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REAL 2090 > Midterm 2 > Flashcards

Midterm 2 Flashcards

(53 cards)

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1
Q

What are the stylized facts of real estate cycles?

A

Prices, rents, and vacancies follow long, deep cycles. Vacancies move first, rents follow. Construction lags rent growth, exacerbating cycles.

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2
Q

Describe the Smith Model’s pure price adjustment mechanism.

A

Rents increase due to demand → asset values rise → developers build → supply increases → rents decline back toward equilibrium.

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3
Q

How does the quantity adjustment mechanism work in the Smith Model?

A

Demand increases → vacancies fall → rents rise → asset values rise → construction begins → vacancies increase again.

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4
Q

What is the purpose of the Property Clock?

A

To show the phase of real estate cycles for different property types (recovery, peak, downturn, trough) and help time investments.

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5
Q

What is a REIT and what are its key IRS requirements?

A

A REIT is a real estate investment trust that must distribute 90% of taxable income, have 100+ shareholders, and derive 75% of income/assets from real estate.

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6
Q

What is FFO and how is it calculated?

A

Funds From Operations = Net Income + Depreciation + Amortization – Gains from property sales.

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7
Q

What is the difference between FFO and AFFO?

A

AFFO adjusts FFO by subtracting recurring CapEx and leasing commissions to reflect sustainable cash flow.

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8
Q

How is Net Asset Value (NAV) calculated for REITs?

A

NAV = Market value of real estate + other assets – liabilities. NAV/share = NAV / total shares and OP units.

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9
Q

What is an UPREIT and why is it used?

A

An UPREIT structure allows property owners to exchange assets for OP units, deferring capital gains tax while gaining liquidity.

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10
Q

What are CMBS and their primary function?

A

CMBS are securities backed by commercial real estate loans, designed to provide liquidity, diversification, and broader capital access.

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11
Q

Who are the key parties in a CMBS structure?

A

Originator, Underwriter, CMBS Trust, Investors, Master Servicer, Special Servicer, Rating Agencies.

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12
Q

What is the purpose of tranching in CMBS?

A

To divide risk and returns into layers (senior to junior), enhancing credit quality of senior bonds while offering returns to risk-seeking investors.

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13
Q

How do CMBS underwriters profit from securitization?

A

They earn spreads by issuing loans at higher interest than the CMBS bonds and also earn fees. Example: Loan pool = $500M, bonds sold for $515M → $15M profit.

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14
Q

What are major risks of CMBS investments?

A

Prepayment, default, structural risks (agency problems), and liquidity risk.

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15
Q

What is the user cost of homeownership formula?

A

UC = LTV(1−τ)rm + (1−LTV)(1−τ)re + (1−τ)b + (1−τ)τp + δ − Π

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16
Q

When should someone buy instead of rent?

A

If the user cost is less than market rent, buying is financially preferred.

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17
Q

What makes the mortgage interest deduction regressive?

A

Only high-income earners who itemize deductions benefit, and the deduction phases out for smaller loans or low-interest mortgages.

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18
Q

What factors influence a corporation’s rent vs. own decision?

A

Space specialization, image, growth, availability, risk management, and timing.

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19
Q

What is the benefit of a sale-leaseback?

A

Provides liquidity and off-balance-sheet financing while retaining use of the space.

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20
Q

What is the corporate user cost formula?

A

UC = LTV(1−τ)rD + (1−LTV)(1−τ)re + (1−τ)b + (1−τ)m + CapEx − τ·Dep − Πe + τACG(Πe − CapEx) + τDCG·Dep

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21
Q

What are the three main approaches to property valuation?

A

Replacement cost, comparables (market approach), and hedonic regression.

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22
Q

What is the replacement cost approach?

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A

Value = cost to duplicate the property – depreciation. Best used in insurance and damage claims.

23
Q

How does the comparables approach work?

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A

Uses prices of similar recent transactions, adjusted for property differences, to estimate market value.

24
Q

What is hedonic regression in real estate appraisal?

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A

A statistical model using property attributes (e.g., square footage, location) to estimate price.

25
Why might market value differ from investment value?
Market value reflects general buyer behavior; investment value includes specific strategic considerations of an investor.
26
Why might a university be indifferent between receiving REIT shares and OP units in an UPREIT deal?
Because as a non-profit, it is tax-exempt and gains no value from capital gains deferral, unlike taxable investors.
27
Does the 5/50 Rule prevent OP unit holders from gaining control in an UPREIT?
No. OP unit holders are not subject to the 5/50 Rule, so they can obtain controlling voting shares.
28
Do REITs benefit more from leverage than other real estate firms?
False. REITs benefit less: 1) no tax benefit from interest expense, 2) market punishes over-leveraged REITs, 3) higher default risk.
29
Where do CMBS securitization profits come from?
From the spread between mortgage rates and the CMBS bond pool's average yield. The securitizer sells bonds for more than loan value.
30
What are some value-adding functions of CMBS securitization?
Tranching, pooling, specialization, credit enhancement, and market segmentation.
31
How is interest allocated in CMBS waterfall structures?
Interest is allocated based on new realized principal after accounting for losses and repayments.
32
What is a risk of originate-to-distribute in CMBS?
Agency problems, such as lax underwriting, because originators do not retain loan risk.
33
What is the IO Strip in a CMBS deal?
A tranche that receives the leftover interest after senior and mezzanine tranches are paid.
34
Who bears the most prepayment risk in a CMBS structure?
The most senior tranche, since it is repaid first and loses expected interest income.
35
Who bears the most default risk in a CMBS structure?
The most junior tranche, also called the 'first loss piece'.
36
Do AAA CMBS bonds have the least prepayment risk?
False. Ratings reflect default risk, not prepayment risk. Senior (AAA) bonds are actually the most exposed to prepayment risk because they are paid first.
37
What is a tenant improvement (TI) in a lease?
A landlord-funded customization to a rental space for a specific tenant. Can increase property value if not too tenant-specific.
38
Why might TIs influence the choice between two leases with equal effective rents?
Because if TIs are value-enhancing, they increase property value; if highly specific, they may create future bargaining problems.
39
Why should mall owners avoid charging high percentage rents to anchor tenants?
Anchor tenants attract foot traffic that benefits other tenants, so taxing them may reduce their incentive to stay.
40
According to the Smith Model, what happens when land use regulations are relaxed?
Construction costs fall → new supply increases → rents fall in short-run → supply contracts → rents rise again in long-run. Real estate stock increases permanently.
41
How does a lower income tax rate affect homeownership attractiveness?
It reduces the value of tax deductions (mortgage interest, property tax), raising user cost and making renting relatively more attractive.
42
How does an increase in the capital gains tax affect acquisitive UPREITs?
It benefits them. Property sellers value deferral more, so UPREITs can negotiate lower prices.
43
What is the tax treatment of depreciation recapture?
Upon sale, prior depreciation is taxed at a higher rate (typically 25%) known as depreciation recapture.
44
Why might REITs classify expenses as OpEx rather than CapEx?
OpEx reduces net income, lowering required dividends under the 90% payout rule. CapEx does not immediately affect net income.
45
Does switching the REIT dividend rule from net income to FFO eliminate incentives to reclassify OpEx?
No. It changes the math but still creates incentives to manage reported earnings and retained cash.
46
Why would a tax cut benefit REIT shareholders more than C-corp shareholders?
REITs pay more in taxable dividends (no retained earnings), so lower income tax rates reduce their tax burden more than for C-corp investors.
47
Why do construction cost changes affect real estate cycles differently than demand shifts?
Cost shocks change supply dynamics directly; demand shocks affect vacancies and rents first. Thus, short-run vacancy and rent behavior differs.
48
What is Funds From Operations (FFO)?
A REIT earnings metric: Net Income + Depreciation + Amortization – Gains on sales. Reflects core real estate profitability.
49
What is Adjusted Funds From Operations (AFFO)?
AFFO = FFO – recurring CapEx – leasing commissions. It approximates sustainable cash available for dividends.
50
What is a CMBS IO Strip?
The interest-only tranche that receives the residual interest payments after senior and mezzanine tranches are paid.
51
What is a Sale-Leaseback?
A transaction where a firm sells a property and leases it back, gaining liquidity while retaining use of the property.
52
What is a cap rate?
Capitalization rate: Net Operating Income / Property Value. Used to value real estate and estimate investor return expectations.
53
What is NAV in a REIT context?
Net Asset Value: estimated market value of assets minus liabilities. Used to assess if a REIT trades at a premium or discount.

REAL 2090 (2 decks)

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