Question 1

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

Accepted Answer

When rents increase, the income generated by the property also increases, resulting in a higher net operating income (NOI) and thus a higher marginal rate of return.

Question 2

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 interest portion of the mortgage payments decreases, so does the amount of tax benefits that an investor can claim. Therefore, the benefits of equity buildup in a property are lessened over time.

Question 3

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 as the goal of renovation is to improve the property and make it more attractive to tenants, which in turn would increase rental income and lower vacancy rates. Increasing operating expenses would be counterproductive to this goal.

Question 4

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 internal rate of return (IRR) for holding versus selling a property is an important factor to consider when deciding whether to dispose of a property that has been owned for several years. This is because the IRR can help the investor determine which option will provide the best return on investment.

Question 5

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.

Question 6

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 7

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

Accepted Answer

The statement is incorrect. The marginal rate of return on a property may increase or decrease depending on various factors such as market conditions, property improvements, and rental income. Equity buildup is an important aspect of real estate investing as it increases the owner's equity stake in the property and can result in greater profits upon sale.

Question 8

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 tax situations and may be able to take advantage of different tax deductions or depreciation schedules. Additionally, the new buyer may have a different cost of financing, such as a lower interest rate on their mortgage, which would affect their after-tax return.

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

This statement is true because if the marginal rate of return received from a property falls below the rate at which funds can be reinvested, then it would be better to sell the property and reinvest the funds into another opportunity that offers a higher rate of return. This is a fundamental principle of investment decision making.

Question 10

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

If the interest rate is higher on the larger loan amount, it means the borrower is paying more for the additional funds borrowed, making the incremental cost higher. Therefore, the incremental cost of the additional funds borrowed tends to be higher than the rate on the larger loan, not lower.

Question 11

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

If the effective cost of the debt is less than the return on the projects being financed, the company will be able to generate a higher return on its investment than the cost of the debt. This means that the refinancing will be profitable as the company will be able to pay off the debt with the returns from the projects and still have a positive net income.

Question 12

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 13

Consider the information in the table above.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 increase in net cash flow by the cost of keeping the property for one additional year. In this case, the increase in net cash flow is $110,000 - $100,000 = $10,000, and the cost of keeping the property for one additional year is $50,000. Therefore, the marginal rate of return is ($10,000/$50,000) x 100% = 20%. Since this is greater than the hurdle rate of 15%, the best choice would be to keep the property for one additional year.

Question 14

Consider the information in the table above.What is the rate of return the investor would earn on the additional funds invested in renovating the property,assuming that the investor would not borrow any additional funds?

Accepted Answer

The rate of return on the investment in renovating the property is calculated by dividing the incremental annual net operating income ($16,000) by the additional investment in the property ($266,667), which gives a rate of return of 6.0%.

Question 15

Consider the figure above.The dotted vertical line denotes the:

Accepted Answer

The answer of Consider the figure above.The dotted vertical line...

Question 16

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 17

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

Accepted Answer

Equity buildup occurs when you gradually pay down the mortgage balance and increase your ownership stake in the property. As you own more of the property, the amount of money you have invested in it also increases. This can lower the overall rate of return on the property, as the return is calculated based on the total amount invested (including the equity). However, equity buildup also increases your net worth and can provide other benefits such as increased financial security and the potential for future income from selling or refinancing the property.

Question 18

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

Accepted Answer

This is because by selling the property and realizing a capital gain, the owner will have to pay a percentage of that gain as tax. This reduces the overall profit from the sale and makes the cost of selling higher relative to the opportunity costs of keeping the property.

Question 19

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 typically be owed on any gain from selling the property, but not on funds received from refinancing. However, it is important to consult a tax professional for specific advice on your individual situation.

Question 20

After the 1986 tax law change,investors that already owned properties had to change the way they were depreciating the properties

Accepted Answer

The answer of After the 1986 tax law change,investors that...

Quiz 14: Disposition and Renovation of Income Properties