Question 1

A seller has offered you a $1,000,000 interest-only 5 year loan at 6% (annual payments), when market interest rates on such loans are 8%. 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?

Accepted Answer

The difference in value due to the financing offer can be calculated by comparing the present value of the loan payments at the market interest rate (8%) versus the offered interest rate (6%). An interest-only loan means that only the interest is paid annually, with the principal ($1,000,000) repaid at the end of the term. At 6%, the annual interest payment is $60,000. The present value of these payments and the repayment of principal at the market rate of 8% can be calculated using the formula for the present value of an annuity for the interest payments, plus the present value of a lump sum for the repayment of the principal. The difference in present value represents the additional amount one should be willing to pay for the property due to the favorable financing terms. Calculating these values shows that the correct answer is indeed the additional amount one would be willing to pay based on the more favorable financing terms offered.

Question 2

Which of the following is true about typical real estate investment (unlevered, at the direct property level) and inflation risk?

Accepted Answer

A

Question 3

All of the following are true about the "property before-tax (PBT) shortcut", except*:

Accepted Answer

D

Question 4

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)?

Accepted Answer

The correct answer is A.The EATCF is calculated as follows:NOI = $40,000Tenant improvement expenditures = $5,000Interest expense = $200,000 * 8% = $16,000Depreciation = $300,000 / 27.5 years = $10,909Taxable income = $40,000 - $16,000 - $10,909 = $13,091Taxes = $13,091 * 33% = $4,320EATCF = $40,000 - $16,000 - $10,909 - $4,320 = $14,680

Question 5

Which statement is true ex ante?

Accepted Answer

Leverage can enhance total returns when the property is bought at market value, as the cost of borrowing is typically lower than the return on investment, including appreciation.

Question 6

Suppose you analyze a particular deal and it appears that for an investment of $1,000,000 your client can obtain a positive NPV of over $500,000. Your client is typical of the type of high tax bracket individual investors who commonly purchase and sell this type of property, and indeed typically determine equilibrium prices in the asset market in which these properties are sold. What should you do?

Accepted Answer

The correct approach when an investment appears to offer a significantly positive NPV, especially one that seems too good to be true, is to carefully review your analysis and assumptions. This ensures that no errors have been made and that the unique characteristics of the client have been properly considered.

Question 7

The table below shows two 10-year cash flow projections (in $ millions, including reversion) for the same property. The upper row is the projection that will be presented by the broker trying to sell the building, the bottom row is the realistic expectations. Suppose that it would be relatively easy for any potential buyers to ascertain that the most likely current market value for the property is about $10 million. What is the most likely amount of "disappointment" in the ex post annual rate of total return earned by an investor who buys this property believing the broker's cash flow projection?
 $$\begin{array} { | l | r | r | r | r | r | r | r | r | r | r | } 
\hline \text { Year } & 1 & 2 & 3 & 4 & 5 & 6 & 7 & \mathbf { 8 } & 9 & 10 \
\hline \text { Presert } & \$ 1.00 & \$ 1.03 & \$ 1.06 & \$ 1.09 & \$ 1.12 & \$ 1.15 & \$ 1.19 & \$ 1.22 & \$ 1.26 & \$ 14.7 \
\text { ted } & 00 & 00 & 09 & 27 & 55 & 93 & 41 & 99 & 68 & 439 \
\hline \text { Realist } & \$ 1.00 & \$ 1.00 & \$ 1.00 & \$ 1.00 & \$ 1.00 & \$ 1.00 & \$ 1.00 & \$ 1.00 & \$ 1.00 & \$ 11.0 \
\text { ic } & 00 & 00 & 00 & 00 & 00 & 00 & 00 & 00 & 00 & 000 \
\hline
\end{array}$$

(a) 0.00%
(b) 1.00%
(c) 3.00% = Presentation IRR - Realistic IRR = (10% + 3%) - (10% + 0%) = 13% - 10%.
(d) 26.68%

Accepted Answer

The answer of The table below shows two 10-year cash...

Question 8

You are trying to apply a multi-year DCF analysis to evaluate an investment property with some long-term leases in it. You observe that other properties with similar lease structure and risk have been selling at cap rates around 11% (based on NOI with no capital reserve). You believe these other properties typically face capital expenditures on the order of 1% of property value per year in the long run, and that given such expenditures their net cash flows and values would reasonably be expected to grow in the long run at about 3% per year. What discount rate should you apply to your subject property in your DCF valuation?

Accepted Answer

The correct discount rate is 13%, calculated as the cap rate (11%) adjusted for the long-term capital expenditures (subtracting 1%) and then adding the expected long-term growth rate (3%). This reflects the net yield (y) plus growth (g) to arrive at the overall discount rate (r).

Question 9

Normally, what relation should be most common between the expected "going-in" and expected "going-out" cap rate?

Accepted Answer

The expected "going-out" cap rate is typically at least as high as the "going-in" cap rate to account for the increased risk and uncertainty over time. This conservative approach in commercial real estate investment helps investors ensure they are not overestimating the future value of the property.

Question 10

Assuming riskless debt, if the return risk is ±15% with a 40% Loan/Value Ratio, then with a 80% Loan/Value Ratio the return risk is:

Accepted Answer

The answer of Assuming riskless debt, if the return risk...

Question 11

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

Accepted Answer

After-tax cash flow exceeds before-tax cash flow when taxable income is negative because the company may receive tax refunds or credits, effectively increasing its cash flow compared to the before-tax scenario.

Question 12

The table below shows the projected cash flows (including reversion) for Property A and Property B. If both properties sell at fair market value for a cap rate (initial and terminal cash yields) of 8%, then which statement below correctly describes the relative investment risk in the two properties?
 $$\begin{array}{l}
\text { Aruual net cash flow projections for two properties (\$ millions) }\
\begin{array} { | l | r | r | r | r | r | r | r | r | r | r | } 
\hline \mathrm { Ye } & 1 & 2 & 3 & 4 & 5 & 6 & 7 & \mathbf { 8 } & 9 & 10 \
\mathrm { ar } & & & & & & & & \
\hline \mathrm { A } & \$ 1.00 & \$ 1.03 & \$ 1.06 & \$ 1.09 & \$ 1.12 & \$ 1.15 & \$ 1.19 & \$ 1.22 & \$ 1.26 & \$ 18 \
& 00 & 00 & 09 & 27 & 55 & 93 & 41 & 99 & 68 & 10 \
\hline \mathrm { B } & \$ 1.00 & \$ 1.00 & \$ 1.00 & \$ 1.00 & \$ 1.00 & \$ 1.00 & \$ 1.00 & \$ 1.00 & \$ 1.00 & \$ 13 \
& 00 & 00 & 00 & 00 & 00 & 00 & 00 & 00 & 00 & 50 \
\hline
\end{array}
\end{array}$$ 
(a) Property A is more risky. (A's going-in IRR = 8% + 3% = 11% = rf + RPA > rf + RPB = 8% = 8% + 0% = B's going-in IRR.)
(b) Property B is more risky.
(c) Both properties are equally risky.

Accepted Answer

The answer of The table below shows the projected cash...

Question 13

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:

Accepted Answer

The answer of A non-residential commercial property which cost $500,000...

Question 14

All of the following are fundamental causal determinants of cap rates in the property asset market, except:

Accepted Answer

Cap rates are influenced by the opportunity cost of capital, expected growth in property rents, and the perceived risk of the property. The net income divided by the property price is actually the definition of a cap rate, not a determinant of it.

Question 15

Total development costs (including sufficient profit for the developers) are $200/SF. Cap rates in the asset market are 10%. What is the "replacement cost rent" in this market?

Accepted Answer

Replacement cost rent is calculated by dividing the total development costs by the cap rate. Here, $200/SF divided by 10% (or 0.10) equals $20.00/SF.

Question 16

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

Accepted Answer

The difference between the net operating income (NOI) and the equity before-tax cash flow (EBTCF) is the debt service and capital expenditures. NOI does not account for financing or capital expenses, while EBTCF subtracts these costs to show the cash flow available to equity investors.

Question 17

The expected return on an investment in a property is inversely related to the price you pay for the property fundamentally because:

Accepted Answer

The expected return on an investment is fundamentally determined by the future cash flows it can generate, which are not affected by the purchase price. A lower purchase price relative to these future cash flows results in a higher expected return, and vice versa, hence the inverse relationship.

Question 18

In which of the following situations would it be most appropriate to measure an investment manager's performance using the IRR rather than the time-weighted average periodic return?

Accepted Answer

The IRR (Internal Rate of Return) is most appropriate when the manager has discretion over the timing of cash flows, such as in the acquisition and disposal of illiquid assets, because it takes into account the timing and magnitude of all cash flows.

Question 19

Which of the following is an example of "negative feedback" in the real estate system?

Accepted Answer

The answer of Which of the following is an example...

Question 20

Suppose the lease on a certain space will expire at the beginning of 2008. You believe that the probability of the existing tenant renewing is 50 percent. If he renews, you will need to spend only an estimated $5.00/SF to upgrade his space. If he does not renew, it will take $25.00/SF to modernize the space, even then you expect 6 months of vacancy. What expected cash flow forecast should you put in year 2008 of your pro-forma for this space, if you expect triple-net market rents on new leases in 2008 to be $20/SF?

Accepted Answer

The answer of Suppose the lease on a certain space...

Quiz 9: Measuring Investment Performance: The Concept of Returns