Question 1

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.

Accepted Answer

The decision to sell a property should not be based solely on the rate of return not meeting initial expectations. Other factors such as market conditions, potential for future appreciation, cash flow, and investment goals should also be considered.

Question 2

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

Accepted Answer

False

Question 3

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

Accepted Answer

Equity buildup refers to the gradual increase in the amount of equity a homeowner has in their property as they pay down their mortgage. This can lower the effective rate of return on the property because the homeowner's equity stake in the property grows over time, while the overall value of the property may not increase at the same rate. As a result, the homeowner's return on investment may be lower than if they had invested the money elsewhere.

Question 4

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

Accepted Answer

For refinancing to be profitable, the cost of the new debt must be lower than the cost of the original debt. The effective cost of the debt takes into account any fees or costs associated with refinancing. The unlevered return on the projects being financed is the return on the projects without taking into account the cost of financing. Therefore, if the effective cost of the new debt is lower than the unlevered return on the projects, the refinancing will be profitable.

Question 5

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.

Accepted Answer

The expected IRR (internal rate of return) is an important factor to consider when deciding whether to hold or sell a property. It helps the investor to determine whether the returns from holding the property over time will be greater than the returns from selling it now, and can guide the decision to dispose of the property if the expected IRR is lower than desired.

Question 6

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

Accepted Answer

The investment foundation of a real estate investment typically refers to the underlying principles or strategies guiding the investment, not just the initial investment amount.

Question 7

Which of the following is NOT a typical benefit of renovating a property?

Accepted Answer

Increasing operating expenses is not a typical benefit of renovating a property. In fact, renovations are usually done to improve the property and attract tenants, thereby increasing rents and lowering vacancy. Renovations can also increase the future property value, making it a worthwhile investment. However, increasing operating expenses would have the opposite effect on the property's profitability.

Question 8

The marginal rate of return for a property is:

Accepted Answer

The marginal rate of return for a property is the return gained by holding the property for one additional year. It is a measure of the incremental return earned by holding the property for an additional period of time beyond the expected holding period return. Therefore, option D is the correct answer.

Question 9

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

Accepted Answer

When the marginal rate of return on a property falls below the rate at which funds can be reinvested, it means that the property is no longer generating a high enough return compared to other investment opportunities. In this case, it would make financial sense to sell the property and invest the funds elsewhere to achieve a higher rate of return.

Question 10

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.

Accepted Answer

This is because the new buyer may have different financing terms and tax rates, which would affect their after-tax return. Additionally, the current owner may have already depreciated the property, while the new buyer would have a fresh depreciation schedule, also affecting their after-tax return.

Question 11

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.

Accepted Answer

This statement is false. Taxes would also have to be paid if the property is sold, particularly capital gains tax if the property has appreciated in value. Refinancing does not trigger capital gains tax, but may result in additional property tax or mortgage interest deductions.

Question 12

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.

Accepted Answer

The incremental return of renovating a building being higher than the overall rate of return of other properties does not automatically make it a good investment. Other factors such as risk, market conditions, and investment horizon must also be considered.

Question 13

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.

Accepted Answer

The incremental cost of the additional funds borrowed tends to be higher, not lower, when the interest rate is higher on the larger loan amount, as it reflects the additional risk or cost associated with lending more money.

Question 14

Consider the information in the table below.What is the marginal rate of return for keeping the property one additional year?

Accepted Answer

The marginal rate of return for keeping the property one additional year can be calculated by dividing the difference in net cash flow between the 8th and 9th year by the cost of keeping the property for the 9th year. Marginal rate of return = (Net cash flow in year 9 - Net cash flow in year 8) / Cost of keeping the property for year 9 = ($537,000 - $447,000) / $2,235,000 = 4.03%. Converting this to a percentage gives a marginal rate of return of 20.0%. Therefore, it is best to keep the property for one additional year.

Question 15

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

Accepted Answer

A property should be considered for sale when the marginal rate of return falls below the rate at which funds can be reinvested, indicating better investment opportunities elsewhere.

Question 16

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

Accepted Answer

Increasing rents lead to higher cash flow, which increases the net operating income (NOI) of a property. As a result, the marginal rate of return on the property, which is the rate of return on the next dollar invested, also increases.

Question 17

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

Accepted Answer

The first statement is incorrect. The marginal rate of return on a property can fluctuate over time and may not necessarily increase until the sale of the property. The second statement is also incorrect. Equity buildup can be a positive result of owning a property, as it can result in increased ownership and potential profits when the property is sold.

Question 18

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.

Accepted Answer

As the balance of the mortgage decreases, so does the amount of interest that can be deducted on taxes. Therefore, the benefits of equity buildup are lessened over time.

Question 19

If an investor is deciding whether to sell a property,his equity buildup in the existing property should be considered as an opportunity cost.

Accepted Answer

The equity buildup in the existing property represents a potential opportunity cost if the investor decides to sell the property, as they may miss out on the potential long-term gains that could have been earned by holding onto the property.

Question 20

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

Accepted Answer

When capital gains tax must be paid, the seller would have to pay a certain amount of their profit to the government. This increases the opportunity cost of selling because it reduces the net income gained from the sale. Consequently, it may become relatively more costly to sell the property compared to keeping it, especially if the potential gains from the sale are not significant enough to offset the tax expenses.

Quiz 14: Disposition and Renovation of Income Properties