Deck 5: Inside the City II: A Closer Look

Question 1

The "Equity" in a real estate investment refers to:

A) The legal "fairness" of the contract between the buyer and seller.
B) The price at which the lender's and borrower's values are balanced.
C) The lender's share of the property value.
D) The borrower's or owner's share of the property value.

Answer 1

D

Question 2

If there is 12% risk in a property investment with no leverage, then how much risk is there if the Leverage Ratio is 3?

A) 6%
B) 15%
C) 20%
D) 30%
E) 36%

Answer 2

E

Question 3

An investor believes that a certain property is worth $10,000,000. The seller refuses to sell it for that amount, but has offered to provide a 5-year interest-only loan for $5,000,000 at 4% interest annual payments at the ends of the years, first payment due in one year). Market interest rates on such a loan are currently 6.5%. How much should the investor be willing to pay for the property from an investment value perspective taking the loan deal) if the investor faces a 30% marginal income tax rate?

A) $10,000,000
B) $10,383,588
C) $10,403,023
D) $10,519,460
E) Insufficient information to answer the question.

Answer 3

B

Question 4

In a certain real estate market the net cash flows are level perpetuities no growth), the going-in IRR at the market price of the assets is 8% at the PBT level, and the marginal investors, who face an effective tax rate of 20% with or without leverage), typically use perpetual 50% LTV loans which are maintained perpetually at 50% LTV) that have a market interest rate of 6%. Ignoring depreciation, what is the market's levered after-tax opportunity cost of capital for these types of properties?

A) 6.4%
B) 8.0%
C) 10.0%
D) 12.0%

Question 5

Assuming riskless debt, if the return risk is ±10% with a 50% Loan/Value Ratio, then with a 75% Loan/Value Ratio the return risk is:

A) ± 7.5%
B) ± 10.0%
C) ± 15.0%
D) ± 17.5%
E) ± 20.0%

Question 6

After-tax cash flow will exceed before-tax cash flow whenever:

A) Taxable income is negative.
B) Capital expenditures exceed net operating income.
C) The building is fully depreciated.
D) Interest and depreciation expenses are less than net operating income.

Question 7

All of the following are arguments against using leverage, except:

A) You increase the volatility of your total returns
B) You bring on the possibility of default and loss of your entire investment
C) You lose flexibility or "financial slack"
D) Lenders make you pay for inflation in the interest rate they charge

Question 8

If the Treasury Bond yield is 7% and the required return on property unlevered) is 11%, then what is the required total return riskfree rate plus risk premium) on the equity investment with a 50% Loan/Value Ratio?

A) 7%
B) 11%
C) 15%
D) 19%

Question 9

All of the following are strategic reasons to use financial leverage when investing in real estate, except:

A) Leverage increases your expected total return
B) You can lever your "human capital" as a property manager
C) You can obtain valuable interest tax shields
D) You can diversify by investing in a greater variety of risky assets

Question 10

"Negative Leverage" implies:

A) You are buying the property at a price below market value.
B) The property cash flows cannot support the debt service payments.
C) The return decreases the more you borrow.
D) The return increases the more you borrow.

Question 11

The NOI is $850,000, the debt service is $600,000 of which $550,000 is interest, the depreciation expense is $350,000. What is the Before-tax Cash Flow to the equity investor EBTCF) if there are no capital improvement expenditures or reversion items this period?

Question 12

The NOI is $120,000, the debt service is $90,000 of which $85,000 is interest, the depreciation expense is $45,000. What is the Before-tax and After-tax Cash Flow to the equity investor EBTCF, & EATCF) if there are no capital improvement expenditures or reversion items this period, and the income tax rate is 35%?

Question 13

In the problem above, what is the after-tax cash flow to the equity investor if the income tax rate is 35%?

Question 14

If the Loan/Value ratio is 75%, what is the "Leverage Ratio"?

A) 0.25
B) 1.0
C) 2.0
D) 4.0
E) 5.0

Question 15

A non-residential commercial property which cost $500,000 is considered to have 30 percent of its total value attributable to land. The annual depreciation expense chargeable against taxable income is:

A) $18,182
B) $15,873
C) $13,967
D) $8,974

Question 16

Which statement is true ex ante?

A) Leverage normally increases the owner's income return cash yield) if you pay market value for the property.
B) Leverage normally increases the owner's income return cash yield) if you pay more than market value for the property.
C) Leverage normally increases the owner's total return including appreciation) if you pay market value for the property.
D) Leverage normally increases the owner's total return including appreciation) if you pay more than market value for the property.

Question 17

According to the WACC Formula, if the Loan/Value Ratio is 50% and the appreciation on the Loan is 0%, and the appreciation in the equity value is 10%, then the appreciation in the property value is:

A) 0%
B) 5%
C) 10%
D) Cannot be determined from the information given.

Question 18

If tax-exempt institutions pass on to borrowers in the real estate investment market a significant share of the tax shields they have, then what empirical evidence of this would we expect to see?

A) Mortgage interest rates would be higher than municipal bond rates
B) Mortgage interest rates would be about the same as municipal bond rates
C) mortgage interest rates would be lower than municipal bond rates
D) Insurance premiums on whole-life policies would be lower than premiums on comparable term insurance

Question 19

The NOI is $40,000; there are $5,000 in tenant improvement expenditures paid for by the landlord; there is a $200,000 interest-only loan at 8 percent annual interest; the depreciable cost basis of this residential property is $300,000; the owner's tax bracket is 33 percent. What is the Equity After-Tax Cash Flow EATCF)?

A) $14,680
B) $27,800
C) $30,680
D) $35,000
E) Cannot be determined from the information given.

Question 20

In the market described in the previous question, what would be the investment value IV) of a property whose initial PBTCF is $100/yr, for an intra-marginal investor who faces a 10% tax rate and who would use the same 50% LTV financing?

A) $1000
B) $1250
C) $1328
D) $1406.

Question 21

Suppose a property has a cap rate of 10% and you can borrow at a mortgage constant of 11%. If you borrow 75% of the property price, what will be your equity yield?

A) 7.00%
B) 8.25%
C) 10.00%
D) 11.00%
E) Cannot be determined from the information given.

Question 22

The difference between the net operating income NOI) and the equity before-tax cash flow EBTCF) is:

A) Property Tax Expense and capital expenditures.
B) The debt service and capital expenditures.
C) Property taxes and income taxes.
D) Interest expense and depreciation expense.

Question 23

Use the following information and the APV decision rule, to answer the following questions. A seller has offered you a $1,500,000 interest only 7 year loan at 6% annual payments), when market interest rates on such loans are 7%. You face a 35% marginal income tax rate.
a) Basing your decision on market values, how much more should you be willing to pay for the property than you otherwise think it is worth, due to the financing offer?
b) Answer the same question only now basing your answer on investment value rather than market value.

Question 24

If the market's required risk premium on the return to equity is 6% with a 50% loan/value ratio, what is the required equity risk premium with a 70% loan/value ratio? Assume riskless debt at either L/V ratio.)

Question 25

The Donald Grump Corporation, a publicly-traded REIT, has expected total return to equity of 13%, average interest rate on their debt of 7.5%, and a Debt/Total Asset Value ratio of 40%. What is Grump's firm-level) average cost of capital?

Question 26

The "Leverage Ratio" equals:

A) The Loan Value divided by the Property Value.
B) The Property Value divided by the Loan Value.
C) The Owner's Share Value divided by the Property Value.
D) The Property Value divided by the Owner's Share Value.

Question 27

A non-residential commercial property which cost $500,000 is considered to have 30 percent of its total value attributable to land. What is the annual depreciation expense chargeable against taxable income?