REAL EXAM 4
Given the following information, calculate the NPV for this property: outflow at time zero: -$200,000; discount rate: 18%; NOI for year 1: $25,876; NOI for year 2: $23,998; NOI for year 3: $23,013; NOI for year 4: $22,105; NOI for year 5: $23,670; BTER in year 5: 345,000. Question options: $25,120 $25,109 $24,590 $20,202 $25,721
$25,721
Given the following information, calculate the estimated Gross Sales Price for this property at the end of year 3: Entrance Cap Rate: 6.00%; Exit Cap Rate: 6.25%; NOI for year 1: $25,876; NOI for year 2: $23,998; NOI for year 3: $23,013; NOI for year 4: $22,105; NOI for year 5: $23,670. Question options: $368,208 $368,417 $353,680 $345,000
$353,680
A broker hired by a prospective tenant offers a landlord (owner) the following lease terms for 4,500 rentable square feet of office space. The broker's contract with the tenant requires a 4% commission be paid to them by a landlord whom they rent space from. How much total commission would the landlord owe the broker if the tenant signs a lease and pays their first month of rent with these terms. Term: 10 Years Rent: $25/sqft (the way office rent is typically quoted)
$45,000
What drives choices of ownership form?
**1. federal income tax issues/rules 2. desire of investors for limited liability 3. management control issues 4. ability to access debt and additional equity capital 5. ability to share risk with investors (including special allocations) 6. ability of investors to dispose of their interests
Funds From Operations (FFO)
- REIT level cash flow, expressed as funds from operations, is often used instead of accounting net income to measure current performance - FFO is a supplemental measure of a REIT's operating performance
Advantages of pooling equity
- allows investors to purchase an interest in larger properties - diversification of portfolio - economies of scale in acquisitions, management, and disposition - access to cheaper debt capital - expertise of management team hired by syndicator/organizer
Development and Construction Lending can be very RISKY:
- developer will fail to complete the project in a timely manner or fail to complete it all - builders may experience cost overruns, poor weather, strikes, structural or design problems, or difficulties with subcontractors - builder may simply be a bad manager - failure to pass various building code inspections may delay ability of tenants to occupy building (and pay rent)
Private Equity Funds (investment through intermediaries)
- did not really exist prior to early 1990s - most finite life (typically 7-10 years) - typically include some degree of side-by-side investment by fund manager/sponsor - LPs earned a preferred return before GP earns bulk of its expected fees/returns - once LPs IRR exceeds threshold, GP receives a disproportionate share of remaining cash distributions - called "carried interest"
Net Asset Value (NAV)
- equal to estimated total market value of a REIT's underlying assets, less all liabilities including mortgages
Limited Partnership
- general partner who sponsors/organizes venture is usually a knowledgable builder, broker, or investor - "flow-through" tax treatment - limited liability for limited partners; unlimited liability for general partner - limited partners give up control of management and policy making - a "principle-agent" relationship is created with its attendant problems
Disadvantages of General Partnership
- general partners liable for all debt - personal assets are subject to claim's of the partnership's creditors (fairly uncommon and those that are created have few partners because of heavy disadvantages)
Ways to pool equity:
- general partnership - limited partnership - c corporation - s corporation - limited liability company - tenancy in common - REIT
Direct Investment
- gives individual and institutional investors complete control (who leases it, who manages it, how much debt financing is used, when it is sold) - but, investor must supply the expertise - liquidity of direct investments reflects the liquidity of the underlying property market (there is no liquidity!)
How is NAV used to make decisions?
- if stock price per share > its NAV per share, REIT is said to be selling for a "premium" to NAV - a stock price in excess of per-share NAV may indicate a REIT is overpriced relative to value of assets currently in the portfolio - REITs selling at "discounts" to NAV may signal buying opportunities for investors (or may reflect that the market believes the company is not well managed / has low growth prospects)
C Corporations
- legal and taxable entity separate from shareholders - potential double taxation - all shareholders have limited liability - separation of ownership and control (which creates agency problems) - many non real estate corporations own real estate, but not a desirable structure for investing in real estate
S Corporations
- limited liability for shareholders - S corps pay no taxes; taxable income is passed through to stockholders who pay taxes - less than or equal to 100 shareholders - all cashflows and taxable income allocated on a pro rata basis - used in some cases by individuals and families to own CRE
Life insurance companies
- long term liabilities a good match for long term, illiquid, private RE investments - more active as CRE lenders than as equity investors
Pension Funds
- long term liabilities well suited to long term real estate investments - direct purchases as well as acquisitions through funds
Limited Liability Companies
- not a corporation, partnership, or sole proprietorship - is a blend of some of the best characteristics of other forms - a "super pass through entity" - is a separate legal entity (like a corporation), but is treated as a partnership for tax purposes - permit all owners to participate in management - all owners have limited liability - managing member creates "operating agreement" that explains operation and management of entity - limits decision making ability of passive investors
Disadvantages of pooling equity
- often relinquish management control to active manager(s) - must compensate sponsor/organizer with fees, salary, and/or disproportionate share of equity ownership
Tenancy in Common (TIC)
- one of the oldest forms of co-ownership - fee simple ownership interest with multiple owners - investors are direct owners - investors may hold different ownership percentages - less than 35 investors - generally considered a BAD form of investing in CRE
Major players in CRE investment
- pension funds - foreign investors - life insurance companies - other (hedge funds, college endowment funds, real estate private equity funds)
Why we use NPV and IRR?
- these measurements are multi-year metrics - unlike ratios which do not incorporate the income producing ability of property beyond 1st year of rental operations
General Partnership
- treated as conduit for tax purposes.. investors avoid double taxation - all partners can make operating decisions - no separation between ownership and control; lessens potential conflicts of interest - share of cash flow and taxable income determined by partnership agreement
For the following levered total cash flow returns, what is the levered NPV, and should you pursue the investment if your levered discount rate is 14%? Total Cash Flow (Pre-Tax) Year 0: $ (400,000) Year 1: $ 30,000 Year 2: $ 30,900 Year 3: $ 31,827 Year 4: $ 32,782 Year 5: $ 533,765 Question Options: 31,795; yes 31,795; no -31,795; yes -31,795; no
-31,795; no
Given the following information, calculate the NPV for this property: initial cash outflow: $200,000; discount rate: 15%; CF for year 1: $25,876; CF for year 2: $23,998; CF for year 3: $23,013; CF for year 4: $22,105; CF for year 5: $144,670 IT MATTERS whether the number is positive or negative, so include a minus sign "-" in front of the number if negative.
-59,657
REITs not taxed at corporate level if they satisfy a set of restrictive conditions on an ongoing basis including:
1. at least 100 shareholders 2. no five investors can own more than 50% of the shares 3. 75% of assets must be RE, cash, or government securities 4. 75% of gross income must come from RE assets 5. 90% of REIT taxable income must be paid out in dividends each year
When using multi-year discounted CF decision making methods, investor must (at least):
1. estimate how long they expect to hold the property 2. make explicit forecasts of property's net cash flow for each year and net cash flow produced by expected sale of property 3. select rate of return at which to discount all future cash flows
As size of investor's portfolio increases, the economics of direct ownership make more sense (easier) to:
1. retain in-house experts or hire consultants 2. diversify risk 3. create liquidity across assets classes (stocks, bonds, etc.)
Given the following information, calculate the Levered Equity Multiple for this property: equity outflow at time zero: -$200,000; discount rate: 18%; Entrance Cap Rate: 6.00%; Exit Cap Rate: 6.25%; BTCF for year 1: -$25,876; BTCF for year 2: -$3,998; BTCF for year 3: $23,013; BTER in year 3: 345,000. Question options: 1.60 12.32 1.20 12.60
1.60
For the following levered total cash flow returns, what is the levered IRR? Total Cash Flow (Pre-Tax) Year 0: $ (400,000) Year 1: $ 30,000 Year 2: $ 30,900 Year 3: $ 31,827 Year 4: $ 32,782 Year 5: $ 533,765 Question Options: 11.86% 12.00% 12.14% 11.51%
11.86%
Using the pro-forma table below, what is your unlevered IRR? Question options: 19.0% 12% 10% 13.0%
13.0%
Using the pro-forma table below, what is your levered IRR? Question options: 19.0% 25% 13.0% 9%
19.0%
Using the pro-forma table below, what is your unlevered NPV? Question options: 194,817 (721,795) 225,590 (1,538,462)
194,817
Using the pro-forma table below, what is your levered equity multiple? Question options: 2.00 2.21 1.74 1.42
2.21
____________ is a typical carried interest, which is more than a pro rata share
20%
Using the pro-forma table below, what is your levered NPV? Question options: 225,590 (721,795) (121,795) 194,817
225,590
___________ of CRE debt is publicly traded
24%
How many solutions to IRR are possible with the following cash flow? CF0:-700,000; CF1: +40,000; CF2: -71,000; CF3:-12,000; CF4: +1,200,000 Question options: None are possible 1, and it's 13.3% 2 3 4
3
Given the following information, calculate the before-tax equity reversion (BTER): NOI: $89,100; annual debt service: $58,444; net sale proceeds: $974,700; remaining mortgage balance: $631,026.
343,674
Suppose equity investors have an agreement whereby the general partner/sponsor will split everything with the limited partners "pari passu" until an equity multiple of 3.00 is reached, then the GP/Sponsor will be entitled to a promote equal to 90% of any additional returns. The sponsor/GP has invested 10% of the equity, and the limited partners have invested 90% of the equity. What is the expected IRR of the sponsor/GP given the levered cash flows below? CF0: -1,000,000CF1: 200,000CF2: 400,000CF3: 600,000CF4: 2,200,000 Question options: 71.3% 18.5% 32.6% 42.1% 92.4% 62.9% 80.0% 34.2%
71.3%
___________ of outstanding commercial mortgage debt is privately held
75%
Net present value (NPV) is interpreted using the following decision rule: The investor will NOT purchase the property as long as the NPV is Question options: >0 =0 <0 = market cap rate (R)
<0
Multiple levels of ownership are commonly at work in ...
CRE investments
Discount Rate Equation
Discount rate = Rf +RPj
Money to finance property generally comes in two primary forms...
Equity (ownership) Debt (loan to ownership)
TRUE/FALSE: Only 25% of private equity is held by institutional investors.
FALSE 48% of private equity is held by institutional investors and the other 52% is mostly held by high net worth investors
TRUE/FALSE: IRR rule is favored by investors over the NPV rule.
FALSE NPV is favored
TRUE/FALSE: There is one discount rate that is used for every investor.
FALSE each individual investor sets their own discount rate
A fixture is an object that formerly was personal property but has become real property. Of the four rules for determining whether an object has become a fixture, character of the article and manner of adaptation is the most dominant rule (i.e., if there is a conflict, the rule that prevails). Question options: True False
False
Assuming the going-in IRR is greater than the effective borrowing cost, if an investor increases his leverage, say from 75% to 80% LTV, we would expect NPV to increase, while going-in would IRR decrease. Question options: True False
False
At the end of 2015, commercial banks and other financial institutions collectively owned $15 billion in commercial real estate equity. The vast majority of these holding are the result of indirect investment through real estate securities. Question options: True False
False
Concerned with a potential information asymmetry problem, state legislators have been proactive in passing legislation that protects the rights and interests of retail tenants more than any other product type tenants. Question options: True False
False
Considering the pro-forma table below, if you change your levered discount rate to 25%, you will make an even higher levered NPV, and should go forward with the investment. Question Options: True False
False
Construction lenders and the equity investors both contribute to the total cost of a development at time zero (before moving forward with the project), just like in any other property investment. Question Options: True False
False
Enhancing the quality of an asset will typically lower NOI, and raise the cap rate. Question Options: True False
False
FFO is the financial metric that measures the value of a REIT by taking the reported value of all the underlying properties it owns and deducting all liabilities such as mortgage payments. Question options: True False
False
Feasibility analysis is often considered the "entry ticket to development" as it is the most important step. Question Options: True False
False
If a general contractor buys screws at Home Depot for a house that they are working on, they will ask that the cost of the purchase be reimbursed by the construction lender as a soft cost. Question Options: True False
False
If an investor increases their leverage rate, say from 75% to 80%, we would expect NPV increases, while IRR decreases. Question options: True False
False
Investment value is based on the expectations of a typical, or average, investor. Question options: True False
False
Marketing a property to prospective tenants would be considered a primary responsibility of an asset manager. Question options: True False
False
Miniperm financing is typically sought if interest rates are forecasted to rise, and the developer plans to sell the building immediately upon stabilization. Question Options: True False
False
Suppose that a wall-street investment bank invests $100MM with a luxury hotel development firm, and asks them to provide at least 15% return on their investment. Of the three occasions for development, this is an example of the use looking for a site. Question Options: True False
False
The development team member / consultant who manages the the detailed design of roads, sewers, water lines, and other aspects on and under the land is the Land Planner. Question Options: True False
False
The limited partnership ownership form requires cash flows to be allocated to each shareholder in proportion to his or her ownership of the entity, thereby preventing special allocations to multiple classes of investors. Question options: True False
False
The most common forms of indirect ownership in commercial real estate that allow for "pass-through" returns are C-Corporations and Tenants in Common. Question options: True False
False
When property managers are looking to secure a mix of tenants for which "the whole is greater than the sum of its parts," or in other words, a group of tenants that shares similar characteristics such that the experience of living together is mutually beneficial, they are seeking what is referred to as permanence potential. Question options: True False
False
____________ is the discount rate that makes NPV=0
IRR
RE private equity funds typically set up as....
Limited Partnerships
FFO =
Net (accounting) income (excluding gains/losses from sales of property) + Depreciation (real property) + Amortization of leasing expenses + Amortization of tenant improvements - Gains/losses from infrequent and unusual events
TRUE/FALSE: LLCs and LPs are dominant ownership structures.
TRUE
TRUE/FALSE: When taking on more leverage, an investor would expect the discount rate to increase to make the debt/risk worth it.
TRUE
There are a set of restrictive conditions that REITs must satisfy on an ongoing basis in order to maintain their special tax status. All of the following statements regarding the main restrictions are false except Question options: - at least 50 investors must own a REIT's shares. - a REIT must distribute at least 75% of its taxable income to shareholders in the form of dividends. - at least 75 percent of the value of a REIT's assets must consist of real estate assets. - no five investors can own more than 10 percent of a REIT's shares.
at least 75 percent of the value of a REIT's assets must consist of real estate assets.
All properties are purchased with _________
capital
For well capitalized investors, choice of direct vs. indirect involves trade-offs between:
control, access to managerial expertise, liquidity, risk sharing
List of investments classifying terms from LEAST risk/return to MOST risk/return
core = low risk, low return core plus value added opportunistic = high risk, high return
As the discount rate INCREASES, the NPV...
decreases
Wall analogy for DCF analysis:
discount rate = height of the wall IRR = the height you jump Positive NPV --> you made it over the wall Negative NPC --> you smashed into the wall
Types of partnerships
general and limited
Since risk premiums vary, so do required yields:
high quality, relatively safe RE investments :6-8% development deals: 15-30%
In contrast to public markets, private markets are characterized by individually negotiated transactions that take place without the aid of a centralized market. Therefore, private markets will generally have Question options: - high transaction costs and low liquidity. - low transaction costs and high liquidity. - high transaction costs and high liquidity. - low transaction costs and low liquidity.
high transaction costs and low liquidity.
Investors can hold ownership (equity) positions directly or through intermediaries, BUT... most investors cannot ...
invest directly
Most RE decisions are made with an...
investment motive
Due to large size of typical RE investments...
investors almost always pool their equity capital
_____________ cash flows measure property's income with debt by subtracted mortgage payments (debt service)
levered (use BTCF)
Small, "local" investments marked to accredited, but non-institutional, investors typically set up as...
limited liability companies
When construction costs exceed the amount of the construction loan, a developer may seek to cover the gap using mezzanine financing. All of the following statements regarding mezzanine debt are false except: Question Options: - mezzanine debt will dilute equity returns. - mezzanine debt use is less expensive than normal construction financing. - mezzanine debt use must go through the foreclosure process in the case of default. - mezzanine debt use is less expensive than equity financing.
mezzanine debt use is less expensive than equity financing.
The main tool that a developer will use in determining the financial feasibility of a project is: Question Options internal rate of return equity dividend rate (cash-on-cash return) net present value analysis direct capitalization
net present value analysis
The management agreement provides for a management fee that is usually in the range of 3% to 6% of which of the following measures of property income? Question options: potential gross income income tax liability net operating income before tax cash flow none of the above
none of the above (effective gross income is correct)
Although vast majority of commercial RE is owned in private markets, >$404 billion is owned and traded in __________________... mostly REITS
public markets
Net Present Value =
pv of the deal - amount of capital you have to put out at time 0
Rf =
risk free rate - yield / return available on U.S. treasury securities with maturity equal to expected holding period of the property - this benchmark rate is readily observable
RPj =
risk premium for "subject" property - this component of discount rate is very difficult to determine
Direct ownership also prevalent at ________ end of investor spectrum
smaller (single family rental homes, duplexes, fourplexes, owner-occupied office buildings)
Construction lenders must have ________________ in monitoring and controlling the construction process
specialized skills
Within debt and equity, there can be numerous subcategories making a "capital stack" including:
sponsor equity, common equity, preferred equity, mezzanine debt, junior debt, senior debt
Equity Multiple =
sum of positive cash flows / sum of negative cash flows (equity multiple of 2 = doubled my money) (equity multiple of 3 = tripled my money)
NPV =
the direct change in the investor's bank account after the project is over
_______________ cash flows measure overall property income without debt
unlevered (use NOI)
