Maximum Loans

As for the borrowing capacity of real estate, this is determined largely by its location. It is greater, the nearer the land is to the center of business and to transportation facilities. More money can be borrowed when there are improvements in the form of buildings upon the property, for such real estate is more readily salable and is more likely to enhance in value as the population increases. Of all property, outlying and unimproved suburban real estate is the most unsatisfactory collateral, as it lacks these essential requirements.

Source Of Capital

The capital which finds its way into real estate investments is drawn from various sources, coming alike from large financial institutions, from wealthy individual investors, and from the humble and thrifty masses. There is an enormous business transacted in real estate mortgages. To serve investors who are not able to buy mortgages outright, large financial institutions have evolved what is called a first-mortgage real estate bond. These bonds they guarantee for both the money invested in them and the interest. This they can well do, for they first thoroughly appraise the value of the property on which the bonds are a mortgage, and satisfy themselves regarding the titles. In New York City there are several of these concerns which have behind them resources in excess of a hundred million dollars, and in no case has there ever been a default in the payment of principal or interest in the mortgage bonds behind which stands their guarantee. This merely serves to show how careful they are with their loans. Their mortgage bonds are sold at a figure producing an income ranging between 4½ and 5 per cent, as they are a part of a first mortgage loan and the laws of safety and prudence require that such loans be confined to desirable property.

Large office buildings, factories, and apartment houses are being financed more and more with outside capital. A blanket mortgage or a trust deed is placed on these structures and divided into bonds of small denominations. These bonds are then offered investors on an attractive basis. This class of business is growing to large proportions. Conservative bankers find it profitable, and the bonds, when issued within proper restrictions, are an excellent security for the medium-grade investor.

No first mortgage real estate bond should be accepted as such unless it is so stipulated on the face of the bond and in the indenture of the mortgage. There are second and third mortgage real estate bonds, but they are graded as more speculative, as they are but a lien on the value of the equity above the first mortgage. This shows how much care should be exercised in their selection. While some of these mortgages may be perfectly sound, in troublesome financial periods they are not the most desirable class of securities to hold, especially when they are a lien on out-of-the-way real estate.

Unless such mortgages are secured by centrally located property, with a liberal margin of value above the underlying mortgages, banks will hesitate to lend any money on them, while savings banks are restricted by law in most states from considering such mortgages at all as collateral for loans.

Second and third mortgages are largely the creation of builders. To make it as easy as possible for buyers of homes to pay off their obligations, they undertake to carry a second mortgage payable in a year or more. It is in this way that builders principally finance themselves.

To show how undesirable are such mortgages, I know of an instance where a woman in the panic of 1907 was compelled to pay a bonus of $100 to renew a second mortgage of $1,000 on a substantial home in Brooklyn. Her interest for one year, including this bonus, came to 16 per cent. This is fairly indicative of the element of risk that capital considers it assumes on such obligations.

Real Estate Debenture Bonds

There have also developed, as a result of the large operations in real estate, corporations offering investors somewhat more inviting inducements for the use of their capital in extending their operations in real estate. A number of these companies have been very successful, and their securities are favorably received in conservative financial circles. Their securities are known as debenture bonds. They are not first mortgage bonds, but merely notes of these corporations and of course, to make them attractive, they are placed on a 6 per cent income basis.

Some of the younger real estate and holding corporations fix the interest on their debenture bonds at a still more attractive figure, but it is well for the investor to remember that his risk increases in proportion to the interest that is paid on his money. In normal times it is not difficult, in a large city, to raise money on real estate at from 5 to 6 per cent, even when it is located in the outlying sections, and any higher rate should be carefully scrutinized.

As real estate debenture bonds have no other security behind them than the credit of the corporations issuing them, it is advisable to inspect carefully their financial condition. The conservatively managed companies are aware of the need of inspiring confidence in their obligations if they are to find a ready market for them, and they accordingly make known their actual financial condition at least once a year. Some of them even go beyond merely publishing a balance sheet; they employ chartered accountants to certify to the correctness of the various items of assets and liabilities, and reliable real estate appraisers to check over their real estate holdings, to assure their bondholders against any inflation or reckless management of the funds intrusted to their care.