Chapter 17 - Review Questions

John purchased his home for $328,000 with 95% financing. Calculate the down payment required. (a) $16,400 (b) $32,800 (c) $295,200 (d) $311,600

(a) $16,400

Which document most closely resembles a deed? (a) Bill of Sale (b) Security Agreement (c) Balance sheet (d) Operating statement

(a) Bill of Sale

What type of risk is caused by changes in general business conditions? (a) Dynamic (b) Equity (c) Leverage (d) Static

(a) Dynamic

Why is the process of real estate investment analysis important to an investor? (a) It helps an investor select properties that meet personal objectives. (b) It determines the amount of taxes due on income-producing property. (c) It determines the exact cash flow from an investment property. (d) It makes possible the best use for a property based on zoning.

(a) It helps an investor select properties that meet personal objectives.

How do current tax laws allow owners of investment properties to depreciate a portion of their investment? (a) Over 27.5 years for residential properties and 39 years for non-residential properties. (b) Over 27.5 years for non-residential properties, and 39 years for residential properties. (c) Over 27.5 years for all investment properties. (d) Over 39 years for all investment properties.

(a) Over 27.5 years for residential properties and 39 years for non-residential properties.

The risk of loss due to fire and theft is normally considered which type of risk? (a) Static risk (b) Market risk (c) Dynamic risk (d) Business risk

(a) Static risk

A developer purchased three lots of 100 ft x 150 ft each for $23.00 per square foot. The lots were then subdivided into four parcels that were sold for $300,000.00 each. What percentage of profit did the developer make on this transaction? (a) 18% (b) 16% (c) 14% (d) 12%

(b) 16%

Which concept applies to the value of businesses that are operational in a profitable capacity? (a) Highest and best use (b) Going concern (c) Liquidation (d) Tangible asset

(b) Going concern

A publishing firm was recently sold for $500,000. The firm owned several copyrighted works. The tangible assets of the business including computers, furniture, and fixtures totalled $150,000. What is the estimated value of the intangible assets? (a) $650,000 (b) $375,000 (c) $350,000 (d) $0

(c) $350,000

Which document indicates the financial condition of a business as of a particular time? (a) Operating statement (b) Profit and loss statement (c) Balance sheet (d) Bank statement

(c) Balance sheet

What is the formula to determine the loan-to-value ratio? (a) Loan multiplied by Value (b) Value divided by Loan (c) Loan divided by Value (d) Loan subtracted from Value

(c) Loan divided by Value

If an investor earns a lower rate of return on invested capital than the rate that is paid on borrowed funds, what type of leverage is indicated? (a) Positive (b) Neutral (c) Negative (d) Cumbersome

(c) Negative

Which of the following is NOT considered an operating expense for appraisal or income tax purposes? (a) Fixed expenses (b) Variable expenses (c) Reserve for replacements (d) Annual debt service

(d) Annual debt service

Which of the following is not considered an operating expense for appraisal or income tax purposes? (a) Fixed expenses (b) Variable expenses (c) Reserve for replacements (d) Annual debt service

(d) Annual debt service

Which of the following statements regarding reserves for replacements is correct? (a) They are a cash expense. (b) They should not be considered in a residential income property.(c) They are used to pay for normal maintenance of the property. (d) They are a noncash expense used to replace short-lived components that wear out from time to time.

(d) They are a noncash expense used to replace short-lived components that wear out from time to time.

Real estate licensees who are engaged in business brokerage might need to have a securities license if the transaction involves which of the following? (a) Negotiation of a new mortgage loan (b) An analysis of financial statements (c) Renegotiation of an existing lease (d) Transferring shares of stock or limited partnership interests

(d) Transferring shares of stock or limited partnership interests

What is the time period specified by tax law for straight-line Depreciation of residential investment property?

27.5 years

Which term refers to the difference between the current market value of a property and the amount the owner still owes on the mortgage?

Equity

The operating expense ratio expresses the relationship between the expenses incurred in operating the property and the amount the investor actually receives. What is the formula for determining the operating expense ratio?

Operating Expenses (OE) ÷ Effective Gross Income (EGI)

An apartment complex was purchased for $100,000; closing costs were $10,000. An appraisal indicated the improvements represented 75% of the value of the property. What amount may the investor deduct each year for tax purposes?

$100,000 Purchase price + $ 10,000 Closing costs = $110,000 Total acquisition cost $110,000 x .75 Improvements percentage = $82,500 Basis for depreciation $82,500 Basis for depreciation ÷ 27.5 Residential depreciation (in years) = $3,000 Per year cost recovery (Deduction) In the example above, the investor can claim $3,000 each year as an expense on his or her personal tax return until the entire $82,500 has been claimed.

What is the operating expense ratio of a property that has an effective gross income of $75,000 and a net operating income of $48,000? (a) 0.36 (b) 0.41 (c) 0.48 (d) 0.64

(a) 0.36

What is the time period established by the IRS over which nonresidential investment real estate can be depreciated? (a) 39 years (b) 27.5 years (c) 22 years (d) 15 years

(a) 39 years

For which of the following would an appraiser likely appraise using the liquidation approach? (a) A business that is failing (b) An income producing business or property (c) A special purpose property (d) A single family home

(a) A business that is failing

Fixed expenses typically include which of the following? (a) Real estate taxes and hazard insurance (b) Management fees and depreciation (c) Utilities and repairs (d) Mortgage payments and income taxes

(a) Real estate taxes and hazard insurance

An investment property is being analyzed and the information shown has been obtained. Based on this information, what is the operating expense ratio? (a) 16% (b) 47% (c) 53% (d) 75%

(b) 47%

All of the following are considered business assets, EXCEPT: (a) Goodwill (b) Notes payable (c) Accounts receivable (d) Furniture and equipment

(b) Notes payable

Generally speaking, what is the most important factor underlying good investment decisions? (a) The yield on the investment (b) The economic soundness of the investment (c) The amount of the tax shelter benefitting the investor (d) The ease of managing the investment

(b) The economic soundness of the investment

Which of the following statements best describes business brokerage? (a) It should not be conducted by real estate licensees. (b) It cannot be conducted by real estate licensees unless they also possess a mortgage broker's license. (c) It consists primarily of analyzing financial statements. (d) It would rarely involve securities transactions.

(c) It consists primarily of analyzing financial statements.

Under the Uniform Commercial Code, what is the document used to secure financing of personal property? (a) Deed (b) Bill of Sale (c) Security Agreement (d) Trust Agreement

(c) Security Agreement

A fitness club leases space at a major shopping center. The club has 10,500 square feet which represents 16% of the total leasable space at the shopping center. Calculate the total leasable space at the center? (a) 1,680 sq. ft. (b) 16,800 sq. ft. (c) 57,000 sq. ft. (d) 65,625 sq. ft.

(d) 65,625 sq. ft.

An investment property is being analyzed and the information shown has been obtained. Based on this information, what is the loan-to-value ratio? (a) 12% (b) 24% (c) 25% (d) 75%

(d) 75%

All of the following items are relevant when estimating the value of a business, EXCEPT: (a) Personal property owned (b) Short-term liabilities (c) Business goodwill (d) Personal income taxes

(d) Personal income taxes

An investor originally paid $76,000 for a townhouse, which he sold after 5 years for $87,400. What percentage of profit did the investor make?

15%

What is the time period specified by tax law for straight-line Depreciation of a hotel purchased as an investment property?

39 Years

What is the operating expense ratio of a property that has an effective gross income of $90,000 and a net operating income of $40,000? (a) 44% (b) 56% (c) 67% (d) 83%

90K - 40K = 50K 50K/90K = .55 (b) 56%

Which type of real estate investment typically includes the purchase of a small local business?

Business Opportunities

The Forecast of income and expenses for investment property analysis is similar to the method performed for an appraisal, but investment analysis has additional steps. What additional information is calculated for an investment analysis?

Cash throw-off (CTO) and After-tax cash flow (ATCF)

What valuation approach is unique to the valuation of a business?

Liquidation value approach

The loan-to-value (LTV) ratio measures financial risk in a real estate investment. What is the formula for determining the LTV ratio?

Loan Amount ÷ Property Value

Assume that an investor paid $100,000 for a parcel of land, divided it into three separate lots, and sold each lot for $50,000. What is the profit on this investment?

Solution: The profit on this investment is 50%. Profits from investments are calculated on the amount that is originally invested, not on the amount received when the investment is sold or liquidated. $50,000 x 3 = $150,000 $150,000 - $100,000 = $50,000 Profit % = $50,000 (made) ÷ $100,000 (Paid) - .50 (50%)

An apartment building was purchased for $100,000 by an investor with a taxable income of $300,000 (which is 15%). Closing costs were $10,000. An appraisal indicated the value of the improvements represent 75% of the value of the property. After five years of ownership, what is the adjusted basis?

Only that portion of the purchase price allocated to the improvements can be depreciated. The basis for depreciation is reduced each year to arrive at the adjusted basis. When the adjusted basis reaches zero, no further depreciation may be claimed. Solution: The adjusted basis is calculated as shown: 1. Determine the Basis for Depreciation: $100,000 Purchase price + $10,000 Closing costs = $110,000 Acquisition cost $110,000 Acquisition cost x .75 Improvement percentage = $82,500 Basis for depreciation 2. Determine the Annual Depreciation Allowances $82,500 Basis for depreciation ÷ 27.5 Residential depreciation (in years) = $3,000 Annual depreciation allowance 3. Determine the total depreciation for 5 years $3,000 Annual depreciation allowance x 5 Years of ownership = $15,000 Total depreciation for 5 years 4. Reduce the basis by the depreciation so far: $82,500 Basis for depreciation - $15,000 Depreciation claimed = $67,500 Adjusted basis After 5 years of ownership, a total of $15,000 in depreciation was taken. If the property was held longer than 12 months and sold for $150,000, the capital gains tax due on sale would be calculated in two steps: Solution 1. Determine capital gains tax Step 1 $150,000 Sales price - $110,000 Acquisition cost = $40,000 Capital gain $40,000 Capital gain x .15 Capital gains tax rate = $6,0000 Tax on gain Capital 2. Determine tax due on recapture; add to capital gains tax Step 2 $15,000 Depreciation recaptured x .25 Tax rate on recapture = $3,750 Tax on recapture $6,000 Capital gains tax + 3,750 Tax on recapture = $ 9,750 Total tax due

What type of real estate investment is a type of business trust that allows group of investors to invest in income-producing property?

Real Estate Investment Trust

Calculate the monthly payment on a new loan of $100,000 at 10% for 30 years, using a monthly loan constant of .0087757.

Solution: Loan Balance x Loan Constant = Monthly Payment $100,000 Loan balance x .0087757 Loan constant $877.57 Monthly payment

What type of risk can be offset with insurance?

Static Risk

What is the advantage of a tax-deferred exchange to a real estate investor?

Unlike property received in a tax-deferred exchange is called boot and is taxable to the recipient. To the extent that the equities are equal, the capital gain is deferred, or postponed, until the property is sold. Note that this does not eliminate the tax; it is allowed to be recognized in a later tax year. This can be an advantage in tax planning, particularly when an investor expects to be in a lower income tax bracket in future years.

All of the following are potential rewards or benefits of Real Estate investment, EXCEPT: a. Income Generation b. Positive leverage c. Illiquidity d. Appreciation

c. Illiquidity

All of the following statements correctly describe business brokerage, EXCEPT: a. business brokerage requires knowledge of income statements and balance sheets as well as other business accounting knowledge and experience b. The sale of a business involving the transfer of ownership of shares of stock may require a separate securities license. c. The sale of a business always includes the sale of real property d. The sale or lease of a business is a real estate transaction and requires a real estate license.

c. The sale of a business always includes the sale of real property

All of the following are considered assets of a business, EXCEPT a. Real estate and personal property b. Cash and accounts receivable c. debts owed d. Goodwill (the value of the name of the business in the market place)

c. debts owed

All of the following statement are correct regarding capital gains, EXCEPT: a. Capital gain is profit made when an income property is sold b. The capital gains tax rate is based on the investor's taxable income within a published range of income amount c. The capital gains tax rate applies to capital assets held over 12 months d. Capital gains tax is paid annually during the ownership period of the investment property

d. Capital gains tax is paid annually during the ownership period of the investment property

Leverage is the use of borrowed funds to purchase assets. when is positive leverage considered to be advantageous to a real estate investor?

if the investment returns less to the investor than the cost of borrowing the money necessary to purchase the investment.