Real Estate Test 2 Textbook Solutions

What is the present value of the following series of cash flows discounted at 12 percent: $40,000 now; $50,000 at the end of the first year; $0 at the end of year the second year; $60,000 at the end of the third year; and $70,000 at the end of the fourth year?

$171,836 (without rounding, answer is $171,835.94)

On a level-payment loan with 12 years (144 payments) remaining, at an interest rate of 9 percent, and with a payment of $1,000, the current balance is:

$87,871.

The acquisition price of a property is $380,000. The loan amount is $285,000. If the property's NOI is expected to be $22,560, operating expenses $12,250, and the annual debt service $19,987, the debt yield ratio (DYR) is approximately equal to:

0.079 or 7.9%

What amount invested at the end of each year at 10 percent annually will grow to $10,000 at the end of five years?

1,637.97

What is the present value of $500 received at the end of each of the next three years and $1,000 received at the end of the fourth year, assuming a required rate of return of 15 percent?

1,713.37

If the property's NOI is expected to be $22,560 operating expenses $12,250, and the debt service $19,987, the debt coverage ratio (DCR) is approximately equal to:

1.13

How much would you pay today for the right to receive $80 at the end of 10 years if you can earn 15 percent interest on alternative investments of similar risk?

19.77 pv=? fv=80 n=10 i/y=15 pmt=0

an appraiser estimates that a property will produce NOI of 25,000 in perpetuity, Yo is 11 percent, and the constant annual growth rate in NOI is 2.0 percent. what is the estimated property value?

277,778

How much will a $50 deposit made today be worth in 20 years if interest is compounded annually at a rate of 10 percent?

336.37 pv=50 n=20 i/y=10 pmt=0 fv=?

How much would you pay today for the right to receive nothing for the next 10 years and $300 a year for the following 10 years if you can earn 15 percent interest on alternative investments of similar risk?

372.17

If a landowner purchased a vacant lot six years ago for $25,000, assuming no income or holding costs during the interim period, what price would the landowner need to receive today to yield a 10 percent annual return on the land investment?

44,289.03

what is the effective gross income multiplier (EGIM)?

6.11

if a comparable property sells for 1,200,000 and the effective gross income of the property is 12,000 per month, the effective gross income multiplier (EGIM) is

8.33

On the following loan, what is the best estimate of the effective borrowing cost if the loan is prepaid six years after origination? Loan: $100,000 Interest rate: 7 percent Term: 180 months Up-front costs: 7 percent of loan amount

8.7 percent.

How much would you pay today to receive $50 in one year and $60 in the second year if you can earn 15 percent interest on alternative investments of similar risk?

88.85

you have just completed the appraisal of an office building and have concluded that the market value of the property is 2,500,000. you expect potential gross income (PGI) in the first year of operations to be 450,000; vacancy and collection losses to be 9 percent of PGI; operating expenses to be 38 percent of effective gross income (EGI), and capital expenditures to be 4 percent of EGI. what is the implied going-in capitalization rate?

9.5 percent

A characteristic of a partially amortized loan is:

A balloon payment is required at the end of the loan term.

What is the difference between a fee simple estate and a leased fee estate?

A fee simple estate is the highest form of property ownership. It is complete ownership of a property without regard to leases. A leased fee estate is ownership of a property subject to leases on the property. When acquiring existing commercial real estate, investors are most often acquiring a leased fee estate because they are acquiring the property subject to the existing leases.

Explain lockout provisions and yield-maintenance agreements. Does the inclusion of one or both of these provisions affect the borrower's cost of debt financing? Explain.

A lockout provision prohibits prepayment of a commercial mortgage over a specified period after the origination of the mortgage. This provision reduces a lender's reinvestment risk from prepayments in falling interest rate environments. A yield-maintenance agreement is another mechanism for creating a prepayment penalty. If interest rates decline and borrowers could prepay at par, lenders would have to reinvest the remaining loan balance at current (lower) rates. The prepayment penalty paid by borrowers with a yield maintenance agreement is set equal to the present value of the lender's loss resulting from reinvesting the remaining loan balance at the lower market rates. The yield-maintenance provision restores the lender's position as if rates had never changed and no prepayment had occurred. The borrower's cost of debt financing is effectively increased because of these provisions. Unlike residential borrowers, who generally have the ability to prepay or refinance existing debt without charge, commercial borrowers are unable to reduce their cost of debt financing if market interest rates fall.

a comparable property sold 10 months ago for $98,500. if the appropriate adjustment for market conditions is 0.30% per month (with compounding), what would be the adjusted price of the comparable property?

ANSWER- $101,495 without compounding: $98,500*(1=(0.003 X 10))= 98,500*1.03= 101,455 with compounding: 98,500*(1.003)^10= 98,500*1.030408= 101,495.21 or 101,495

you find 2 properties that have sold twice within the last two years. property A sold 22 months ago for $98,500; it sold last week for $108,000. property B sold 20 months ago for $105,000; it sold two weeks ago for $113,500. assuming no compounding, what is the average monthly rate of change in sales price?

ANSWER- 0.42% property A: $108,000/$98,500= 1.096447 property B: $113,500/$105,000= 1.08095 average monthly increase with no compounding: property A: 0.096447/22= 0.00438 property B: 0.08095/20= 0.00405 add and divide by 2= 0.00843/2= 0.004215 or .42% with compounding: property A: 1.096447^(1/22)= 1.004194 or .004194 property B: 1.08095^(1/20)= 1.00390 or 0.00390 add and divide by 2= 0.008094/2= 0.004047 or .40%

a comparable property sold six months ago for 150,000. the adjustments for the various elements of comparison have been calculated as follows: location -5 percent market conditions +8 percent physical characteristics +12,500 financing terms -2,600 conditions of sale 0 property rights conveyed 0 use none nonrealty items -3,000 making the final adjustments in the order suggested in exhibit 7-6, what is the comparables final adjusted price?

Answer- 160,732

What monthly deposit is required to accumulate $10,000 in eight years if the deposits earn an annual rate of 8 percent, compounded monthly?

Assuming an 8% discount rate and a future value of $10,000, the monthly amount required to be deposited is $74.70. n=96 i=8/12 pv=0 pmt=? fv=10,000

Which of the following statements is true about 15-year and 30-year fixed-payment mortgages?

Assuming they can afford the payments on both mortgages, borrowers usually should choose a 30-year mortgage over an otherwise identical 15-year loan if their discount rate (opportunity cost) exceeds the mortgage rate.

How much would you pay today for an investment that provides $1,000 at the end of the first year if your required rate of return is 10 percent? Now compute how much you would pay at 8 percent and 12 percent rates of return.

At 10%, an investor would be willing to pay $909.09 n=1 i=10 pv=? pmt=0 fv=1,000 At 8%, an investor would be willing to pay $925.93. n=1 i=8 pv=? pmt=0 fv=1,000 At 12%, an investor would be willing to pay $892.86. n=1 i=12 pv=? pmt=0 fv=1,000

If you purchase a parcel of land today for $25,000 and you expect it to appreciate 10 percent per year in value, how much will your land be worth 10 years from now assuming annual compounding?

At a 10% discount rate, the investment will be worth $64,843.56 in ten years. n=10 i=10 pv= -25,000 pmt=0 fv=?

A family trust will convey property to you in 15 years. If the property is expected to be worth $50,000 when you receive it, what is the present value of your interest, discounted at 10 percent annually?

At a 10% discount rate, the present value of this future payment is $11,969.60. n=15 i=10 pv=? pmt=0 fv=50,000

You are at retirement age and one of your benefit options is to accept an annual annuity of $75,000 for 15 years. The first payment would be received one year from today. What lump sum settlement, if paid today, would have the same present value as the $75,000 annual annuity? Assume a 10 percent annual discount rate.

At a 10% discount rate, the present value of this series of future payments is $570,455.96. This is the lump sum equivalent of receiving $75,000 for 15 years. n=15 i=10 pv=? pmt=75,000 fv=0

If someone pays you $1 a year for 20 years, what is the present value of the series of future payments discounted at 10 percent annually?

At a 10% discount rate, the present value of this series of future payments, or annuity, is $8.51. n=20 i=10 pv=? pmt=1 fv=0

If you deposit $50 per month in a bank account at 10 percent annual interest (compounded monthly), how much will you have in your account at the end of the 12th year?

At a 10% discount rate, this series of payments, or annuity, will be worth $13,821.89 in 12 years. n=144 i=10/12 pv=0 pmt=50 fv=?

If you deposit $1 at the end of each of the next ten years and these deposits earn interest at 10 percent compounded annually, what will the series of deposits be worth at the end of the 10th year?

At a 10% discount rate, this series of payments, or annuity, will be worth $15.94 in ten years. n=10 i=10 pv=0 pmt=1 fv=?

If your parents purchased an endowment policy of $10,000 for you and the policy will mature in 12 years, how much is it worth today, discounted at 15 percent annually?

At a 15% discount rate, the present value of this future payment is $1,869.07. n=12 i=15 pv=? pmt=0 fv=10,000

On an adjustable rate mortgage, do borrowers always prefer smaller (tighter) rate caps that limit the amount the contract interest rate can increase in any given year or over the life of the loan?

Borrower preference is dependent, at elast in part, on their expectations of future interest rates. Borrowers choosing ARMs with price caps are charged a higher initial interest rate, a higher margin, more upfront costs, or a combination of the three. The borrower must consider these factors. For example, borrowers may prefer larger caps if they believe interest rates will not increase substantially. In this scenario, the loan interest rate will be lower because the borrower, not the lender, bears the risk of interest rates increasing.

Discuss several differences between long-term commercial mortgages and their residential counterparts.

Commercial mortgages have shorter terms than residential mortgages; five to ten- year terms are common for commercial mortgages and residential mortgages can be payable for up to 30 years. Commercial loans are typically nonrecourse, while residential borrowers are personally responsible for the amount borrowed. Restrictions on prepayment are commonly included with commercial mortgages but not residential mortgages. Residential mortgages are typically standardized; in contrast, most commercial mortgages do not conform to any specific standards or regulations, although this is changing rapidly as an increasing number of commercial real estate loans are being securitized.

What is the difference between contract rent and market rent? Why is this distinction more important for investors purchasing existing office buildings than for investors purchasing existing apartment complexes?

Contract rent refers to the actual rent paid under existing lease contracts executed between owners and tenants. Market rent refers to the potential rental income a property could receive on the open market as of the effective date of an appraisal. The distinction is particularly important for investors in office buildings because commercial leases tend to be for multiple years, unlike apartment leases. Existing leases at below market rates will be included in the calculation of potential gross income, which will depress the appraised value of the property relative to the appraised value assuming market rental rates.

In what situations or for which types of properties might discounted cash flow analysis be preferred to direct capitalization?

Direct capitalization is dependent on information obtained from sales of properties that are deemed to be comparable to the subject property. Identifying comparable properties is particularly difficult with commercial real estate investments. Discounted cash flow analysis is useful for valuing income-producing properties because the unique expected cash flows for a particular property are evaluated using the appropriate required internal rate of return. DCF is especially useful when valuing multi-tenant office buildings and shopping centers were lease terms can vary widely across even otherwise similar properties.

Dr. Bob Jackson owns a parcel of land that a local farmer has offered to rent from Dr. Bob for the next 10 years. The farmer has offered to pay $20,000 today or an annuity of $3,200 at the end of each of the next 10 years. Which payment method should Dr. Jackson accept if his required rate of return is 10 percent?

Dr. Jackson should choose the payment method that maximizes his net present value. If he chooses the lump sum payment, the net present value is simply the $20,000 he will receive today. If he chooses the annuity plan, the net present value will be only $19,662.61. n=10 1/y=10 pv=? pmt=3,200 fv=0 Therefore, Dr. Jackson should choose the lump sum payment of $20,000.

Lender's yield differs from effective borrowing cost (EBC) because:

EBC accounts for additional third party up-front expenses that lender's yield does not.

Your grandmother gives you $10,000 to be invested in one of three opportunities: real estate, regular bonds, or zero coupon bonds. If you invest the entire $10,000 in one of these opportunities with the expected cash flows shown below, which investment offers the highest NPV? Assume for simplicity that an 11 percent discount rate is appropriate for all three investments *chart in packet

Entering the annual income stream and discount rate into the cash flow registers of our financial calculator, we obtain the following net present value calculations: real estate, (625.76); regular bond, (369.5); and zero coupon bond, 682.12.

Raw land at the edge of urban development that lacks the necessary permits for development is one of the most risky kinds of real estate investment. Defend or refute this assertion.

Evaluated against the two types of investment risk confronting real estate investors, uncertainty of costs and uncertainty of value, raw land lacking permitting can be viewed as the riskiest form of real estate investment. Raw land at the edge of urban development that lacks necessary permitting for development possesses a large degree of value uncertainty because the future cash flows are not established. The value of the land is typically dependent on future growth to create market potential that is not currently in existence. Additionally, the probability of this occurring is dependent on land use regulations and the actions of the local planning authority. The total cost required to acquire and develop the raw land is unknown at the time of purchase. Only urban redevelopment projects possess comparable cost uncertainty as raw land without permitting.

Give some examples of up-front financing costs associated with residential mortgages. What rule can one apply to determine if a settlement (closing) cost should be included in the calculation of the effective borrowing costs?

Examples of upfront costs include discount points, loan origination fee, loan application and documentation preparation fees, appraisal fees, credit check fees, title insurance, mortgage insurance, charges to transfer the deed and record the mortgage, pest inspection, survey costs, and attorney's fees. The effective borrowing cost calculation should not include expenses that would be incurred if no mortgage financing were obtained. Therefore, only upfront costs associated with obtaining the mortgage funds should be included.

A homeowner is attempting to decide between a 15-year mortgage loan at 5.5 percent and a 30-year loan at 5.90 percent. Assume the up-front costs of the two alternatives are equal. What would you advise? What would you advise if the borrower also has a large amount of credit card debt outstanding at a rate of 15 percent?

If the borrower does not have a significant amount of debt at a rate well above the rates on the loan, then the difference in mortgage rates should be viewed as a maturity premium difference, and the borrower can consider the loans as equivalent on a purely financial basis. If the borrower owes significant amounts of high interest consumer debt, then the longer-term loan is preferable. It will have a lower present value (present cost) discounted at the borrower's opportunity cost. In other words, if the opportunity costs of the household are substantially greater than the mortgage interest rate, the household will be better off with the longer-term mortgage.

Suppose a one-year ARM loan has a margin of 2.75, an initial index of 3.00 percent, a teaser rate for the first year of 4.00 percent, and a cap of 1.00 percent. If the index rate is 3.00 percent at both the beginning and the end of the first year, what will be the interest rate on the loan in year two? If there is more than one possible answer, what does the outcome depend on?

If the periodic cap applies to the teaser rate, the interest rate in year two will be constrained to 5.00 percent. If the cap applies only to index plus margin, the rate in year two would be 5.75 percent.

which of the following statements is most accurate?

Joint ventures usually decrease the amount of equity capital the developer/borrower must invest in the project.

Distinguish among land acquisitions loans, land development loans, and construction loans. How would you rank these three with respect to lender risk?

Land acquisition loans finance the purchase of raw land. Land development loans finance the installation of the onsite and offsite improvements to land that are necessary to prepare the land for construction. Construction loans are used to finance the costs associated with erecting the building(s).

List and briefly describe the typical items included in a commercial mortgage loan submission package

Loan submission packages provide lenders with the information they need to quickly evaluate the borrower's loan request, including information on type, size, and location of the property, maps and photographs, age of the property and date of the most recent renovation, purchase price of the property, the requested laon amount and other basic loan terms, the operating history of the property over the last several years, and the current rent roll.

Assume an investment is priced at $5,000 and has the following income stream (year 1, $1,000; year 2, -$2,000; year 3, $3,000; and year 4, $3,000). Would an investor with a required rate of return of 15 percent be wise to invest at a price of $5,000?

No, because the investment has a net present value of -$1,954.91.

You have signed a new lease today to rent office space for five years. The lease payments are fixed at $4,500 per month for the first two years, but rise to $5,500 per month in years 3-5. What is the present value of this lease obligation if the appropriate discount rate is 8 percent?

Present value of $5,500 per month for five years: n=60 i=8/12 pv=? pmt=5,500 fv=0 Present value = $273,060 (this is an annuity due; use "begin" mode) Present value of $1,000 per month for two years: n=24 i=8/12 pv=? pmt=1,000 fv=0 Present value = $22,258 (this is an annuity due; use "begin" mode) Total PV of lease = $273,060 - $22,258 = $250,802.

Calculate the original loan size of a fixed-payment mortgage if the monthly payment is $1,146.78, the annual interest is 8.0%, and the original loan term is 15 years.

Rounding to the nearest whole dollar, the original size of the loan is $120,000. This problem is solved using the following keystrokes on a financial calculator: n=180 i=8/12 pv=? pmt=1,146.78 fv=0

The required calculation of the annual percentage rate (APR) by the lender is a result of:

The Truth-in-Lending Act of 1968

What is the difference in the present value of these two loan alternatives? Assume the appropriate discount rate is 6 percent.

The difference in NPVs is $50,000: Option "A" is more expensive. Present value of Option A is $1,050,000: initial equity ($300,000) + upfront financing fees ($50,000) + present value of interest payments ($578,123) + present value of loan principal upon repayment ($121,877). Present value of Option B is $1,000,000: initial equity ($250,000) + present value of interest payments ($619,417) + present value of loan principal upon repayment ($130,583).

Discuss the potential advantages of a miniperm loan from the prospective of the developer/investor, relative to the separate financing of each stage of the development.

The existence of a single lender and a single application process simplifies the financing process. Miniperm loans enable developers to proceed with construction without long-term financing. A miniperm loan is an attractive financing option if the developer expects to sell the project or refinance into a permanent loan before the term of the miniperm expires.

Estimate the market value of the following small office building. The property has 10,500 square feet of leasable space that was leased to a single tenant on January 1, four years ago. Terms of the lease call for rent payments of $9,525 per month for the first five years, and rent payments of $11,325 per month for the next five years. The tenant must pay all operating expenses. During the remaining term of the lease, there will be no vacancy and collection losses; however, upon termination of the lease it is expected that the property will be vacant for three months. When the property is released under short-term leases, with tenants paying all operating expenses, a vacancy and collection loss allowance of 8 percent per year is anticipated. The current market rental for properties of this type under triple net leases is $11 per square foot, and this rate has been increasing at a rate of 3 percent per year. The market discount rate for similar properties is about 11 percent, the "going-in" cap rate is about 9 percent, and terminal cap rates are typically 1 percentage point above going-in cap rates. Prepare a spreadsheet showing the rental income, expense reimbursements, NOIs, and the net proceeds from the sale of the property at the end of an 8-year holding period. Then use the information provided to estimate the market value of the property.

The fifth year of the 10-year lease is the first year of analysis. The problem calls for an 8-year analysis--one for the last year of the 1st 5-year period, five for the second 5-year period, one to allow the vacancy and collection loss to achieve a normal level, and one at the normal level for calculating the property's value (sale price) at that time. Assume vacancy and collections losses in year 7 are 25 percent, which reflects 100 percent vacancy for three months and no vacancy for 9 months. Assume the "normal" vacancy rate of 8 percent will apply in year 8 of the analysis and beyond. Sale price at the end of Yr. 8: = [NOI (yr9) / Terminal cap rate] = $134,606 / 0.10 = $1,346,060 Cash Flows: CF1 = 114,300 CF2 = 135,900 CF3 = 135,900 CF4 = 135,900 CF5 = 135,900 CF6 = 135,900 CF7 = 103,435 CF8 = 1,476,746 (130,686+1,346,060) PV of Cash Flows @ 11 percent = $1,246,090

A mortgage banker is originating a level-payment mortgage with the following terms: Annual interest rate: 9 percent Loan term: 15 years Payment frequency: monthly Loan amount: $160,000 Total up-front financing costs (including discount points): $4,000 Discount points to lender: $2,000 a. Calculate the annual percentage rate (APR) for Truth-in-Lending purposes.

The first step is to solve for the payment, which is $1,622.83, with the following calculator keystrokes: n=180 i=.75 pv= -160,000 pmt=? fv=0 a. The APR is approximately 9.43 percent as solved below: n=180 i=? pv= -156,000 pmt=1,622.83 fv=0

For a loan of $100,000, at 7 percent annual interest for 30 years, find the balance at the end of 4 years and 15 years assuming monthly payments.

The loans balance at the end of 4 years and 15 years is $95,474.55, and $74,018.87, respectively, as solved below First, the loan payment must be calculated. The loan payment is $665.30, as solved below: n=360 i=.5833 pv=100,000 pmt=? fv-0 The balance at the end of four years is $95,474.55, which is calculated by entering the following data into a financial calculator. n=312 i=.5833 pv=? pmt=665.30 fv=0 The balance at the end of 15 years is $74,018.87, which is calculated by entering the following data into a financial calculator. n=180 i=.5833 pv=? pmt=665.30 fv=0

You are thinking about purchasing some vacant land. You expect to be able to sell the land ten years from now for $500,000. What is the most you can pay for the land today if your required rate of return is 15 percent? What is the expected (annualized) return on this investment over the 10-year holding period if you purchase the land for $170,000?

The maximum amount you can spend to purchase this property is the present value of the future price, discounted at 15 percent for ten years. Using a financial calculator, this amount is $123,592.35. n=10 i=15 pv=? pmt=0 fv=500,000 The expected annualized return on this investment can be solved using a financial to obtain for the interest rate that equates a present value of $170,000 to $500,000 in ten years. The annualized return of this investment is 11.39% n=10 i=? pv= -170,000 pmt=0 fv=500,000 Alternatively, the cash flow function can be used to calculate the IRR of this investment, whereby the initial cash outflow at time zero is $170,000, the cash flows for the time period 1-9 is zero, and the cash flow received in year 10 is $500,000. Using this approach, the IRR is 11.39%.

Consider a $75,000 mortgage loan with an annual interest rate of 8%. The loan term is 7 years, but monthly payments will be based on a 30-year amortization schedule. What is the monthly payment? What will be the required balloon payment at the end of the loan term?

The monthly payment is $550.32 and the balloon payment is $69,358.07. The payment is calculated using the following calculator keystrokes: n=360 i=.667 pv= -75,000 pmt=? fv=0 The balloon payment at the end of year seven is $69,358.07, as calculated with the following calculator keystrokes: n=276 i=.667 pv=? pmt=550.32 fv=0

You are contemplating replacing your conventional hot water heater with a solar hot water heater system at a cost of $4,000. How should you define the potential benefits that you need to receive to justify the investment?

The potential benefit gained from this investment is a reduction in future utility costs. This purchase requires an analysis of the initial costs and the value of the future benefit received in the form of lower utility bills. The homeowner should consider whether to finance this $4,000 investment and, if so, how much to borrow. The homeowner should also analyze how financing this purchase impacts the present and future cash flows associated with the purchase of the solar hot water heating system.

describe the conditions under which the use of effective gross income multipliers to value the subject property is appropriate

The use of gross income multipliers is predicated on two primary assumptions. First, it is assumed that the operating expense percentage of the subject property and the comparable properties are equal. Second, this approach assumes that the subject property and comparable properties are collecting market rents. In practice, gross income multipliers are most appropriate for valuing apartment buildings.

You are able to buy an investment today for $1,000 that gives you the right to receive $438 in each of the next three years. What is the internal rate of return on this investment?

This is simply a yield calculation problem. Like any time-value-of-money problem, we are given four inputs and are asked to solve for the fifth. In this case, we must solve for the interest rate as follows: n=3 i=? pv= -1,000 pmt=438 fv=0 Solving this setup tells us the above loan yields a 15 percent return.

Calculate the present value of the income stream given below assuming a discount rate of 8 percent. What happens to present value if the discount rate increases to 20 percent? year 1- 3,000 income year 2- 4,000 income year 3- 6,000 income year 4- 1,000 income

This problem is solved by entering the annual income stream and discount rate into the cash flow registers of any standard financial calculator and solving for the net present value. Assuming an 8% discount rate, the income stream is valued at $11,705.16. Alternatively, if the discount rate is 20%, the value of the income stream will be $9,232.25.

You want to buy a house for which the owner is asking $625,000. The only problem is that the house is leased to someone else with five years remaining on the lease. However, you like the house and believe it will be a good investment. How much should you pay for the house today if you could strike a bargain with the owner under which she would continue receiving all rental payments until the end of the five-year leasehold at which time you would obtain title and possession of the property? You believe the property will be worth the same in five years as it is worth today and that this future value should be discounted at a 10 percent annual rate?

This problem requires you to determine the present value of the house today if you are willing to purchase it for $625,000 five years from today. Using a 10% discount rate, the home is worth $388,075.83 today. n=5 i=10 pv=? pmt=0 fv= 625,000

Calculate the IRR and NPV for the following two investment opportunities. Assume a 16 percent discount rate for the NPV calculations: year project 1 cash flows project 2 cash flows 0 -10,000 -10,000 1 1,000 1,000 2 2,000 12,000 3 12,000 1,800

To solve this problem, simply enter each set of cash flows into the cash flow registers of your financial calculator and ask it to find the IRR. For Project 1, the internal rate of return is 16.16%, while for Project 2, the internal rate of return is 21.23%. The NPV for Project 1 is $36.29 and the NPV for Project 2 is $933.21. If these projects were independent, each IRR should be individually compared to the required rate of return to determine whether the investment should be made. However, if the projects are mutually exclusive and are of equivalent risk, Project 2 is preferred to Project 1. Additionally, the higher NPV of Project 2 clearly makes this alternative the most attractive investment option because the investor's net worth will increase by $933.21.

You are considering the purchase of a small income-producing property for $150,000 that is expected to produce the following net cash flows: End of Year Cash Flow 1 - $50,000 2 - $50,000 3 - $50,000 4 - $50,000 Assume your required internal rate of return on similar investments is 11 percent. What is the net present value of this investment opportunity? What is the going-in internal rate of return on this investment? Should you make the investment?

Using the cash flow function on a financial calculator and entering the information provided above, the NPV of this investment is $5,122.28. Alternatively, the NPV can be solved as follows: n=4 i=11 pv=? pmt= 50,000 fv=0 The present value of this series of payments is $155,122.28. Subtracting the amount of the cash outflow at period zero ($150,000), the present value is also $5,122.28. The going-in IRR for this investment is 12.59%. Yes, you should make the investment.

As the level of perceived risk increases

Values decrease and expected returns increase

Consider the stand-alone locations favored by Walgreens for locating their drugstores. In most cases, Walgreens does not own these properties. Instead, they lease the properties on a long-term basis from institutional owners. What does Walgreens gain by leasing instead of owning? What do they lose?

Walgreens obtains the use of a structure that is well suited to its needs. They gain the benefit of investing their funds in its core business operations rather than committing their money in real estate. They also benefit from tax benefits associated with sale-leasebacks. Conversely, Walgreens will not benefit from the appreciation of the property and the tax depreciation benefits that come with ownership.

Distinguish between recourse and nonrecourse financing.

When a note is used and the borrower has personal liability, the arrangement is known as recourse financing. The borrower has personal responsibility for recourse debt, and, upon default and foreclosure, the borrower is liable for the difference between the proceeds generated from foreclosure sale and the amount owed to the lender. When a note is not used and the borrower does not have personal liability for the debt, the arrangement is known as nonrecourse financing. In these cases, the provisions of the debt are contained in the mortgage or a separate contract. The borrower is not personally liable for nonrecourse debt and the lender receives the property pledged as collateral in satisfaction of the loan deficiency.

contrast self-contained appraisal reports, summary appraisal reports, and restricted appraisal reports.

a self- contained appraisal report includes all the detail and information that were used by the appraiser to derive his or her estimate of market value or the other conclusions within the report. a summary appraisal reports simply summarizes the conclusions of the appraisal. the majority of data and techniques used in the appraisal are kept in the appraiser's work file. a restricted appraisal reports provides a minimal discussion of the appraisal with many references to the appraiser's work file/international documentation.

what is a self-contained appraisal report?

a self-contained appraisal report is the document prepared by the fee appraiser to convey the client has his opinion of value. this report contains the appraiser's final estimate of value, the data forming the foundation of this estimate, and the calculations supporting the estimate.

Assume the annual interest rate on a $500,000 7-year balloon mortgage is 6 percent. Payments will be made monthly based on a 30-year amortization schedule. a. What will be the monthly payment? b. What will be the balance of the loan at the end of year 7? c. What will be the balance of the loan at the end of year 3?

a. Based on a 30-year amortization schedule, the monthly payment is $2,997.75 (n=360, I =6/12, PV=-500,000, and FV = 0). b. The balance of the loan at the end of year 7 is $448,197 (solving for the present value of the remaining payments: N=276, I =6/12, PV= ?, PMT = 2,997.75, and FV=0). c. The balance of the loan at the end of year 3 is $480,420 (solving for the present value of the remaining payments: N=324, I =6/12, PV= ?, PMT = 2,997.75, and FV=0)

Answer the following questions on financial leverage, value, and return: a. Define financial risk b. Should the investor select the origination LTV that maximizes the IRR on equity? Explain why or why not.

a. Financial risk refers to the risk that NOI will be less than debt service. A positive correlation exists between the amount of debt service and financial risk. b. Higher expected returns are gained from additional leverage but the average return per unit of risk decreases as leverage increases. Leverage maximizes return when a property is performing well but amplifies the downside when a property is performing poorly. Therefore, the use of leverage may increase the investor's going-in IRR on equity, but financial leverage also increases the riskiness of the equity because of the increased risk of default and the increased sensitivity of the realized return on equity to changes in rental rates and resale values. Thus, the increase in expected return from the use of debt may not be large enough to offset the corresponding increase in risk.

13. You are considering purchasing an office building for $2,500,000. a. What is the implied first-year overall capitalization rate? b. What is the expected debt coverage ratio in year 1 of operations? c. If the lender requires DCR to be 1.25 or greater, what is the maximum loan amount? d. What is the debt yield ratio?

a. PGI $450,000 Vacancy and collections (40,500) EGI 409,500 Op Expenses and CAPX (171,990) NOI 237,510 DS (138,170) BTCF $ 99,340 the implied first-year overall capitalization rate is $237,510/$2,500,000 or 0.095 b. The expected debt coverage ratio in year 1 of operations is 1.72 ($237,510/$138,170) c. If the lender requires DCR to be 1.25 or greater, the maximum loan amount is determined by first calculating the maximum debt service amount: $190,008 ($237,510/1.25). The maximum loan amount implied by this debt service amount is $2,578,460 (N = 300, I = 5.5/12, PMT = 190,008/12, and FV = 0) d. The loan amount is $1,875,000 (0.75 x $2,500,000). Therefore, the debt yield ratio is 0.095 or 9.5% ($237,510/$2,500,000).

Consider the following table of annual mortgage rates and yields on 10-year Treasury securities. a. What was the average annual spread on mortgage rates relative to the 10-year Treasury securities over the 1990-2005 period? b. What was the correlation between annual mortgage rates and Treasury yields over the 1990-2005 period?

a. The average annual spread on mortgage rates relative to the 10-year Treasury securities was 1.71% b. The correlation between annual mortgage rates and yields over the 1990-2005 period was 96.9%.

You are considering the purchase of an industrial warehouse. a. Calculate the overall rate of return (or "cap rate") b. Calculate the debt coverage ratio. c. What is the largest loan that you can obtain (holding the others terms constant) if the lender requires a debt service coverage ratio of at least 1.2?

a. The overall rate of return (or "going-in" cap rate) is 10.8% (NOI of 108,000/purchase price of 1,000,000) b. The debt coverage ratio is computed below: DCR = NOI/DS = 108,000/42,000 = 2.57 c. The maximum amount of interest that you can afford to pay based on the lender's requirements is $90,000 (108,000/1.2). Therefore, the largest loan you can obtain is $90,000/.06, or $1,500,000.

Adjustable rate mortgages (ARMs) commonly have all the following except:

an inflation index

If a mortgage is to mature (i.e. become due) at a certain future time without any reduction in the original principal, this is called:

an interest-only mortgage

estimated capital expenditures

are subtracted from NOI in a below-line treatment

b. Calculate the lender's yield with no prepayment.

b. The lender's yield to maturity is 9.22 percent n=180 i=? pv= -158,000 pmt=1,622.83 fv=0

Which of these ratios is an indicator of the financial risk for an income property?

both a and b, but not c

An interest-only balloon mortgage loan is commonly referred to as a(n):

bullet loan

c. Calculate the lender's yield with prepayment is five years.

c. In order to calculate the lender's yield, the loan balance remaining at the end of year five must first be calculated" n=120 i=.75 pv=? pmt=1,622.83 fv=0 The remaining balance is $128,108.67. With this information, the lender's yield is 9.34 percent as calculated below: n=60 i=? pv= -158,000 pmt= 1,622.83 fv=128,108.67

which of the following statements regarding capitalization rates on commercial real estate investments is the most correct?

cap rates vary positively with the perceived risk of investment

Solve for the unknown discount rate in each of the following:

chart in packet

Solve for the unknown number of years in each of the following:

chart in packet

assume the market value of the subject site (land only) is 120,000. you estimate that the cost to replicate improvements to the subject property would be 428,000 today. in addition, you estimate the accrued depreciation on the subject is 60,000. what is the indicated value of the subject using the cost approach?

construction cost of improvements 428,000 less: accrued depreciation (60,000) depreciated value of improvements 368,000 plus: value of site 120,000 indicated value by cost approach 488,000

d. Calculate the effective borrowing costs with prepayment in five years.

d. The effective borrowing cost with prepayment in five years is 9.69 percent. n=60 i=? pv= -156,000 pmt=1,622.83 fv=128,108.67

d. Assume that interest rates have fallen to 4.5% at the end of year 3. If the remaining mortgage balance at the end of year 3 is refinanced at the 4.5 percent annual rate, what would be the new monthly payment assuming a 27-year amortization schedule? e. What is the difference in the old 6 percent monthly payment and the new 4.5 percent payment?

d. The new monthly payment assuming a 27-year amortization schedule is $2,564.10 (n=324, I =4.5/12, PV = 480,420.35, and FV = 0). e. The new loan payment on the new 4.5 percent loan is $433.65 less than the payment on the old 6 percent loan

Due-on-sale clauses are included in commercial mortgages primarily to protect lenders from:

default risk

Commercial mortgage borrowers may decide to prepay the principal on their loan even if they face prepayment penalties. One way that lenders protect themselves from prepayments in such circumstances is by requiring the borrower who prepays to purchase for the lender a set of U.S. Treasury securities whose coupon payments replicate the cash flows the lender will lose as a result of the early retirement of the mortgage. This process is referred to as:

defeasance

f. What will be the remaining mortgage balance on the new 4.5 percent loan at the end of year 7 (four years after refinancing)? g. What will be the difference in the remaining mortgage balances at the end of year 7 (four years after refinancing)? h. At the end of year 3 (beginning of year 4), what will be the present value of the difference in monthly payments in years 4-7, discounting at an annual rate of 4.5 percent?

f. The remaining mortgage balance on the new 4.5 percent loan at the end of year 7 (four years after refinancing) is $440,400 (solving for the future value: n=48, I = 4.5/12, PV = 480,420 and PMT = 2,564.10. g. The difference in the remaining mortgage balances at the end of year 7 (four years after refinancing) is as follows: The balance at year seven for the original loan at 7% is $448,197. The balance of the new loan fours years after refinancing is $440,400. The difference between the two is $7,797. h. At the end of year 3 (beginning of year 4), the present value of the differences in monthly payments in years 4-7, discounting at an annual rate of 4.5 percent, is $19,017 (n = 48, I = 4.5/12, PMT= 433.65, and FV = 0).

The final price for each comparable property reached after all adjustments have been made is termed the

final adjusted sales price

The dominant loan type originated by most financial institutions is the:

fixed-payment, fully amortized mortgage

what is meant by functional obsolescence? could a new building suffer from functional obsolescence?

functional obsolescence refers to a building's loss in value resulting from changes in taste, technical innovations or market standards. typically, functional obsolescence is associated with a building's decline in utility through the passage of time, but it is possible for a newer building to suffer from functional obsolescence. for example, customer preferences and demands may change soon after a relatively new building is complete.

how would you go about estimating the current market value of a publically-traded common stock? would this take more or less time than most real estate appraisals?

i would simply observe the price at which the stock is currently selling or the closing price of the stock at the end of the most recent trading day. this would take significantly less time than a formal real estate appraisal.

i. At the end of year 3 (beginning of year 4), what will be the present value of the difference in loan balances at the end of year 7, discounting at an annual rate of 4.5 percent? j. At the end of year 3 (beginning of year 4), what will be the total present value of lost payments in years 4-7 from the lender's perspective? k. If the mortgage contains a yield maintenance agreement that requires the borrower to pay a lump sum prepayment penalty at the end of year 3 equal to the present value of the borrower's lost payments in years 4-7, what should that lump sum penalty be?

i. At the end of year 3 (beginning of year 4), the present value of the differences in loan balances at the end of year 7, discounting at an annual rate of 4.5 percent, is $6,515 (n = 48, I = 4.5/12, PMT = 0, and FV = 7,797). j. At the end of year 3 (beginning of year 4), the total present value of lost payments in years 4-7 from the lender's perspective is $19,017 (n = 48, I = 4.5/12, PMT = 433.65, and FV = 0) k. The lump sum payment should be 25,532 ($19,017 + $6,515).

in the sales comparison approach, if the comparable property is superior to the subject property in some way, is an upward or downward adjustment to the sale price of the comparable required? explain

if the comparable property is superior to the subject property in some way, a downward adjustment to the sales price of the comparable to account for the difference

assume a reserve for non-recurring capital expenditures is to be included in the pro forma for the subject property. explain how an above-line treatment of this expenditure would differ from a below-line treatment

in an above-line treatment, the reserve for non-recurring capital expenditures would be taken out in the calculation of net operating income (ex above line). in a below-line treatment, the reserve for non-recurring capital expenditures would be subtracted from net operating income (ex. below line)

the cost approach to market valuation does not work well in markets that are overbuilt. explain

in an overbuild market, the market value of an existing property is frequently less than the construction of the property. that is, the adjustment needed for economic depreciation is large and difficult to estimate.

why is an estimate of the developer's fair market profit included in the cost estimate?

in practice, developers and contractors frequently include their profit in the calculated cost amount because a fair and reasonable profit amount is considered a cost of constructing the improvements.

a new house in good condition that has a poor floor plan would suffer from which type of accrued depreciation?

incurable functional obsolescence

in the sales comparison approach, the value obtained after reconciliation of the final adjusted sales prices from the comparable sales is termed the

indicated opinion of value

Consider a 30-year, 7 percent, fixed rate, fully amortizing mortgage with a yield maintenance provision. Relative to this mortgage, a 10-year balloon mortgage with the same interest rate and yield maintenance provisions will primarily reduce the lender's:

interest rate risk

to reflect a change in market conditions between the date on which a comparable property sold and the date of appraisal of a subject property, an adjustment must be made for which of the following?

market conditions

what is the difference between market value and investment value?

market value is the most probably selling price; investment value is the value to a particular investor

which of the following expenses is not an operating expense?

mortgage payment

You are trying to accumulate a $40,000 down payment to purchase a home. You can afford to save $1,000 per quarter. If these quarterly investments earn an annual rate of 7 percent, how many quarters will it take to reach your goal?

n= 30.57 quarters or 7.65 years n=? i=7/4 pv=0 pmt=1,000 fv=40,000

Suppose you are going to receive $10,000 per year for five years. The appropriate interest/discount rate is 11 percent. b. Suppose you plan to invest the payments for five years. What is the future value if the payments are an ordinary annuity?

n=5 i=11 pv=0 pmt=10,000 fv=? fv= 62,278 what if the payments are an annuity due? fv= 69,129

Suppose you are going to receive $10,000 per year for five years. The appropriate interest/discount rate is 11 percent. a. What is the present value of the payments if they are in the form of an ordinary annuity?

n=5 i=11 pv=? pmt=10,000 fv=0 pv= 36,959 what is the present value if the payments are an annuity due? pv= 41, 024

an overall capitalization rate (Ro) is divided into which type of income or cash flow to obtain an indicated market value?

net operating income (NOI)

The most common adjustment interval on an adjustable rate mortgage (ARM) once the interest begins to change is:

one year

Assume the total cost of a college education will be $310,000 when your infant child enters college in 18 years. How much you invest at the end of each month in order to accumulate the required $310,000 at the end of 18 years if your monthly investments earn an annual interest rate of 5 percent, compounded monthly?

payment= 887.74 n=18*2 i=5/12 pv=0 pmt=? fv=310,000

the methodology of appraisal differs from that of investment analysis primarily regarding

point of view

which of the following type of properties probably would not be appropriate for income capitalization?

public school

what is the market value of real estate determined partly by the lender's requirements and partly by the requirements of equity investors?

real estate investments are frequently financed using a combination of equity and mortgage debt. a real estate investment can be viewed as a joint investment made by both the lender and equity investors, and therefore, both parties' required rates of return are relevant. consequently, the investor's minimum required rate of return is heavily influenced by the ability and terms of financing provided by lenders, as well by evaluating the required returns on alternative investments of similar risk. in general, a levered investment has greater risk than an unlevered investment, which increases the investor's required rate of return.

Using financial leverage on a real estate investment can be for the purpose of all of the following except:

reduction of financial risk for the leveraged investment

under the cost approach to appraisal, the estimated expenditure required to construct a building with equal utility as the one being appraised is termed the

replacement cost

replacement costs have been estimated as 350,000 for a property with a 70-year economic life. the current effective age of the property is 15 years. the value of the land is estimated to be 55,000. what is the estimated market value of the property using the cost approach, assuming no external or functional obsolescence.

replacement cost 350,000 less: depreciation (75,000)----[350,000 * 15/70] depreciation cost of building improvements 275,000 add: estimated value of site 55,000 indicated value by cost approach 330,000

number 4 in ch 8 packet question3- assuming the relevant required yield/return on levered cash flows is 15 percent, and that the property will be held by a buyer for five years, what is the present value of the levered cash flows

sales price 2,000,000 less cost of sale/selling price (125,000) net sale proceeds 1,875,000 less mortgage balance 1,500,000 before tax equity reversion 375,000

number 4 in ch 8 packet question 2- assuming the required yield/return on unlevered cash flows is 10 percent, and the property will be held by a buyer for five years, compute the value of the property based on discounting unlevered cash flows

sales price: 2,000,000 less: cost of sale/selling expense (125,000) = net sale proceeds 1,875,000

a comparable property recently sold for 250,000. the comparable contained an estimated 3,000 in non-reality items. in addition, the appraiser estimates that market value (conditions) have increased a total of 2 percent since the sale of the comparable. what is the adjusted price of the comparable if the dollar adjustment for non-reality items is made before the market conditions adjustment? what is the adjusted price of the comparable if the percentage adjustment for market conditions is made before the adjustment for non-reality items?

solution in packet

number 14 on chapter 7

solution in packet

given the following owners income and expense estimates for an apartment property formulate a reconstructed operating statement. the building consists of 10 units that could rent for 550 per month each. - chart in ch 8 textbook solutions estimating vacancy and collection losses at 5 percent of potential gross income, reconstruct the operating statement to obtain an estimate of NOI. assume an above-line treatment of CAPEX. remember, there may be items in the owner's statement that should not be included in the reconstructed operating statement. using the NOI and Ro of 11.0 percent, calculate the property's indicated market value, round your answer to the nearest 1,000.

solution in packet note- mortgage payments and depreciation are not included in the calculation of the property's NOI. the indicated value of the property is 362,727 (39,900/.11) which rounds to 363,000

which of the following is not included in accrued depreciation when applying the cost approach to valuation?

tax depreciation

you have been asked to estimate the market value of an apartment complex that is producing an annual net op income of 44,500. four highly similar and competitive apartment properties within two blocks of the subject property have sold in the past three months. all four offer essentially the same amenities and services as the subject. all were open-market transactions with similar terms of sale. all were financed with 30-year fixed-rate mortgages usinf 70 percent debt and 30 percent equity. the sales prices and estimated first-year net operating incomes were as follows: comparable 1- sales price 500,000; NOI 55,000 comparable 2- sales price 420,000; NOI 50,400 comparable 3- sales price 475,000; NOI 53,400 comparable 4- sales price 600,000; NOI 69,000 what is the indicated value of the subject property using direct capitalization?

the abstracted going-in capitalization rates from the four properties are listed below comparable 1- 0.110 comparable 2- 0.120 comparable 3- 0.112 comparable 4- 0.115 simple ave- 0.114 the simple average of the four comparable cap rates is 0.114. thus the indicated value of the subject property is 390,351 (44,500/0.114) which rounds to 390,000

with a mezzanine loan

the borrower's promise to pay is secured by the equity interest in the borrower's limited partnership or limited liability company.

you are estimating the value of a small office building. suppose the estimated NOI for first year of operations is 100,000. c. if you expect the initial 100,000 NOI will grow forever at a 3% annual rate, what is the value of the building assuming a 12.2% discount rate? if you pay this amount, what is the indicated initial cap rate?

the capitalization rate consists of a required IRR on equity and a growth rate. applying the general constant-grown formula and assuming that the growth rate is 3%, the indicated capitalization rate is equal to 9.2% (12.2-3.0%). therefore, using a cap rate of 9.2%, the indicated value of the building is 100,000/0.092 or 1,086,957

what main difficulty would you foresee in attempting to estimate the value of a 30 year old property by means of the cost approach?

the cost approach assumes that the market value of a new building is similar to that of constructing the building today, minus accrued depreciation. calculating an accurate estimate of accrued accrued depreciation for a 30-year old property is difficult because physical deterioration/depreciation, functional obsolescence, and external/economic depreciation are likely to increase as the building ages.

what is the theoretical basis for the direct sales comparison approach to the market valuation?

the direct sales comparison approach to the market valuation relies on value judgements made by willing buyers and sellers. therefore, this method is uses market-driven information. the sales comparison approach involves comparing a subject property with recently sold comparable properties.

how would you define the highest and best use of a property?

the highest and bets use of a property is defined as that use found to be (1) legally permissible, (2) physically possible, (3) financially feasible, and (4) maximally productive (ex yielding the greatest benefit to an owner). in short HABU is the use that would maximize the property.

data for five comparable income properties sold recently are shown below what is the indicated overall rate (Ro)

the indicated overall cap rate of 10.05 percent is the simple average pf the overall rates for the five comparable properties.

you are estimating the value of a small office building. suppose the estimated NOI for first year of operations is 100,000. a. if you expect that NOI will remain constant at 100,000 over the next 50 years and that the office building will have no value at the end of 50 years, what is the present value of the building assuming a 12.2% discount rate? if you pay this amount, what is the indicated initial cap rate?

the present value, using the finaincial calculator is 817,078 n=50 i=12.2 pv=? pmt=100,000 fv=o the initial (going-in) cap rate is 100,000/817,078= 12.24%

you are estimating the value of a small office building. suppose the estimated NOI for first year of operations is 100,000. b. if you expect that NOI will remain constant at 100,000 forever, what is the value of the building assuming a 12.2% discount rate? if you pay this amount, what is the indicated initial cap rate?

the value of the building with NOI remaining constant at 100,000 is calculated using the formula for a perpetuity which is 100,000/0.122 or 819,672. if you pay 819,672 for the property, the initial (going-in) cap rate is 12.2% (100,000/819,672).

number 4 in ch 8 packet question 1- assuming the going-in capitalization rate is 8.0 percent, compute a value for the property using direct capitalixation

value= NOI1/R= 150,000/.08= 1,875,000