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Question
You represent a REIT which is considering purchasing a certain lease. You are evaluating the potential transaction using the following given information:- Lease term: Perpetual.
- Tenant: Investment grade commercial tenant. This tenant just issued a perpetual bond at a 6% yield (interest rate).
- No capital expenditures necessary, absolute triple net (NNN) lease.
- Rent is fixed at $1,000 per year, payable annually on 12/31.
- Your company has access to perpetual debt at 6%.
- Your company has a corporate WACC of 8% based on 50% debt/total value with 6% cost of debt and 10% target return on stockholder equity. (Recall that REITs are exempt from corporate-level income taxes.)
- The market yield is 4.5% in the municipal (tax-exempt) bond market for perpetual debt of similar risk to the lease and the REIT's debt.
(b) Suppose the marginal personal tax rate on investment earnings applicable to marginal investors in your REIT's equity shares (traded in the stock market) is 25%. (Note that REITs are not subject to the 15% limit on dividend taxes.) What discount rate would you use to determine the investment value (IV) of the lease for your REIT (i.e., the likely effect on your REIT's equity value in the stock market)? What is the PV of the lease at this discount rate? (Show your work or calculator steps.) Why did you select the cash flow level and the discount rate that you used (1 short sentence answer)?
Answer
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Related questions
Q:
Consider the following period-by-period total returns:
Year 1: 5.00%
Year 2: 15.00%
Year 3: 25.00%
What is the arithmetic average total return per year for the Years 1-3 period?
(a) 5.00%
(b) 14.71%
(c) 15.00%
(d) 15.23%
(e) 45.00%
Q:
All are true, except:
(a) The "Risk Premium" is the total expected return minus the risk-free rate.
(b) "Risk" is the possibility the ex post return may differ from the ex ante expectation.
(c) "Risk" is measured by the standard deviation of the distribution of returns.
(d) Higher risk is associated with higher expected returns.
Q:
All are ways to break up (or add up to) the total return except:
(a) Income + Appreciation
(b) Yield + Capital Gain
(c) Riskfree Rate + Risk Premium
(d) Real Return + Inflation Premium
(e) Nominal Return + Real Return
Q:
The present value of the future sum of $30,000 two years from now, if the opportunity cost of capital is 15% nominal annual rate of return compounded monthly is:
Q:
Which statement is most accurate?
(a) Real Estate is a better inflation hedge than Treasury Bills.
(b) Stocks are a better inflation hedge than Real Estate.
(c) Long-Term Bonds are a better inflation hedge than real estate.
(d) Real estate is a better inflation hedge than stocks.
Q:
All of the following are examples of the "income objective" of investment except:
(a) A 65-year-old planning how to use his wealth to support himself now that he is retired.
(b) A pension fund trying to match revenues to its current pension payout needs.
(c) A university endowment fund wanting to use gift assets to fund an annual scholarship program.
(d) A 25-year-old planning to be able to buy a house in 5 years.
(e) A bank investing assets so as to be able to pay interest on current savings deposits.
Q:
Improvements in transportation infrastructure will tend to:
a) Increase the value of geographical location centrality
b) Reduce the value of geographical location centrality
c) Have no effect on the value of geographical location centrality
d) Cannot determine with the information given
Q:
At site "A" the best current construction project is a retail plaza that would cost $3,000,000 to build (exclusive of land cost) and would then generate net rents of $400,000/yr, expected to grow at 2% per year indefinitely. At site "B" the best current construction project is an office building that would generate net rents of $500,000 per year, expected to remain constant. Construction of the office building would cost $4,000,000 (exclusive of land cost). Suppose investors require a cap rate (current net income as percent of investment) equal to 10% minus the expected annual growth rate in the net income.
Suppose the current market value of both undeveloped sites is $1,500,000 each. On which site or sites is it currently profitable to develop?
(a) Site A.
(b) Site B.
(c) Both sites A and B.
(d) Neither site A nor B.
Q:
At site "A" the best current construction project is a retail plaza that would cost $3,000,000 to build (exclusive of land cost) and would then generate net rents of $400,000/yr, expected to grow at 2% per year indefinitely. At site "B" the best current construction project is an office building that would generate net rents of $500,000 per year, expected to remain constant. Construction of the office building would cost $4,000,000 (exclusive of land cost). Suppose investors require a cap rate (current net income as percent of investment) equal to 10% minus the expected annual growth rate in the net income.
Based on the current best projects described above, which site is most valuable?
(a) Site A.
(b) Site B.
(c) Both sites are equal in value.
(d) Insufficient information to answer the question.
Q:
A simple monocentric city (Roundville) has a population of 3,000,000 with a homogeneous density of 5 inhabitants per acre, and one person per household. Agricultural rents are $500/acre/yr, housing construction costs (including developer profit) can be paid for with a perpetual loan charging interest of $5000/house/yr, and transportation costs are $250/person/yr per mile of distance from the center of the city. (Recall that there are 640 acres per Mi2.)
If Roundville's population increases by 10% but its density remains constant, approximately how much will its radius increase?
(a) None.
(b) 5%.
(c) 10%.
(d) 20%.
Q:
As opposed to the concentric ring model of urban growth, the sector model dictates that similar land uses tend to:
a) Mix naturally over time, leading to a more integrated city
b) Lie at a similar distance from the center of the city
c) Cluster along rays or in pie-shaped wedges emanating from the center
d) Be dictated more by ephemeral political coincidence than by well considered plans
Q:
According to the rank/size rule (Zipf's Law), the rank of a city's population should be approximated by knowledge of the following two factors:
a) The city's population and the population of the largest city in the system of cities
b) The city's population and the city's growth component
c) The city's growth component and the population of the largest city in the system of cities
d) The city's population and the objective rank of how nice the city is
Q:
The primary centralizing (centripetal) forces acting on a city include the following, except:
a) Economies of scale
b) Economies of agglomeration
c) High population density
d) Positive locational externalities
Q:
The difference between gross absorption and net absorption is best described as follows:
(a) Gross absorption indicates the total amount of movement in the market while net absorption indicates the growth in overall demand.
(b) Gross absorption indicates the growth in overall demand while net absorption indicates the total amount of movement in the market.
(c) Gross absorption indicates demand for both Class A and Class B space, while net absorption refers only to demand for Class A space.
(d) The wise student realizes that, at a deep and fundamental level, gross absorption and net absorption are really the same thing!
Q:
According to Neighborhood Succession Theory, in a mature (fully built up) neighborhood:
(a) Location value tends to grow steadily over time in real terms (net of inflation).
(b) Location value tends to decline steadily over time in real terms.
(c) Location value tends to remain about constant in real terms unless there are substantial changes in the city, under which case value might go in either direction.
(d) Location value is determined purely by the average income of the residents.
Q:
Industry Local Employment National EmploymentState & Federal Government 50,000 10,000,000Legal Services 13,000 2,000,000Computer Manufacturing & Repair 4,000 2,500,000Total All Employment 200,000 120,000,000Which of the three industries in the above table is not in the export sector of this locality?(a) State & Federal Government.(b) Legal Services.(c) Computer Manufacturing & Repair.(d) They all are in the export base.
Q:
Real estate space markets are segmented for all of the following reasons except:
(a) Space users require specific locations and types of buildings.
(b) Built space is fungible.
(c) Buildings cannot move.
(d) It is difficult and expensive to change buildings from one usage type to another (e.g., from office to apartment).
Q:
Suppose demand for apartments in a metropolitan area is: #Apt.units=60,000 +(0.30)(# households)-(80)*($Rent/unit/mo.)
In the question above, suppose the number of apartment units remained at 88,000 while the number of households grew from 200,000 to 220,000. To what level would real rents rise?
(a) $500
(b) $475
(c) $450
(d) $425
(e) Cannot be determined from the information given.
Q:
Which are the two fundamental markets in commercial real estate?
(a) The space market and the asset market.
(b) The space market and the money market.
(c) The construction market and the land market.
(d) The asset market and the stock market.
Q:
A certain property market is characterized by 100,000 SF spaces that are expected to rent in 8-year fixed-rent leases, successively in perpetuity (annual payments at the ends of the years). Properties are typically sold just after a lease is signed (1 year prior to first rent payment). There is no vacancy down-time between the successive leases. The rent in each lease is constant, but between new lease signings the rent is expected to grow at a rate of 2% per year. The current market rent is $10/SF per year. In general, the rents are uncertain prior to lease signings. The opportunity cost of capital (OCC) for investments providing contractually-fixed cash flows is 6% per year, and the typical prevailing cap rate in this property market is 7%. (a) What is the market value of space per square foot? (b) What is the implied inter-lease discount rate applicable to risky cash flows that depend on the real estate market?
Q:
Suppose market rate apartments produce net cash flow of $10,000/yr in perpetuity, while affordable units provide only $5,000. However, if the developer commits that 25% of the units will be forever affordable, then she will qualify for a perpetual loan $4,375,000 at an interest rate 50 basis points (0.5%) below the market interest rate. (However, this is not a tax-exempt loan " its interest is taxable.) Also, the developer can receive perpetual (and transferable) annual LIHTC equal to $1,000/yr per low-income unit. If property yields (total returns, opportunity cost of capital) are 10% at the PBT level (assume same for market and affordable apartments), loan market interest rates before-tax are 5%, yields on otherwise similar municipal bonds (tax-exempt loans) are 4%, and the developer faces an income tax rate on investment returns of 20%, then should the developer make her 100-unit apartment complex a mixed-income affordable development or a 100% market development? Tell why, and how much difference it makes (i.e., evaluate the two alternatives). Answer this question from a market value (MV) perspective (but be careful: the LIHTCs are after-tax cash flows).
Q:
The table below shows the projected net cash flows (including reversion) for Property A and Property B. If both properties sell at fair market value for a cap rate (initial and terminal net cash yields) of 7%, then which statement below correctly describes the relative investment risk in the two properties?Annual net cash flow projections for two properties ($1,000,000s):Year:12345678910A$1.0000$1.0000$1.0000$1.0000$1.0000$1.0000$1.0000$1.0000$1.0000$15.2857B$1.0000$1.0200$1.0404$1.0612$1.0824$1.1041$1.1262$1.1487$1.1717$18.6093(a) Property A is more risky.(b) Property B is more risky. (c) They both are equally risky.(d) Insufficient information to determine the answer.
Q:
Projected Year 1 NOI: $100,000.Projected Year 11 NOI: $121,899.Projected Year 10 resale (reversion) value: $1,523,738.Current (going-in) market cap rate for similar properties: 7%.What is the current market value of the property?(a) $7,000.(b) $1,000,000.(c) $1,428,571.(d) $1,741,414.(e) Insufficient information to determine answer.
Q:
All of the following are typical "GIGO" mistakes in common application of the DCF method to real estate investment analysis except:(a) The growth rate in the rents is projected too high.(b) The level of required capital improvement expenditures, or the going-out cap rate, are projected too low.(c) The discount rate or going-in IRR is too high.(d) The going-in cap rate is projected too low.
Q:
a) Consider the following fully-amortizing 5-year ARM (contract interest rate can change once every 60 months) with 15-year maturity, monthly payments. The ARM has initial interest rate 6.5% with 2 points, caps are 2% per jump, 5% lifetime, margin is 300 basis points, index is Treasury Bonds that are currently yielding 6.0%. The loan amount is $100,000. Under the "straight line" assumption about future interest rates (i.e., assuming the market rate on the index remains constant), what is the yield to maturity? (Show your work if you want to possibly get partial credit.)b) Consider a $4,000,000, 7%, 25-year mortgage with monthly payments and a 7-year maturity with balloon. If the market yield is 7.5% (BEY), how many disbursement discount points must the lender charge to avoid doing a negative NPV deal from a market value perspective?
Q:
(a) Fully explain and clarify the following statement: "There are two types of tax shields available to investors in property equity: deprecation tax shields (DTS) and interest tax shields (ITS), but only one of these types of tax shields generally adds to the investment value of the investment no matter what the investor's marginal tax rate." (b) As part of your answer, quantify the NPV to two different borrowers, from an after-tax investment value perspective, of a perpetual loan of $1,000,000 at 6% interest when the market yield on corporate bonds is 6% and on otherwise identical municipal bonds is 4%, and Borrower A faces a marginal tax rate of 30% while Borrower B faces a marginal tax rate of 35%. (c) Also, compare the NPV to Borrower B to the PV of that borrower's interest tax shields (the PV of the borrower's tax deductions associated with the loan).
Q:
Suppose the riskfree (i.e., Government Bond) interest rate is 5%, the current cash yield payout rate on newly built property is 7.5%, and the annual volatility of individual property total returns is 25% for built properties that are leased up and operational. Use the Samuelson-McKean formula to answer the following questions concerning a vacant but developable land parcel. (a) If built property has a 4% risk premium in its expected total return (9% total return), then what is the risk premium and expected total return for the land parcel? (hint: use the elasticity formula 8.11a and the risk premium formula 8.11c) (b) What is the value of the land parcel if a building currently worth $2,500,000 new could be built on the land for a construction cost of $2,200,000? (c) What is the "hurdle benefit/cost ratio" above which the land should be immediately developed? (d) What value of newly built property does this suggest is required before the land should be developed? (e) Under these conditions should the land be developed immediately or is it better to wait?
Q:
The "option premium" is:
a) The excess of the option value over its immediate exercise value.
b) The risk premium in the required investment return to option investment.
c) The excess of the option value over the current value of the underlying asset.
d) Difficult to quantify using the Samuelson-McKean Formula.
Q:
Alex and Kay are two retail property investment managers hired one year ago by two different investors. In both cases the managers were free to use their own judgment regarding geographical allocation between properties in the East versus West of the country. Kay allocated her capital equally between the two regions, while Alex placed 65% of his capital in the Western region. After one year their respective total returns were as depicted in the table below. As you can see, Kay beat Alex by 60 basis-points in her total portfolio performance for the year.Alex & Kay's returns realized for clients:Weights:AlexKayEast35%50%West65%50%Returns:AlexKayTotal Portfolio6.65%7.25%East6.00%6.50%West7.00%8.00%How would you attribute this 60 basis-point differential between pure allocation performance, pure selection performance, and a combined interaction effect, if you wanted to compute an unconditional performance attribution that was independent of the order of computation? (Note: This is equivalent to taking Alex as the benchmark against which Kay's performance is being compared.)
Q:
Suppose the riskfree rate is 3% and the market risk premium is 6% and a certain asset has a beta of 0.5. The asset in question is expected to produce a perpetuity of net cash flow to its investors equal to $1,000,000 per year. Suppose the CAPM is "true", and disequilibrium in asset market prices does not endure beyond (i.e., "gets corrected" within) one year. Should you buy this asset if you can get it for a current price of $15,000,000? What would be the NPV of such an acquisition, and what would be the minimum expected return on a one-year investment in this asset at that price, and how much of that return (if any) would be considered "super-normal" (i.e., more than what is warranted by the amount of risk in the investment)?