NYU Schack Institute Of Real Estate School Of Continuing
Nyu Schack Institute Of Real Estateschool Of Continuing And Profession
Nyu Schack Institute Of Real Estateschool Of Continuing And Profession
NYU Schack Institute of Real Estate School of Continuing and Professional Studies The Real Estate Institute 11 West 42nd Street, New York, NY 10036 Real Estate Finance - REAL1-GC.1035 Final Examination
- An investor believes that a certain property is worth $10,000,000. The seller refuses to sell it for that amount, but has offered to provide a 5-year interest-only loan for $5,000,000 at 4% interest (annual payments at the ends of the years, first payment due in one year). Market interest rates on such a loan are currently 6.5%. How much should the investor be willing to pay for the property from an investment value perspective (taking the loan deal) if the investor faces a 30% marginal income tax rate?
a) $10,000,000
b) $10,383,588
c) $10,403,023
d) $10,519,460
e) Insufficient information to answer the question.
- A property has a McDonald’s restaurant on it, which can earn $50,000 per year. In any other use (including another brand of restaurant), the most it can earn is $40,000 per year. Assuming a discount rate of 10% and constant cash flow in perpetuity, what is the "investment value" of this property to McDonalds, and what is its "market value"?
a) Both investment value and market value are $400,000.
b) Both investment value and market value are $500,000.
c) Investment value is $400,000 and market value is $500,000.
d) Investment value is $500,000 and market value is $400,000.
- Suppose the risk free rate of return is 7%, and the expected total return on the property free & clear is 11%, and you have a target total expected return of 15%. Assuming you can borrow at the risk free rate, what Loan/Value ratio must you obtain for this real estate investment to meet your target expected return?
a) 0%
b) 25%
c) 50%
d) 75%
e) 80%
- Suppose a property has a cap rate of 10% and you can borrow at a mortgage constant of 11%. If you borrow 75% of the property price, what will be your equity yield?
a) 7.00%
b) 8.25%
c) 10.00%
d) 11.00%
e) Cannot be determined from the information given.
- Two loans have the same interest rate and maturity. Loan A has a 15-year amortization rate. Loan B has a 30-year amortization rate. In comparing these two loans from a borrower’s perspective:
a) The advantage of Loan A is lower monthly payments and lower balloon payment at maturity.
b) The advantage of Loan B is lower monthly payments and lower balloon payment at maturity.
c) The advantage of Loan A is lower monthly payments but its disadvantage is a higher balloon at maturity.
d) The advantage of Loan B is lower monthly payments but its disadvantage is a higher balloon at maturity.
- Consider an 8.5% loan amortizing at a 25-year rate with monthly payments. What is the maximum amount that can be loaned on a property whose net operating income (NOI) is $500,000 per year, if the underwriting criteria specify a debt service coverage ratio (DCR) no less than 125%?
a) $2,789,406
b) $3,409,091
c) $3,844,614
d) $4,000,000
e) $4,139,
- For the same property as above, suppose the underwriting criteria is a maximum loan/value ratio (LTV) of 75%, and we estimate property value by direct capitalization using a rate of 11% on the stated NOI. By this criterion what is the maximum loan amount?
a) $2,789,406
b) $3,409,091
c) $3,844,614
d) $4,000,000
e) $4,139,
- Suppose a construction project anticipates end-of-month draws of $400,000, $300,000, and $600,000 consecutively. What will be the balance owed at the end of the third month if the interest on the loan is 7% per annum (nominal annual rate, compounded monthly), and no payments of either principal or interest are required during the construction period?
a) $1,306,430
b) $1,314,051
c) $1,378,960
d) Cannot be computed with the information given.
- Consider the investment evaluation of a real estate development in which the property to be built is projected to reach stabilized occupancy at the end of Year 2 (two years from the time the investment decision must be made and construction will begin). The project is speculative in that there are no leases signed as of Time Zero (the present, when the investment decision must be made).
The property level opportunity cost of capital is considered to be 9% for stabilized investments, and 10% for assets not yet stabilized (lease-up investments). Which of the following is true?
a) Property level before-tax cash flows beyond Year 2 should be discounted back to the end of Year 2 at 9%, and the projected stabilized asset value as of the end of Year 2 should be discounted two years to Time Zero at 10%.
b) Property level before-tax cash flows beyond Year 2 should be discounted back to the end of Year 2 at 10%, and the projected stabilized asset value as of the end of Year 2 should be discounted two years to Time Zero at 9%.
c) Property level before-tax cash flows beyond Year 2 should be discounted all the way back to Time Zero at the 10% rate.
d) Property level before-tax cash flows beyond Year 2 should be discounted all the way back to Time Zero at the 9% rate.
- The opportunity cost of capital (discount rate) applicable on an unlevered basis to assets that are not yet leased up (“speculative built properties”) is best described as:
a) Usually about 50 to 200 basis-points above the OCC for the same property with stabilized occupancy, based in part on analysis of the “interlease” discount rate implied in the property market.
b) Usually about 300 to 500 basis-points above the OCC for the same property with stabilized occupancy, based in part on analysis of the “interlease” discount rate implied in the property market.
c) Usually about 50 to 200 basis-points below the OCC for the same property with stabilized occupancy, based on the typical upward slope of the yield curve in the bond market, because lease-up is near term.
d) Usually about 300 to 500 basis-points below the OCC for the same property with stabilized occupancy, based on the typical upward slope of the yield curve in the bond market, because lease-up is near term.
- All of the following are typical types of real options found in development projects or developable land ownership, except:
a) The wait option
b) The phasing option
c) The switch option
d) The refinance option
- The replicating portfolio of a development option (land) consists of:
a) A long position in an asset like the stabilized building to be built and a short position (borrowing) in a riskless bond.
b) A short position in an asset like the stabilized building to be built and a long position (lending) in a riskless bond.
c) Long positions in both the stabilized building and a bond.
d) Short positions in both the stabilized building and a bond.
- Consider a 20-year (monthly-payment), 8%, $80,000 mortgage with 2 points prepaid interest up front. What is the yield to maturity?
a) 8.00%
b) 8.12%
c) 8.20%
d) 8.27%
- A REIT has expected total return on equity of 15%, interest on their debt is 9%, and their debt-to-total-value ratio is 40%. What is the REIT’s average cost of capital?
a) 9.0%
b) 10.4%
c) 12.6%
d) 15.0%
e) Insufficient information to answer this question.
- The NOI is $1,000,000, the debt service is $800,000 of which $700,000 is interest, the depreciation expense is $250,000. What is the Before-tax Cash Flow to the equity investor (EBTCF) if there are no capital improvement expenditures or reversion items this period?
a) $50,000
b) $182,500
c) $200,000
d) $300,000
e) $750,
- Two loans have the same interest rate and maturity. Loan A has a 15-year amortization rate. Loan B has a 30-year amortization rate. In comparing these two loans from a borrower’s perspective:
a) The advantage of Loan A is lower monthly payments and lower balloon payment at maturity.
b) The advantage of Loan B is lower monthly payments and lower balloon payment at maturity.
c) The advantage of Loan A is lower monthly payments but its disadvantage is a higher balloon at maturity.
d) The advantage of Loan B is lower monthly payments but its disadvantage is a higher balloon at maturity.
- Consider a 30-year (monthly-payment), 6%, $300,000 mortgage with 3 points prepaid interest up front. What is the yield to maturity?
a) 5.87%
b) 6.00%
c) 6.29%
d) 6.50%
e) Insufficient information to answer the question.
- Consider a 6.5% loan amortizing at a 20-year rate with monthly payments. What is the maximum amount that can be loaned on a property whose net operating income (NOI) is $1,000,000 per year, if the underwriting criteria specify a debt service coverage ratio (DCR) no less than 120%?
a) $69,444
b) $8,000,000
c) $9,314,236
d) $11,177,084
e) $13,412,
- For the same property as above, suppose the underwriting criteria is a maximum loan/value ratio (LTV) of 80%, and we estimate property value by direct capitalization using a rate of 7% on the stated NOI. By this criterion what is the maximum loan amount?
a) $80,000
b) $8,000,000
c) $11,177,084
d) $11,428,571
e) $14,285,
- All of the following are characteristics of the classical “Simple Financial Feasibility Analysis” (SFFA) procedure for real estate development projects, except:
a) The procedure is easy to understand and apply without advanced or specialized financial knowledge or knowledge of the capital markets (other than the local mortgage market).
b) The procedure can be applied from either a “front door” or “back door” perspective.
c) It generally assumes the developer will take out the largest mortgage possible upon completion of the project, and that the project cost will equal its value for applying lender’s loan/value criteria.
d) It is based fundamentally on the NPV investment evaluation principle and therefore is consistent with wealth maximization.
- In translating construction cost cash flows across time to arrive at the present certainty-equivalent value of the construction cost as of time zero, the opportunity cost of capital (OCC) that should be used as the discount rate is best described as follows:
a) Use the contract interest rate on the construction loan.
b) Use a rate equal to or only slightly above the risk free interest rate.
c) Use the development phase OCC reflecting the leverage in the construction project.
d) Use the yield on long-term Government bonds.
- What we have called in class the “canonical” formula for determining the OCC of a development project investment is based on all of the following except:
a) Equilibrium exists within the market for developable land.
b) Equilibrium exists across the markets for developable land, stabilized (built) properties, and bonds (or instruments with low-risk debtlike cash flows).
c) The investor will be irreversibly committed to completing the subject development project.
d) Development is a “real option” in which the developer/landowner has the flexibility to postpone development.
- The NPV investment decision rule is applicable even in the case of a real option, such as a real estate development investment, because:
a) The NPV rule states that any investment with a positive NPV should be undertaken.
b) The real options nature of development enables a negative NPV investment to be rational.
c) The NPV rule will insure that a development project that presents a higher IRR will be chosen over one that presents a lower IRR.
d) The NPV rule requires making the decision that maximizes the NPV over all mutually exclusive alternatives, and building today versus waiting are mutually exclusive alternatives on a given piece of land.
- According to real option theory, even if construction were instantaneous and the property market were perfectly liquid, it might be optimal not to immediately build a project whose value currently exceeds its construction cost, because:
a) There is sufficient probability that the value of the project will rise sufficiently in the future, and building today is mutually exclusive with building in the future.
b) There is sufficient probability that the value of the project will fall sufficiently far in the future such that you would lose money if you built it today.
c) There is never any reason to exercise a call option before its expiration date.
d) The cost of construction can be invested at a rate less than the cap rate (or current cash yield) of the completed project.
Paper For Above instruction
Real estate investment analysis involves a complex interplay of valuation methods, risk assessment, financing strategies, and market dynamics. A nuanced understanding of these elements enables investors and developers to make informed decisions that optimize returns while managing risks effectively. This paper explores key concepts such as valuation adjustments, perpetuity cash flows, leverage and capital structure, real options, and the intricacies of REIT operations, providing a comprehensive overview aligned with advanced real estate financial principles.
Valuation Adjustments in Property Investment
The value an investor assigns to a property often exceeds its market price due to strategic considerations, such as unique features or expected future cash flows. For instance, in the case of the property worth $10 million with an offered interest-only loan, the calculation of an appropriate bid considers after-tax cash flows, adjusting for the interest rate environment and tax impacts. Specifically, the investor accounts for tax shielding from interest expenses, effectively increasing the property's valuation from the perspective of after-tax returns (Brueggeman & Fisher, 2011). The calculation involves discounting after-tax cash flows at the market interest rate, considering the tax rate to determine the net benefit, leading to an investment value that exceeds the simple market valuation under certain conditions.
Perpetuity and Investment Value
Perpetuity valuation is crucial when assessing the ongoing cash flows from income-generating properties like fast-food outlets. The investment value of a property to a specific tenant—say, McDonald's—depends on the incremental cash flows attributable solely to that tenant's operation. When the net cash flow is $50,000, and alternative uses yield only $40,000, the difference reflects the additional economic benefit generated by the current tenant. Using the perpetuity formula \(V = \frac{C}{r}\), where \(C\) is the annual cash flow and \(r\) the discount rate, both the market value and the investor's valuation converge, depending on market conditions and tenant-specific rent premiums (Ling & Archer, 2014).
Leverage, Cap Rate, and Equity Yield
Leveraging property investments involves strategic borrowing to amplify returns. When the cap rate and mortgage constants differ, the equity yield reflects both the property's income performance and financing costs. Borrowing at a mortgage constant of 11% against a cap rate of 10% implies that the net operating income must surpass debt obligations for positive leverage effect. The equity yield can be derived as the ratio of net cash flow after debt service to the equity invested. Under these assumptions, the calculations indicate how leverage can either enhance or diminish investor returns depending on debt costs relative to property yields (Geltner et al., 2014).
Loan Structure and Borrower Perspectives
The amortization schedule significantly affects borrower risk and payment stability. A shorter amortization (15 years) results in higher monthly payments but lower balloon payments at maturity, reducing refinancing risk. Conversely, a longer schedule (30 years) yields lower monthly payments but exposes borrowers to larger balloon payments, potentially increasing rollover risk. Borrower preferences often depend on cash flow stability, refinancing options, and risk appetite. These dynamics underline the importance of analyzing capital structures critically from both borrower and lender perspectives (Fabozzi, 2007).
Underwriting Criteria and Loan-to-Value Ratios
In determining maximum lending amounts, underwriting ratios like debt service coverage ratio (DSCR) and loan-to-value (LTV) are fundamental. For example, a DSCR of 125% on NOI of $500,000 requires calculating maximum debt that the property's cash flows can support, leading to specific loan amounts based on debt service limits. Similarly, the direct capitalization approach estimates property value using NOI and an appropriate cap rate, which then constrains the maximum loan under LTV restrictions. These methodologies safeguard lenders while enabling sufficient leverage for investors (White & Sirmans, 2017).
Construction Financing and Time-Value Conversion
Construction loans involve multiple draws, incurring interest that compounds over time. Using the monthly compounding formula and interest rate, the closing balance after several draws can be computed iteratively. This process is integral to project financing, ensuring accurate assessment of total borrowing costs and liquidity planning amidst construction timelines (Hendershott et al., 2012).
Development Timing and Discounting