Unit 11 Q Cards
Which of the following registers the securities and packages the program for a limited partnership? A) Syndicator B) Limited partners C) General partner D) Property manager
A
All of the following characteristics are advantages of a real estate investment trust (REIT) except A) tax deferral. B) diversification. C) professional management. D) liquidity.
A - A REIT is a professionally managed company that invests in a diversified portfolio of real estate holdings. REITs are traded on exchanges and over the counter, which provides liquidity. The IRS does not permit tax deferrals on REIT investments.
One of the key requirements in offering a DPP to a customer is that the program must be suitable. FINRA has some specific suitability requirements for DPPs. Among those is the investor A) has a net worth sufficient to sustain the risks of the DPP, including loss of investment. B) has sufficient experience in the type of business the program is undertaking. C) does not own a DPP that will compete with the program being offered. D) has sufficient net worth to be deemed an accredited investor.
A - FINRA's Rule 2310 lists a few suitability standards necessary for recommending DPPs. Among those is the need for the investor to have a net worth sufficient to sustain the risks of the DPP, including loss of the investment. Although many DPPs, but not all, are limited to accredited investors, that is not a FINRA suitability standard; that is an SEC requirement. It is the general partner who cannot be in a business that competes with the DPP.
An investor in which of the following products may not receive dividends? A) Oil and gas limited partnership interests B) Units in a UIT C) Shares of preferred stock D) Shares of common stock
A - The structure of a limited partnership does not allow for the payment of dividends. If there is income, it flows through to the investor, but it is not considered a dividend. Common stock can pay dividends and preferred stock is purchased for its dividend payout. UITs pay dividends in a manner similar to mutual funds.
A major risk associated with investing in DPPs is the lack of liquidity. What steps could the program sponsor take that could have the effect of increasing the liquidity of an existing program? A) A DPP cancellation B) A DPP rollup C) A DPP transfer D) A DPP dissolution
B - A DPP rollup is a transaction involving the combination or reorganization of one or more limited partnerships into securities of a successor corporation. The securities of the successor corporation would likely have greater liquidity. This would have the effect of turning the illiquid DPP into more liquid securities. Disclosure documents must be provided to investors prior to the transaction disclosing risk, the GPs opinion regarding fairness of transaction, and reports and appraisals in connection with the transaction.
Which of the following is not generally associated with an existing real estate direct participation program? A) Immediate income stream B) Appreciation potential C) Known history of income and expenses D) Lower risk than other types of real estate programs
B - Appreciation potential is generally not associated with existing real estate programs because most appreciation occurs in the earliest years for real estate assets.
All of the following would flow through as a loss to limited partners except A) accelerated depreciation. B) principal repayment on recourse debt. C) depletion. D) interest payments on recourse debt.
B - Principal repayments are not deductible for tax purposes. The interest is deductible.
All of the following are redeemable securities except A) variable annuities. B) unit investment trusts. C) mutual funds. D) real estate investment trusts (REITs).
D - A redeemable security has no secondary market. To sell (redeem) a redeemable security, the investor must go back to the issuer or its agent. REITs trade in the secondary markets either on exchanges or over the counter.
Depletion allowances in oil and gas programs are based on the amount of oil A) lost to shrinkage. B) in reserve. C) extracted. D) sold.
D - Depletion allowances are allowed to compensate for a mineral resource, which is considered accomplished when it is sold.
A real estate limited partnership is created for $800,000 with 1 general partner and 10 limited partners. Each of the limited partners has an equal 10% share. The proceeds are used to purchase an office building for $2 million. The additional financing is provided by a nonrecourse bank loan. Economic conditions cause the occupancy rate to fall dramatically, and the partnership is dissolved as insolvent. Each limited partner may claim a loss of A) $2,000,000. B) $120,000. C) $80,000. D) $200,000.
D - Losses may only be claimed to the extent of tax basis. The initial $800,000 was divided 10 ways, so each LP had a basis of $80,000. To this was added the share of the financing of $1.2 million. That is another $120,000 basis (10% of $1.2milion) bringing the total to $200,000 ($80,000 + $120,000). That is the maximum loss that can be claimed. It is important to note that nonrecourse financing adds to basis only in RELPs. Because the loan adds to the basis of all LPs equally, you could also solve this by taking the total $2 million investment and dividing it by 10 to arrive at the same $200,000.
Income from which of the following investments is passive income? Real estate direct participation programs (DPPs) Vacation cottage rentals Real estate investment trusts (REITs) Collateralized mortgage obligations (CMOs) A) I and III B) II and IV C) II and III D) I and II
D - Passive income results from DPPs and personal real estate rentals. REITs and CMOs are securities, and income from securities is considered portfolio income.
The price paid for a listed REIT is most similar to the pricing of A) a real estate limited partnership. B) an open-end investment management company. C) a collateralized mortgage obligation. D) a closed-end investment management company.
D - Pricing of a listed REIT (real estate investment trust) is based on supply and demand. In this respect, they trade similarly to a closed-end investment management company. Open-end investment management companies are mutual funds and their pricing is based on the net asset value as computed daily. On the exam, unless stated otherwise, all real estate limited partnership offerings are offered through private placements. This means that they are not publicly traded and have limited liquidity.
If a customer holds certificates of beneficial interest in a real estate investment trust (REIT), all of the following statements regarding this investment are true except A) investors receive dividends periodically. B) the issuer must redeem certificates on shareholder request. C) a mortgage REIT represents pooled capital for real estate financing. D) the certificates are publicly traded.
B - REITs are not redeemed by the issuer. REITS are publicly traded units that represent either an interest in pooled capital for real estate financing or an interest in real property that pass through income and capital gains distributions to investors. Investors who wish to liquidate their interests must sell them in the secondary market.
Which of the following statements describes an oil and gas blind pool offering? A) The income from producing wells is purchased at a discount from the present value of the projected future flows. B) An unknown number of representatives participate in the sale of known partnership units. C) Money is raised without a specific property being stated, and the general partner selects the investments. D) The oil exploration occurs in an area that is not adjacent to any known oil reserves.
C - A blind pool offering, also known as a nonspecified program, involves an investment in a program without specific prospects or properties being identified. Many times, large real estate or oil and gas programs are offered in the form of a blind pool. In a blind pool, 25% or more of the specific properties (in real estate) or sites (in oil and gas) have not been identified at the time of the offering. When investing in a blind pool, the participants are relying on the expertise of the program sponsor to select locations that will prove profitable.
A customer invests $20,000 in a direct participation program and signs a recourse note for $50,000. During the first year of operation, the customer receives a cash distribution of $15,000 from the partnership. At year's end, the customer receives a K-1 statement reporting his share of partnership losses of $75,000. How much of the loss may the customer deduct from passive income? A) $35,000 B) $75,000 C) $55,000 D) $0
C - A limited partner can only deduct partnership losses to the extent of his basis. To determine basis, add the original investment ($20,000) to any recourse debt assumed by the investor ($50,000). Recourse debt adds to basis as the partner is liable for this amount. Cash distributions received reduce basis ($15,000). At year's end, the investor's basis and the amount he can deduct from passive income is $55,000.
Which of the following could an analyst use to establish the rate of return on a direct participation program (DPP)? Present value Internal rate of return Yield to maturity First-in, first-out A) I and IV B) II and III C) I and II D) III and IV
C - Analysts use both present value and internal rate of return to establish a DPP's rate of return. Both involve assumptions based on future cash flows generated by the program.
A registered representative must obtain written verification of an investor's net worth for which of the following investments? A) Variable contract B) Real estate investment trust C) Direct participation program D) Mutual fund
C - Before an investor can become a limited partner, the investor must provide a written verification of net worth. The investor is accepted as a limited partner only when the general partner signs the subscription agreement.
A married couple both hoping to retire within the next five to seven years have expressed having a low-risk tolerance regarding the stock market. They have a combined income of $350,000. Given this information, which of the following portfolio mixes would be most suitable? A) Treasury bills, common stock, options B) Direct participation programs, real estate investment trusts, preferred stock C) Treasury notes, municipal bonds, GNMAs D) Treasury bills, corporate bonds, preferred stock
C - In light of their low risk tolerance, U.S. government securities would certainly be suitable, and the time frame noted for retirement allows for middle term T-notes to be useful. Given their higher income level, tax-free municipal bonds could also have a place in the portfolio. Longer term GNMAs would accommodate monthly income, should that be desirable upon retirement. The remaining product suggestions are either illiquid (DPPs) or do not align with their risk aversion (common, preferred, options, and REITs).
Which of the following best describes an intangible drilling cost? A) Proven reserve of oil or gas B) Tax liability C) Labor, fuel, or drilling rig rental D) Exploratory well drilling
C - Intangible drilling costs are the noncapital costs of putting in a well. They are currently deductible expenses such as fuel, wages, and rent. An intangible drilling cost is one that, after expenditure, has no salvage value. Intangible drilling costs are those associated with drilling a well, but do not include the cost of capital equipment (e.g., pumps, casing). They include wages, fuel, repairs, hauling, supplies, surveys, tests, and drilling mud, and they are incidental to and necessary for the drilling activity.
Your client is interested in a direct participation program (DPP) limited partnership. Which of the following are most likely to factor into a discussion on suitability of such an investment? Beta Liquidity Alpha Investor's age A) II and III B) I and IV C) II and IV D) I and III
C - The key here is to recognize that with DPPs, the customer's age is a relevant consideration in determining suitability. DPPs are long-term and illiquid. For example, it is unlikely that DPPs would be suitable for a customer near retirement age, regardless of the customer's financial situation. Beta, having to do with measuring an investment's volatility as related to the overall market, and alpha, being a measure of performance adjusted for risk, are not factors generally associated with DPPs.
Which of the different sharing arrangements for limited partnerships between the general partners (GPs) and the limited partners (LPs) is generally considered the most common? A) Overriding royalty interest B) Net operating profits interest C) Functional allocation D) Carried interest
C - While both LPs and GPs share equally in the revenues with a functional allocation arrangement, it is most commonly used because it gives the best tax benefits to each. The LPs receive the immediate tax write-offs from the intangible drilling costs, whereas the GPs receive continued write-offs from the tangible costs over the course of several years.
Which of the following characteristics are applicable to real estate investment trusts (REITs)? A) Any losses from the real estate portfolio flow through to the REIT shareholders. B) REIT shares cannot be bought or sold in the secondary market and are therefore considered illiquid. C) Dividends from REITs are taxed as ordinary income. D) REITs have guaranteed minimum dividends.
C - While income flows through to REIT shareholders in the form of dividends, losses do not flow through. When a REIT pays a dividend, it will be taxed as ordinary income, but there are no guaranteed minimum dividend payouts. They trade both on exchanges and over the counter, and are therefore considered to be liquid investments.
