Real Estate Chapter 14 - Effects of Times and Risk on Value

An office building has a projected net income of $45,000 per year, and its projected net sales price after five years is $250,000. Considering its risk, you require a 16% annual return on this investment. How much would you be willing to pay for it?

$266,371.47

You want to buy a new sports car 5 years from now, and you plan to save $5,800 per year, beginning one year from today. You will deposit your savings in an account that pays 6% interest. How much will you have just after you make the 5th deposit, 5 years from now?

$32,695

You want to buy a new sports car five years from now, and you plan to save $5,800 per year, beginning today. You will deposit your savings in an account that pays 6% interest. How much will you have in the account after making the 5th deposit, 5 years from now?

$34,657

Assume an industrial building can be purchased for $1,500,000 today, is expected to yield cash flows of $80,000 for each of the next five years (with the cash flows occurring at the end of each year), and can be sold at the end of the fifth year for $1,625,000. Assuming that the required rate of return is 10%, calculate the NPV for this transaction.

-187,739.91

An investor originally paid $22,000 for a vacant lot 12 years ago. If the investor is able to sell the lot today for $63,000, what would be her annual rate of return (rounded to the nearest full percent)?

9%

Jeff is about to retire, and he wants to buy an annuity that will provide him with $90,000 of income a year for 20 years, with the first payment coming at the end of the first year. The going rate on such annuities is 6%. How much would it cost him to buy the annuity today?

$1,032,293

Educational Realty Corporation is considering a student housing investment which is expected to produce $41,000 at the end of every year for three years. If the company invests $100,000 today, what is the IRR of this investment?

11.11%

X Realty Corporation is considering an investment that has the following expected cash flow. What is the investment's IRR?Year 0: - $1,500,000Year 1: $400,000Year 2: $400,000Year 3: $500,000Year 4: $800,000Year 5: $100,000

14.61%

You are investing your money at a compound annual return of 8%. It will take about ___ years for your money to double. (Round your answer to the nearest integer)

9

A cash inflow or outflow that is forecasted to occur once over the analysis period, should be entered in the _________ register.

FV

Which of the following type of real estate investment is the generally considered the least risky? Office properties Hospitality properties Properties net leased to a high quality tenant "Raw" land held for future development

Properties net leased to a high quality tenant

Which of the following investments is generally considered the least risky? U.S. Treasury securities "Raw" land held for development Office properties Technology stocks

U.S. Treasury securities

Opportunity cost is the return the investor is forgoing on an alternative investment of ___ risk in order to invest in the current opportunity.

equal

The "total" yield on an investment opportunity

is equal to current yield plus the appreciation yield

Future benefits are discounted because of ________.

risk opportunity cost

As the perceived risk of expected future cash flows increases,

the required (expected) return should increase

The expected (required) IRR of an investment is composed of a risk-free rate and the required risk premium. The risk-free component is compensation for

the time value of money

In the real estate appraisal business, the IRR is often referred to as the ________.

total yield

Timelines are useful because they allow us to ___ the time pattern of money returns.

visualize

True or false: All else the same, a change in the discount rate affects the present value of a 15-year loan more than a 30-year loan.

False

True or false: Theoretically, treasury bills (T-bills) are securities with a maturity less than 1 year. They are typically viewed as riskless securities, therefore the return on them should be zero.

False

True or false: An ordinary annuity is defined as a fixed amount of money paid or received at the beginning of every period.

False Reason: Ordinary annuity is defined as a fixed amount of money paid or received at the end of every period.

A coastal city has seen significant appreciation in housing prices over the last decade. Suppose Jacob bought a $250,000 condo in this city in 2006, and the require rate of return on condos with similar risk is 20%/year from 2006 to 2015 (10 years). How much would his condo be worth in 2015? (round to the nearest cent)

$1,547,934.11

You are estimating that the price of a trip around the world will be $30,000 10 years from now. How much should you put aside today in a lump sum in order to save for this trip? Assume the interest rate is 10%, compounded annually (round to the nearest cent).

$11,566.30

Assume that a piece of land is currently valued at $50,000. If this piece of land is expected to appreciate at an annual rate of 5% per year for the next 20 years, how much will the land be worth at the end of 20 years?

$132,665

Jenny wants to go to Europe four years from now. She can save $4,000 per year, beginning one year from today. She plans to invest the funds in the S&P 500 index fund that she thinks will return 10% per year. Under these conditions, how much will she have saved after she makes the 4th deposit, 4 years from now?

$18,564

Suppose a U.S. Treasury bond will pay a lump sum of $3,000 five years from now. If the current required rate of return on this 5-year treasury bonds is 4.5%, how much is the bond worth today?

$2,407.35

What is the PV of an ordinary annuity with 5 annual payments of $4,700 if the appropriate interest rate is 4.5% (rounded to the nearest dollar)?

$20,633

An apartment property has a projected net income of $15,000 per year, and its projected net sales price after five years is $300,000. Considering its risk, you require a 14% annual return on this investment. How much would you be willing to pay for it today?

$207,306.81

Assuming a 7% discount rate, the present value of the right to receive $10,000 at the end of 10 years is _________. If you must wait until the end of year 11 to receive the $10,000, the present value decreases by ________.

$5,083.49, $332.56

Ben Franklin invested 1,000 pounds (about $50,000 today) at the beginning of the year 1785. Assume the average annual return he earned from 1785 to the end of 1984 (200 years) was 2.4%. How much was Franklin's investment worth at the end of 1984? (Round your answer to the nearest cent).

$5,740,653.48

Paul wants to buy a new condo six years from now and plans to save $8,000 per year for the down payment, beginning one year from today. He will invest in a fund that offers an 8% return. How much will Paul have accumulated after he makes the 6th deposit, 6 years from now?

$58,687

Mary currently has $5,000. How much will she have after 6 years if she leaves it invested at 5.5% with annual compounding?

$6,894.21

You just inherited some money, and a broker offers to sell you an annuity that pays $5,200 at the beginning of each year for 20 years. You could earn 5.5% on your money in other investments with equal risk. What is the most you should pay for the annuity today?

$65,560

Last year, Harvey Realty Inc.'s sales were $450 million. If sales grow at 12% per year, how large (in millions) will they be 5 years later?

$793.05

Equity Real Estate Investment Trusts are REITs that invest in and operate commercial properties. From 2000 to 2006, equity REITs delivered an average annualized return of 22.9%. John invested $5,000 in equity REITs at the beginning of every year from 2000 to 2006. How much was his investment worth at the end of 2006?

$86,810.74

What is the present value of an apartment building that generates an after-tax cash flow of $30,000 in year one, $32,000 in year two, $35,000 in year three, $20,000 in year four, and $21,000 in year five? Assume that the discount rate is 16%. (round to the nearest cent)

$93,110.50

Suppose an investor is interested in purchasing the following income producing property at a price of $450,000. The investor has estimated the expected cash flows over the next four years to be as follows: Year 1 = $40,000, Year 2 = $45,000, Year 3 = $50,000, Year 4 = $55,000. Assuming that the estimated proceeds from selling the property at the end of year four is $500,000, what is the IRR of the project?

12.69%

Linda is developing an apartment building in New York City that she expects to own for 10 years. She requires an 18% IRR on such an investment. The current 10-year Treasury bond (T-bond) yield is 4%. What is the required risk premium on Linda's investment?

14%

Tom is developing an apartment building in downtown Boston. He requires an 20% going-in IRR on equity on the expected 20-year investment. The current 20-year Treasury bond (T-bond) yield is 3%. What is the risk premium on Tom's investment?

17%

Maxwell Realty Corporation is considering an apartment investment that is expected to produce an after-tax cash flow of $2,000 at the end of year one, $2,025 in year two, $2,050 in year three, $2,075 in year four, and $2,100 in year five. If the company invests $9,500 today, what is the IRR of this investment?

2.57%

The average annual return for the S&P 500 since its inception in 1928 through 2014 is approximately 10%. assume a person invested $1.00 in S&P 500 Index in the end of 1928. It would have grown to $ ___ in the end of 2014 (Round your answer to the nearest cent).

3,628.87

A house is bought for $240,000 in at the end of 2010. By the end of 2015, it seems that the market has increased at a rate of 8% per year since 2010. What is the estimated current value of the house?

326,517.35 In your calculator, input 5 for [N], 8 for [I/Y], -240,000 for [PV], 0 for [PMT], use [CPT] and [FV] to find the answer.

The average annual return for the S&P 500 since its inception in 1928 through 2014 is approximately 10%. Assume a person invested $1.00 in the S&P 500 Index every year since the end of 1928. It would have grown into $ ___ by the end of 2014 (Round your answer to the nearest cent).

36,278.66

Suppose a firm expects to receive the following cash flows over the next four years: Year 1: $1,200 Year 2: $1,200 Year 3: $1,500 Year 4: $1,000 Discount rate=10% What is the present value of this uneven cash flow stream? (round to the nearest cent)

3892.63

Assume an industrial building can be purchased for $1,500,000 today. The investment is expected to yield cash flows of $80,000 for each of the next five years (with the cash flows occurring at the end of each year), and can be sold at the end of the fifth year for $1,625,000. Calculate the internal rate of return (IRR) on this investment.

6.78%

A fixed (level) cash inflow or outflow (ex., monthly or annually) should be entered in the PV register I register PMT register FV register

FV register

Which of the following characteristics describe(s) the type of properties that are the focus of the quarterly RERC survey?

Market values greater than $10 million Relatively new

Arbitrage means taking advantage of temporary differences in market prices to make a profit. Assume two real estate companies, A and B, both operate in New York area and focus on office properties. You have determined that Company A's shares have an intrinsic value of $20 per share but are trading at $22 per share, while Company B's shares are worth $25 per share but are trading at $22 per share. What would a rational investor (or an arbitrageur) do to take advantage of this price difference (no short-selling constraint and transaction fee)?

Sell short company A's shares, buy the same number of company B's shares. Reason: In our example, a rational investor can maximize her profit by shorting the overvalued shares (company A's shares), use the fund to finance the purchase of company B's shares. Therefore the investor pays zero initial cost (assuming no transaction fee). When the prices adjust to the market expectation, the investor can buy company A's shares at $20 per share, make a profit of $2 (22 - 20) times the number of shares she bought; and sell company B's shares at $25 per share, make a profit of $3 (25 - 20) times the number of shares she shorted. However, one would imagine that such arbitrage opportunities rarely exist in a highly-competitive, efficient market.

Which of the following statements is correct? Timelines can only be constructed for annuities where the payments occur at the end of the periods, i.e., for ordinary annuities. Timelines are not useful for visualizing complex problems prior to doing actual calculations. Timelines can be constructed to deal with situations where some of the cash flows occur annually but others occur quarterly. A timeline is not meaningful unless all cash flows occur annually.

Timelines can be constructed to deal with situations where some of the cash flows occur annually but others occur quarterly.

Which of the following statements is correct? The cash flows for an annuity due must all occur at the beginning of each period. The cash flows for an ordinary annuity all occur at the beginning of each period. If an uneven cash flow stream has regular intervals, such as once a year, then it is an annuity. The cash flows for an annuity may vary from period to period, but they must occur at regular intervals, such as once a year or once a month.

The cash flows for an annuity due must all occur at the beginning of each period.

True or false: The U.S. Federal Reserve ("The Fed") periodically increase interest rates when the risk of overheated economy is perceived. Rate hikes are viewed as bad for real estate investors because the present value of future cash flows is inversely related to the magnitude of the interest rate used for discounting.

True Reason: If a real estate investment is expected to produce a fixed set of cash flows, and the required rate of return surges because of the rate hikes, the present value of the investment will decline.

Assume an investment is expected to be worth $10,000 at the end of ten years and that you expect to earn 10% (annually) on investments of similar risk. The present value of this investment opportunity to you is therefore $3,855. Which of the following is true?

You're happy to pay $3,000 for this investment today. If you invested $3,000 for 10 yrs. at 10% you wouldn't accumulate $10,000 at the end of 10 yrs.

When you invest in a risky investment, you should expect to earn

at least what you could earn on an alternative investment of equal risk

The increase in the value of a one time (lump sum) investment that grows at a given rate will be greatest with __________ compounding.

daily

As the opportunity cost of waiting for future cash flows increases, the present value of those future cash flows ___________.

decreases

All else equal, the future value of an annuity due will be __________ the future value of a "regular" annuity.

greater than

An investment is expected to be wealth increasing if the NPV is ________ zero.

greater than

According to the RERC data displayed in Exhibit 14-2, mean required rates of return on high quality real estate investments

have been trending downward since 2009

The compounding of interest causes the value of an investment to grow at an ___ rate.

increasing