Unit 17

The market value of an apartment building is $475,900. The investor has leveraged $380,720. What is the investor's equity in the property?

$95,180. The solution is: $475,900 market value - $380,720 leverage amount = $95,180 equity.

Real Estate Investment Trust (REIT)

A method of pooling investment money using the trust form of ownership.

______________ properties are often purchased by a farsighted investor-developer looking for large tracts of land that lie in the path of foreseeable urban growth; period to realize such development potential may be many years.

Agricultural

Liquidation analysis

An appraiser's methodology and estimate of the value of a business that is being liquidated. An assessment of such factors as the ability of the firm to pay off short-term obligations, the value of the inventory on hand, and the liquidation value of preferred stock.

Appreciation

An increase in value (to a property due to economic causes).

Goodwill

An intangible asset (value) of a business.

Tax Shelter

An investment that shields items of income or gain from payment of income taxes; a term used to describe some tax advantages of owning real property (or other investments), including postponement or even elimination of certain taxes.

The basis is adjusted by adding any capital improvements made to the property and deducting depreciation expenses taken on tax returns during the years of ownership.

An investor purchases a property for $900,000. Improvements to the property during ownership total $100,000. During the ownership period, the investor took $125,000 in depreciation. The investor's adjusted basis is $875,000. $900,000 cost + $100,000 capital improvements - $125,000 depreciation = $875,000 adjusted basis.

Asset

Anything of value (to a business, including tangibles and intangibles such as accounts and notes receivable, cash, inventory, equipment, real estate, and goodwill. The difference between assets and liabilities is net worth).

Types of real estate investment properties include:

Commercial, Residential, Industrial, Agricultural, and Business Opportunities.

The buyer should sign which type of agreement before releasing financial information concerning a business?

Confidentiality (Nondisclosure) agreement

Positive leverage occurs when the benefits from borrowing exceed the costs of borrowing. Negative leverage occurs when the borrowed funds cost more than they are producing.

Consider a property that costs $500,000 and produces a net income of $50,000 per year. If purchased for cash, the investor's annual rate of return on the equity invested is 10% ($50,000 income ÷ $500,000 equity). Assume that this investor leverages the purchase by borrowing $375,000 at 5% ($18,750 interest) annually and makes a down payment of $125,000. The $50,000 income earned from the investment is reduced by the cost of financing ($18,750). The income remaining after mortgage expense is $31,250. The resulting return on equity investment is an attractive 25%. $31,250 income after financing costs ÷ $125,000 equity = .25 or 25% rate of return on equity The investor made a greater return on equity investment by leveraging the investment. Positive leverage is the result.

The ability to sell an investment quickly without loss of capital is called leverage. T/F

False, liquidity is the ability to sell an investment quickly

Negative leverage occurs when the benefits of borrowing exceed the costs of borrowing. T/F

False, that is positive leverage; If the borrowed funds cost more than they are producing, it is called negative leverage.

Equity is the property's value minus fixed expenses. T/F

False. It is the property value minus any debt against it.

Safety risk is composed of financial risk and risk of default. T/F

False; it is composed of market risk (possible loss of invested capital) and risk of default (possible loss of earnings).

The methods used to estimate the value of a business are very different from the techniques used to appraise real property. T/F

False;; The methods employed to arrive at an estimate of a business's value consist of techniques similar to those used in appraising real property with one additional technique called liquidation analysis.

A disadvantage of investing in real estate is the relatively high degree of risk. T/F

TRUE

An advantage of investment in real estate is that real estate is typically highly leveraged. T/F

TRUE

Real estate investments require active management. T/F

TRUE

Liquidity

The ability to convert noncash assets into cash quickly; refers to a firm's cash position and its ability to meet obligations.

Risk

The chance of losing all or a part of an investment; the uncertainty of financial loss; Generally, investors demand a higher return for higher investment risk.

Basis

The initial cost of an investor's property.

Equity

The market value of a property less any debt against it; in a business entity, assets minus liabilities equals capital (owner's equity); a system of legal rules administered by a court of chancery.

Capital gain (or loss)

The profit (or loss) from the sale of an asset, including real property.

Cash flow

The resulting amount when annual debt service, tax liability, and capital improvement costs are subtracted from net operating income; Expenses, for example, include property taxes, operating costs, and maintenance. The cash flow is determined by at least three important factors: the income received; operating expenses, and the method of debt repayment. Cash flow may be positive or negative.

Leverage

The use of borrowed funds to finance the purchase of an asset; the use of another's money to make more money.

Going-concern value

The worth of a business, including real estate, goodwill, and earning capacity.

A lack of maintenance is called deferred maintenance. T/F

True

Business risk is associated with the degree of variance between projected income and expenses and actual income and expenses. T/F

True

Purchasing power risk is associated with inflation. T/F

True

All the resources of a business, including tangibles and intangibles, are called the

assets

Real estate is "any interest in business enterprises or business opportunities." This category includes the sale or lease of a business and goodwill of an existing business, including business ______ such as the stock of a corporation.

assets

Real estate licensees who engage in the sale, purchase, or lease of businesses are called business ___________. This real estate activity is sometimes called business opportunity brokerage.

brokers

List the types of risk:

business, financial, interest-rate, and purchasing-power

Which accounting term refers to the total amount of money generated from an investment after the expenses are paid?

cash flow

Existing properties should be inspected carefully, and repair and maintenance records should be studied to ensure that the property has been well maintained. A lack of proper maintenance is called __________ maintenance.

deferred

Real estate licensees have one major commodity to offer the public—_______________.

expertise

The value of an established business property, compared with the value of just the physical assets of a business that is NOT yet established, is called

going-concern value

The value of ___________ is approximated by subtracting the value of tangible assets from the value of the business. Other intangible assets that add value include licenses, franchises, copyrights, and patents.

goodwill

Which financial report indicates the results of business operations over a specific period of time?

income statement

To be suitable for ____________ use, a site should be located near transportation facilities such as railroad stations, expressways, and airports because of the need to receive and ship by rail, truck, and air. T/F

industrial

Generally, an investor can receive a maximum return from an ________ investment by making a small down payment, paying a low interest rate, and spreading mortgage payments over a long period of time.

initial

Intangible assets of a business does NOT include

inventory

In assessing the desirability of an apartment complex, several criteria should be considered, including the following: ___________, effective gross income, operating expenses, and property taxes.

location

A case in which the interest paid for borrowed funds is more than the overall rate of return to an investor is an example of

negative leverage

Which type of risk is also called inflation risk?

purchasing power risk

The cost to duplicate the business structure being appraised having the same use but differing physically somewhat is called

replacement cost

Individual REITs generally specialize in a particular type of property, such as multifamily communities, retail malls and shopping centers, office properties, and so forth. They may be purchased through a ____________.

stockbroker

An advantage of real estate investment trusts is

that it offers diversification.

An advantage of real estate as an investment is

the leverage of borrowed money.

An active real estate license is required to perform business brokerage activities for others. T/F

true

It is advisable to have the buyer sign a confidentiality (nondisclosure) agreement before releasing financial information concerning the business. t/f

true

Liquidation analysis may be necessary because of the death of a sole proprietor. T/F

true

One of the steps in the sale of a business is to subtract the value of all liabilities (including the value of preferred stock) from the value of the business. T/F

true

One of the ways business brokerage is different from real estate brokerage is that business brokerage includes intangible assets. T/F

true

The going-concern value of a business may be different from the real estate value. T/F

true