REAE 4321: Real Estate Investment
Exam II
October 6, 1999
Name _________________________
Part I: Multiple Choice - Please select the best answers by carefully filling in the appropriate oval on you answer sheet. (55 questions, 1 point each)
1. Which of the following is NOT an example of operating expenses?
a. Property taxes
b. Maintenance fees
c. Income taxes
d. All of the above are examples of operating expenses
2. The need for real estate market research exists because:
a. real estate markets are relatively efficient.
b. all relevant information is quickly reflected in market prices.
c. firms view their marginal revenue curves as horizontal.
d. data for rational decision making are often not readily available.
3. A property has a potential gross income of $1,500,000; operating expenses of $765,750; a vacancy allowance of $45,000; and other income of $9,000. What is its effective gross income?
a. $1,455,000
b. $1,464,000
c. 698,250
d. None of the above
4. Longitudinal studies:
a. involve one-time sampling from a population of research interest.
b. Measure changes over time.
c. Are the most frequent type of data-collection assignment.
d. Provide a single snapshot of the variables under observation.
5. To forecast future benefits from a proposed venture, which of the following should be considered?
a. The property’s immediate post operating history.
b. Anticipated changes in the social and political environment.
c. The likely change in a property’s market value over the holding period.
d. All of the above
6. Operating management users research data for planning, problem solving, and control purposes. Which one of the following is most likely to be used for control purposes?
a. Data on basic trends in the economic environment.
b. Data on standard amenity packages including in competitive buildings.
c. Data on typical tenant mix in competitive commercial rental projects.
d. Tracking operating expense ratios for buildings in one’s portfolio.
7. The amount of revenue a property would generate if fully occupied at market rents, and with no uncollectible rent, is its:
a. effective gross income
b. potential gross income
c. net operating income
d. before-tax cash flow
8. Which of the following is an example of primary data?
a. Information taken from the Census of Population
b. Data bought from university research studies
c. Telephone interviews
d. None of the above
9. A property’s market area is:
a. the geographic area from which tenants will be drawn.
b. a precisely definable area in terms of boundaries.
c. determined by subdivision controls and zoning regulations.
d. the area within which functional obsolescence is operative.
10. A property’s income-generating potential depends on:
a. the interaction of supply and demand in its market area.
b. its desirability relative to competing properties in the market area.
c. both (a) and (b).
d. none of the above are true.
11. The revenue a property is expected to generate after adjusting for operating expense but before providing for debt service or income tax consequences is:
a. net operating income
b. effective gross income
c. normalized gross income
d. before-tax cash flow
12. The decline in a building’s competitive position due to defective or dated design is called:
a. functional obsolescence
b. functional disutility
c. physical obsolescence
d. physical disutility
13. Which one of the following is not considered an operating expense?
a. Property management fees
b. Depreciation
c. Janitorial wages
d. Insurance premiums
14. A property’s desirability relative to competing properties is influenced by all of the following except:
a. neighborhood economic and social conditions
b. relative physical durability
c. relative functional efficiency
d. the owner’s income tax bracket
15. Activity at one location generates movement of people and things, the expense of which is called:
a. transfer costs
b. hard costs
c. linkages
d. soft costs
16. Capitalization rates:
a. are a measure of the relationship between a property’s market value and net operating income.
b. are used primarily as an income-forecasting tool.
c. are a measure of the relationship between a property’s market value and gross rental income.
d. none of the above are true.
17. Neighborhood influences:
a. are environmental factors that influence site value.
b. affect the degree of functional efficiency.
c. are influenced by the degree of functional obsolescence.
d. are most commonly referred to as restrictive covenants.
18. If the NOI, as a percent rate of return on assets (Ro), drops below the debt-service constant (Rm):
a. using financial leverage will reduce the current return on equity.
b. using financial leverage will increase the current return on equity.
c. the greater the financial leverage, the higher the current return on equity.
d. b and c above.
19. The initial tax basis may include:
a. legal fees
b. commissions
c. second mortgage note signed by purchaser
d. all of the above
20. The difference between the rate of return on assets and the cost of borrowing is:
a. financial leverage
b. spread
c. debt service
d. none of the above
21. Consideration is:
a. only the cash paid directly to the seller by the buyer.
b. the difference between the selling price and the adjusted basis.
c. all items of value given to the seller in exchange for the property.
d. none of the above
22. Mortgage financing affects:
a. before-tax cash flow
b. income tax consequences
c. after-tax cash flow
d. all the above
23. The major attractions of co-tenancy are:
a. its pride of personal ownership and freedom from personal income tax liability
b. its ease of legal arrangements, and its status as a non-taxpaying entity
c. its limited liability and its ease of management
d. none of the above
24. The debt coverage ratio is the relationship between:
a. the amount borrowed and the annual debt service
b. the amount borrowed and the value of the mortgaged property
c. the net operating income and the annual debt service
d. the net operating income and the amount borrowed
25. As a general rule, using financial leverage:
a. decreased risk to the equity investor
b. increases risk to the equity investor
c. has no impact on risk to the equity investor
d. may increase or decrease risk to the equity investor, depending on the income tax treatment of interest expense and the equity investor’s marginal income tax bracket
26. Limited partnership arrangements alleviate which traditional problem associated with real estate investments?
a. high initial investment required
b. low disaster threshold
c. need for the specialized knowledge of the market
d. all of the above
27. An important aspect of the depreciation allowance is that:
a. it is an out of pocket cost of doing business, reducing both cash flow and taxable income.
b. the tax shelter it generates can never exceed the income from the property.
c. both (a) and (b) are true.
d. none of the above is true.
28. The tax basis is adjusted to reflect:
a. depreciation allowance
b. capital improvements
c. partial dispositions
d. all of the above
29. Depreciation allowance affects:
a. income tax consequences
b. net operation income
c. before-tax cash flow
d. all of the above
30. Potential disadvantages of the limited partnership include:
a. losses for all limited partners, without exception, are treated as passive in nature.
b. losses in excess of $25,000 in any one taxable year are treated as passive in nature.
c. losses are treated as passive in nature, if the partner’s gross income exceeds $125,000.
d. losses are treated as passive, as the partner’s gross income moves from $100,000 to $125,000.
31. The realized gain on disposal is:
a. always taxed as ordinary income.
b. the amount on which tax is due in the year of disposal.
c. consideration paid on acquisition, minus consideration received on disposal.
d. the market value of consideration received, minus the adjusted tax basis of property conveyed.
32. Limited partnership arrangements alleviate which traditional problem associated with real estate investments?
a. low tolerance for risk
b. high initial investment required
c. need for portfolio liquidity
d. high taxes on salary and business income
33. Which is a key difference between tenancy in common and joint tenancy?
a. tenancy in common carries right of survivorship
b. joint tenancy interests must be equal and undivided.
c. tenancy in common interests must be equal but need not be undivided
d. joint tenancy interests are taxed as an association
34. In the absence of express agreement to the contrary, partners in a general partnership:
a. share profits and losses equally
b. share profits and losses in proportion to their equity investment
c. are liable for partnership obligations only to the extent of their investment in the partnership
d. share liability for partnership obligations in the same ratio that they share profits and losses.
35. The allocation of the initial tax basis may be done by:
a. using the allocation estimated by the tax assessor
b. writing the allocation into the contract
c. using the allocation estimated by an independent appraiser
d. all of the above
36. For our class discussion, which of the following was not a ‘criticism of market studies.’
A. failure to define the client’s objectives (scope)
B. unsupported belief in the project’s uniqueness
C. inexperience of the analyst and/or client
D. continuing nature of the assignment ignored
E. all of the above were discussed
37. The adjusted basis can be defined as:
A. original cost + capital improvements - accumulated depreciation.
B. sales price - mortgage balance - sales costs.
C. sales price - accumulated depreciation.
D. original cost - mortgage balance - sales costs.
38. A property is sold for $200,000. Typical financing terms are an 85% loan with a 10% interest rate over 15 years (monthly amortization). If the before-tax cash flow is $2,000, what is the overall capitalization rate?
A. 10.96%
B. 11.96%
C. 19.13%
D. 9.96%
39. What type of organizational form does not provide limited liability to investors?
A. Corporation
B. General partnership
C. Limited partnership
D. S corporations
40. 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? (ATIRR = after tax IRR)
A. 12.39%
B. 11.42%
C. 6.42%
D. 9.37%
41. A property is purchase for $15 million. Financing is obtained at a 75% loan-to-value ratio with total annual payments of $1,179,000. The property produces an NOI of $1,400,000. What is the equity dividend rate?
A. 5.89%
B. 9.33%
C. 7.86%
D. 8.64%
42. A 1,500 square foot office space is leased at $12.00 square foot. The space is vacant one month out of the year. Office expenses are $6.50 per square foot and an expense stop is set at $6.00 per square foot. What is the annual net operating income?
A. $7,500
B. $6,750
C. $15,750
D. $8,250
43. 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?
A. $37,500 or higher
B. $37,500 or lower
C. $54,000 or higher
D. $54,000 or lower
44. A property is sold for $5,100,000 with selling costs of 3% of the sales price. The mortgage balance at the time of sale is $3,600,000. The property was purchased 5 years ago for $4,820,000. Annual depreciation allowances of $153,016 have been taken. If the tax rate is 28%, what is the after-tax cash flow from sale of the property?
A. $1,184,062
B. $969,840
C. $1,347,000
D. $1,097,218
45. A property that produces a first year NOI of $80,000 is purchased for $750,000. The NOI is expected to increase by 15% in the sixth year when some of the leases turnover. The resale price in year 10 is expected to be $830,000. What is the net present value of the property based on a 10-year holding period and a discount rate of 9.5%?
A. $87,433
B. $87,221
C. $95,294
D. $116,490
46. Which of the following expenses would most likely not be considered a fixed expense?
A. Management expenses
B. Repairs and maintenance
C. Property insurance
D. Property taxes
47. 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? (ATIRR = after tax IRR)
A. Negative leverage exists
B. Positive leverage exists
C. No leverage exists
D. Can not tell without knowing the ATIRR on equity
48. From class discussion, which of the following was not classified as a ‘Data Problem’ in the context of market studies.
A. description without prediction
B. continuing nature of the assignment ignored
C. unsupported standards or normal rates
D. inaccurate or imprecise data
E. unreliable and outdated data
49. A property that produces an annual NOI of $100,000 was purchased for $1,200,000. Debt service for the year was $95,000 of which $93,400 was interest and the remainder was principal. Annual depreciation is $38,095. What is the taxable income?
A. $5,000
B. $6,600
C. -$31,495
D. -$33,095
50. Given: Net operating income is $60,000, Vacancy and collection loss is 9%, and the Operating expense ratio is 40%, what is Potential Gross Income?
A. $109,890
B. $100,000
C. $164,835
D. $1,666,667
E. $60,000
51. Income multipliers:
a. are useful as a preliminary analysis tool to weed out obviously unacceptable investment opportunities.
b. Are adequate as the sole indication of a property’s investment worth.
c. Relate the property’s price or value to after tax cash flow.
d. None of the above.
52. The overall capitalization rate:
a. is the reciprocal of the net income multiplier.
b. Is the ratio of net income to favorable financial leverage.
c. Is the inverse of the debt coverage ratio.
d. All of the above is true.
53. The payback period:
a. is a simple method of determining a project’s acceptability
b. is easily adaptable to each investor’s risk preference
c. ignores all cash flows after the payback period
d. all of the above are true
54. The net present value is equal to:
a. the present value of expected cash flows, plus the initial cash outlay
b. the present value of expected cash flows, less the initial cash outlay
c. the future value of the expected cash flows, less the present value of the cash flows
d. a and c above
e. b and c above
55. The internal rate of return equation incorporates:
a. future cash outflows and inflows, but not initial cash flows
b. future cash outflows and inflows, and initial cash outflow, but not initial cash inflow
c. initial cash outflow and inflow, and future cash inflows, but not future cash outflows
d. initial cash outflows and inflow, and future cash outflow and inflow
Part II: Short Answer Questions (8) – Please answer the following questions in the space provided below. (25 points total)