Discount

Definition

In real estate, a discount refers to the difference between the face amount of an obligation (such as a loan or mortgage) and the amount that is actually advanced or received. This often occurs when an obligation is sold for less than its face value. Discounts represent a form of cost-saving for the buyer and a way to attain liquidity for the seller.

Details

A discount can be thought of as essentially the opposite of a premium. When a loan or mortgage is issued, its face value represents the principal amount that is to be repaid. However, market conditions or a need for quick cash might lead the holder of the loan (such as a lender) to sell the rights to collect the full amount of the loan at a discounted price.

Examples

Mortgage Sale at Discount: Abel sells a piece of land for $100,000 and offers financing to the buyer by providing a $60,000 mortgage at 5% interest. Abel later decides to sell this mortgage to another investor. However, instead of selling it for the full $60,000 face value, Abel sells it for $45,000. In this case, there is a $15,000 discount.
Commercial Real Estate Financing: A developer receives a $2 million construction loan with a face amount of $2 million. They are quickly looking to free up capital, so they sell this loan for $1.8 million. Thus, the discount is $200,000.

Frequently Asked Questions (FAQs)

1. Why would someone sell a mortgage at a discount?

A mortgage might be sold at a discount to quickly obtain liquidity or because the seller may expect that the future payments may be uncertain or delayed.

2. How does a discount affect the buyer?

The buyer acquires the mortgage or loan at a lower price than its face value, which can result in a higher yield or profit over time, assuming the borrower continues to make payments as agreed.

3. How is the amount of the discount determined?

The discount amount is generally based on market conditions, the risk of the obligation, and the urgency of the seller’s need for liquidity.

4. Are discounts common in real estate transactions?

Yes, discounts are fairly common, especially in distressed loan sales or secondary mortgage markets.

Face Value: The nominal or dollar value assigned to a security or the amount on the face of a loan or mortgage that must be repaid by the borrower.

Premium: The amount paid at maturity of an obligation that is greater than its face value, or the price at which a mortgage or loan is sold above its face value.

Yield: The interest or dividends received from a security expressed annually as a percentage based on its current or face value.

Liquidity: The ability to quickly convert assets or securities into cash without a significant loss in value.

Online Resources

References

Geltner, D., & Miller, N. G. (2013). Commercial Real Estate Analysis and Investments. OnCourse Learning.
Linneman, P. (2016). Real Estate Finance & Investments: Risks and Opportunities. Linneman Associates.
Brueggeman, W. B., & Fisher, J. D. (2010). Real Estate Finance and Investments. McGraw-Hill Education.

Suggested Books for Further Studies

Brueggeman, W. B., & Fisher, J. D. (2020). Real Estate Finance and Investments. McGraw-Hill Education.
Brealey, R. A., Myers, S. C., & Allen, F. (2019). Principles of Corporate Finance. McGraw-Hill Education.
Linneman, P. (2018). The Real Estate Finance and Investment Manual. Linneman Associates.

Real Estate Basics: Discount Fundamentals Quiz

### What does a discount in real estate refer to? - [x] The difference between the face amount of an obligation and the amount advanced or received - [ ] The increase in property value over time - [ ] The commission earned by real estate agents - [ ] The tax deduction on a mortgage > **Explanation:** In real estate, a discount represents the difference between the face amount of an obligation and the amount actually advanced or received. This often occurs when an obligation is sold for less than its face value. ### Why might a lender sell a mortgage at a discount? - [x] To obtain liquidity quickly - [ ] To defer tax liabilities - [ ] To increase the interest rate on the mortgage - [ ] To extend the repayment period > **Explanation:** A lender might sell a mortgage at a discount to quickly obtain liquidity, perhaps in urgent need of cash or to divest risky assets. ### What determines the amount of a loan discount? - [x] Market conditions, risk of the obligation, and urgency of the seller’s need - [ ] The borrower’s credit score alone - [ ] The real estate agent’s commission - [ ] The age of the property > **Explanation:** The discount amount is often determined by market conditions, the risk associated with the obligation, and the seller's urgency to liquidate assets. ### What does a buyer gain from purchasing a mortgage at a discount? - [x] A higher yield or profit over time - [ ] An insured investment - [ ] A guaranteed increase in property value - [ ] Immediate tax benefits > **Explanation:** A buyer who purchases a mortgage at a discount can achieve a higher yield or profit over time, assuming the borrower makes payments as required. ### When can a discount be considered large? - [x] When market conditions are unstable or risky. - [ ] When the property is newly constructed. - [ ] When interest rates drop. - [ ] When real estate laws become stricter. > **Explanation:** Discounts can be large during unstable market conditions or when the risk associated with the obligation is high. ### What financial advantage does a discount provide to a seller? - [x] Quick access to liquidity - [ ] Improved credit rating - [ ] Higher long-term income - [ ] Tax-free income > **Explanation:** Discounts provide sellers with quick access to liquidity, enabling them to access cash swiftly. ### Why is liquidity important for a seller of a discounted loan? - [x] It allows them to meet immediate financial obligations. - [ ] It increases the property’s resale value. - [ ] It acts as collateral for future loans. - [ ] It raises their credit score. > **Explanation:** Liquidity is crucial because it allows sellers to meet immediate financial obligations or invest the proceeds in other opportunities. ### How does the concept of discount apply to both real estate and financial markets? - [x] By offering a way to sell obligations or assets at less than their face value to achieve quick liquidity. - [ ] By reducing property taxes. - [ ] By providing tax deductions for borrowers. - [ ] By increasing loan interest rates. > **Explanation:** Discounts in both real estate and financial markets provide a mechanism to sell obligations or assets quickly by receiving less than their face value, thereby obtaining fast access to funds. ### Are discounts more common in high-risk or low-risk markets? - [x] High-risk markets - [ ] Low-risk markets - [ ] Stable markets - [ ] Government-insured properties > **Explanation:** Discounts tend to be more common in high-risk markets where liquidity is tough, and asset quality may be perceived uncertain. ### How do investors analyze a discounted mortgage before purchasing? - [x] By assessing market risk, property value, and borrower reliability - [ ] By reviewing the seller’s credit history - [ ] By calculating the real estate agent's commission - [ ] By evaluating local zoning laws > **Explanation:** Prior to purchasing a discounted mortgage, investors will analyze market risk, the underlying property's value, and the borrower's reliability to understand the potential for profit and risk.