Chapter 4: Real Estate Investments

Question 1

Feasibility Study

Answer 1

A detailed statistical analysis that involves the investigation of all facets of a real estate investment project and the comparison of the data with other similar projects.

Question 2

Time Value of Money

Answer 2

Process that calculates the value of an asset in the past, present or future and is based on the premise that the original investment or principal will increase in value over time.

Question 3

Operating Statement

Answer 3

For a property includes income, vacancy rates and expenses.

Question 4

Gross Income

Answer 4

Income received without deducting expenses.

Question 5

Effective Gross Income

Answer 5

Losses from vacancies and credit losses deducted from potential gross income.

Question 6

Net Operating Income

Answer 6

When operating expenses are deducted from effective gross income.

Question 7

Debt Service

Answer 7

Mortgage principal and interest payments. The interest which is an allowable deduction is deducted from net operating income to arrive at net taxable income.

Question 8

Rent Roll

Answer 8

The number of rental units that are currently occupied in a building multiplied by the rental amount per unit. That figure is multiplied by 12 to obtain the annual rental income.

Question 9

Proforma Statement

Answer 9

Or schedule is an operating statement adjusted to reflect a potential change in income and expenses based upon the investor’s knowledge of the real estate market. Before investing, an investor must create this or have an expert create this. It analyzes a property’s potential or lackthereof.

Question 10

Valuation of A Property

Answer 10

Establishes an opinion of value utilizing a totally objective approach. It is the process of estimating the market value of an identified interest in a specific property as of a given date.

Question 11

Market Value

Answer 11

Defined as the most probably price, as of a specific date, in cash or in terms equivalent to cash.

Question 12

Investment Value

Answer 12

Determined by the amount of return on a certain dollar investment property will produce. If an investor requires a 20 percent return and a property returns $20,000, the investment value is $100,000.

Question 13

Insured Value

Answer 13

The cost of replacing or reproducing the structure because of a total loss because of an insured hazard. This estimates the value of the property as a basis for determining the amount of insurance coverage necessary to protect the structure adequately against loss by fire or other casualty.

Question 14

Value In Use

Answer 14

The value of the property based on its usefulness to an owner or investor. This is defined more for its value to the owner and not for its value if placed on the market. Ex: A second home used for vacation purposes.

Question 15

Assessed Value

Answer 15

Determined by a local or state official. It is the value to which a local tax rate is applied to establish the amount of tax imposed on the property.

Question 16

Mortgage Loan Value

Answer 16

Whatever the lender believes the property will bring at a foreclosure sale or subsequent resale. This almost always differs from the market value.

Question 17

Evaluation of a Property

Answer 17

A study of the nature, quality, or utility of certain property interests in which a value estimate is not necessarily required. These can be land utilization studies, highest- and best-use studies, marketability studies, feasibility studies and supply-and-demand studies.

Question 18

Syndicates

Answer 18

Denote multiple joint participation in a real estate investment and may involve joining of assets and talents of individuals, general partnerships, limited partnerships or corporations in some combination.

Question 19

Joint Venture

Answer 19

An organization formed by two or more parties to invest in real estate or another investment. These are usually for one project only.

Question 20

Real Estate Investment Syndicate

Answer 20

A joint venture typically controlled by one or two persons who hope for profitable return to all investors. Profit for investors is generated when the syndicate buys, sells, and develops real estate.

Question 21

Leverage

Answer 21

The use of borrowed funds.

Question 22

Land Acquisition

Answer 22

One of the more risky types of investment. It is difficult to obtain lender financing for this type of investment.

Question 23

Anchor Store

Answer 23

A large store such as Wal-Mart or Kmart, a supermarket, and clothing and furniture stores.

Question 24

Rate of Return

Answer 24

Percentage of income per dollar amount invested that the investor gets back on an investment.

Question 25

Risk Factor

Answer 25

The greater the risk of loss, the greater potential rate of return the investor is entitled to expect.

Question 26

Income Capitalization Approach

Answer 26

Converts income into value so that an investor can look at an investment’s validity and reasonableness. This approach is the primary method that appraisers use for estimating the value of properties that produce rental income.

Question 27

To Obtain Financing For A Project

Answer 27

An investor must present a portfolio to a lender, including documentation of past and current investment projects, a description of the subject project, a financial statement and a detailed presentation about how the investor intends to pay the loan.

Question 28

Sensitivity Analysis

Answer 28

A study of how a change in one factor can affect the income of the property. Ex: If a vacancy rate is higher that predicted, then the rental income will decrease.

Question 29

Participation Mortgage

Answer 29

Relates to two different types of mortgage:

• A mortgage in which two or more lenders participate in making the loan.
• A mortgage in which the lender participates in the profits generated by a commercial property used to secure payment of the debt in the mortgage loan.

Question 30

Leasehold Mortgage

Answer 30

Pledges a leasehold estate rather than a freehold estate to secure payment of a note. The usual case is a lease for vacant land in which the lessee is to construct an improvement such as a shopping mall, hotel, or an office building as an investment.

Question 31

Sale of a Primary/Principal Residence - $250,000 / $500,000 Rule

Answer 31

A special exclusion in the IRS law gives home sellers a tax break on capital gains when selling their home. Home sellers may be eligible to exclude up to $250,000 if single or up to $500,000 if married, of the capital gain on the sale of the residence. The home seller must have owned and resided in his home for at least two years of the last five years before the sale of the residence.

Question 32

Second Home Capital Gains Exclusion

Answer 32

The home sale exclusion may include gain from the sale of vacant land that was used as a part of the residence, if the land sale occurs within two years before or after the sale of the residence.

Question 33

Marginal Income Tax Bracket

Answer 33

The tax rate applied to income. 0, 15, 28, 31, 36 and 39.6. Most taxpayers fall in the 15-28 percent tax brackets.

Question 34

Three major classifications for income

Answer 34

Active income: earned by salaries or in a business
Portfolio income: Interest annuities, dividends and royalties
Passive activity income: Invested funds. Most rental activities and limited partnerships.

Question 35

Mortgage Interest

Answer 35

The current limits of home mortgage interest deductions are $1,000,000 of acquisition indebtedness plus $100,000 of additional indebtedness used for any purpose. Acquisition refers to debt incurred to buy, build, or improve the personal residence including refinancing of these debts.

Question 36

Capital Gain

Answer 36

The profit realized from the sale of a real estate investment. Assets such as stock, real property and collectibles fall into the category of capital assets.

Question 37

Long-Term Capital Gains

Answer 37

Gains on capital assets held for longer than 12 months. These gains are taxed at a rate of 15 percent when the taxpayer’s rate is above the 15 percent income bracket and 5 percent when the taxpayer is in the 15 percent bracket and below.

Question 38

Short-Term Capital Gains

Answer 38

Gains on capital assets held less than one year. They are taxed at the marginal rate for the taxpayer’s income.

Question 39

Adjusted Basis

Answer 39

The original cost or other basis plus certain additions and minus certain deductions such as depreciation and casualty losses. Ex: Fire or water damage.

Question 40

Capital Loss

Answer 40

When investment or other types of property is sold at a loss.

Question 41

Economic Depreciation

Answer 41

Results from physical deterioration of property.

Question 42

Tax depreciation

Answer 42

A provision of the tax law that is applicable to certain types of assets. This permits a property owner to take a business deduction for annual depreciation. It is a deductible allowance from net income of property used to arrive at taxable income.

Question 43

Appreciation

Answer 43

Refers to an increase in value due to economic or other reasons.

Question 44

Straight-line Depreciation

Answer 44

The portion allocated to the building is divided by 27.5 to determine an equal amount of depreciation allowance each year. This is 3.6 percent (1/27.5) for each full year. Ex: Building portion is $125,000, depreciation is $4545 ($125,000 x 3.6 percent).

Question 45

Cost Recovery

Answer 45

Allows the total cost of the property that is depreciable to be deducted over a certain time.

Question 46

Mortgage Forgiveness Debt Relief Act of 2007

Answer 46

This Act offers tax breaks in three important areas:
Mortgage Debt Forgiveness - Creates a three-year exception for debt forgiveness on home loans because of a short sale, foreclosure, deed in lieu of foreclosure, or other arrangement that relieves the borrower from paying some portion of their debt.
PMI Tax Deduction - Available to families with an adjusted gross income of $100,000 or less. $109,000 or less have partial.
Capital Gain Exclusion- Allows an individual taxpayer whose spouse died to exclude up to $500,000 in capital gains on the sale of their principal residence.

Question 47

Cash Flow

Answer 47

Represents the net proceeds after all expenses are met and may be measured before or after taxes are considered.

Question 48

Tax Shelter

Answer 48

A paper loss; a phrase used to describe some of the advantages of real estate investments. When the tax-deductible expenses are greater than the income.

Question 49

1031 Tax Deferred Exchange

Answer 49

Allows an individual to defer capital gains taxes on real estate bought and sold for investment purposes. To qualify, properties must be “like-kind.” Ex: Apartment building for retail store, city property for farm property, or land for building.

Question 50

Qualified Intermediary (QI)

Answer 50

Must not be unqualified. No licensing requirements. Accepts funds from the sale and handles the contracts. Coordinates with the exchangers and their advisors, prepares the documentation for the relinquished and the replacement property, furnishes escrow, secures funds in escrow, provides documents and submits a 1099 to taxpayer and IRS.

Question 51

Boot

Answer 51

Cash received in a tax-deferred exchange.

Question 52

1031 Exchanges

Answer 52

There is a 45-day period from the day of closing for the exchanger to contract for another property.
The new property must close within 180 days from the date the exchanger sold the original property.
When the exchanger sells his property, and when he purchases the replacement property, he must inform the parties to the transactions that it is part of a like-kind exchange.

Question 53

Common objectives of investment property ownership

Answer 53

• A hedge against an inflationary economic trend
• For the tax savings generated by passive losses or depreciation deductions
• As a means of providing regular income (cash flow)
• To build a strong portfolio of properties for resale at retirement or for other future needs.