Question 1

Which of the following is also referred to as a negative amortization loan?

Accepted Answer

A negative amortization loan is one where the payments made by the borrower are less than the interest charge on the loan. This causes the loan balance to increase rather than decrease over time. "Accrual loan" is another term used for this type of loan, as the interest that isn't covered by the payments accrues and is added to the principal balance.

Question 2

A lender requires a 1.20 debt coverage ratio as a minimum. If the net operating income of a property is $45,000, what annual amount of debt service would provide the required debt coverage ratio?

Accepted Answer

To calculate the annual debt service required for a 1.20 debt coverage ratio, we divide the net operating income by 1.20.

Annual Debt Service = Net Operating Income / Debt Coverage Ratio 
Annual Debt Service = $45,000 / 1.20 
Annual Debt Service = $37,500

Therefore, the answer is B) $37,500 or lower, as any amount higher than $37,500 would result in a debt coverage ratio higher than 1.20.

Question 3

A loan in which the lender receives a percentage of the net operating income from the property is known as an):

Accepted Answer

A participation loan is a type of loan in which the lender receives a percentage of the net operating income from the property. This means that the lender is taking on some of the risk of the property, and will share in the profits if the property performs well. This can be a good option for lenders who are looking to invest in property without actually owning it.

Question 4

Which of the following gives the lender an option to purchase a full or partial interest in the property at the end of some specified period of time?

Accepted Answer

A convertible loan gives the lender the option to convert their debt into equity and potentially purchase a partial or full interest in the property. The other options listed do not include this type of option for the lender.

Question 5

Which of the following is NOT a benefit of a sale-leaseback of land for investors?

Accepted Answer

A sale-leaseback allows investors to free up capital and potentially obtain 100% financing (A), and lease payments are typically tax-deductible (B). Land cannot be depreciated for tax purposes (C), which is a reason for sale-leaseback. However, the potential increase in land value (D) is not a benefit of a sale-leaseback, as the investor no longer owns the land.

Question 6

If properly constructed and assuming everything but the structure of the interest payment is equal, which of the following loans would typically have the highest first-year debt service?

Accepted Answer

Conventional loans typically have the highest first-year debt service because they include both principal and interest payments from the start, unlike interest-only loans which only require interest payments initially, or accrual loans where interest might be added to the principal. Participation loans' payments can vary based on the agreement but don't inherently have the highest first-year debt service.

Question 7

A property is financed with an 85% loan-to-value ratio at 10% interest over 25 years. What would the BTIRRE on equity be estimated at given that the BTIRRP is 10.75%?

Accepted Answer

The BTIRRE (Before-Tax Internal Rate of Return on Equity) is typically higher than the BTIRRP (Before-Tax Internal Rate of Return on Property) due to the leverage effect. With an 85% loan-to-value ratio, the equity portion is relatively small, amplifying the return on equity. Therefore, 15.0% is a reasonable estimate for the BTIRRE given a BTIRRP of 10.75%.

Question 8

Which of the following is FALSE regarding negative amortization?

Accepted Answer

Negative amortization loans typically have higher interest rates than conventional loans, as the borrower is paying less than the monthly interest rate, causing the interest to accrue and compound. This can result in a debt amount that exceeds the original loan amount, which can decrease the borrower's equity and increase default risk. The debt coverage ratio (DCR) is also typically lower for negative amortization loans due to the lower monthly payment amount.

Question 9

Which of the following typically would NOT be used as a basis for a participation loan?

Accepted Answer

Potential gross income is not typically used as a basis for a participation loan because it does not account for operating expenses or other deductions that affect the actual cash flow available for loan participation.

Question 10

Which of the following would NOT be considered an advantage that an investor might consider under a sale-leaseback of land?

Accepted Answer

Appreciation of the land over the holding period is not an advantage that an investor specifically considers under a sale-leaseback arrangement, as appreciation potential exists regardless of whether the investor chooses to sell and lease back the property or not. The other options (A, B, and C) are all advantages that an investor may consider under a sale-leaseback arrangement.

Question 11

Which of the following is FALSE regarding interest only loans?

Accepted Answer

Interest only loans have lower amortization than conventional loans because the borrower is only making payments on the interest portion of the loan, not the principal. This means that at the end of the loan term, the borrower still owes the full amount of the principal, which is often paid off with a balloon payment. Interest only loans may result in more cash flow to the investor because of the lower monthly payments, but they may also allow for a lower debt coverage ratio (DCR), meaning the property may not be generating enough income to cover the loan payments if it were a conventional loan with both principal and interest payments.

Question 12

A property is financed with a 75% loan at 11.5% over 25 years. The property produces an ATIRR on total investment of 7.34% based on a tax rate of 31%. What can be said about the leverage associated with the property?

Accepted Answer

Negative leverage exists because the cost of borrowing (11.5%) is higher than the return on the total investment (ATIRR of 7.34%).

Question 13

A property produces an 8.92% ATIRR on the total investment considering a tax rate of 28%. What is the maximum interest rate that could be paid on debt without causing the leverage to be negative?

Accepted Answer

The maximum interest rate that could be paid on debt without causing the leverage to be negative is the same as the after-tax internal rate of return (ATIRR) on the total investment, which is 8.92%. This means that as long as the cost of debt is less than or equal to the ATIRR, leverage will not be negative. However, the question asks for the maximum interest rate, which implies looking for the highest rate that does not exceed the profitability of the investment. Given the options, 12.39% is incorrectly marked as correct due to a misunderstanding of the concept. The correct interpretation should be that none of the provided options correctly match the ATIRR of 8.92%, and the premise of my explanation was based on a misunderstanding of how leverage and ATIRR interact. The correct approach involves calculating the break-even cost of debt based on the ATIRR, but without the specific formula or additional data provided in the question, the direct application of the ATIRR as the maximum interest rate for debt is incorrect.

Question 14

A loan in which the lender has an option to purchase an equity interest in a property is known as an):

Accepted Answer

The answer of A loan in which the lender has...

Quiz 12: Financial Leverage and Financing Alternatives