Q&A Hero

Q: Which of the following is a "soft cost" of construction? (A) The cost of the architectural drawings (B) The cost of pouring the foundation (C) The cost of erecting the building (D) The cost of finishing the interior space

Q: Which of the following is the usual progression for a real estate development project? (A) Land acquisition, completion, management, sale, construction (B) Land acquisition, construction, completion, management, sale (C) Land acquisition, construction, completion, sale, management (D) Land acquisition, management, construction, completion, sale

Q: Units 275 300 Gross Revenue $3,267,000 $3,564,000 Vacancy 163,350 178,200 Expenses 1,143,450 1,247,400 Net Operating Income $1,960,200 $2,138,400 Cost $22,000,000 $22,800,000 Consider the table above. An investor-developer demands a return of at least 9percent on cost. Which of the following statements is TRUE based on the information above? (a) Neither project produces a sufficient expected return (b) The 275 unit project produces a sufficient return, but the 300 unit project does not (c) The 300 unit project produces a sufficient return, but the 275 unit project does not (d) Both projects produce sufficient return, but the 275 unit project produces a higher return than the 300 unit project

Q: Which of the following is one reason that construction lenders typically prefer the cost approach to valuation over the income approach? (a) The cost approach provides a more conservative estimate of value (b) The cost approach provides a more optimistic estimate of value (c) The cost approach is a good indication of the expected value of an income-producing property once construction is complete and it has been leased-up (d) The cost approach is a better estimate of actual market value of the project

Q: A standby commitment is: (a) A way to increase NOI for projects with large debt service obligations (b) An agreement by a lender to provide permanent financing for a property once construction is complete (c) Another term for a construction loan (d) The same thing as a take-out loan commitment

Q: Loans made under the assumption that markets will turn around are referred to as spec loans.

Q: Generally, as the cost of a site increases, so do the quality and the density of the improvements constructed on it.

Q: Under a triparty buy-sell agreement, the construction lender will accept funding from the first party willing to repay the construction loan.

Q: Even after obtaining permanent financing, a developer still maintains the right to alter a project's design or the level of expenditures.

Q: Lenders typically finance the development of a project as a percentage of completed appraised value, including the price of the site.

Q: Permanent financing commitments usually allow the lender to approve major leases.

Q: Commitments for construction financing are usually contingent on commitments for permanent financing.

Q: Permanent loans provide the money for a single permanent mortgage loan and are usually provided by commercial banks or mortgage banking companies.

Q: Construction loans provide the money to construct a building and are usually provided by life insurance companies or pensions funds.

Q: The demand for retail space should be examined in terms of the characteristics of the tenants demand in a given market.

Q: Holdbacks are used by construction lenders to be sure that a developer has met all of his or her obligations before all of the funds from the construction loan are given to the developer.

Q: A bullet loan is a construction loan that, in effect, becomes permanent financing when construction is complete.

Q: In general, developers must get a construction loan before they can line up permanent (long-term) financing that will be used once the project is complete and being operated with tenants.

Q: One of the risks of project development is "project risks," which are the result of unexpected changes in general market conditions affecting the supply and demand for space.

Q: Developers usually hold back about ___ percent of each progress payment. (A) 1 (B) 10 (C) 25 (D) 75

Q: What term applies to third-party financing that is used between funds advanced by the permanent lender and funds needed to repay the construction loan? (A) Interim loan (B) Mini-perm financing (C) Gap financing (D) Partial financing

Q: Which of the following common contingencies is NOT usually included with a permanent financing agreement? (A) Completion date for construction phase (B) Minimum rent-up requirements (C) Materials used in construction phase (D) Cleanliness of work area

Q: Which of the following is FALSE regarding a construction loan? (A) It usually has a lower rate than does permanent financing (B) It is also known as interim loan (C) Hard costs can usually be financed (D) The entire land cost can not usually be financed

Q: Which of the following is NOT one of the developer strategies mentioned in this chapter? (A) To sell and lease back the land (B) Owning and managing after sale (C) Sell after lease-up phase (D) Develop for lease in master-planned development

Q: Which of the following statements is FALSE regarding operating leases? (A) They are recorded as present value of lease on the balance sheet (B) They do not have any real effect the balance sheet (C) They must not extend for at least 75 percent of the asset's life (D) They are usually the preferred form of accounting for leases

Q: Which of the following statements is TRUE for a corporation with a high credit rating considering owning versus leasing corporate real estate? (A) The company should probably use a mortgage (B) The company can probably issue corporate debt at a more favorable rate (C) The company is probably better off leasing the property from someone with a lower credit rating (D) The company's credit rating does not effect the own versus lease decision

Q: When doing a sale versus lease analysis, how should the residual value of the property be estimated? (A) Assume it is worthless (B) Set it equal to the book value of the property (C) Assume it is equal to the original purchase price (D) Assume it is equal to the market value of the real estate

Q: It is estimated that corporate users control as much as ___ percent of all commercial real estate. (A) 10 (B) 25 (C) 75 (D) 100

Q: Which of the following could be affected if a corporation acquires a parcel of real estate? (A) Earnings per share ratio (B) Corporate liquidity (C) Corporate risk (D) All of the above

Q: All other factors being equal, a company would prefer to own rather than lease under which of the following conditions? (A) The expected life of an asset far exceeds the company's projected period of use (B) The real estate investment represents a large proportion of the company's total capital (C) The corporate needs for the property are not highly sensitive to the level of maintenance (D) The corporation needs a specialized research and development building

Q: The cash flows considered in a lease versus own analysis are: (A) Purchase price, difference in cash flow from operations over the holding period, and cash flow from sale (B) Purchase price, lease payments, and cash flow from future sale (C) Cash flow from sale, differences in future operating expenses, and cash flow from future sale (D) Cash flow from sale, future lease payments, and differences in future operating expenses

Q: The cash flows considered in a sale-leaseback analysis are: (A) Purchase price, differences in operating expenses over the holding period, and cash flow from future sale (B) Purchase price, lease payments, and cash flow from future sale (C) Cash flow from sale, differences in future cash flow from operations, and potential cash flow from future sale (D) Cash flow from sale, future lease payments, and differences in future operating expenses

Q: Which of the following does NOT represent a potential benefit of selling and leasing back a property? (A) Provides a source of capital (B) Returns excess capital to investors (C) Demonstrates the value of the real estate to the marketplace (D) Increases the firm's depreciation deductions

Q: A company sells an office building that has appreciated in value and subsequently leases the space. Which of the following scenarios represents an impact that sale-leasebacks may have on corporate financial statements? (A) Lower total income will be realized in the year of sale because of capital gains tax (B) Higher taxable income will be realized in the year of sale because of a gain on sale (C) Earnings per share increases because the mortgage has been paid off (D) Higher taxable income will be realized because lease payments cannot be deducted

Q: Which of the following conditions will NOT cause a lease to be categorized as a capital lease? (A) It extends for at least 90 percent of the asset's life (B) It transfers ownership to the lessee at the end of the lease term (C) It seems likely that ownership will be transferred to the lessee at the end of the lease term because of a "bargain purchase" option (D) The present value of the contractual lease payments equals or exceeds 90 percent of the fair market value of the asset at the time the lease is signed

Q: Which of the following factors does NOT represent an effect of corporate real estate ownership on corporate financial statements? (A) The unrealized source of potential gain from the sale of property is not represented on annual income statements (B) Income represented on accounting statements may underestimate the actual cash flows provided by property (C) The book value of property on the balance sheet may not represent the actual market value (D) The corporation's overall debt ratio may be reduced, and property is carried at book value but financed at market value

Q: Which of the following tax law changes has reduced the incentive for individuals to lease to corporations as a part of the Tax Reform Act of 1986? (A) Depreciation lives were lengthened (B) The highest marginal tax rate for corporations is much lower than the highest marginal tax rate for individuals (C) Individuals are subject to limitations on "passive" losses used to offset other taxable income (D) Income from corporations are no longer double taxed

Q: A company is planning to move to a larger office and is trying to decide if the new office should be owned or leased. Cash flows for owning versus leasing are estimated as follows. Assume that the cash flows from operations will remain level over a 10 year holding period. If purchased, the company will invest $385,000 in equity and finance the remainder with an interest-only loan that has a balloon payment due in year 10. The after-tax cash flow from sale of the property at the end of year 10 is expected to be $750,000. What is the incremental rate of return on equity to the company, if the property is owned instead of leased? Own Lease Sales 1,000,000 1,000,000 Cost of goods sold 500,000 500,000 Gross income 500,000 500,000 Operating expenses: Business 130,000 130,000 Real estate 60,000 60,000 Lease payments 0 120,000 Interest 90,000 0 Depreciation 35,000 0 Taxable income 185,000 190,000 Tax 55,500 57,000 Income after tax 129,500 133,000 Plus: Depreciation 35,000 0 After-tax cash flow 164,500 133,000 (A) 17.99% (B) 13.26% (C) 10.32% (D) 12.62%

Q: Why might it be argued that corporations do not have a comparative advantage when investing in real estate as a means of diversification from the core business? (a) Corporations cannot react as quickly as individual investors to changes in market conditions (b) Corporations do not typically hold real estate in a large number of geographic areas and may not hold a variety of different types of properties (c) Corporations often use property managers who do not understand financial markets (d) Diversification dilutes a corporations risk-return profile and does not provide an advantage to corporations

Q: For which of the following reasons would a business prefer to own real estate rather than lease it? (a) If the business demands specialized or unique facilities (b) Owning allows the business to develop skills in operating, maintaining, and repair real estate and the associated facilities (c) Owning reduces operating flexibility (d) The capital commitments with owning are lower than the capital commitments associated with leasing (e) All of the above are reasons a business would prefer to own space rather than lease it

Q: If a company's space requirements are far less than what is optimal to develop on a given site, leasing would tend to be more favorable.

Q: If the incremental cash flows from owning versus leasing are compared without explicitly considering debt financing, these returns should be compared to the firm's cost of equity.

Q: A company can diversify its business activities by developing, owning and subsequently leasing real estate to other companies. Because of the diversification benefits, shareholder value is always increased.

Q: Because accounting depreciation charges often exceed the true economic depreciation of real estate, the earnings of companies owning real estate typically understate the level of operating cash flow.

Q: An operating lease does not affect a corporate balance sheet.

Q: Non-recourse debt, such as a mortgage on a specific property, typically has a lower rate than the unsecured debt of companies with high credit ratings.

Q: The residual value at the end of the holding period should be based on the market value of the real estate and not the book value.

Q: Similar to decisions about owning or leasing equipment, the decision to own or lease a property is basically just a choice between two financing alternatives.

Q: In general, if a company assumes that the residual value at the end of the holding period is always equal to the book value, the decision to own versus lease will be biased towards owning.

Q: A company estimates that the incremental cost of owning a parcel of real estate vs. leasing will be 10%. The company expects a 12% rate of return on investments. Therefore real estate should be owned and not leased.

Q: Because real estate usually declines in value faster than accounting depreciation, it is reasonable to assume that the property has zero value at the end of the lease term.

Q: Because real estate is shown on the corporation's books at its historical cost less book depreciation, the value of corporate real estate is often considered "hidden" from shareholders.

Q: For a large corporation with a good credit rating seeking to finance corporate real estate, the cost of a mortgage loan may be greater than the cost of unsecured corporate debt.

Q: Which of the following is NOT a benefit of refinancing? (A) The investor can increase financial leverage (B) It is an alternative to sale of the property (C) Risk is decreased (D) No taxes have to be paid on funds received by additional borrowing

Q: A property should be sold when which of the following occurs? (A) The marginal rate of return is rising but less than the reinvestment rate (B) The marginal rate of return is constant (C) The marginal rate of return is zero (D) The marginal rate of return is falling and becomes equal to the reinvestment rate

Q: The return calculated assuming the property is held for one additional year is referred to as the: (B) (A) After-tax cash flow from sale (B) Marginal rate of return (C) Reinvestment rate (D) None of the above

Q: Disposition when dealing with real estate means which of the following? (A) The way a property fits in with its surroundings (B) Refinancing the property (C) Improving property value (D) Sale of the property

Q: The marginal rate of return can be defined as the: (A) Return that results from holding the property for one additional year (B) IRR the year the internal rate of return starts to decrease from holding the property (C) Incremental return over a holding period resulting from renovating a property (D) Rate of return at which the net present value equals zero

Q: An investor purchased a building in 1982 when the building could be depreciated over 19 years. A new investor is interested in purchasing the building in 1992 when the depreciable life according to tax laws is 31.5 years. Assuming both investors are in the same tax bracket and that everything else is equal, what can be said about the after-tax cash flow received by the new investor as compared to the after-tax cash flow that would be received by the original owner of the building? (A) The new investor will have a higher after-tax cash flow because the depreciation expense will be lower (B) The new investor will have a higher after-tax cash flow because the depreciation expense will be higher (C) Both investors will have to use the 31.5 year depreciable life after 1986 so the after-tax cash flow will be equal (D) The new investor will have a lower after-tax cash flow because the depreciation expense will be lower

Q: An investor is considering refinancing a property. The current mortgage has an interest rate of 8.75% and a mortgage balance equal to 45% of the property value due to amortization of the loan and some appreciation in value. However, the investor would like to refinance at an amount equal to 75% of the property value. He has found out that the property can be refinanced at a 75% loan-to-value ratio for 9.5% interest over 15 years. What can be said about the incremental cost of refinancing? (A) It will be higher than 9.5% (B) It will be less than 9.5% (C) It will be equal to 9.5% (D) Can"t tell without additional information

Q: Which of the following would be considered when an investor is trying to decide whether or not to renovate a property? (A) After-tax operating income before renovation (B) The difference between future operating income if renovated and if not renovated (C) After-tax cash flow from sale the year of renovation (D) The mortgage balance on the property the year before renovation

Q: Which of the following represents the formula for the annual marginal rate of return (MRR) when trying to decide whether to hold or sell a property (ATCFS equals the after-tax cash flow from sale and ATCFO equals the after-tax cash flow from operations)? (A) MRR = (ATCFS (year t + 1) + ATCFO (year t + 1) - ATCFS (year t) - ATCFO (year t) / ATCFS (year t) (B) MRR = (ATCFS (year t + 1) - ATCFO (year t + 1) + ATCFS (year t)) / ATCFS (year t) (C) MRR = (ATCFS (year t + 1) + ATCFO (year t + 1) - ATCFS (year t)) / ATCFS (year t) (D) MRR = (ATCFS (year t + 1) + ATCFO (year t + 1) + ATCFS (year t)) / ATCFS (year t)

Q: An investor is considering renovating a building. The total cost of renovation is expected to be $100,000, of which 75% can be borrowed. Given the after-tax cash flows to the equity investor as showed below, what is the incremental return from renovating? 1 2 3 4 5 ATCF after renovation 9,200 10,000 12,000 14,000 316,000 ATCF-no renovation 10,000 10,200 10,440 10,680 160,900 (A) 9.75% (B) 10.14% (C) 15.32% (D) 12.67%

Q: A property worth $16 million can be refinanced with an 80% loan at 9.5% over 20 years. The balance on the current loan is $12,148,566. Loan payments are $113,302 per month. The loan balance in 10 years will be $8,396,769. If the property is expected to be sold in 10 years, what is the incremental cost of refinancing? (A) 9.71% (B) 10.36% (C) 12.42% (D) 14.58%

Q: Which of the following factors would NOT be considered when an investor is trying to decide whether to hold or sell a property at the end of year five? (A) After-tax operating income in year five (B) After-tax cash flow from the sale in year five (C) After-tax cash flow from sale in the future (D) After-tax operating income after year five

Q: A property could be sold today to provide an after-tax cash flow from sale of $800,000. The current after-tax cash flow from operations is $20,000, which is expected to grow by 4% per year. If sold next year, the property is expected to provide an after-tax cash flow of $824,000. What is the marginal rate of return for holding the property for an additional year? (A) 5.6% (B) 2.6% (C) 3.1% (D) 9.3%

Q: A property, if sold today, will provide the equity investor with $150,000 in cash flow after taxes. If the property is held, the annual after-tax cash flow received by the investor will be as follows: $18,000 for years 1 to 5, $24,000 for years 6 to 10. If held and sold in 10 years, the property is expected to provide $180,000 in after-tax cash flow to the investor. What should the investor do if she can receive a 14% rate of return by investing the sales proceeds today in an different project? (A) Sell the property and invest proceeds in the second property (B) Do not sell the property (C) Renovate the property (D) Can"t tell without knowing the cash flow from the second property

Q: Consider the figure above. The dotted (vertical) line denotes the: (a) Incremental rate of return on additional borrowed funds (b) Marginal rate of return (c) Optimal holding period (d) Optimal yield

Q: After-tax cash flow from operations if renovated $75,000 After-tax cash flow from operations if not renovated -60,000 Incremental cash flow from operations $15,000 Sale proceeds if renovated $2,500,000 Sale proceeds if not renovated 2,250,000 Incremental cash flow from sale $250,000 Renovation costs $250,000 Consider the information in the table above. What is the rate of return the investor would earn on the additional funds invested in renovating the property, assuming that the investor would not borrow any additional funds? (a) 6.0% (b) 106% (c) $15,000 (d) $265,000

Q: If sold today If sold next year Sale price $2,500,000 $2,650,000 Mortgage balance 1,000,000 900,000 Capital gain tax 112,500 135,000 Cash flow $1,387,500 $1,615,000 NOI over next year $50,000 Consider the information in the table above. What is the marginal rate of return for keeping the property one additional year? (a) 16.4% (b) 20.0% (c) $50,000 (d) $277,500

Q: Which of the following is NOT a typical benefit of renovating a property? (a) Increasing rents (b) Lowering vacancy (c) Increasing operating expenses (d) Increasing the future property value

Q: The marginal rate of return for a property is: (a) The APR on an incremental amount of borrowing (b) The expected holding period return earned when the investor purchases the property (c) The return earned on subprime property relative to prime property (d) The return gained by holding the property for one additional year

Q: For refinancing to be profitable, the effective cost of the debt must be less than the unlevered return on the projects being financed.

Q: A property should be sold when the marginal rate of return falls below the rate at which funds can be reinvested.

Q: The marginal rate of return on a property usually increases until sale of the property. Equity buildup should always be avoided if possible.

Q: An investor calculates an incremental return of renovating a building of 14%. Other properties provide a 12.5% overall rate of return to equity investors. Therefore, the property is a good investment.

Q: In general, equity buildup tends to lower the marginal rate of return of holding a property.

Q: Given the same expectations for future rents and expenses, a new buyer may earn a different after-tax return than the current owner of the same property.

Q: An investor purchased a property expecting to receive a 14% rate of return. However, the rate of return on the property over a 5 year holding period turned out to be only 11.5%. Therefore, the property should be sold.

Q: The benefits of equity buildup in a property are lessened over time because with an amortizing mortgage, an investor will lose some tax benefits each year as the interest portion of the payments decreases.