Real Estate Principles Chapter 19

Assume the following annual cash inflows and outflows: year 0: ($80,000); year 1: $10,000; year 2: $20,000; year 3: $20,000; year 4: $75,000. The net present value (to the nearest dollar) if discounting at 10% is ______________.

$11,872

Use the following information: PGI: $600,000; vacancy and collection losses: $42,000; operating expenses: $88,000; capital expenditures: $10,000. Mortgage payments total $206,728 annually. Assume an above-line treatment of capital expenditures. The before-tax cash flow from operations is equal to

$253,272

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

An investor expects to hola potential property acquisition for 10 years. NOI at the end of year 10 is projected to be $300,000; NOI at the end of year 11 is forecasted to be $310,000. The going-in cap rate i 6%; the appropriate going-out cap rate is determined to be 6.7%. The estimate sale price at the end of year 10 (rounded to the nearest dollar) is:

$4,626,866

Assume the following annual cash inflows and outflows: year 0: ($5,000); year 1: $2,000; year 2: $3,000; year 3: $4,000; year 4: ($4,000). The net present value if discounting at 12% is ______.

(517.65)

Discounted cash flow analysis is sometimes considered to be superior to the use of single-year returns and ratios because:

-DCF considers cash flows beyond the first year of operations -DCF considers the time value of money

Which of the following statements about the IRR are true?

-Multiple IRRs may exist for the same set of cash flows -IRR always gives the same accept/reject signal as NPV with respect to an individual investment opportunity -The IRR may rank alternative investment opportunities differently than NPV

Scenario analysis:

-helps quantify the impact of important assumptions on NPV and IRR -helps to evaluate the potential risk of the investment

Holding everything but the loan-to-value (LTV) constant, the expected equity return (IRR) divided by the standard deviation of the equity return (IRR):

-is a measure of expected return per unit of risk -may actually decrease as as the LTV increases

An observed transaction price:

-is less than or equal to the buyer's investment value -is greater than or equal to the seller's investment value

Investment value:

-is unique to the individual investor -may differ than market value

The Centre Point case example presented in this and prior chapters shows the general form of a real estate pro forma for an existing property. However, a typical "real world" pro forma contains:

-more expense detail than the Centre Point pro forma -more revenue detail than the Centre Point pro forma

An investment opportunity is wealth increasing when:

-the present value of all inflows exceeds the present value of all outflows -the internal rate of return on equity exceeds the required rate of return on equity -the net present value is positive

A potential property acquisition with a higher going-in cap rate than comparable properties may signal:

-the seller's asking price is below market value -the seller has delayed badly needed capital expenditures

Given the following information, calculate the terminal value of the property at the end of its estimated holding period: Going-out cap rate: 9%; estimated holding period: 5 years; NOI for year 5: $100,500; NOI for year 6: $102,000.

1,133,333

For stabilized income producing propertied, the industry standard is construct a ________ year pro forma.

10

Calculate the simple (non-weighted) mean of the following potential IRRs. Scenario 1: 12.0%; scenario 2: 11.0%; scenario 3: 9.0%; scenario 4: 10,0%; scenario 5: 12.0%.

10.8%

An investor calculates that the levered, before-tax internal rate of return on a potential investment is 16%. The levered, after-tax return is estimated to be 11.2%. The effective tax rate of this investment is _____________ percent.

30

Given the following information, calculate the estimated before-tax cash flow from annual operations (BTCF): NOI: $89,100; Annual Debt Service: $58,444; Net Sale Proceeds: $974,700; Remaining Mortgage Balance: $631,026.

30,656

You are contemplating a commercial real estate investment. You believe your before-tax, levered, risk-adjusted opportunity cost of investing in the opportunity is 12%. If you believe the effective tax rate you will pay on this investment is 37%, what is the appropriate after-tax discount rate?

7.6%

Given the following information, calculate the appropriate after-tax discount rate. Tax rate on comparable risk investment: 35%; Investor's before-tax opportunity cost: 12%; Capitalization rate: 8%.

7.8%

Suppose an industrial building can be purchased for $2,500,000 today and is expected to yield cash flows of $180,000 each of the next five years. (Note: assume cash flows are received at end of year.) If the building is expected to be sold at the end of the fifth year for $2,800,000, calculate the IRR for this investment over the five year holding period.

9.20%

The equity dividend rate is equal to

BTCF in year 1 divided by the initial equity investment

All else the same, levered cash flows associated with a potential real estate investment should be discounted at ___________ unlevered cash flows.

a higher rate

The use of debt financing along with the investors' equity directly affects the property's estimated:

before-tax cash flow from rental operations

A property's investment value to a particular investor:

can be affected by the type of debt financing available to the equity investor

As the required internal rate of return increase, the calculated net present value will:

decline

As the required internal rate of return increases, the calculated net present value will:

decline

A borrower's current wealth is ________ by the present value of future mortgage payments.

decreased

The expected IRR on a commercial real estate investment is compromised of two basic parts: (1) the periodic cash flow return from rental operations and (2) expected appreciation in the market value of the property. All else equal, as the percentage of the expected IRR that is associated with price appreciation increases, the effective tax rate.

decreases

In DCF analysis, the sale price of the property myst be estimated at the end of the expected holding period. The most common method for determining the terminal value (sale price) of the property is

direct capitalization method

Relative to other valuation models, the assumptions required to perform ____________ appear to place the greatest analytical burden on the investor.

discounted cash flow analysis

True or false: Decisions based on the internal rate of return (IRR) will always be consistent with wealth maximization.

false

True or false: If investment A has greater risk to the equity investor and a higher expected rate of return than investment B, then A dominates B.

false

Which of the following has the first claim on cash flows generated by a commercial property?

first mortgage lender

Projecting the cash flow performance of a potential investment opportunity beyond the investor's expected holding period:

forces the investor to consider all of the changes that could affect the property's long-term ability to produce cash flows

The effective borrowing cost of a mortgage loan is typically _________ the contract interest rate.

greater than

Net present value (NPV) involves the use of the following decision rule: The investor should purchase the property as long as the NPV is:

greater than zero

When the expected performance of an investment opportunity is expressed _____________ it often hinders a comparison to other alternatives.

in dollar terms

All else equal, how does the presence of income taxes impact the levered going-in IRR?

income taxes reduce the leveled going-in IRR

Holding everything else constant, increasing the amount of leverage used to finance an investment:

increase the standard deviation of the equity return

Generally, using financial leverage ______ risk to the equity investor.

increases

ARGUS Enterprise:

is a software program for performing discounted cash flow analysis based on the assumptions of the analyst

The effective tax rate on commercial real estate investment is typically:

less than the tax rate on ordinary income

It is common for investors in commercial real estate to use mortgage debt to help finance property acquisitions. The use of debt can have a profound impact on the expected cash flows received by the investor for a particular property. Which of the following terms refers to cash flows that represent the property's income after subtracting any payments due to the lender?

levered cash flows

For taxable investors, the appropriate rate to discount after-tax cash flows is ___________ the appropriate rate to before-tax cash flows.

lower than

Although increased financial leverage often increases the calculated IRR of an investment, this increase in the estimated IRR

may not be enough to offset the increased risk to the equity investor associated with increased leverage

In order for positive financial leverage to be observed in the calculation of NPV, the effective borrowing cost:

must be lower than the investor's discount rate

Net present value is equal to the:

present value of expected cash inflows, minus the present value of all expected cash outflows

The investment cash flows most important to taxable equity investors are:

the after-tax cash flows from annual rental operations and sale

The purchase price that produces an IRR equal to the investor's required rate of return is

the property's investment value to that investor

True or False: Although the use of financial leverage will usually increase an investments' expected rate of return on equity, it may also increase its risk.

true

True or False: Decisions based on net present value (NPV) will always be consistent with wealth maximization.

true

True or False: Expected federal income taxes generally reduce the net cash flows realized by the investor(s) from annual operations.

true

True or False: The cash flow proceeds to the owner from the sale of the property is called the equity reversion.

true

True or false: A typical commercial real estate pro forma contains the investor's point estimates or best guesses of income, expenses, and future sale prices.

true

Holding other assumptions constant, increasing the LTV will increase the equity dividend rate

when the annual mortgage payment divided by the net loan proceeds is less than the overall cap rate

Multiple IRRs are possible

when the signs of the cash flows (+ or -) change more than once over the expected holding period

The internal rate of return:

will exceed the discount rate used to calculate NPV when the NPV is positive

Holding every else constant, if the equity discount rate is greater than the effective borrowing cost, increasing the amount of financial leverage used to finance a real estate investment:

will increase the calculated NPV