chapter 16

susan is considering buying a class-A office building in Miami. the acquisition price is $2,500,000. she expects the first-year potential gross income (PGI) to be $300,000. based on her pro forma analysis, vacancy and collection losses comprise 5% of PGI, and operating expenses and capital expenditures will consume 40% of EGI. the interest rate on her commercial mortgage is 6%, with monthly payments and 25-year amortization schedule. if the lender requires the DCR to be 1.35 or greater, what is the maximum loan amount?

$1,638,294.68

assume you want to purchase a 100,000 square feet office property in downtown baltimore. you have to set aside $0.50 per square foot per year (end of each year) for nonrecurring capital costs over the next five years. suppose the deposit rate is 2% and compounding frequency is annual. how much would you accumulate by the end of year 5?

$260,202.01

suppose howard realty group prepaid a 10-year, 6% commercial mortgage loan with $1,800,000 remaining balance 3 years after its origination (mortgage interest rate is 6%, monthly compounding). assume the interest rates have declined to 4% at the end of the third year, how much loss would the lender suffer as a result of the borrower's prepayment by the end of the tenth year, all else equal?

$356,140.39

scholars and practitioners have found that lessees, on average, experience positive stock market reactions following the announcements of sale-leasebacks. which of the following factors are likely to explain this shareholder wealth effect?

- 100% debt financing - more capital for investment in the company's core business

the most typical loan term and amortization period on fixed-rate commercial mortgages are _____ years.

- 30 - 10

which of the following statements about the DYR are correct?

- DYR is not affected by the interest rate and the amortization period of a loan - DYR indicated the lender's cash-on-cash return on its invested capital

which of the following statements about HUD are correct?

- HUD finances rental housing for the elderly - HUD refinances mortgage on low-income properties - HUD provides loan guarantees for multifamily mortgages

potential outcomes of the lender's discovery of inconsistencies or errors in the loan submission package include:

- a reduction in the loan amount - a refusal to fund the loan - an alternation of the loan terms

in commercial mortgage financing, a note contains the terms of the loan and provisions agreed to by the borrower and lender. typically, the provisions of the note dealing with which of the following?

- amounts and timing of periodic payments - default - penalties for late payments - property maintenance

which of the following items are typically included in the lender's due dilligence?

- an analysis of the property's income-generating ability - a careful examination of the leases - a request for environmental reports

with a sale-leaseback, the entire lease payment is tax-deductible. to receive this benefit, the lessee (seller of the property) has to forgo:

- appreciation in the value of the property - mortgage interest deductions - tax depreciation deductions

permanent financing is long-term debt financing for existing income-generating properties. which of the following provides permanent financing to borrowers?

- commercial banks - HUD - freddie mac

the expression of prepayment penalties may be a _____ percentage as the loan is amortized.

- declining - constant

financial leverage is commonly used by real estate investors to alter the risk-return relationship in their investments. which of the following statements about financial leverage are correct?

- financial leverage is used partially because of limited financial resources available to the investors - positive financial leverage occurs when the cost of borrowing is less than the unlevered IRR

typically, financial leverage alters the risk-return relationship of real estate investments by:

- increasing the expected IRR on equity - increasing default risk

a rate lock agreement:

- is purchased by the borrower for the benefit of the borrower - may result in a higher contract interest rate than if the rate is not locked

which of the following are advantages to the lessee (seller of the property) of a sale-leaseback?

- it allows the lessee to focus on her core business - potential 100% debt financing

which of the following features describe the note used in commercial mortgage financing?

- it is usually quite lengthy - it is used to create a legal debt

which of the following are characteristics of a participation loan?

- lender usually provides a larger loan amount, which is often attractive to borrowers - lender receives a specified portion of a property's cash flows

which of the following options are the main repayment mechanisms used in long-term commercial mortgages?

- partially amortizing loans - interest-only loans - fully amortizing loans

which of the following are usually contained in a commercial mortgage loan submission packages?

- property size - requested loan amount

land acquisition, development, and construction loans:

- usually have floating rates - are usually prepayable at anytime without penalty

which of the following give commercial mortgage borrowers the flexibility to prepay, but increase the cost of refinancing for the borrowers?

- yield-maintenance agreement - prepayment penalties

A multifamily property is acquired at a price of $1,000,000. the loan amount is $750,000. the property's first-year pro forma is as follows: NOI: $75,000, operating expenses: $30,000; capital expenditures: $0, and annual debt service: $60,000. what is the estimated DYR?

10%

all else being equal, which of the following balloon mortgages minimizes the lender's interest rate risk?

3-year loan

HUD actively participates in the mortgage market by issuing loan guarantees for multifamily mortgages through _____ (enter the acronym).

FHA

a property investment is said to be "cash flowing" when:

NOI exceeds required mortgage payments

in recent years, lenders have been unwilling to relieve borrowers from personal liability in the event of fraud, environmental problems, or unpaid property tax obligations. a clause that holds the actual borrower liable in such instances is commonly referred to as:

a bad boy clause

the due diligence process normally occurs _____ the signing of loan application.

after

a borrower can increase his or her financial leverage by applying for a second mortgage, which is secured by the borrower's pledge of the property as _____.

collateral

all else being equal, floating-rate mortgages _____ the lender's interest rate risk.

decrease

all else equal, when the DCR ratio increases, the likelihood of default _____.

decreases

the yields on commercial mortgages have been approximately 2 percentage points higher, on average, than the yields on comparable maturity treasury securities over the past 15 years. often considered the signature risk of commercial mortgage lending, this lending spread primarily represents compensation to the lender for:

default risk

which of the following types of risk is typically most relevant to commercial mortgage lenders?

default risk

which of the following statements about defeasance clauses are correct?

defeasance clauses eliminate any interest savings associated with mortgage prepayment

with a participation mortgage, the lender participates in cash flows that are generally received only by the

equity investor

true or false "good faith" deposits are always nonrefundable.

false

when a lender foreclosures on a mortgage loan, the _____ lien holder is entitled to the foreclosure sales proceeds before the _____ mortgage holder receives any of the proceeds from the sale.

first; second

payments on commercial mortgage loans are expected to come from:

income generated by the property

a traditional second mortgage, which is subordinate to the secured first mortgage in the event of default and foreclosure, usually _____ the expected return on equity, but also _____ the risk of default.

increases; increases

in order to hedge borrower risk on floating rate loans, the borrower may be required to purchase a(n) _____.

interest rate cap from the lender

of the following, which is the primary risk that a lender reduces their exposure to through the use of a balloon mortgage?

interest rate risk

which of the following is a characteristic of a mezzanine loan?

it is secured by the borrower's equity interest in the ownership entity

which of the following types of loans is used to finance improvements to the land, such as sewers, streets, and utilities?

land development loans

due-on-sale clauses protect the _____.

lender

on a partially amortizing loan, payments are based on an amortizing term that is _____ the actual term of the loan.

longer than

recently, loans on retail properties have been associated with higher delinquency rates. assuming this trend is going to continue in the near future, lenders will likely to require _____ LTVs on such loans.

lower

the _____ the LTV, the lower is the likelihood of default, all else equal.

lower

interest rates on floating-rate mortgages are usually tied to the London interbank offer rate (LIBOR). all else being equal, compared to fixed-payment mortgages, floating-rate mortgages are likely to be associated with:

lower interest rate risk, higher default risk

the use of financial leverage amplifies the IRR on investors' equity. this _____ of equity returns is know as financial leverage.

magnification

the use of financial leverage amplifies the IRR on investors' equity. this _____ of equity returns is known as financial leverage.

magnification

reducing the term of a fixed rate mortgage from 30 years to 10 years but keeping a 30-year amortizing schedule:

reduces the lender's interest rate risk

lockout provisions, defeasance clauses, prepayment penalties, and yield-maintenance agreement are employed to restrict borrower's prepayment when mortgage rates are declining. they all reduce the lender's _____.

reinvestment risk

relative to home loan underwriting, the underwriting of commercial real estate loans is more focused on:

the property pledged as collateral

financial risk is the risk that NOI will be insufficient to cover the mortgage payment obligation. therefore, financial risk is closely linked to:

the risk of default

true or false an advantage to the borrower of using a mortgage broker is that the broker will generally obtain quotes from multiple lenders.

true

in order to have positive financial leverage when a second mortgage or mezzanine loan is used, the _____ property return (cap rate) must be greater than the _____.

unlevered; weighted average cost of debt