Chapter 17

Question 1

What is the most important factor underlying every investment decision?

Answer 1

Economic soundness

Question 2

Which factors need to be taken into consideration when performing an investment analysis?

Answer 2

Land use controls (zoning laws)
Economic forces (population grown, taxation)

Question 3

What are the benefits of being a real estate investor?

Answer 3

Income, equity build-up, tax benefits, prestige

Question 4

What are the disadvantages of being a real estate investor?

Answer 4

Illiquidity of assets (can’t get money out quickly if needed), management expenses, need for expert advice

Question 5

What are the types of investment properties?

Answer 5

Agricultural
Business (buying/managing a business)
Commercial
Industrial
Office
Residential

Question 6

What is a real estate investment trust (REIT)?

Answer 6

Investment that allows groups of investors to pool their resources to invest in larger, professionally managed, income-producing properties such as office buildings, apartment complexes, retail centers

Question 7

What is Amount realized, or net proceeds from a sale?

Answer 7

Sales price - cost of the sale

Question 8

What is Cost Basis?

Answer 8

Original value of an asset for tax purposes, used to determine the gain or loss on the sale of the property

Question 9

What is Adjusted Basis?

Answer 9

Amount invested in the property for tax purposes including any capital improvements which would lower the total amount in gains

Question 10

What is Capital Gain/Loss?

Answer 10

Increase or decrease in value of a property when it is sold

Question 11

What is Cash Flow?

Answer 11

Movement of money into or out of a business or investment, measured over a period of time

Question 12

What is appreciation?

Answer 12

Increase in value of an investment over time

Question 13

What is Tax depreciation (cost recovery)?

Answer 13

Income tax deduction that allows a taxpayer to recover the cost of investment properties over a number of years

Question 14

What is Equity?

Answer 14

Difference between the current market value of a property and the amount the owner still owes on the mortgage.
Equity begins with the initial down payment

Question 15

What is liquidity?

Answer 15

An asset’s ability to be converted quickly into cash without causing a significant movement in price and with a minimum loss of value

Question 16

What is a Tax shelter?

Answer 16

Legal method of decreasing an investor’s taxable income, and therefore, how much they owe in taxes

Question 17

What are the types of risks involved in real estate investment?

Answer 17

Static risk - can be offset by insurance (flood, fire, robbery)

Dynamic risk - caused by changes in the market conditions (financial, liquidity, interest rate, inflation)

Question 18

What is Leverage?

Answer 18

The use of other people’s money (loans) to purchase investments

Question 19

What are the types of leverage?

Answer 19

Positive - If the investment returns more to the investor than the cost of the loan

Negative - If the investment returns less than the cost of the loan

Question 20

What are the types of operating expenses used to estimate value with direct capitalization?

Answer 20

Fixed expenses - does not change with occupancy
Variable Expenses - changes with occupancy
Reserve for replacements - set aside to replace items

Question 21

Which items are not included in operating expenses?

Answer 21

Mortgage payments, capital improvements, personal expenses

Question 22

What is the first step in evaluating an investment property?

Answer 22

Preparing an operating statement showing annual forecasts of income and expenses over a period of time

Question 23

What is Cash throw-off or Before-tax cash flow? How is it calculated?

Answer 23

Net operating income - annual debt service

Question 24

How is the operating expense ratio calculated?

Answer 24

Operating expenses / effective gross income

Question 25

How is loan to value ratio calculated?

Answer 25

Loan / value of the property

Question 26

How is profit or loss % calculated?

Answer 26

Amount made / Original amount paid

Question 27

For how many years can a residential investment property owner claim depreciation of the property under current tax law?

Answer 27

27.5 years on a straight-line basis

Question 28

For how many years can a non-residential investment property owner claim depreciation of the property under current tax law?

Answer 28

39 years on a straight-line basis

Question 29

How much can a residential property investor deduct each year for tax purposes on a straight-line basis?

Answer 29

Basis for depreciation / 27.5

Question 29

How much can a residential property investor deduct each year for tax purposes on a straight-line basis?

Answer 29

Basis for depreciation / 27.5

Question 30

How do you determine the basis of depreciation for an investment property?

Answer 30

Total acquisition cost * % the improvement represents of the total investment

Question 31

How much can a non-residential property investor deduct each year for tax purposes on a straight-line basis?

Answer 31

Basis for depreciation / 39

Question 32

What is Capital gain?

Answer 32

Profit made when an income producing property is sold

Question 33

What are the classifications of income under the tax reform act of 1986?

Answer 33

Active - salaries and wages Passive - investments, like rental income Portfolio - dividends

Question 34

What is a tax-deferred exchange?

Answer 34

Method in which real estate investors defer capital gain by exchanging properties with another real estate investor

Question 35

For which type of seller financing, is the capital gains tax spread out over several years?

Answer 35

Installment sale

Question 36

What is a business enterprise?

Answer 36

Sale or lease of a business involving a transaction in excess of $200,000

Question 37

What is a business opportunity?

Answer 37

Sale or lease of a business involving a transaction with a sales price of $200,000 or less

Question 38

How is a business that is failing/closing appraised?

Answer 38

Liquidation value approach The liquidation value is the value that is left after liquidating all the assets of the business and paying off all the debts

Question 39

What is "goodwill" in a business appraisal?

Answer 39

Intangible value of the name of the business

Question 40

What is Going Concern Value?

Answer 40

Value of a business that is still operating

Question 41

How is a business owner's equity calculated?

Answer 41

Assets - liabilities