NYU Schack Institute of Real Estate School of Continuing and Professional Studies The Real Estate Institute 11 West 42nd Street, New York, NY 10036 Real Estate Finance – REAL1-GC.1035 Final Examination 1. An investor believes that a certain property is worth $10,000,000. The seller refuses to sell it for that amount, but has offered to provide a 5-year interest-only loan for $5,000,000 at 4% interest (annual payments at the ends of the years, first payment due in one year). Market interest rates on such a loan are currently 6.5%. How much should the investor be willing to pay for the property from an investment value perspective (taking the loan deal) if the investor faces a 30% marginal income tax rate? a) $10,000,000 b) $10,383,588 c) $10,403,023 d) $10,519,460 e) Insufficient information to answer the question. 2. A property has a McDonald’s restaurant on it, which can earn $50,000 per year. In any other use (including another brand of restaurant), the most it can earn is $40,000 per year. Assuming a discount rate of 10% and constant cash flow in perpetuity, what is the “investment value” of this property to McDonalds, and what is its “market value”? a) Both investment value and market value are $400,000. b) Both investment value and market value are $500,000. c) Investment value is $400,000 and market value is $500,000. d) Investment value is $500,000 and market value is $400,000. 3. Suppose the risk free rate of return is 7%, and the expected total return on the property free & clear is 11%, and you have a target total expected return of 15%. Assuming you can borrow at the risk free rate, what Loan/Value ratio must you obtain for this real estate investment to meet your target expected return? a) 0% b) 25% c) 50% d) 75% e) 80% 4. Suppose a property has a cap rate of 10% and you can borrow at a mortgage constant of 11%. If you borrow 75% of the property price, what will be your equity yield? a) 7.00% b) 8.25% c) 10.00% d) 11.00% e) Cannot be determined from the information given. 5. Two loans have the same interest rate and maturity. Loan A has a 15-year amortization rate. Loan B has a 30-year amortization rate. In comparing these two loans from a borrower’s perspective: a) The advantage of Loan A is lower monthly payments and lower balloon payment at maturity. b) The advantage of Loan B is lower monthly payments and lower balloon payment at maturity. c) The advantage of Loan A is lower monthly payments but its disadvantage is a higher balloon at maturity. d) The advantage of Loan B is lower monthly payments but its disadvantage is a higher balloon at maturity. 6. Consider an 8.5% loan amortizing at a 25-year rate with monthly payments. What is the maximum amount that can be loaned on a property whose net operating income (NOI) is $500,000 per year, if the underwriting criteria specify a debt service coverage ratio (DCR) no less than 125%? a) $2,789,406 b) $3,409,091 c) $3,844,614 d) $4,000,000 e) $4,139,619 7. For the same property as above, suppose the underwriting criteria is a maximum loan/value ratio (LTV) of 75%, and we estimate property value by direct capitalization using a rate of 11% on the stated NOI. By this criterion what is the maximum loan amount? a) $2,789,406 b) $3,409,091 c) $3,844,614 d) $4,000,000 e) $4,139,619 8. Suppose a construction project anticipates end-of-month draws of $400,000, $300,000, and $600,000 consecutively. What will be the balance owed at the end of the third month if the interest on the loan is 7% per annum (nominal annual rate, compounded monthly), and no payments of either principal or interest are required during the construction period? a) $1,306,430 b) $1,314,051 c) $1,378,960 d) Cannot be computed with the information given. 9. Consider the investment evaluation of a real estate development in which the property to be built is projected to reach stabilized occupancy at the end of Year 2 (two years from the time the investment decision must be made and construction will begin). The project is speculative in that there are no leases signed as of Time Zero (the present, when the investment decision must be made). The property level opportunity cost of capital is considered to be 9% for stabilized investments, and 10% for assets not yet stabilized (lease-up investments). Which of the following is true? a) Property level before-tax cash flows beyond Year 2 should be discounted back to the end of Year 2 at 9%, and the projected stabilized asset value as of the end of Year 2 should be discounted two years to Time Zero at 10%. b) Property level before-tax cash flows beyond Year 2 should be discounted back to the end of Year 2 at 10%, and the projected stabilized asset value as of the end of Year 2 should be discounted two years to Time Zero at 9%. c) Property level before-tax cash flows beyond Year 2 should be discounted all the way back to Time Zero at the 10% rate. d) Property level before-tax cash flows beyond Year 2 should be discounted all the way back to Time Zero at the 9% rate. 10. The opportunity cost of capital (discount rate) applicable on an unlevered basis to assets that are not yet leased up (“speculative built properties”) is best described as: a) Usually about 50 to 200 basis-points above the OCC for the same property with stabilized occupancy, based in part on analysis of the “interlease” discount rate implied in the property market. b) Usually about 300 to 500 basis-points above the OCC for the same property with stabilized occupancy, based in part on analysis of the “interlease” discount rate implied in the property market. c) Usually about 50 to 200 basis-points below the OCC for the same property with stabilized occupancy, based on the typical upward slope of the yield curve in the bond market, because lease-up is near term. d) Usually about 300 to 500 basis-points below the OCC for the same property with stabilized occupancy, based on the typical upward slope of the yield curve in the bond market, because lease-up is near term. 11. All of the following are typical types of real options found in development projects or developable land ownership, except: a) The wait option b) The phasing option c) The switch option d) The refinance option 12. The replicating portfolio of a development option (land) consists of: a) A long position in an asset like the stabilized building to be built and a short position (borrowing) in a riskless bond. b) A short position in an asset like the stabilized building to be built and a long position (lending) in a riskless bond. c) Long positions in both the stabilized building and a bond. d) Short positions in both the stabilized building and a bond. 13. Consider a 20-year (monthly-payment), 8%, $80,000 mortgage with 2 points prepaid interest up front. What is the yield to maturity? a) 8.00% b) 8.12% c) 8.20% d) 8.27% 14. A REIT has expected total return on equity of 15%, interest on their debt is 9%, and their debt-to-total-value ratio is 40%. What is the REIT’s average cost of capital? a) 9.0% b) 10.4% c) 12.6% d) 15.0% e) Insufficient information to answer this question. 15. The NOI is $1,000,000, the debt service is $800,000 of which $700,000 is interest, the depreciation expense is $250,000. What is the Before-tax Cash Flow to the equity investor (EBTCF) if there are no capital improvement expenditures or reversion items this period? a) $50,000 b) $182,500 c) $200,000 d) $300,000 e) $750,000 16. Two loans have the same interest rate and maturity. Loan A has a 15-year amortization rate. Loan B has a 30-year amortization rate. In comparing these two loans from a borrower’s perspective: a) The advantage of Loan A is lower monthly payments and lower balloon payment at maturity. b) The advantage of Loan B is lower monthly payments and lower balloon payment at maturity. c) The advantage of Loan A is lower monthly payments but its disadvantage is a higher balloon at maturity. d) The advantage of Loan B is lower monthly payments but its disadvantage is a higher balloon at maturity. 17. Consider a 30-year (monthly-payment), 6%, $300,000 mortgage with 3 points prepaid interest up front. What is the yield to maturity? a) 5.87% b) 6.00% c) 6.29% d) 6.50% e) Insufficient information to answer the question. 18. Consider a 6.5% loan amortizing at a 20-year rate with monthly payments. What is the maximum amount that can be loaned on a property whose net operating income (NOI) is $1,000,000 per year, if the underwriting criteria specify a debt service coverage ratio (DCR) no less than 120%? a) $69,444 b) $8,000,000 c) $9,314,236 d) $11,177,084 e) $13,412,500 19. For the same property as above, suppose the underwriting criteria is a maximum loan/value ratio (LTV) of 80%, and we estimate property value by direct capitalization using a rate of 7% on the stated NOI. By this criterion what is the maximum loan amount? a) $80,000 b) $8,000,000 c) $11,177,084 d) $11,428,571 e) $14,285,714 20. All of the following are characteristics of the classical “Simple Financial Feasibility Analysis” (SFFA) procedure for real estate development projects, except: a) The procedure is easy to understand and apply without advanced or specialized financial knowledge or knowledge of the capital markets (other than the local mortgage market). b) The procedure can be applied from either a “front door” or “back door” perspective. c) It generally assumes the developer will take out the largest mortgage possible upon completion of the project, and that the project cost will equal its value for applying lender’s loan/value criteria. d) It is based fundamentally on the NPV investment evaluation principle and therefore is consistent with wealth maximization. 21. In translating construction cost cash flows across time to arrive at the present certainty-equivalent value of the construction cost as of time zero, the opportunity cost of capital (OCC) that should be used as the discount rate is best described as follows: a) Use the contract interest rate on the construction loan. b) Use a rate equal to or only slightly above the risk free interest rate. c) Use the development phase OCC reflecting the leverage in the construction project. d) Use the yield on long-term Government bonds. 22. What we have called in class the “canonical” formula for determining the OCC of a development project investment is based on all of the following except: a) Equilibrium exists within the market for developable land. b) Equilibrium exists across the markets for developable land, stabilized (built) properties, and bonds (or instruments with low-risk debtlike cash flows). c) The investor will be irreversibly committed to completing the subject development project. d) Development is a “real option” in which the developer/landowner has the flexibility to postpone development. 23. The NPV investment decision rule is applicable even in the case of a real option, such as a real estate development investment decision, because: a) The NPV rule states that any investment with a positive NPV should be undertaken. b) The real options nature of development enables a negative NPV investment to be rational. c) The NPV rule will insure that a development project that presents a higher IRR will be chosen over one that presents a lower IRR. d) The NPV rule requires making the decision that maximizes the NPV over all mutually exclusive alternatives, and building today versus waiting are mutually exclusive alternatives on a given piece of land. 24. According to real option theory, even if construction were instantaneous and the property market were perfectly liquid, it might be optimal not to immediately build a project whose value currently exceeds its construction cost, because: a) There is sufficient probability that the value of the project will rise sufficiently in the future, and building today is mutually exclusive with building in the future. b) There is sufficient probability that the value of the project will fall sufficiently far in the future such that you would lose money if you built it today. c) There is never any reason to exercise a call option before its expiration date. d) The cost of construction can be invested at a rate less than the cap rate (or current cash yield) of the completed project. REITs 25. Which of following is a Real Estate Investment Trust Requirement? A. Pay 90% of taxable income to shareholders annually in the form of dividends B. Assets are primarily Real Estate (90%) C. Income primarily from Real Estate operations (90%) D. Minimum of 90 shareholders 26. REITs hurt by real estate downturn in late 1980’s “Not” due to: A. Passage of Tax Reform Act of 1986 B. Failures of many mortgage REITs C. Massive overbuilding 27. What is the mostly commonly Accepted and Reported measure of REITs operating performance? A. Funds from Operations (FFO) B. Net Asset Value (NAV) C. Earnings per Share (EPS) 28. Which of the following is not a benefit of REITs as an Investment vs Direct Real Estate Ownership? A. Turns an illiquid asset into an easily traded and valued asset B. Broad diversification of real estate investments C. professional management & Corporate Governance D. Tax Shelter 29. When rating REITs, Rating Agency generally seek the following A. Management Quality and Structure B. Financial Disclosure and Corporate Governance C. Capital Access and Balance Sheet Management D. All of the above 30. With respect to Management Quality and Structure, Expertise & Track Record usually reflects which of the following? Please choose all applicable. A. Operating Skills B. Management and Strategy C. Understanding of the Capital Markets 31. When appraising capital structure and credit, Rating Agency generally analyze the firm’s financing strategy in relationship to: A. Secured/Unsecured debt mix B. Debt maturity schedule and refinancing challenges C. Liquid resources D. A & B E. All of the Above 32. MOST REITs are: A. Equity trusts B. Mortgage trusts C. Hybrid trusts D. Partnership trusts 33. Which of the following regarding private (unlisted) REITs is TRUE? A. Unlisted REITs are less expensive than listed REITs B. Unlisted REITs are less liquid than listed REITS C. Unlisted REITs are more subject to short-term market price volatility than listed REITS D. “List or liquidate” provisions in unlisted REITs make such REITs less risky than listed REITS 34. Which of the following is NOT a type of REIT? A. Mortgage trust B. Equity trust C. Hybrid trust D. Partnership trust 35. A hybrid REIT is comprised of what primary classifications of REITs? A. UPREITs, mortgage B. Mortgage, equity, retail C. Mortgage, equity D. Healthcare, retail, office 36. Which of the following REIT types is NOT likely to own real property? A. Hybrid REIT B. Mortgage REIT C. Equity REIT D. All of the above 37. Which of the following is likely to occur upon the sale of a REIT-owned property? A. If a capital gain is realized, the REIT can retain the gain for future investment and be taxed at the appropriate corporate capital gains tax rate B. If a capital gain is realized, the REIT can retain the gain for future investment and be taxed at the shareholder’s capital gains tax rate C. If a capital gain is realized, the REIT can distribute the gain as a dividend to shareholders who will realize it as dividend income for individual tax reporting purposes D. If a capital loss is realized, the loss can be passed through to individual investors 38. The funds from operations (FFO) for a REIT is roughly equal to: A. NOI less interest deductions B. Earnings before tax plus depreciation deductions C. NOI plus interest deductions D. Earnings per share plus capital gains 39. The difference between EPS (earnings per share) and FFO (funds from operations) is: A. Irrelevant B. Determined by growth of the company C. Due to depreciation and amortization D. Due to the number of shares outstanding 40. REIT dividends are considered ________ income and thus do not qualify as passive income to offset passive losses. A. Portfolio B. Operating C. Trading D. Outside professional