TX 122 Real Estate Principles II-Lesson 6 Flashcards
(96 cards)
1
Q
What are the common goals of most investments?
A
Generate income, appreciation, tax shelter, or a combination of these goals.
2
Q
How are investments typically analyzed?
A
In terms of their return on the original investment.
3
Q
Who can manage investments?
A
The investor or someone hired by the investor.
4
Q
What can impact the value of investments?
A
Reasons beyond the investor’s control.
5
Q
How can tax policies affect investments?
A
They can impact investments positively or negatively.
6
Q
What can investments be used as?
A
Collateral for loans.
7
Q
What types of losses can investments usually be insured against?
A
Losses due to fire, vandalism, and natural disasters.
8
Q
What is a characteristic of real estate investments regarding permanence?
A
Most real property will not disappear barring catastrophic events.
9
Q
What does finite supply refer to in real estate?
A
The limited availability of land.
10
Q
What does replaceability mean in real estate?
A
Improvements on a parcel can generally be repaired or replaced.
11
Q
What degree of control does an investor have over a real estate investment?
A
Control over how the property is used, developed, improved, maintained, etc.
12
Q
What is amenity real estate investing?
A
Investing in properties that provide recreational value, like homes in desirable locations.
13
Q
What can careful planning in real estate lead to?
A
Potentially higher returns.
14
Q
What is the tangibility characteristic of real estate?
A
The ability to observe and touch the investment.
15
Q
What tax advantages can real estate provide?
A
Depreciation, mortgage insurance deductions, and capital gains tax treatment.
16
Q
What is leverage in real estate?
A
The ability to purchase real estate with borrowed money.
17
Q
What is specific performance in real estate contracts?
A
A legal remedy requiring the seller to transfer the specific property to the buyer.
18
Q
Why is real estate considered unique?
A
No two properties are identical, which affects contract enforcement.
19
Q
What is a major aspect of the investment decision?
A
Having an exit strategy.
20
Q
What are the five major benefits of investing in real estate?
A
- Cash Flow or Rate of Return
- Federal Tax Benefits
- Leverage of OPM (Other People’s Money)
- Principal Pay Down
- Appreciation
21
Q
What is a rollback tax?
A
A penalty imposed when agricultural land is taken out of production.
22
Q
What are some major income tax advantages for real estate investors?
A
- Interest on loans is deductible
- Operating expenses are deductible
- Depreciation deductions can shelter income
- Favorable capital gain treatment upon sale
- Installment sale reporting allowed
- 1031 exchanges to defer taxes
23
Q
What is the definition of depreciation in real estate?
A
An expense deduction taken for an investment in depreciable property.
24
Q
What is the straight-line depreciation calculation?
A
Dividing the adjusted basis of a property by the number of years of estimated remaining useful life.
25
What classifications exist for income in the context of taxation?
* Active Income
* Passive Income
* Portfolio Income
26
What is the basis in real estate?
The dollar amount attributed to an asset for depreciation and gain/loss determination.
27
What is the formula for calculating straight-line depreciation?
Divide the adjusted basis of a property by the number of years of estimated remaining useful life.
28
What does 'basis' refer to in real estate?
The dollar amount that the IRS attributes to an asset for determining annual depreciation or cost recovery.
29
What is the initial basis of a property acquired by purchase?
The purchase price plus the capitalized buyer's closing costs.
30
How is the initial basis determined for a property received as a gift?
The donor's adjusted cost basis or market value at the date of gift, whichever is less.
31
What is the initial basis for inherited property?
Market value at the date of death of the decedent.
32
What is the initial basis of property acquired through an exchange?
The market value of the new property, less the deferred capital gain from the old property.
33
What is the depreciation formula?
Basis of property + Remaining life = Depreciation.
34
What is the cost recovery period for residential rental property?
27.5 years.
35
What is the cost recovery period for nonresidential rental property?
39 years.
36
What tax may be assessed when the use of an agriculturally exempt property changes?
Rollback taxes.
37
Define leverage in real estate.
The use of borrowing power to acquire more valuable property, allowing investors to control investments with less capital.
38
What is the benefit of a fixed interest rate loan for an investor?
It eliminates the risk of increasing payments due to rising interest rates.
39
What is a 51031 exchange?
A swap of one investment property for another, which may allow for little to no tax due at the time of the exchange.
40
How does leverage affect return on investment (ROI)?
ROI increases as the down payment decreases, despite net operating income potentially decreasing.
41
What is the primary benefit of real estate investment?
Appreciation of property value over time.
42
What is a significant risk associated with leverage?
Interest rate increases can negatively impact cash flow.
43
List some negative aspects of leverage.
* Interest rate fluctuations
* Change in property value
* Vacancies
* Uninsured losses
* Unbudgeted repairs/replacements
* Legal expenses
* New laws/regulations
44
What does the 'Golden Rule' in investment state?
'He (or she) that has the gold makes the rules.'
45
What is an inflation hedge?
An investment that provides protection against decreased purchasing power due to rising prices.
46
How can real estate act as a hedge against inflation?
Rental income is expected to increase with inflation while debt payments remain fixed.
47
What are some disadvantages of real estate investment?
* Illiquidity
* Interest rate fluctuations
48
What impact do interest rate fluctuations have on real estate investments?
An increase in rates can lead to negative cash flow for adjustable rate loans and can depress sales prices due to higher borrowing costs.
49
Define immobility in the context of real estate investment.
Immobility refers to the inability to move real estate properties, as they cannot be taken with the investor when leaving the area.
50
What is a slow recovery period in real estate?
It is the prolonged time it takes for real estate prices to recover after a slump, often months or years, unlike other investments.
51
List the costs associated with real estate ownership.
* Real estate taxes
* Maintenance/repair/replacement
* Insurance
* Utilities
* Management fees
52
What management challenges do real estate investors face?
Management can take time and money; poor management can lead to financial losses, while other investments may not decline in value due to mismanagement.
53
What problems can arise from lousy or non-existent tenants?
They can lead to ongoing financial losses due to lack of income, legal fees, and leasing expenses.
54
Identify potential disadvantages in commercial real estate investment.
* High transaction costs
* Negative cash flow
* Limited marketability
* Management headaches
55
What is the significance of the capitalization (CAP) rate in real estate?
The CAP rate is the ratio of first-year Net Operating Income (NOI) to asking price, helping investors assess property value.
56
What does the equity dividend rate measure?
It measures the Before Tax Cash Flow divided by the initial equity, indicating the return on investment.
57
How is the Debt Coverage Ratio (DCR) calculated?
DCR is calculated as the ratio of NOI to the mortgage payment.
58
What is Net Present Value (NPV) in real estate investment?
NPV indicates that the present value of future cash flows exceeds the initial equity investment.
59
What does cash flow represent in real estate?
Cash flow is the spendable income from an investment after deducting all operating and fixed expenses.
60
Define business risk in real estate investment.
Business risk is the uncertainty associated with maintaining income generation and compliance with laws.
61
What is financial risk in real estate?
Financial risk involves the potential loss of investment or earnings due to debt, inflation, and interest rates.
62
What is liquidity risk?
Liquidity risk is the difficulty associated with liquidating a property due to market changes.
63
What are the four essential elements of value in real estate?
* Utility
* Scarcity
* Demand
* Transferability
64
What are the three approaches to estimating property value?
* Sales comparison approach
* Cost approach
* Income approach
65
Explain the sales comparison approach.
It estimates value based on the principle of substitution, comparing similar properties in an active market.
66
How does the cost approach estimate property value?
It estimates the replacement cost of improvements, deducts accrued depreciation, and adds land value.
67
What is the income approach to determining value?
It estimates property value based on the expected rental income, often used for income-producing properties.
68
Define Gross Income Multiplier (GIM).
GIM is a calculation method for the income approach that expresses the relationship of gross income to sales price.
69
What is Potential Gross Income (PGI)?
PGI is the rent a property would earn if it were 100% rented, used for market analysis.
70
What formula is used to calculate Effective Gross Income?
Potential gross income x gross income multiplier = Effective gross income.
71
What does Gross Rent Multiplier estimate?
It estimates the market value of income-producing residential property based on comparable sales.
72
What is the Gross Rent Multiplier used for?
Estimating a property's market value based on gross rent
## Footnote
It is calculated by multiplying the estimated gross rent by a multiplier.
73
What does the Gross Rent Multiplier not account for?
* Variations in vacancies
* Uncollectible rents
* Property taxes
* Management issues
## Footnote
These factors can significantly impact the accuracy of the estimate.
74
What is the formula for Gross Rent Multiplier?
Asking Price + Effective Gross Income = Gross Rent Multiplier
75
What does CAP rate represent?
The percentage used in the income approach to value improved property
## Footnote
It reflects the recapture of the original investment over the economic life of the improvements.
76
How is the overall capitalization rate calculated if the rate of return is 8% and the recapture rate is 2%?
10%
## Footnote
Overall capitalization rate = Rate of return + Recapture rate.
77
What factors influence the selection of an appropriate CAP rate?
* Conditions of the investment
* Availability of funds
* Prevailing interest rates
* Risk factors
78
What is the formula for CAP rate?
NOI + Asking price = CAP rate
79
What determines the cash investment in real estate?
* Current state of the real estate market
* Current state of the financial market
* Current state of occupancy and cash flow
* Credit rating and financial strength of the investor
80
What are the key factors to consider when determining a price for a property?
* Value of the property
* Gross rent multiplier
* Capitalization rate
* Cash investment
81
What is a real estate investment syndicate?
A company that pools investors' money to invest in real estate projects
82
What forms can a real estate syndication take?
* Corporations
* Limited liability companies
* Full or limited partnerships
83
What is the primary benefit of investing in a real estate syndicate?
Owning a small percentage in real property without day-to-day management involvement
84
How does a real estate syndication typically make money?
* Fees for locating and acquiring property
* Management fees based on gross revenue
* Interest paid to investors
85
What oversight do real estate syndications typically have?
Regulation by the Department of Corporations requiring yearly reporting
86
What is a Real Estate Investment Trust (REIT)?
A trust that owns and operates income-producing real estate
87
What are the requirements for a REIT?
* 100 or more owners of certificates
* 50% of certificates cannot be owned by 5 or fewer persons
* Certificates must be transferable
* Income must primarily come from rent or interest, not capital gains
* 90% of earned income must be distributed to beneficiaries
88
What is a Real Estate Mortgage Investment Conduit (REMIC)?
A type of mortgage-backed security that entitles the owner to claims on mortgage payments
89
What tax treatment do REMICs qualify for?
Special tax treatment established by the Tax Reform Act of 1986
90
What is Return on Investment (ROI)?
A performance measure to evaluate the efficiency or profitability of an investment
91
How is ROI calculated?
Benefit (return) of an investment divided by the cost of the investment
92
What does appreciation refer to in real estate?
An increase in the value of an investment
93
What is depreciation in the context of real estate?
The IRS allows capturing the expense of wear on assets as depreciation
94
What is the capital gains tax?
Tax applied to the sale of property at a lower rate than income taxes
95
What is the significance of REITs for everyday investors?
They allow access to real estate investments without direct management or financing
96
What is the primary difference between REITs and real estate syndication?
REITs involve investing in a fund with diversified properties, while syndication focuses on specific commercial properties
