Q&A Hero

Q: If a company decides to lease a piece of real estate it will typically arrange for off-balance-sheet financing for the payments since they will be tracked on the income statement and not on the balance sheet.

Q: If a company's management is unsure of how long it will need access to a real estate asset, it is likely that the company will lease the property.

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: 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: 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: Consider the figure below. 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: Consider the information in the table below. 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? 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 A) 6.0% B) 106% C) $15,000 D) $265,000

Q: Consider the information in the table below. What is the marginal rate of return for keeping the property one additional year? 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 $ 1,387,000 $ 1,615,000 NOI over next year $ 50,000 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: If an investor is deciding whether to sell a property, his equity buildup in the existing property should be considered as an opportunity cost.

Q: The investment foundation of a real estate investment is another name for the initial investment.

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 the sale of the property. Equity buildup should always be avoided if possible.

Q: If a real estate tax law becomes more favorable, this generally benefits existing investors over new investors.

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.

Q: When evaluating the incremental costs of borrowing, if the interest rate is higher on the larger loan amount, the incremental cost of the additional funds borrowed tends to be lower than the rate on the larger loan.

Q: If capital gains tax must be paid, the opportunity cost of selling increases relative to the opportunity costs of keeping the property.

Q: One disadvantage of refinancing a property instead of selling the property is that taxes have to be paid on funds received by additional borrowing, but no taxes would have to be paid if the property is sold.

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

Q: Increasing rents tend to increase the marginal rate of return on a property.

Q: One factor an investor should consider when trying to decide whether to dispose of a property he or she has owned for several years is the expected IRR for holding versus sale of the property.

Q: In a real estate transaction, gross profit divided by the contact price is referred to as the: A) Net profit B) Operating profit C) Profit ratio D) Mortgage profit

Q: A property sale in which the buyer may make payments over time instead of paying the full price at the time of purchase, is referred to as a(an): A) Like kind sale B) Carry over sale C) Equivalent investment sale D) Installment sale

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: 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 the sale in the future D) After-tax operating income after year five

Q: A property owner may incur some downtime due to the expiration of a lease that has not been renewed. The time period that occurs before the owner can contract with a new tenant is referred to as: A) Absentia turnover B) Market turnover C) Lease turnover D) Vacancy turnover

Q: Which of the following would be most suitable for use in analyzing the best-case, worst-case, and most-likely outcomes for potential investment opportunity? A) Risk analysis B) Financial analysis C) Sensitivity analysis D) Cost analysis

Q: Which of the following increases with use of leverage in a business? A) Financial risk B) Liquidity risk C) Environmental risk D) Inflation risk

Q: An investor is analyzing the risk of a possible investment by producing three different scenarios. Under a pessimistic scenario, the property would produce a BTIRRp of 8%; a most-likely scenario would produce a BTIRRp of 12%; and an optimistic scenario would produce a BTIRRp of 16%. The investor assigns the pessimistic scenario a 25% chance of occurring, the most-likely case a 60% chance of occurring, and the optimistic scenario a 15% chance of occurring. What is the standard deviation of the returns? A) 0.062% B) 1.248% C) 2.498% D) 2.904%

Q: Which of the following is an example of a "real option" in an investment decision? A) Valuation of vacant land B) Valuation of projects with phases of development C) Valuation of a building that can be renovated D) All of the above

Q: Which of the following best describes the approach to valuing land as a "real option"? A) The land value reflects the fact that the developer can wait to decide whether to construct a building on the site B) The seller provides the investor with an option to purchase the land at a specific price before a certain date C) The land is valued at its most probable use D) The seller has an option to repurchase the land from the buyer before construction takes place

Q: If the renewal probability for a lease is assumed to be 60% and the number of months vacant would be 12 months if the lease is not renewed, what is the expected vacancy at the end of the lease? A) 4.8 months B) 7.2 months C) 9.0 months D) 12.0 months

Q: Which of the following may be used as a market leasing assumption (including a renewal probability) in an analysis related to a lease renewal? A) Market rent paid after the existing lease ends B) Vacancy after the existing lease ends. C) Leasing commissions paid after the existing lease ends D) All of the above

Q: When sales exceed a breakpoint sales volume in a retail lease with percentage rent, the additional rent is referred to as: A) Retail rent B) Participation rent C) Overage rent D) Sales rent

Q: Which of the following BEST describes the process of "partitioning the IRR"? A) Dividing the IRR into income and appreciation components B) Using the IRR as a discount rate and determining how much of the present value comes from income and resale C) Dividing the IRR into before-tax and after-tax IRRs D) Determining how much of the IRR comes from each property in a portfolio

Q: Which of the following refers to the risk real estate investors face stemming from changes in general economic conditions? A) Financial risk B) Liquidity risk C) Environmental risk D) Business risk

Q: When an investor performs an investigation while considering acquisition of a property, this is referred to as: A) Investigation B) Risk analysis C) Due diligence D) Acquisition analysis

Q: Risk due to potential tax law changes is referred to as: A) Business risk B) Financial risk C) Legislative risk D) Tax risk

Q: Consider an investment in which a developer plans to begin construction, of a building that will cost $1,000,000, in one year if, at that point, rent levels make construction feasible. There is a 50 percent chance that NOI will be $160,000 and a 50 percent chance that NOI will be $80,000. Assuming a cap rate of 10 percent (12 percent discount rate and an NOI growth rate of 2 percent) what would the land value be at the completion of the construction, under the real options approach? A) $120,000 B) $200,000 C) $300,000 D) $833,333

Q: Consider an investment in which a developer plans to begin construction, of a building that will cost $1,000,000, in one year if, at that point, rent levels make construction feasible. There is a 50 percent chance that NOI will be $160,000 and a 50 percent chance that NOI will be $80,000. Using the traditional approach, which is similar to the "highest and best use" approach, what will the land value of the property be at the completion of the construction, assuming a cap rate of 10 percent (12 percent discount rate and an NOI growth rate of 2 percent)? A) $120,000 B) $200,000 C) $300,000 D) $833,333

Q: Which of the following is NOT a component of lease rollover risk? A) Commissions paid to a leasing agent to find a new tenant B) Costs of tenant improvements demanded by new tenants C) Liquidity risk D) Reduced revenues from vacancy until a new tenant is found

Q: Consider two investments: Investment 1 has a 50% chance of producing a return of zero and a 50% chance of producing a return of 40% Investment 2 has a 50% chance of producing a return of 10% and a 50% chance of producing a return of 30% Which of the following statements regarding the investments is TRUE? A) Investment 1 is riskier than Investment 2 B) Investment 2 is riskier than Investment 1 C) Investment 1 and Investment 2 have the same amount of risk D) Investment 1 is a better investment because it has the potential to produce the highest returns

Q: Consider risk-return characteristics of Investments A-D, given above. Which of the following statements is TRUE? A) Investment C is preferred to Investment D B) Investment D is preferred over all other investments C) Investment A is preferred to Investment B D) Investment B is preferred to Investment C

Q: A property with a higher standard deviation and a higher return is preferable to a property with a lower standard deviation and a lower return.

Q: In general, real estate is usually considered more risky than bonds but less risky than stocks.

Q: The term "financial risk" refers to the probability of interest rates changing.

Q: Land can be viewed as having an "option" to develop the land.

Q: The term "due diligence" refers to conducting an investigation before buying a property.

Q: The range of returns (highest to lowest) is the most common risk measure.

Q: Use of leverage always increases the amount of business risk.

Q: Real estate is generally dramatically affected by inflation risk.

Q: Real estate that is not leveraged is not affected by interest rate risk.

Q: In general, investors are assumed to be risk seekers who must be compensated more for the higher risk of some investments.

Q: Partitioning the internal rate of return is useful because it helps the investor to determine how much of the return is from annual operating cash flow and how much is from the projected resale cash flow.

Q: The maximum interest rate that could be paid on a debt before the leverage becomes unfavorable is referred to as the: A) Incremental cost of debt B) Break-even interest rate C) Favorable interest rate D) Optimistic interest rate