Question 1

A gross lease is riskier for the lessor than a net lease.

Accepted Answer

In a gross lease, the lessor is responsible for paying all property expenses such as taxes, utilities, maintenance, and insurance. This means that if these expenses increase, the lessor may not be able to recover those costs from the tenant, which makes it riskier for the lessor compared to a net lease where the tenant is responsible for paying these expenses.

Question 2

In making an investment decision,IRR analysis will lead to a different "go/no-go" decision than NPV analysis.

Accepted Answer

Both IRR (Internal Rate of Return) and NPV (Net Present Value) methods are used to evaluate investments, but they generally lead to the same "go/no-go" decision because both methods are based on the same set of cash flows and the time value of money. The main difference lies in the way they present their results, not in the final decision on whether an investment is worthwhile.

Question 3

The use of a CPI index in a lease contract shifts risk to the tenant.

Accepted Answer

CPI index (Consumer Price Index) is a measure of inflation that tracks the change in the purchasing power of a currency over time. If a lease contract includes a clause that the rent will be adjusted based on changes in the CPI index, it means that if inflation rises, the rent will increase, and if inflation falls, the rent will decrease. This shifting of risk to the tenant is because the tenant will be responsible for paying higher rent if inflation increases, even if they may not be able to afford it. Hence, the correct answer is A.

Question 4

Expense stops shift the risk of increases in expenses to the lessee while allowing the lessor to retain the benefit of any decrease in expenses.

Accepted Answer

Expense stops are commonly used in commercial leases to shift the risk of increases in operating expenses such as taxes, insurance, utilities, and maintenance to the lessee. The lessee is responsible for paying their pro-rata share of expenses up to a certain limit, known as the expense stop. If the expenses exceed that limit, the lessor bears the cost of the excess. However, if the expenses are below the expense stop, the lessor retains the benefit of the savings. This allows the lessor to maintain a predictable revenue stream while sharing some of the risk of operating expenses with the lessee.

Question 5

Operating expenses associated with the maintenance and upkeep of a residential property are generally tax deductible.

Accepted Answer

Operating expenses for personal residential property are generally not tax deductible. However, if the property is used for rental purposes, some maintenance and operating expenses may be deductible for tax purposes.

Question 6

If an individual actively participates in the management of a rental property,he may deduct the full amount of the passive activity losses from active income,regardless of his adjusted gross income.

Accepted Answer

The ability to deduct passive activity losses from active income is limited and subject to certain conditions, such as participation level and income thresholds. Active participation in management may allow some losses to be deducted, but there are caps and phase-outs based on the individual's adjusted gross income.

Question 7

The deductibility of depreciation in calculating taxable income will usually cause the effective tax rate to be lower than the actual tax rate.

Accepted Answer

Depreciation reduces taxable income, which in turn can lower the effective tax rate. The actual tax rate is typically higher than the effective tax rate due to various tax deductions and credits.

Question 8

CPI adjustments shift the risk of unexpected inflation to the lessor.

Accepted Answer

CPI adjustments shift the risk of unexpected inflation to the lessee, as the rent is adjusted according to inflation, protecting the lessor from inflation risk.

Question 9

Expense stops protect the lessee from unexpected changes in market rents.

Accepted Answer

Expense stops are provisions in a lease that set a maximum limit on the amount of operating expenses that a tenant is responsible for paying; they do not protect against changes in market rents.

Question 10

Debt coverage ratio measures the degree to which the NOI from the property is expected to exceed the mortgage payment.

Accepted Answer

The debt coverage ratio is calculated by dividing the net operating income (NOI) of a property by its annual debt service. A higher debt coverage ratio indicates that there is greater potential for the property to generate sufficient income to cover its mortgage payments. Therefore, the statement that "Debt coverage ratio measures the degree to which the NOI from the property is expected to exceed the mortgage payment" is true.

Question 11

When calculating IRR,the projected cash flows are discounted such that they will equal the initial investment amount.

Accepted Answer

The Internal Rate of Return (IRR) is calculated by finding the discount rate that makes the net present value (NPV) of all cash flows (both positive and negative) from a particular investment equal to zero. This involves discounting projected cash flows to the point where they equal the initial investment amount.

Question 12

Residential property is depreciated over 27.5 years where as non-residential property is depreciated over 31.5 years.

Accepted Answer

This statement is true. According to the US tax code, residential property is depreciated over 27.5 years and non-residential property is depreciated over 31.5 years.

Question 13

The equity dividend rate is an accurate measure of investment yield because it takes into account future cash flows.

Accepted Answer

The equity dividend rate primarily focuses on the current dividend payment relative to the stock's price, and does not directly account for future cash flows or capital gains.

Question 14

Which of the following is NOT one of the primary benefits of investing in real estate income property?

Accepted Answer

The primary benefits of investing in real estate income property include net income, potential for property sale profits, and diversification of an investment portfolio. However, the statement that real estate income properties tend to generate higher incomes when other investments are in decline (D) is not accurate as a primary benefit. Real estate markets can also be affected by economic downturns and do not necessarily perform inversely to other investment types.

Question 15

When the sale of a passive activity produces a capital loss and unused passive losses from previous years remain,the unused losses can be used to offset any other source of income.

Accepted Answer

This statement is true. Passive losses can be carried forward indefinitely and used to offset income from other sources, including capital gains.

Question 16

Property held as a personal residence cannot be depreciated.

Accepted Answer

Property held as a personal residence is generally not eligible for depreciation because it is considered a personal asset rather than a business asset. However, if a portion of the residence is used for business purposes (such as a home office or rental unit), that portion may be eligible for depreciation.

Question 17

During a recessionary period,it is possible the amount of space that is absorbed by the market will actually be negative.

Accepted Answer

During a recessionary period, businesses may downsize or close altogether, leading to a decrease in demand for commercial real estate. As a result, the amount of space that is absorbed by the market may be negative, meaning more space becomes vacant than is leased or sold.

Question 18

An effective tax rate:

Accepted Answer

Effective tax rate takes into account the effects of depreciation and time value of money, measures the actual difference between the BTIRR and the ATIRR, and can be less than the actual marginal tax rate. Therefore, all three options are correct, making D the best choice.

Question 19

Which of the following statements regarding equity is TRUE?

Accepted Answer

Equity is the difference between the market value of a property and the outstanding loan balance. Therefore, if either the property value or loan balance changes, the amount of equity an investor has in the property will also change. Option B is not true because the amount of equity in other investments does not affect the equity in a specific property. Option C is not true because the outstanding loan balance is a key factor in determining equity.

Question 20

The debt coverage ratio is used by lenders to indicate the riskiness of a loan.

Accepted Answer

The debt coverage ratio is one of the financial ratios used by lenders to assess the creditworthiness of a borrower and determine the likelihood of repayment. It measures the borrower's ability to meet their debt obligations, and a higher debt coverage ratio indicates a lower level of risk for the lender. Therefore, it can be concluded that the debt coverage ratio is used to indicate the riskiness of a loan, and the statement is true.

Quiz 11: Investment Analysis and Taxation of Income Properties