HW Quiz 8

Question 1

True or False: The extent to which one can leverage a real estate transaction with debt is generally tied to the current and anticipated future trajectory of real estate pricing.

Answer 1

True

Question 2

Which investor(s) is/are non-taxable? (Select all that apply)
-pension funds
-commercial banks
-none of these
-private equity funds
-real estate developers

Answer 2

Pension funds are non-taxable entities

Question 3

Combining the expected annual cash-on-cash yield with the expected annualized capital appreciation gives you a quick estimate of what?

Answer 3

Total annual return

Question 4

True or False: The debtor is the lender, or the person who issues the debt

Answer 4

False

Question 5

What is the phantom income problem?

Answer 5

Income that triggers taxes but has no real cash flow associated with it

Question 6

The two components of total returns to equity are ______________, and ________.

Answer 6

capital appreciation, cash flow return

Capital appreciation is the return you earn as the building’s value increases, while the cash flow return is driven by the cash flows generated by the property, net of any debt service.

Question 7

Select all of the primary reasons for borrowing:
-tax advantages
-diversify investment base
-enhance equity returns and capital appreciation
-more expensive than equity financing
-you want to increase equity returns without additional risk
-lenders are fun people to deal with
-you do not have sufficient funds to purchase the asset

Answer 7

-tax advantages
-diversify investment base
-enhance equity returns and capital appreciation
-you do not have sufficient funds to purchase the asset

Question 8

Why do mezzanine loans carry higher interest rates than senior loans?

Answer 8

The mezzanine lender is taking on additional risk due to their subordination to the senior lender
-this additional risk is compensated for with higher interest rates

Question 9

The terms positive leverage and negative leverage describe the effects of debt on cash returns. What are the metrics used in determining positive or negative leverage?

Answer 9

Annual property cash flow yield and annual interest rate
-Positive leverage simply means that the annual property cash flow yield % (NOI after normal reserves / Purchase Price) is greater than the annual interest rate paid to the lender. Negative leverage refers to situations where the property generates a lower cash flow yield than the interest rate.

Question 9

The terms positive leverage and negative leverage describe the effects of debt on cash returns. What are the metrics used in determining positive or negative leverage?

Answer 9

Annual property cash flow yield and annual interest rate
-Positive leverage simply means that the annual property cash flow yield % (NOI after normal reserves / Purchase Price) is greater than the annual interest rate paid to the lender. Negative leverage refers to situations where the property generates a lower cash flow yield than the interest rate.

Question 10

The largest portion of a real estate transaction’s capitalization is typically what?

Answer 10

Senior debt –typically 60-70% of the capitalization of a real estate transaction

Question 11

True or False: Loan contracts trump bankruptcy law.

Answer 11

False

Question 12

True or False: The lower the proportion of debt, the higher the expected equity appreciation return.

Answer 12

False

Question 13

Positive leverage means that the property cash flow yield % (NOI after standard reserves / Purchase Price) is ___ the interest rate paid to the lender. Negative leverage means that the property cash flow yield % is ___ the interest rate paid to the lender

Answer 13

greater than, less than

Question 14

What are the components of total returns to equity for real estate transactions? (Select all that apply)
-tax shield
-benefits of diversification
-cash-on-cash yield
-none of the options
-capital appreciation
-international rate of return
-interest cost
-treasury rates

Answer 14

-cash-on-cash yield
-capital appreciation

Question 15

What is the difference between Chapter 7 and Chapter 11 bankruptcy? (select all that apply)
-Chapter 7 generally occurs before Chapter 11. If Chapter 7 does not present solutions, then you advance to Chapter 11
-None of the options
-Chapter 7 bankruptcy is more effective in retaining the faith of equity investors
-Chapter 7 creates tax liabilities from liquidating the firm’s assets
-Chapter 11 creates strategic opportunities

Answer 15

-Chapter 7 creates tax liabilities from liquidating the firm’s assets
-Chapter 11 creates strategic opportunities

Question 16

How can diversification of a real estate portfolio potentially impact one’s investments? (Select all that apply)
-lowering your tax bill
-enhancing your revenues
-lowering your geographic, tenant, lease expiration, and asset risk exposure
-creating economies of scale

Answer 16

-enhancing your revenues
-lowering your geographic, tenant, lease expiration, and asset risk exposure
-creating economies of scale

Diversifying your real estate portfolio will not lower your tax bill. Instead, this results from borrowing, as interest payments can be deducted from your taxable income.

Question 17

In a foreclosure sale, the first payment goes to:
-The government to settle any outstanding tax or environmental claims
-Unsecured debtors
-Lawyers and brokers hired in the foreclosure process
-None of these
-The senior lender to settle any outstanding debt

Answer 17

-The government to settle any outstanding tax or environmental claims

The government, as it has the “superposition”

Question 18

Why might you choose a loan with negative leverage? (Select all that apply)
-To diversify your equity in other investments
-To juice your total equity returns
-To lower your risk
-None of the options
-You do not have enough equity

Answer 18

-To diversify your equity in other investments
-To juice your total equity returns
-You do not have enough equity

Question 19

Once a defaulting borrower enters Chapter 11 bankruptcy (during the 180-day exclusivity period), who takes control of the borrower company’s business decision?

Answer 19

The borrower – one of the key provisions of the U.S. bankruptcy code is that once a borrower enters Chapter 11 bankruptcy, secured lenders cannot immediately seize their collateral. This is why people refer to “seeking bankruptcy protection.” U.S. bankruptcy law allows the defaulting borrower to remain in control of business decisions (subject to bankruptcy court oversight) until the point is reached when the bankruptcy court rules that either a successful reorganization has occurred or that a successful reorganization is impossible.

Question 20

You buy Kathy Place in Year 0 for $500. You sell it in year 7 for $1,000. While owning the property without any debt, you made $50 a year. What is your annual return from property appreciation?

Answer 20

10.41%

Question 21

A senior lender generally has the right to foreclose on the property if the borrower violates the terms of the loan agreement. In foreclosure, a lender with the first security position can take control of the property and auction it off. The sale proceeds will pay the following parties sequentially. (Seniority 1 to 5)

Answer 21

1. government
2. foreclosure lawyers and sale brokers
3. senior creditor
4. junior creditor
5. common equity holder

Question 22

True or False: Life companies are typically regarded as originating the lowest-risk loans.

Answer 22

True

Question 23

Mathew Caplan Hotel and Resorts has a cash flow yield of 13%. Select all the scenarios where debt financing would create positive leverage.
-95% LTV loan at 8% interest
-10% LTV loan at 5% interest
-75% LTV loan at 9% interest
-1% LTV loan with 15% interest
-5% LTV loan at 14% interest
-None of the options

Answer 23

-95% LTV loan at 8% interest
-10% LTV loan at 5% interest
-75% LTV loan at 9% interest

Question 24

A short sale is defined as:

Answer 24

A sale that does not generate enough proceeds to pay back the full owed amount

Question 25

The real estate industry frequently uses the terms positive/negative leverage to describe the effects of debt on cash returns.

Positive leverage is achieved when a certain annual property return measure is higher than the annual interest rate paid to the lender. What is the definition of the return measure used in the positive leverage definition?

Answer 25

Cash flow yield % (NOI after normal reserves/purchase price)

Question 26

What is mezzanine financing? (Select all that apply)
-None of the options
-Participating debt
-A variety of financing that is not straight debt or pure equity
-Junior debt
-Financing of the second floor of a building
-Convertible debt
-Preferred equity

Answer 26

-Participating debt
-A variety of financing that is not straight debt or pure equity
-Junior debt
-Convertible debt
-Preferred equity

Question 27

Which of the following statements is true?
-Bankruptcy law is the same in the USA and UK
-Bankruptcy law is the same throughout the world
-Under Chapter 11 bankruptcy, the borrower does not have to pay interest on his loans
-Bankruptcy law is the same throughout Western nations
-Landlords are still paid during bankruptcy proceedings
-None of the above
-US bankruptcy law forbids debtors in bankruptcy to secure additional financing

Answer 27

-Under Chapter 11 bankruptcy, the borrower does not have to pay interest on his loans

Question 28

How many days does U.S. bankruptcy law provide debtors to submit a reorganization plan?

Answer 28

180 days

Question 29

If a property’s value has appreciated 24% over a two-year period, what is the compounded annual growth rate (CAGR)?

Answer 29

11.36

Question 30

You purchased the Sterling Tower for $10 million and you believe that the building will increase 5% in value over the next year (in other words, the building’s value will be $10.5 million). If you plan to borrow 40% debt, what percentage is your estimated total equity return over the next year?

Answer 30

8.33

Question 31

You purchased the Sterling Tower for $10 million. The building’s value has decreased by 10% over the past year (in other words, the building’s value is $9 million). If you have borrowed 20% debt, what percentage is your total equity return?

Answer 31

-12.50

Question 32

The capital stack for a real estate transaction is formed from the following capital sources. Their value and interest rates are also given in the table. Please compute the Weighted Average Cost of Capital (WACC).

Capital stack
Sources of capital Value Interest Rate
Equity 1,000,000 19%
Debt - Mezzanine Loan 1,500,000 11%
Debt - Senior Secured Loan 7,500,000 6%
Total | Weighted Average 10,000,000 ?

Answer 32

8.05