is just what readers, and especially instructors, need. With the new edition, Clauretie and Sirmans present an ideal textbook for upper-level undergraduate and graduate-level (e.g., MBA programs) real estate finance courses. Because of the vast and well-documented facts it offers, this text can also be used as a resource book for research for financial economists or as a reference book for practitioners in real estate markets.

The first fourteen chapters cover topics in residential real estate financing markets, and the next eight chapters discuss the concepts involved in commercial markets. In Chapters 2 and 3, the authors provide an intellectually stimulating review on economics and finance theories closely related to real estate finance. As a part of the introduction, these two chapters set the tone for the entire text: real estate financial markets are not isolated; rather, they are a segment of the capital market and follow the principles of general economics theories. These two chapters are extremely helpful especially for teaching undergraduate students who tend to think that real estate finance is just how to borrow through a mortgage loan. In Chapters 4, 5, and 6, the materials on different types of mortgages are presented. This type of material can easily become mired in technical matters and boring. But the authors take an unusual approach to deliver a thorough review of how and why the mortgages evolve under specific historical economic conditions and events. The discussions on the concepts of disintermediation and the tilt effect are excellent examples. Discussions of market dynamics and equilibrium are presented as Problems of Demand and Problems of Supply, which pinpoint the central issue on the emergence of alternative mortgage instruments. Being put in historical and theoretical contexts, the materials in these chapters are insightful and vivid.

One significant contribution the authors make with this text is the coverage on housingpolicy-related issues in Chapters 8 and 9. Housing policies have a direct impact on real estate financial market structures and activities, but they are often overlooked in real estate texts. The truth is, professors would have to personally prepare for these materials without this book. Readers in fields such as urban economics and public administration can also be pleasantly surprised by the richness of this material and find it useful.

Subsequently, the authors discuss the secondary mortgage market and the valuation of mortgage securities (in Chapters 10 and 11), mortgage underwriting and default-related issues (in Chapters 12, 13, and 14). Discussing mortgage-backed securities, they pay close attention to details in the figures and numerical examples to help make complicated matters intuitive. For example, in Figures 10-1 and 10-2, they draw two-way flows of mortgages and cash with clear descriptions. They also reflect the implication of mortgagebacked securities on balance sheets. In addition to explaining the mortgage-backed security specifications, the authors emphasize the prepayment risk to help the readerstudent identify and understand the key factors in the residential mortgage-backed security market. They begin with excellent descriptions on prepayment risk and the PSA models. For example, Figure 11-2 interprets different PSA schedules with a clarity that one cannot always find in real estate teaching materials. They then demonstrate the relationships between the prepayment risk and the interest-rate differentials in Figure 11-3. Subsequently, they illustrate the impact of the prepayment risk reflected by different PSA schedules on cash flows in GNMA9 pools (in Figure 11-5) and on the yield of a realistic example of CMOs (in Figure 11-10). The discussion of the prepayment risk exemplifies the presentation style in this text: clear demonstrations of problem solving and emphases on understanding the issues and relationships. Chapter 11 also introduces the bond valuation material, which any instructor would find valuable while teaching MBS valuation. The second half of this textbook concentrates on commercial real estate financing. Chapters 15 and 16 lay a solid foundation by depicting the capital structures in the market and real estate-related federal taxation. It is a great idea to have an independent chapter on federal taxation. The authors discuss the specifications of tax regulations, particularly the significant effect of Tax Reform Act of 1986.

Chapters 17 through Chapter 21 cover specific issues in commercial real estate financing. The authors offer detailed examples in each area. What stands out is the introduction to commercial mortgage-backed securities in Chapter 17. As we all know, information on CMBS is still scarce. It is nice to see that the authors provide a section on commercial CMOs. For example, in Table 17-4 they demonstrate in details the Moody's rating systems for the CMBS.

This book also comes with a compact disc, which includes files of problem-solving spreadsheets, examples of federal housing programs, tables containing housing and finance data, and exhibits referred to in the text. Both instructors and students will find these files useful. For example, the CMO spreadsheet allows a reader to analyze the cash flows in different tranches, which is very time consuming to construct. At the end of each chapter, lists of key terms, suggested readings, and related websites are provided, in addition to review questions and problems. Technical materials are explained in details in the appendix at the end of each chapter. The instructor's manual is helpful in that it provides page-size copies of all figures used in the text in addition to the usual contents. There is also an accompanying Problem Workbook that provides problems and solutions for the types of problems found in the text. Both the professor-researcher and the student will find this text insightful on issues and yet helpful on financial concepts and techniques.

In summary, Clauretie and Sirmans consistently focus on issues and facts throughout the text instead of providing readers with a collection of tactics and techniques, which is a common pitfall for textbooks. They have substantially achieved their goals "to apply the theoretical aspects of financial economics to explain how real estate financial institutions and markets have developed and evolved to their present state, and why they take the form they do," and "to promote a greater understanding of how real estate financial markets work." Moreover, the text provides numerical examples to problem solving as detailed as calculator keystrokes when necessary. The vast body of literature and documents introduced in this book are original and unparalleled by other texts in the field of real estate. Instructors and researchers will find them extremely helpful.

Shiawee X. Yang

Northeastern University